DISCA-2012.9.30 10Q

 
 
 
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2012
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to             
Commission File Number: 001-34177
 
Discovery Communications, Inc.
(Exact name of Registrant as specified in its charter)
 
Delaware
 
35-2333914
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
One Discovery Place
Silver Spring, Maryland
 
20910
(Address of principal executive offices)
 
(Zip Code)
(240) 662-2000
(Registrant’s telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year, if changed since last report.)
 
 
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ý    No  o
Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files).    Yes  ý    No  ¨


Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
ý
Accelerated filer
¨
Non-accelerated filer
o  (Do not check if a smaller reporting company)
Smaller reporting company
¨
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  ý
Total number of shares outstanding of each class of the Registrant’s common stock as of October 31, 2012:
Series A Common Stock, par value $0.01 per share
144,968,328

Series B Common Stock, par value $0.01 per share
6,563,538

Series C Common Stock, par value $0.01 per share
87,324,903

 
 
 
 
 



DISCOVERY COMMUNICATIONS, INC.
FORM 10-Q
TABLE OF CONTENTS

 
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


3

PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements.

DISCOVERY COMMUNICATIONS, INC.
CONSOLIDATED BALANCE SHEETS
(unaudited; in millions, except par value) 
 
 
September 30, 2012
 
December 31, 2011
ASSETS
 
 
 
 
Current assets:
 
 
 
 
Cash and cash equivalents
 
$
1,553

 
$
1,048

Receivables, net
 
1,079

 
1,042

Content rights, net
 
107

 
93

Deferred income taxes
 
62

 
73

Prepaid expenses and other current assets
 
194

 
175

Total current assets
 
2,995

 
2,431

Noncurrent content rights, net
 
1,482

 
1,302

Property and equipment, net
 
368

 
379

Goodwill
 
6,314

 
6,291

Intangible assets, net
 
552

 
571

Equity method investments
 
821

 
807

Other noncurrent assets
 
155

 
132

Total assets
 
$
12,687

 
$
11,913

LIABILITIES AND EQUITY
 
 
 
 
Current liabilities:
 
 
 
 
Accounts payable
 
$
54

 
$
53

Accrued expenses and other current liabilities
 
618

 
554

Deferred revenues
 
133

 
113

Current portion of long-term debt
 
21

 
26

Total current liabilities
 
826

 
746

Long-term debt
 
5,210

 
4,219

Deferred income taxes
 
260

 
337

Other noncurrent liabilities
 
124

 
92

Total liabilities
 
6,420

 
5,394

Commitments and contingencies (Note 13)
 


 


Equity:
 
 
 
 
Discovery Communications, Inc. stockholders’ equity:
 
 
 
 
Series A convertible preferred stock: $0.01 par value; 75 shares authorized; 71 shares issued
 
1

 
1

Series C convertible preferred stock: $0.01 par value; 75 shares authorized; 57 shares issued
 
1

 
1

Series A common stock: $0.01 par value; 1,700 shares authorized; 147 and 142 shares issued
 
1

 
1

Series B convertible common stock: $0.01 par value; 100 shares authorized; 7 shares issued
 
—

 
—

Series C common stock: $0.01 par value; 2,000 shares authorized; 142 shares issued
 
2

 
2

Additional paid-in capital
 
6,665

 
6,505

Treasury stock, at cost
 
(2,248
)
 
(1,102
)
Retained earnings
 
1,851

 
1,132

Accumulated other comprehensive loss
 
(8
)
 
(23
)
Total Discovery Communications, Inc. stockholders’ equity
 
6,265

 
6,517

Noncontrolling interests
 
2

 
2

Total equity
 
6,267

 
6,519

Total liabilities and equity
 
$
12,687

 
$
11,913

The accompanying notes are an integral part of these consolidated financial statements.

4

DISCOVERY COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited; in millions, except per share amounts)


 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2012
 
2011
 
2012
 
2011
Revenues:
 
 
 
 
 
 
Distribution
 
$
549

 
$
580

 
$
1,665

 
$
1,563

Advertising
 
468

 
442

 
1,455

 
1,328

Other
 
59

 
58

 
167

 
171

Total revenues
 
1,076

 
1,080

 
3,287

 
3,062

Costs and expenses:
 
 
 
 
 
 
 
 
Costs of revenues, excluding depreciation and amortization
 
296

 
328

 
890

 
860

Selling, general and administrative
 
314

 
293

 
932

 
855

Depreciation and amortization
 
27

 
29

 
87

 
88

Restructuring charges
 
1

 
2

 
4

 
7

Gain on disposition
 
—

 
—

 
—

 
(129
)
Total costs and expenses
 
638

 
652

 
1,913

 
1,681

Operating income
 
438

 
428

 
1,374

 
1,381

Interest expense
 
(68
)
 
(56
)
 
(184
)
 
(154
)
Other expense, net
 
(21
)
 
(5
)
 
(77
)
 
(10
)
Income from continuing operations before income taxes
 
349

 
367

 
1,113

 
1,217

Provision for income taxes
 
(134
)
 
(127
)
 
(381
)
 
(418
)
Income from continuing operations, net of taxes
 
215

 
240

 
732

 
799

Loss from discontinued operations, net of taxes
 
(9
)
 
(3
)
 
(11
)
 
(3
)
Net income
 
206

 
237

 
721

 
796

Net income attributable to noncontrolling interests
 
(1
)
 
—

 
(2
)
 
—

Net income available to Discovery Communications, Inc. stockholders
 
$
205

 
$
237

 
$
719

 
$
796

Income per share from continuing operations available to Discovery Communications, Inc. stockholders:
 
 
 
 
 
 
 
 
Basic
 
$
0.58

 
$
0.60

 
$
1.92

 
$
1.98

Diluted
 
$
0.57

 
$
0.60

 
$
1.91

 
$
1.96

Loss per share from discontinued operations available to Discovery Communications, Inc. stockholders:
 
 
 
 
 
 
 
 
Basic
 
$
(0.02
)
 
$
(0.01
)
 
$
(0.03
)
 
$
(0.01
)
Diluted
 
$
(0.02
)
 
$
(0.01
)
 
$
(0.03
)
 
$
(0.01
)
Net income per share available to Discovery Communications, Inc. stockholders:
 
 
 
 
 
 
 
 
Basic
 
$
0.55

 
$
0.60

 
$
1.89

 
$
1.97

Diluted
 
$
0.55

 
$
0.59

 
$
1.88

 
$
1.95

Weighted average shares outstanding:
 
 
 
 
 
 
 
 
Basic
 
372

 
398

 
380

 
404

Diluted
 
375

 
401

 
383

 
408

Income per share amounts may not sum since each is calculated independently.
The accompanying notes are an integral part of these consolidated financial statements.

5

DISCOVERY COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(unaudited; in millions)


 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2012
 
2011
 
2012
 
2011
Net income
 
$
206

 
$
237

 
$
721

 
$
796

Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
 
Currency translation adjustments
 
15

 
(12
)
 
16

 
11

Derivative and market value adjustments
 
—

 
—

 
(1
)
 
—

Comprehensive income
 
221

 
225

 
736

 
807

Comprehensive income attributable to noncontrolling interests
 
(1
)
 
—

 
(2
)
 
—

Comprehensive income attributable to Discovery Communications, Inc. stockholders
 
$
220

 
$
225

 
$
734

 
$
807

The accompanying notes are an integral part of these consolidated financial statements.

6

DISCOVERY COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited; in millions)


 
Nine Months Ended September 30,
 
2012
 
2011
Operating Activities
 
 
 
Net income
$
721

 
$
796

Adjustments to reconcile net income to cash provided by operating activities:
 
 
 
Equity-based compensation expense
112

 
70

Depreciation and amortization
87

 
90

Content amortization and impairment expense
638

 
623

Loss (gain) on disposition
6

 
(129
)
Equity in losses and distributions from investee companies
91

 
22

Deferred income tax (benefit) expense
(60
)
 
71

Other, net
26

 
36

Changes in operating assets and liabilities:
 
 
 
Receivables, net
(36
)
 
(127
)
Content rights
(828
)
 
(653
)
Accounts payable and accrued liabilities
82

 
8

Equity-based compensation liabilities
(39
)
 
(107
)
Income tax receivable
—

 
91

Other, net
(29
)
 
(31
)
Cash provided by operating activities
771

 
760

Investing Activities
 
 
 
Purchases of property and equipment
(53
)
 
(42
)
Business acquisition, net of cash acquired
(20
)
 
—

Distribution from equity method investee
17

 
—

Investments in and advances to equity method investees
(115
)
 
(93
)
Other investing activities, net
(24
)
 
—

Cash used in investing activities
(195
)
 
(135
)
Financing Activities
 
 
 
Borrowings from long term debt, net of discount and issuance costs
981

 
639

Principal repayments of capital lease obligations
(17
)
 
(16
)
Repurchases of common stock
(1,146
)
 
(732
)
Proceeds from issuance of common stock in connection with equity-based plans
76

 
43

Excess tax benefits from equity-based compensation
37

 
18

Other financing activities, net
(3
)
 
(7
)
Cash used in financing activities
(72
)
 
(55
)
Effect of exchange rate changes on cash and cash equivalents
1

 
(4
)
Net change in cash and cash equivalents
505

 
566

Cash and cash equivalents, beginning of period
1,048

 
466

Cash and cash equivalents, end of period
$
1,553

 
$
1,032

The accompanying notes are an integral part of these consolidated financial statements.





7

DISCOVERY COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited; in millions)



 
Nine Months Ended September 30,
 
2012
 
2011
Supplemental Cash Flow Information
 
 
 
Cash paid for taxes, net
$
(354
)
 
$
(206
)
Cash paid for interest
$
(136
)
 
$
(115
)
Noncash Investing and Financing Transactions
 
 
 
Investment in OWN
$
7

 
$
273

Assets acquired under capital lease arrangements
$
10

 
$
—

Acquisitions
 
 
 
Fair value of assets
$
32

 
$
—

Fair value of liabilities
(12
)
 
—

Cash paid, net of cash acquired
$
20

 
$
—

The accompanying notes are an integral part of these consolidated financial statements.

8

DISCOVERY COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF EQUITY
(unaudited; in millions)


 
 
Three Months Ended September 30, 2012
 
Three Months Ended September 30, 2011
 
 
Discovery
Stockholders
 
Noncontrolling
Interests
 
Total Equity
 
Discovery
Stockholders
 
Noncontrolling
Interests
 
Total Equity
Beginning balance
 
$
6,471

 
$
2

 
$
6,473

 
$
6,513

 
$
1

 
$
6,514

Comprehensive income
 
220

 
1

 
221

 
225

 
—

 
225

Equity-based compensation
 
15

 
—

 
15

 
13

 
—

 
13

Excess tax benefits from equity-based compensation
 
4

 
—

 
4

 
1

 
—

 
1

Issuance of common stock in connection with equity-based plans
 
9

 
—

 
9

 
5

 
—

 
5

Repurchases of common stock
 
(454
)
 
—

 
(454
)
 
(355
)
 
—

 
(355
)
Cash distributions to noncontrolling interests
 
—

 
(1
)
 
(1
)
 
—

 
—

 
—

Ending balance
 
$
6,265

 
$
2

 
$
6,267

 
$
6,402

 
$
1

 
$
6,403

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30, 2012
 
Nine Months Ended September 30, 2011
 
 
Discovery
Stockholders
 
Noncontrolling
Interests
 
Total Equity
 
Discovery
Stockholders
 
Noncontrolling
Interests
 
Total Equity
Beginning balance
 
$
6,517

 
$
2

 
$
6,519

 
$
6,225

 
$
8

 
$
6,233

Comprehensive income
 
734

 
2

 
736

 
807

 
—

 
807

Equity-based compensation
 
47

 
—

 
47

 
41

 
—

 
41

Excess tax benefits from equity-based compensation
 
37

 
—

 
37

 
18

 
—

 
18

Issuance of common stock in connection with equity-based plans
 
76

 
—

 
76

 
43

 
—

 
43

Repurchases of common stock
 
(1,146
)
 
—

 
(1,146
)
 
(732
)
 
—

 
(732
)
Cash distributions to noncontrolling interests
 
—

 
(2
)
 
(2
)
 
—

 
(7
)
 
(7
)
Ending balance
 
$
6,265

 
$
2

 
$
6,267

 
$
6,402

 
$
1

 
$
6,403

The accompanying notes are an integral part of these consolidated financial statements.

9
DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)





NOTE 1. DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION
Description of Business
Discovery Communications, Inc. (“Discovery” or the “Company”) is a leading nonfiction media and entertainment company that provides programming across distribution platforms throughout the world and owns and operates a diversified portfolio of website properties. The Company also develops and sells curriculum-based education products and services. The Company classifies its operations in three segments: U.S. Networks, consisting principally of domestic television networks, websites and other digital distribution services; International Networks, consisting principally of international television networks and websites; and Education, consisting principally of curriculum-based education product and service offerings. Financial information for Discovery’s reportable segments is discussed in Note 14.
Basis of Presentation
The consolidated financial statements include the accounts of Discovery and its majority-owned subsidiaries in which a controlling interest is maintained. Inter-company accounts and transactions between consolidated entities have been eliminated in consolidation.
Unaudited Interim Financial Statements
These consolidated financial statements are unaudited; however, in the opinion of management, they reflect all adjustments, consisting only of those of a normal recurring nature, necessary to state fairly the financial position, results of operations and cash flows for the periods presented in conformity with U.S. generally accepted accounting principles (“GAAP”) applicable to interim periods. The results of operations for the interim periods presented are not necessarily indicative of results for the full year or future periods. These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in Discovery’s Annual Report on Form 10-K for the year ended December 31, 2011 (the “2011 Form 10-K”).
Use of Estimates
The preparation of financial statements in accordance with GAAP requires management to make estimates, judgments and assumptions that affect the amounts and disclosures reported in the consolidated financial statements and accompanying notes. Management continually re-evaluates its estimates, judgments and assumptions, and management’s assessments could change. Actual results may differ from those estimates.
Significant estimates inherent in the preparation of the consolidated financial statements include accounting for asset impairments, revenue recognition, allowances for doubtful accounts, content rights, depreciation and amortization, business combinations, equity-based compensation, income taxes, contingencies, and the determination of whether the Company is the primary beneficiary of entities in which it holds variable interests.
Accounting and Reporting Pronouncements Adopted
Fair Value Measurements
In May 2011, the Financial Accounting Standards Board (“FASB”) and the International Accounting Standards Board (“IASB”) issued guidance that results in a consistent definition between GAAP and International Financial Reporting Standards (“IFRS”) of fair value and common requirements for measurement and disclosure of fair value. There are several changes under the new guidance. The highest and best use valuation concepts are relevant only when measuring the fair value of nonfinancial assets. The prohibition of the application of a blockage factor extends to all financial measurements. The Company must disclose quantitative information about unobservable inputs used to assess fair value and provide a qualitative discussion about the sensitivity of the measurements for recurring Level 3 fair value measurements. The Company prospectively adopted the new guidance effective January 1, 2012. The adoption of the new guidance did not have a material impact on the Company's financial statements.
Comprehensive Income
In June 2011, the FASB issued guidance eliminating the option to report other comprehensive income and its components in the statement of changes in equity. Entities may elect to present items of net income and other comprehensive income in one continuous statement or in two separate, but consecutive, statements. Under the new guidance, each component of net income

10
DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)




and each component of other comprehensive income, together with totals for comprehensive income and its two parts, net income and other comprehensive income, are required to be disclosed under either alternative. The Company retrospectively adopted the new guidance effective January 1, 2012 and elected to present comprehensive income in a separate statement.
Accounting and Reporting Pronouncements Not Yet Adopted
Testing Indefinite-Lived Intangible Assets for Impairment
In July 2012, the FASB issued guidance that is intended to reduce the cost and complexity of the annual impairment test for indefinite-lived intangible assets other than goodwill by providing entities an option to perform a qualitative assessment to determine whether a quantitative impairment test is necessary. The revised standard is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012, but early adoption is permitted. The Company does not expect that this guidance will have a material effect on its consolidated financial statements.
Concentrations Risk
Customers
The Company has long-term contracts with distributors, including the largest operators in the U.S. and major international distributors. In the U.S., approximately 90% of the Company's distribution revenue comes from the Company's top 10 distributors. Outside of the U.S., approximately 50% of the Company's distribution revenue comes from the Company's top 10 distributors. Agreements with the Company’s major cable and satellite customers expire at various times beginning in 2012 through 2020. Failure to secure a renewal or a renewal on less favorable terms may have a material adverse effect on the Company’s results of operations and financial condition. Not only could the Company experience a reduction in distribution revenue, but advertising revenue could decline due to lower affiliate subscriber levels and viewership.
No individual customer accounted for more than 10% of total consolidated revenues for the three and nine months ended September 30, 2012 or 2011. The Company’s trade receivables do not represent a significant concentration of credit risk as of September 30, 2012 or December 31, 2011 due to the wide variety of customers and global markets in which the Company operates.
Financial Institutions
Cash and cash equivalents are maintained with financial institutions such as banks and money market mutual funds. The Company has deposits, redeemable on demand, held with banks that exceed the amount of insurance provided on such deposits. These deposits are maintained with financial institutions of reputable credit and, therefore, bear minimal credit risk.
Lender Counterparties
There is a risk that the counterparties associated with the Company’s revolving credit facility will not be available to fund as obligated under the terms of the facility. If funding under the revolving credit facility is unavailable, the Company may have to acquire a replacement credit facility from a different counterparty at a higher cost or may be unable to find a suitable replacement. Typically, the Company seeks to manage these exposures by contracting with experienced large financial institutions and monitoring the credit quality of its lenders. As of September 30, 2012, the Company did not anticipate nonperformance by any of its counterparties.
NOTE 2. ACQUISITIONS AND DISPOSITIONS
Acquisitions
During the nine months ended September 30, 2012, the Company acquired businesses for total consideration of $31 million, net of cash acquired. Contingent consideration of up to $13 million may be paid if certain performance targets are achieved. The Company recorded $21 million of goodwill in connection with these acquisitions.
Dispositions
Postproduction Audio Business - Discontinued Operations
On September 17, 2012, the Company sold its postproduction audio business, CSS Studios, LLC, which resulted in a $6 million loss, net of taxes. The results of the postproduction audio business are not material to the Company and have been

11
DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)




reflected in loss from discontinued operations, net of taxes, in the consolidated statements of operations for all periods presented. The postproduction audio business was an operating segment combined with Education as a reportable segment.
Discovery Health Network
On January 1, 2011, the Company contributed the domestic Discovery Health network to OWN LLC in connection with the launch of The Oprah Winfrey Network (“OWN”), which resulted in a pretax gain of $129 million (see Note 3). As the Company continues to be involved in the operations of the Discovery Health network through its ownership interests in OWN LLC, the Company has not presented the financial position, results of operations and cash flows of the Discovery Health network as discontinued operations.
NOTE 3. VARIABLE INTEREST ENTITIES
In the normal course of business, the Company makes investments that support its underlying business strategy and enable it to enter new markets and develop programming. In certain instances, an investment may qualify as a variable interest entity (“VIE”). As of September 30, 2012 and December 31, 2011, the Company’s VIEs primarily consisted of Hub Television Networks LLC and OWN LLC, which operate pay-television networks.
The Company accounts for its interests in VIEs using the equity method. The aggregate carrying values of these equity method investments were $811 million and $807 million as of September 30, 2012 and December 31, 2011, respectively. During the three and nine months ended September 30, 2012, the Company recognized losses of $24 million and $81 million, respectively, for its portion of net losses generated by these VIEs. During the three and nine months ended September 30, 2011, the Company recognized losses of $3 million and $10 million, respectively, for its portion of net losses generated by VIEs. The Company's portion of net losses generated by VIEs were recorded in other expense, net in the consolidated statements of operations.
As of September 30, 2012, the Company’s estimated risk of loss for investments in VIEs was approximately $839 million, which includes investment carrying values, unfunded contractual commitments and guarantees made on behalf of equity method investees. Actual amounts funded to OWN LLC have exceeded contractual funding commitments. The Company intends to continue funding OWN LLC, but has not recorded any obligations for future funding. The estimated risk of loss excludes the Company’s operating performance guarantee for Hub Television Networks LLC disclosed below.
Hub Television Networks LLC
Hub Television Networks LLC operates The Hub, which is a pay-television network that provides children’s and family entertainment and educational programming. The Company is obligated to provide The Hub with funding up to $15 million; the Company has not provided funding as of September 30, 2012. The Company also provides services such as distribution, sales and administrative support for a fee (see Note 12).
Based upon the level of equity investment at risk, The Hub is a VIE. Discovery and its partner, Hasbro Inc. (“Hasbro”), share equally in voting control and jointly consent to decisions about programming and marketing strategy and thereby direct the activities of The Hub that most significantly impact its economic performance. Neither has special governance rights, and both are equally represented on the board of The Hub. The partners also share equally in the profits, losses and funding of The Hub. The Company has determined that it is not the primary beneficiary of The Hub. Accordingly, the Company accounts for its investment in The Hub using the equity method.
Through December 31, 2015, the Company has guaranteed the performance of The Hub and is required to compensate Hasbro to the extent that distribution metrics decline versus levels historically achieved by the Discovery Kids channel. This guarantee extends on a declining basis through the period of guarantee. Upon inception of The Hub on May 22, 2009, the maximum amount potentially due under this guarantee was $300 million. As of September 30, 2012, the maximum amount potentially due under this guarantee was less than $125 million. The maximum exposure to loss is expected to decline to zero during 2015. As The Hub’s distribution is generally provided under long-term contracts with stable subscriber levels, the Company believes the likelihood is remote that the guaranteed performance levels will not be achieved and, therefore, believes the performance guarantee is unlikely to have an adverse impact on the Company.
The carrying values of the Company’s investment in The Hub were $323 million and $334 million as of September 30, 2012 and December 31, 2011, respectively. The value of the investment may decline if future results vary negatively from the current long range plan. The Company continues to monitor the valuation of its investment in accordance with GAAP, which requires an impairment charge when there is an other-than-temporary decline in the investment’s value. No impairment was recorded during the nine months ended September 30, 2012.

12
DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)




OWN LLC
OWN LLC operates OWN, which is a pay-television network and website that provides adult lifestyle content focused on self-discovery and self-improvement. Based upon the level of equity investment at risk, OWN is a VIE. While the Company and Harpo Inc. ("Harpo") are partners who share equally in voting control, power is not shared because certain activities that significantly impact OWN’s economic performance are directed by Harpo. Harpo holds operational rights related to programming and marketing, as well as selection and retention of key management personnel. Accordingly, the Company has determined that it is not the primary beneficiary of OWN and accounts for its investment in OWN using the equity method.
In connection with the launch of OWN on January 1, 2011, the Company contributed the domestic Discovery Health network to the venture. The contribution did not impact the Company’s ownership interest, voting control or governance rights related to OWN. Subsequent to the contribution, the Company no longer consolidates the domestic Discovery Health network, which was a component of its U.S. Networks segment. However, the Company provides OWN funding, content licenses and services such as distribution, sales and administrative support for a fee (see Note 12).
The Company recorded the contribution at fair value, which resulted in a pretax gain of $129 million and tax expense of $27 million. The fair value of the Company’s retained equity interest in OWN was estimated to be $273 million. The gain represents the fair value of the equity investment retained less the carrying values of contributed assets, which included goodwill and other identifiable assets with carrying values of $136 million and $8 million, respectively. The fair value of the contribution of the Discovery Health network to OWN was determined utilizing customary valuation methodologies including discounted cash flow valuation models. The underlying assumptions, such as future cash flows, weighted average costs of capital and long-term growth rates were generally not observable in the marketplace and therefore involved significant judgment.
As of September 30, 2012 and December 31, 2011, the Company’s advances to and note receivable from OWN were $450 million and $317 million, respectively. During the nine months ended September 30, 2012, the Company provided OWN with funding of $112 million and accrued interest earned on the note receivable of $21 million. The note receivable is secured by the net assets of OWN. While the Company has no further funding commitments, the Company expects to provide additional funding to OWN and to recoup amounts funded. The funding to OWN accrues interest at 7.5% compounded annually. There can be no event of default on the borrowing until 2023. However, borrowings are scheduled for repayment four years after the borrowing date to the extent that OWN has excess cash to repay the borrowings then due following such repayment, OWN’s subsequent cash distributions will be shared equally between the Company and Harpo.
In accordance with the venture agreement, losses generated by OWN are generally allocated to both investors based on their proportionate ownership interests. However, the Company has recorded its portion of OWN’s losses based upon accounting policies for equity method investments. Prior to the contribution of the Discovery Health network to OWN at its launch, the Company recognized $104 million or 100% of OWN’s net losses. During the three months ended March 31, 2012, accumulated operating losses at OWN exceeded the equity contributed to OWN, and Discovery began again to record 100% of OWN’s net losses. The Company will continue to record 100% of OWN's operating losses as long as Discovery provides all funding to OWN and OWN’s accumulated losses continue to exceed the equity contributed. Future net income generated by OWN will initially be recorded 100% by the Company until Discovery recovers losses absorbed in excess of Discovery’s equity ownership interest.
The carrying value of the Company’s investment in OWN, including its equity method investment and note receivable balance, was $457 million and $420 million as of September 30, 2012 and December 31, 2011, respectively. Given that the early results of OWN’s operations have been below its initial business plan, there is a possibility that the results of OWN’s future operations will fall below the revised long-term projections. The Company continues to monitor the financial results of OWN along with other relevant business information to assess the recoverability of the OWN note receivable and determine whether there is impairment of the Company’s equity investment in OWN. No impairment was recorded during the nine months ended September 30, 2012.
Harpo has the right to require the Company to purchase all or part of Harpo’s interest in OWN at fair market value up to a maximum put amount every two and one half years commencing January 1, 2016. The maximum put amount ranges from $100 million on the first put exercise date up to $400 million on the fourth put exercise date. The Company has recorded no amounts for the put right.

13
DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)




NOTE 4. FAIR VALUE MEASUREMENTS
Fair value is defined as the amount that would be received for selling an asset or paid to transfer a liability in an orderly transaction between market participants. Assets and liabilities carried at fair value are classified in the following three categories: 
Level 1
–
Quoted prices for identical instruments in active markets.
Level 2
–
Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets.
Level 3
–
Valuations derived from valuation techniques in which one or more significant inputs are unobservable.
The table below presents assets and liabilities measured at fair value on a recurring basis (in millions).
 
 
 
 
September 30, 2012
Category
 
Balance Sheet Location
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets:
 
 
 
 
 
 
 
 
 
 
Trading securities:
 
 
 
 
 
 
 
 
 
 
Mutual funds
 
Prepaid expenses and other current assets
 
$
94

 
$
—

 
$
—

 
$
94

Available-for-sale securities:
 
 
 
 
 
 
 
 
 
 
Money market mutual funds
 
Cash and cash equivalents
 
301

 
—

 
—

 
301

U.S. Treasury securities
 
Cash and cash equivalents
 
—

 
650

 
—

 
650

Total assets
 
 
 
$
395

 
$
650

 
$
—

 
$
1,045

Liabilities:
 
 
 
 
 
 
 
 
 
 
Deferred compensation plan
 
Accrued expenses and other current liabilities
 
$
94

 
$
—

 
$
—

 
$
94

Total liabilities
 
 
 
$
94

 
$
—

 
$
—

 
$
94

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2011
Category
 
Balance Sheet Location
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets:
 
 
 
 
 
 
 
 
 
 
Trading securities:
 
 
 
 
 
 
 
 
 
 
Mutual funds
 
Prepaid expenses and other current assets
 
$
76

 
$
—

 
$
—

 
$
76

Available-for-sale securities:
 
 
 
 
 
 
 
 
 
 
Money market mutual funds
 
Cash and cash equivalents
 
635

 
—

 
—

 
635

Total assets
 
 
 
$
711

 
$
—

 
$
—

 
$
711

Liabilities:
 
 
 
 
 
 
 
 
 
 
Deferred compensation plan
 
Accrued expenses and other current liabilities
 
$
76

 
$
—

 
$
—

 
$
76

Total liabilities
 
 
 
$
76

 
$
—

 
$
—

 
$
76

Trading securities are comprised of investments in mutual funds held in a separate trust which are owned as part of the Company’s deferred compensation plan. The fair value of Level 1 trading securities was determined by reference to the quoted market price per unit in active markets multiplied by the number of units held without consideration of transaction costs. The fair value of the related deferred compensation plan liability was determined based on the fair value of the related investments elected by employees.
Available-for-sale securities represent investments in highly liquid instruments with original maturities of 90 days or less. The fair value of Level 1 available-for-sale securities was determined by reference to the quoted market price per unit in active markets multiplied by the number of units held without consideration of transaction costs. The fair value of Level 2 available-for-sale securities was determined by reference to quoted market prices in active markets for similar assets.
In addition to the financial instruments listed in the tables above, the Company holds other financial instruments, including cash deposits, accounts receivable, accounts payable and debt. The carrying values for cash, accounts receivable and accounts payable approximated their fair values. The estimated fair value of the Company’s outstanding senior notes using

14
DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)




quoted prices from over the counter markets, considered Level 2 inputs, was $5.9 billion and $4.6 billion as of September 30, 2012 and December 31, 2011, respectively.
NOTE 5. CONTENT RIGHTS
The table below presents the components of content rights (in millions). 
 
 
September 30, 2012
 
December 31, 2011
Produced content rights:
 
 
 
 
Completed
 
$
2,567

 
$
2,257

In-production
 
315

 
221

Coproduced content rights:
 
 
 
 
Completed
 
507

 
491

In-production
 
95

 
80

Licensed content rights:
 
 
 
 
Acquired
 
434

 
346

Prepaid
 
17

 
21

Content rights, at cost
 
3,935

 
3,416

Accumulated amortization
 
(2,346
)
 
(2,021
)
Total content rights, net
 
1,589

 
1,395

Current portion
 
(107
)
 
(93
)
Noncurrent portion
 
$
1,482

 
$
1,302

Content expense consists of content amortization, impairments and other production charges and is included in cost of revenues in the consolidated statements of operations. Content expense was $228 million and $259 million for the three months ended September 30, 2012 and 2011, respectively, and $688 million and $666 million for the nine months ended September 30, 2012 and 2011, respectively. Content impairments were $12 million and $33 million for the three months ended September 30, 2012 and 2011, respectively, and $26 million and $43 million for the nine months ended September 30, 2012 and 2011, respectively.
NOTE 6. DEBT
The table below presents the components of outstanding debt (in millions).
 
 
September 30, 2012
 
December 31, 2011
3.70% Senior Notes, semi-annual interest, due June 2015
 
$
850

 
$
850

5.625% Senior Notes, semi-annual interest, due August 2019
 
500

 
500

5.05% Senior Notes, semi-annual interest, due June 2020
 
1,300

 
1,300

4.375% Senior Notes, semi-annual interest, due June 2021
 
650

 
650

3.30% Senior Notes, semi-annual interest, due May 2022
 
500

 
—

6.35% Senior Notes, semi-annual interest, due June 2040
 
850

 
850

4.95% Senior Notes, semi-annual interest, due May 2042
 
500

 
—

Capital lease obligations
 
98

 
106

Total long-term debt
 
5,248

 
4,256

Unamortized discount
 
(17
)
 
(11
)
Long-term debt, net
 
5,231

 
4,245

Current portion of long-term debt
 
(21
)
 
(26
)
Noncurrent portion of long-term debt
 
$
5,210

 
$
4,219

On May 17, 2012, Discovery Communications, LLC ("DCL"), a wholly-owned subsidiary of the Company, issued $1.0 billion aggregate principal amount of senior notes consisting of $500 million aggregate principal amount of 3.30% Senior

15
DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)




Notes due May 15, 2022 and $500 million aggregate principal amount of 4.95% Senior Notes due May 15, 2042 (the "2022 and 2042 Notes"). DCL received net proceeds of approximately $983 million from the offering after the $8 million issuance discount and $9 million of deferred financing costs.
DCL has the option to redeem some or all of the 2022 and 2042 Notes at any time prior to their maturity by paying a make-whole premium plus accrued and unpaid interest, if any, through the date of repurchase. Interest on the 2022 and 2042 Notes is payable on May 15 and November 15 of each year. The 2022 and 2042 Notes are unsecured and rank equally in right of payment with all of DCL's other unsecured senior indebtedness and are fully and unconditionally guaranteed on an unsecured and unsubordinated basis by Discovery.
On September 25, 2012, the Company modified its existing $1.0 billion revolving credit facility agreement to extend the expiration date two years to October 12, 2017. The terms of the revolving credit facility otherwise remained substantially the same: DCL continues to be the borrower, Discovery continues to be the unconditional guarantor, the lenders named therein remained the same and the obligations under the credit agreement remain unsecured. There were no amounts drawn under the revolving credit facility as of September 30, 2012 or December 31, 2011. If the Company were to draw on the revolving credit facility, outstanding balances would bear interest at a variable rate determined pursuant to the lending agreement and would be due on the expiration date.
As of September 30, 2012 and December 31, 2011, the Company was in compliance with all covenants in, and there were no events of default under, its revolving credit agreement.
NOTE 7. EQUITY
Stock Repurchase Program
On April 25, 2012, the Company’s Board of Directors approved an additional authorization of $1.0 billion under the stock repurchase program, bringing the total authorization under the stock repurchase program to $3.0 billion. As of September 30, 2012, the Company had remaining authorization of $752 million for future repurchases of its common stock under the stock repurchase program, which will expire on April 25, 2014. Under the stock repurchase program, management is authorized to purchase shares through open market transactions or privately negotiated transactions at prevailing prices as permitted by securities laws and other legal requirements and subject to stock price, business conditions, market conditions and other factors.
The stock repurchases are recorded in treasury stock on the consolidated balance sheet. All repurchases during the three and nine months ended September 30, 2012 and 2011 were made through open market transactions and were funded using cash on hand. As of September 30, 2012, the Company had repurchased 1.6 million and 52.9 million shares of Series A and Series C common stock over the life of the program for the aggregate purchase price of $86 million and $2.2 billion, respectively. As of December 31, 2011, the Company had repurchased 30.1 million shares of Series C common stock over the life of the program for the aggregate purchase price of $1.1 billion. There were no shares of Series A common stock repurchased as of December 31, 2011.
The table below presents a summary of stock repurchases (in millions).
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2012
 
2011
 
2012
 
2011
Series A Common Stock:
 
 
 
 
 
 
 
Shares repurchased
1.3
 
—

 
1.6
 
—

Purchase price
$
71

 
$
—

 
$
86

 
$
—

Series C Common Stock:
 
 
 
 
 
 
 
Shares repurchased
7.7
 
9.8
 
22.8
 
20.2
Purchase price
$
383

 
$
355

 
$
1,060

 
$
732

Total shares repurchased
9.0

 
9.8
 
24.4
 
20.2
Total purchase price
$
454

 
$
355

 
$
1,146

 
$
732


16
DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)




Other Comprehensive Income (Loss)
The table below presents the activity within other comprehensive income (loss) (in millions).
 
Three Months Ended September 30, 2012
 
Three Months Ended September 30, 2011
 

Pretax
 
Tax
Benefit (Provision)
 

Net-of-tax
 

Pretax
 
Tax
Benefit (Provision)
 

Net-of-tax
Currency translation adjustments
$
18

 
$
(3
)
 
$
15

 
$
(18
)
 
$
6

 
$
(12
)
Other comprehensive income (loss)
$
18

 
$
(3
)
 
$
15

 
$
(18
)
 
$
6

 
$
(12
)

 
Nine Months Ended September 30, 2012
 
Nine Months Ended September 30, 2011
 

Pretax
 
Tax
Benefit (Provision)
 

Net-of-tax
 

Pretax
 
Tax
Benefit (Provision)
 

Net-of-tax
Currency translation adjustments
$
18

 
$
(2
)
 
$
16

 
$
18

 
$
(7
)
 
$
11

Derivative and market value adjustments
(2
)
 
1

 
(1
)
 
—

 
—

 
—

Other comprehensive income
$
16

 
$
(1
)
 
$
15

 
$
18

 
$
(7
)
 
$
11

The table below presents the changes in the components of other accumulated comprehensive loss, net of taxes (in millions).
 
Three Months Ended September 30, 2012
 
Three Months Ended September 30, 2011
 
Currency Translation Adjustments
 
Derivative
and Market
Value
Adjustments
 
Accumulated
Other
Comprehensive
Loss
 
Currency Translation Adjustments
 
Derivative
and Market
Value
Adjustments
 
Accumulated
Other
Comprehensive
Loss
Beginning balance
$
(28
)
 
$
5

 
$
(23
)
 
$
(16
)
 
$
6

 
$
(10
)
Current period other comprehensive income (loss)
15

 
—

 
15

 
(12
)
 
—

 
(12
)
Ending balance
$
(13
)
 
$
5

 
$
(8
)
 
$
(28
)
 
$
6

 
$
(22
)
 
 
Nine Months Ended September 30, 2012
 
Nine Months Ended September 30, 2011
 
Currency Translation Adjustments
 
Derivative
and Market
Value
Adjustments
 
Accumulated
Other
Comprehensive
Loss
 
Currency Translation Adjustments
 
Derivative
and Market
Value
Adjustments
 
Accumulated
Other
Comprehensive
Loss
Beginning balance
$
(29
)
 
$
6

 
$
(23
)
 
$
(39
)
 
$
6

 
$
(33
)
Current period other comprehensive income (loss)
16

 
(1
)
 
15

 
11

 
—

 
11

Ending balance
$
(13
)
 
$
5

 
$
(8
)
 
$
(28
)
 
$
6

 
$
(22
)

NOTE 8. EQUITY-BASED COMPENSATION
The Company has various incentive plans under which unit awards, stock options, performance based restricted stock units (“PRSUs”), time based restricted stock units (“RSUs”) and stock appreciation rights (“SARs”) have been issued. During the nine months ended September 30, 2012, the vesting and service requirements of equity-based awards granted were consistent with the arrangements disclosed in the 2011 Form 10-K.

17
DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)




Equity-Based Compensation Expense
The table below presents the components of equity-based compensation expense (in millions).
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2012
 
2011
 
2012
 
2011
Unit awards
 
$
19

 
$
8

 
$
52

 
$
29

Stock options
 
7

 
8

 
24

 
26

PRSUs and RSUs
 
8

 
5

 
23

 
15

SARs
 
6

 
—

 
13

 
—

Total equity-based compensation expense
 
$
40

 
$
21

 
$
112

 
$
70

Tax benefit recognized
 
$
15

 
$
8

 
$
42

 
$
26

Compensation expense for all awards was recorded in selling, general and administrative expense in the consolidated statements of operations. As of September 30, 2012 and December 31, 2011, the Company recorded total liabilities for cash-settled awards of $62 million and $37 million, respectively.
Equity-Based Award Activity
Unit Awards
The table below presents unit award activity (in millions, except years and weighted-average grant price).
 
 
Unit Awards
 
Weighted-
Average
Grant
Price
 
Weighted-
Average
Remaining
Contractual
Term
(years)
 
Aggregate
Intrinsic
Value
Outstanding as of December 31, 2011
 
5.5

 
$
31.44

 
 
 
 
Granted
 
—

 
—

 
 
 
 
Settled
 
(2.2
)
 
27.50

 
 
 
$
38

Forfeited
 
—

 
—

 
 
 
 
Outstanding as of September 30, 2012
 
3.3

 
$
34.14

 
0.93

 
$
82

Vested and expected to vest as of September 30, 2012
 
3.1

 
$
34.11

 
0.93

 
$
78

Unit awards represent the contingent right to receive a cash payment for the amount by which the vesting price exceeds the grant price. Because unit awards are cash-settled, the Company remeasures the fair value and compensation expense of outstanding unit awards each reporting date until settlement. As of September 30, 2012, the weighted-average fair value of unit awards outstanding was $25.58 per unit award. The Company made cash payments to settle vested unit awards totaling $38 million and $106 million during the nine months ended September 30, 2012 and 2011, respectively. As of September 30, 2012, there was $32 million of unrecognized compensation cost, net of estimated forfeitures, related to unit awards, which is expected to be recognized over a weighted-average period of 1.70 years.

18
DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)




Stock Options
The table below presents stock option activity (in millions, except years and weighted-average exercise price).
 
 
Stock Options
 
Weighted-
Average
Exercise
Price
 
Weighted-
Average
Remaining
Contractual
Term
(years)
 
Aggregate
Intrinsic
Value
Outstanding as of December 31, 2011
 
12.7

 
$
22.52

 
 
 
 
Granted
 
1.2

 
48.42

 
 
 
 
Exercised
 
(4.5
)
 
17.16

 
 
 
$
139

Forfeited
 
(0.2
)
 
31.29

 
 
 
 
Outstanding as of September 30, 2012
 
9.2

 
$
28.20

 
5.52

 
$
288

Vested and expected to vest as of September 30, 2012
 
8.9

 
$
27.69

 
5.52

 
$
283

Exercisable as of September 30, 2012
 
3.5

 
$
21.36

 
5.12

 
$
133

The Company received cash payments from the exercise of stock options totaling $76 million and $43 million during the nine months ended September 30, 2012 and 2011, respectively. The weighted average grant date fair value of stock options granted during the nine months ended September 30, 2012 was $16.87 per option. As of September 30, 2012, there was $43 million of unrecognized compensation cost, net of expected forfeitures, related to stock options, which is expected to be recognized over a weighted-average period of 2.03 years. 
PRSUs and RSUs
The table below presents PRSU and RSU activity (in millions, except years and weighted-average grant price).
 
 
 
PRSUs and
RSUs
 
Weighted-Average
Grant
Price
 
Weighted-Average
Remaining
Contractual
Term
(years)
 
Aggregate
Fair
Value
Outstanding as of December 31, 2011
 
2.2

 
$
35.48

 
 
 
 
Granted
 
0.9

 
47.99

 
 
 
 
Converted
 
(0.1
)
 
32.79

 
 
 
$
5

Forfeited
 
(0.1
)
 
36.47

 
 
 
 
Outstanding as of September 30, 2012
 
2.9

 
$
39.62

 
1.62

 
$
170

Vested and expected to vest as of September 30, 2012
 
2.7

 
$
39.56

 
1.59

 
$
158

PRSUs represent the contingent right to receive shares of the Company’s Series A common stock based on continuous service and whether the Company achieves certain operating performance targets. As of September 30, 2012, there were approximately 2 million outstanding PRSUs with a weighted-average grant price of $39.23. As of September 30, 2012, unrecognized compensation cost, net of expected forfeitures, related to PRSUs was $34 million, which is expected to be recognized over a weighted-average period of 1.29 years.
RSUs represent the contingent right to receive shares of the Company’s Series A common stock based on continuous service. As of September 30, 2012, there were approximately 1 million outstanding RSUs with a weighted-average grant price of $40.68. As of September 30, 2012, there was $20 million of unrecognized compensation cost, net of expected forfeitures, related to RSUs, which is expected to be recognized over a weighted-average period of 2.52 years.
SARs
There were 2 million and zero SARs outstanding as of September 30, 2012 and December 31, 2011, respectively. As of September 30, 2012, the weighted-average fair value of SARs outstanding was $19.35 per award. The Company made cash payments of $1 million to settle exercised SARs during both the nine months ended September 30, 2012 and 2011. As of September 30, 2012, there was $21 million of unrecognized compensation cost, net of estimated forfeitures, related to SARs, which is expected to be recognized over a weighted-average period of 1.73 years.

19
DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)




NOTE 9. INCOME TAXES
The Company's provisions for income taxes on income from continuing operations were $134 million and $381 million, and effective income tax rates were 38% and 34%, for the three and nine months ended September 30, 2012, respectively. The Company's provisions for income taxes on income from continuing operations were $127 million and $418 million, and effective income tax rates were 35% and 34%, for the three and nine months ended September 30, 2011, respectively.
The following table reconciles the Company's effective income tax rate to the U.S. federal statutory income tax rate of 35%.
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2012
 
2011
 
2012
 
2011
U.S. federal statutory income tax rate
35
 %
 
35
 %
 
35
 %
 
35
 %
State and local income taxes, net of federal income taxes
2
 %
 
2
 %
 
2
 %
 
2
 %
Effect of foreign operations
3
 %
 
—
 %
 
3
 %
 
—
 %
Domestic production activity deductions
(2
)%
 
(2
)%
 
(3
)%
 
(2
)%
Reorganization of operations
—
 %
 
—
 %
 
(2
)%
 
—
 %
Other, net
—
 %
 
—
 %
 
(1
)%
 
(1
)%
Effective income tax rate
38
 %
 
35
 %
 
34
 %
 
34
 %

In November 2011, the Company restructured certain of its foreign business operations and transferred certain assets from the U.S. to foreign affiliates. The "Effect of foreign operations" in the above table includes the U.S. tax cost of that transfer. In June 2012, the Company became certain that it would recognize a tax benefit from the legal restructuring of certain assets. The "Reorganization of operations" in the above table includes the U.S. tax benefit of that restructuring.
The Company is currently under examination by the Internal Revenue Service (“IRS”) for its 2009 and 2008 consolidated federal income tax returns. The Company has not been advised of any material adjustments. With few exceptions, the Company is no longer subject to audit by the IRS, state tax authorities, or foreign tax authorities for years prior to 2006.

20
DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)




NOTE 10. NET INCOME PER SHARE
The table below sets forth the computation of the weighted-average number of shares outstanding utilized in determining basic and diluted net income per share (in millions, except per share amounts).
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2012
 
2011
 
2012
 
2011
Numerator:
 
 
 
 
 
 
 
Income from continuing operations, net of taxes
$
215

 
$
240

 
$
732

 
$
799

Less:
 
 
 
 
 
 
 
Net income attributable to noncontrolling interests
(1
)
 
—

 
(2
)
 
—

Income from continuing operations available to Discovery Communications, Inc. stockholders
214

 
240

 
730

 
799

Loss from discontinued operations, available to Discovery Communications, Inc. stockholders
(9
)
 
(3
)
 
(11
)
 
(3
)
Net income available to Discovery Communications, Inc. stockholders
$
205

 
$
237

 
$
719

 
$
796

Denominator:
 
 
 
 
 
 
 
Weighted average shares outstanding — basic
372

 
398

 
380

 
404

Weighted average dilutive effect of equity awards
3

 
3

 
3

 
4

Weighted average shares outstanding — diluted
375

 
401

 
383

 
408

Income (Loss) Per Share:
 
 
 
 
 
 
 
Income from continuing operations available to Discovery Communications, Inc. stockholders:
 
 
 
 
 
 
 
Basic
$
0.58

 
$
0.60

 
$
1.92

 
$
1.98

Diluted
$
0.57

 
$
0.60

 
$
1.91

 
$
1.96

Loss from discontinued operations, available to Discovery Communications, Inc. stockholders:
 
 
 
 
 
 
 
Basic
$
(0.02
)
 
$
(0.01
)
 
$
(0.03
)
 
$
(0.01
)
Diluted
$
(0.02
)
 
$
(0.01
)
 
$
(0.03
)
 
$
(0.01
)
Net income available to Discovery Communications, Inc. stockholders:
 
 
 
 
 
 
 
Basic
$
0.55

 
$
0.60

 
$
1.89

 
$
1.97

Diluted
$
0.55

 
$
0.59

 
$
1.88

 
$
1.95

Income per share amounts may not sum since each is calculated independently.
The table below presents the details of the equity-based awards and preferred shares that were excluded from the calculation of diluted net income per share (in millions).
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2012
 
2011
 
2012
 
2011
Anti-dilutive stock options and RSUs
1
 
3
 
1
 
2
PRSUs whose performance targets are not achieved
2
 
2
 
2
 
1
Contingently issuable preferred shares
1
 
1
 
1
 
1
Net income per share is calculated by dividing the applicable net income available to Discovery Communications, Inc. stockholders by the weighted-average number of shares outstanding. Diluted net income per share adjusts basic net income per share for the dilutive effect of the assumed exercise of outstanding stock options and stock-settled SARs, the vesting of outstanding service based RSUs, and the expected shares issued under the Discovery Communications, Inc. 2011 Employee Stock Purchase Plan using the treasury stock method. Diluted net income per share also adjusts basic net income per share for

21
DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)




the dilutive effect of the assumed vesting of outstanding PRSUs whose performance targets have been achieved as of the last day of the most recent fiscal period.
At September 30, 2012 and 2011, the weighted average number of basic and diluted shares outstanding included the Company’s outstanding Series A, Series B and Series C common stock, as well as its outstanding Series A and Series C convertible preferred stock, as the holder of each common and preferred series legally participates equally in any per share distributions.
NOTE 11. SUPPLEMENTAL DISCLOSURES
The table below presents the components of accrued expenses and other current liabilities (in millions).
 
September 30, 2012
 
December 31, 2011
Accrued payroll and related benefits
$
236

 
$
229

Content rights payable
85

 
86

Accrued income taxes
53

 
38

Accrued interest
78

 
25

Current portion of equity-based compensation liabilities
47

 
27

Accrued other
119

 
149

Total accrued expenses and other current liabilities
$
618

 
$
554

The table below presents the components of other expense, net (in millions).
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2012
 
2011
 
2012
 
2011
Losses from equity investees, net
$
(22
)
 
$
(4
)
 
$
(76
)
 
$
(12
)
Other, net
1

 
(1
)
 
(1
)
 
2

Total other expense, net
$
(21
)
 
$
(5
)
 
$
(77
)
 
$
(10
)
NOTE 12. RELATED PARTY TRANSACTIONS
In the normal course of business, the Company enters into transactions with related parties. The Company provides equity method investees, including unconsolidated VIEs, with content licenses and services such as distribution, sales and administrative support (see Note 3). Other related parties include entities that share common directorship or ownership. The majority of the revenue earned under contractual arrangements with other related parties relates to multi-year network distribution arrangements. The most significant of the Company's other related parties is Liberty Global, Inc. ("Liberty Global"). Discovery’s Board of Directors includes three members who serve as directors of Liberty Global. John C. Malone is Chairman of the Board of Liberty Global and beneficially owns approximately 36% of the aggregate voting power with respect to the election of directors.
The table below presents a summary of the transactions with related parties (in millions).
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2012
 
2011
 
2012
 
2011
Revenues and service charges:
 
 
 
 
 
 
 
Equity method investees
$
22

 
$
19

 
$
70

 
$
63

Liberty Global
8

 
9

 
23

 
26

Other
—

 
1

 
—

 
3

Total revenues and service charges
$
30

 
$
29

 
$
93

 
$
92

Interest income(a)
$
8

 
$
4

 
$
21

 
$
12

Expenses
$
2

 
$
5

 
$
12

 
$
16

 
 
 
 
 
(a) The Company records interest earnings from loans to equity method investees as a component of losses from equity method investees, net, which is a component of other expense, net in the consolidated statements of operations.

22
DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)




Of the revenues and other service charges earned from transactions with equity method investees, the Company provided funding for $7 million and $29 million for the three and nine months ended September 30, 2012, respectively, and $7 million and $23 million for the three and nine months ended September 30, 2011, respectively.
The table below presents receivables due from related parties (in millions).
 
 
September 30, 2012
 
December 31, 2011
Receivables
 
$
25

 
$
14

Note receivable (see Note 3)
 
$
450

 
$
317

NOTE 13. COMMITMENTS, CONTINGENCIES, AND GUARANTEES
Commitments
In the normal course of business, the Company enters into various commitments, which primarily include programming and talent arrangements, operating and capital leases, employment contracts, sponsorship commitments, arrangements to purchase various goods and services, future funding commitments to equity method investees (see Note 3), and the obligation to issue additional shares of preferred stock under the anti-dilution provisions of its outstanding preferred stock.
Contingencies
Put Right
Harpo has the right to require the Company to purchase its interest in OWN for fair value at various dates (see Note 3). No amounts have been recorded for put right obligations.
Legal Matters
In the normal course of business, the Company experiences routine claims and legal proceedings. It is the opinion of the Company’s management, based on information available at this time, that none of the current claims and proceedings will have a material adverse effect on the Company’s consolidated financial position, results of operations or cash flows.
Guarantees
The Company has guaranteed a certain level of operating performance for The Hub (see Note 3). There were no amounts recorded for guarantees associated with equity method investees as of September 30, 2012 or December 31, 2011.
The Company may provide indemnities intended to protect others from certain business risks. Similarly, the Company may remain contingently liable for certain obligations in the event that a third party does not fulfill its obligations under an indemnification obligation. The Company records a liability for its indemnification obligations and other contingent liabilities when probable and estimable. There were no material amounts for indemnifications or other contingencies recorded as of September 30, 2012 or December 31, 2011.
NOTE 14. REPORTABLE SEGMENTS
The Company’s reportable segments are determined based on (i) financial information reviewed by its chief operating decision maker (“CODM”), the Chief Executive Officer, (ii) internal management and related reporting structure, and (iii) the basis upon which the CODM makes resource allocation decisions.
The accounting policies of the reportable segments are the same as the Company’s, except that certain inter-segment transactions that are eliminated for consolidation are not eliminated at the segment level. In determining segment performance, inter-segment transactions are treated as third-party transactions. Inter-segment transactions, which primarily include advertising and content purchases between segments, were not significant for the periods presented.
The Company evaluates the operating performance of its segments based on financial measures such as revenues and adjusted operating income before depreciation and amortization (“Adjusted OIBDA”). Adjusted OIBDA is defined as revenues less costs of revenues and selling, general and administrative expenses excluding: (i) mark-to-market equity-based compensation, (ii) depreciation and amortization, (iii) amortization of deferred launch incentives, (iv) exit and restructuring charges, (v) certain impairment charges and (vi) gains and losses on business and asset dispositions. The Company uses this measure to assess the operating results and performance of its segments, perform analytical comparisons, identify strategies to

23
DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)




improve performance and allocate resources to each segment. The Company believes Adjusted OIBDA is relevant to investors because it allows them to analyze the operating performance of each segment using the same metric management uses. The Company excludes mark-to-market equity-based compensation, exit and restructuring charges, certain impairment charges, and gains and losses on business and asset dispositions from the calculation of Adjusted OIBDA due to their volatility. The Company also excludes depreciation of fixed assets, and amortization of intangible assets and deferred launch incentives as these amounts do not represent cash payments in the current reporting period. Adjusted OIBDA should be considered in addition to, but not a substitute for, operating income, net income and other measures of financial performance reported in accordance with GAAP. Certain corporate expenses are excluded from segment results to enable executive management to evaluate segment performance based upon the decisions of segment executives.
The tables below present summarized financial information for each of the Company’s reportable segments (in millions).
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2012
 
2011
 
2012
 
2011
Revenues:
 
 
 
 
 
 
 
U.S. Networks
$
664

 
$
695

 
$
2,045

 
$
1,942

International Networks
390

 
363

 
1,175

 
1,054

Education
25

 
22

 
70

 
66

Corporate and inter-segment eliminations
(3
)
 
—

 
(3
)
 
—

Total revenues
$
1,076

 
$
1,080

 
$
3,287

 
$
3,062

 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2012
 
2011
 
2012
 
2011
Total Adjusted OIBDA:
 
 
 
 
 
 
 
U.S. Networks
$
386

 
$
378

 
$
1,207

 
$
1,107

International Networks
173

 
156

 
520

 
473

Education
5

 
4

 
14

 
17

Corporate and inter-segment eliminations
(66