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 March 31, 2014
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 April 29, 2014:
Series A Common Stock, par value $0.01 per share | 147,610,321 | |
Series B Common Stock, par value $0.01 per share | 6,543,969 | |
Series C Common Stock, par value $0.01 per share | 75,369,764 | |
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)
March 31, 2014 | December 31, 2013 | |||||||
ASSETS | ||||||||
Current assets: | ||||||||
Cash and cash equivalents | $ | 757 | $ | 408 | ||||
Receivables, net | 1,341 | 1,371 | ||||||
Content rights, net | 307 | 277 | ||||||
Deferred income taxes | 76 | 73 | ||||||
Prepaid expenses and other current assets | 259 | 281 | ||||||
Total current assets | 2,740 | 2,410 | ||||||
Noncurrent content rights, net | 1,902 | 1,883 | ||||||
Property and equipment, net | 522 | 514 | ||||||
Goodwill | 7,370 | 7,341 | ||||||
Intangible assets, net | 1,516 | 1,565 | ||||||
Equity method investments | 1,080 | 1,087 | ||||||
Other noncurrent assets | 181 | 179 | ||||||
Total assets | $ | 15,311 | $ | 14,979 | ||||
LIABILITIES AND EQUITY | ||||||||
Current liabilities: | ||||||||
Accounts payable | $ | 151 | $ | 141 | ||||
Accrued liabilities | 947 | 992 | ||||||
Deferred revenues | 137 | 144 | ||||||
Current portion of debt | 18 | 17 | ||||||
Total current liabilities | 1,253 | 1,294 | ||||||
Noncurrent portion of debt | 6,900 | 6,482 | ||||||
Deferred income taxes | 614 | 637 | ||||||
Other noncurrent liabilities | 326 | 333 | ||||||
Total liabilities | 9,093 | 8,746 | ||||||
Commitments and contingencies (Note 15) | ||||||||
Redeemable noncontrolling interests | 37 | 36 | ||||||
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; 44 shares issued | 1 | 1 | ||||||
Series A common stock: $0.01 par value; 1,700 shares authorized; 150 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; 151 shares issued | 2 | 2 | ||||||
Additional paid-in capital | 6,845 | 6,826 | ||||||
Treasury stock, at cost | (3,797 | ) | (3,531 | ) | ||||
Retained earnings | 3,123 | 2,892 | ||||||
Accumulated other comprehensive income | 4 | 4 | ||||||
Total Discovery Communications, Inc. stockholders’ equity | 6,180 | 6,196 | ||||||
Noncontrolling interests | 1 | 1 | ||||||
Total equity | 6,181 | 6,197 | ||||||
Total liabilities and equity | $ | 15,311 | $ | 14,979 | ||||
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 March 31, | ||||||||
2014 | 2013 | |||||||
Revenues: | ||||||||
Distribution | $ | 657 | $ | 583 | ||||
Advertising | 689 | 508 | ||||||
Other | 65 | 65 | ||||||
Total revenues | 1,411 | 1,156 | ||||||
Costs and expenses: | ||||||||
Costs of revenues, excluding depreciation and amortization | 482 | 342 | ||||||
Selling, general and administrative | 409 | 365 | ||||||
Depreciation and amortization | 83 | 32 | ||||||
Restructuring charges | 3 | 1 | ||||||
Total costs and expenses | 977 | 740 | ||||||
Operating income | 434 | 416 | ||||||
Interest expense | (81 | ) | (68 | ) | ||||
Income (loss) from equity investees, net | 13 | (2 | ) | |||||
Other (expense) income, net | (17 | ) | 31 | |||||
Income from continuing operations before income taxes | 349 | 377 | ||||||
Provision for income taxes | (118 | ) | (146 | ) | ||||
Net income | 231 | 231 | ||||||
Net income attributable to redeemable noncontrolling interests | (1 | ) | — | |||||
Net income available to Discovery Communications, Inc. | $ | 230 | $ | 231 | ||||
Net income per share available to Discovery Communications, Inc. stockholders: | ||||||||
Basic | $ | 0.66 | $ | 0.64 | ||||
Diluted | $ | 0.66 | $ | 0.63 | ||||
Weighted average shares outstanding: | ||||||||
Basic | 348 | 363 | ||||||
Diluted | 352 | 367 | ||||||
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 March 31, | ||||||||
2014 | 2013 | |||||||
Net income | $ | 231 | $ | 231 | ||||
Other comprehensive income (loss), net of tax: | ||||||||
Currency translation adjustments | 1 | (59 | ) | |||||
Derivative and market value adjustments | (1 | ) | 4 | |||||
Comprehensive income | 231 | 176 | ||||||
Comprehensive income attributable to redeemable noncontrolling interests | (1 | ) | — | |||||
Comprehensive income attributable to Discovery Communications, Inc. | $ | 230 | $ | 176 | ||||
The accompanying notes are an integral part of these consolidated financial statements.
6
DISCOVERY COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited; in millions)
Three Months Ended March 31, | |||||||
2014 | 2013 | ||||||
Operating Activities | |||||||
Net income | $ | 231 | $ | 231 | |||
Adjustments to reconcile net income to cash provided by operating activities: | |||||||
Equity-based compensation expense | 19 | 60 | |||||
Depreciation and amortization | 83 | 32 | |||||
Content amortization and impairment expense | 350 | 231 | |||||
Remeasurement gain on previously held equity interest | — | (92 | ) | ||||
Equity in (earnings) losses and distributions from investments, net | (11 | ) | 4 | ||||
Deferred income tax (benefit) expense | (35 | ) | 134 | ||||
Launch amortization expense | 2 | 5 | |||||
Loss from hedging instruments, net | — | 39 | |||||
Other, net | 11 | 25 | |||||
Changes in operating assets and liabilities: | |||||||
Receivables, net | 31 | (20 | ) | ||||
Content rights | (391 | ) | (301 | ) | |||
Accounts payable and accrued liabilities | 6 | (70 | ) | ||||
Equity-based compensation liabilities | (81 | ) | (59 | ) | |||
Income tax receivable | 53 | (62 | ) | ||||
Other, net | (27 | ) | (26 | ) | |||
Cash provided by operating activities | 241 | 131 | |||||
Investing Activities | |||||||
Purchases of property and equipment | (28 | ) | (26 | ) | |||
Business acquisitions, net of cash acquired | (17 | ) | (60 | ) | |||
Hedging instruments, net | — | (39 | ) | ||||
Distributions from equity method investees | 16 | — | |||||
Returns from (investments in) equity method investees, net | 1 | (25 | ) | ||||
Cash used in investing activities | (28 | ) | (150 | ) | |||
Financing Activities | |||||||
Borrowings from debt, net of discount and issuance costs | 412 | 1,186 | |||||
Principal repayments of capital lease obligations | (4 | ) | (11 | ) | |||
Repurchases of common stock | (266 | ) | — | ||||
Cash proceeds from equity-based plans, net | — | 7 | |||||
Other financing activities, net | (2 | ) | — | ||||
Cash provided by financing activities | 140 | 1,182 | |||||
Effect of exchange rate changes on cash and cash equivalents | (4 | ) | (4 | ) | |||
Net change in cash and cash equivalents | 349 | 1,159 | |||||
Cash and cash equivalents, beginning of period | 408 | 1,201 | |||||
Cash and cash equivalents, end of period | $ | 757 | $ | 2,360 | |||
7
DISCOVERY COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited; in millions)
Three Months Ended March 31, | |||||||
2014 | 2013 | ||||||
Supplemental Cash Flow Information | |||||||
Cash paid for taxes, net | $ | (41 | ) | $ | (63 | ) | |
Cash paid for interest, net | $ | (20 | ) | $ | (29 | ) | |
Noncash Investing and Financing Transactions | |||||||
Repurchases of preferred stock | $ | — | $ | 256 | |||
Assets acquired under capital lease arrangements | $ | 14 | $ | — | |||
Accrued purchases of property and equipment | $ | 7 | $ | 3 | |||
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 March 31, 2014 | Three Months Ended March 31, 2013 | |||||||||||||||||||||||
Discovery Stockholders | Noncontrolling Interests | Total Equity | Discovery Stockholders | Noncontrolling Interests | Total Equity | |||||||||||||||||||
Beginning balance | $ | 6,196 | $ | 1 | $ | 6,197 | $ | 6,291 | $ | 2 | $ | 6,293 | ||||||||||||
Comprehensive income | 230 | — | 230 | 176 | — | 176 | ||||||||||||||||||
Equity-based compensation | 20 | — | 20 | 20 | — | 20 | ||||||||||||||||||
Issuance of common stock for equity-based plans | 10 | — | 10 | 16 | — | 16 | ||||||||||||||||||
Excess tax benefits from equity-based compensation | 16 | — | 16 | 13 | — | 13 | ||||||||||||||||||
Tax settlements associated with equity-based compensation | (26 | ) | — | (26 | ) | (22 | ) | — | (22 | ) | ||||||||||||||
Other adjustments for equity-based plans | (1 | ) | — | (1 | ) | — | — | — | ||||||||||||||||
Repurchases of common stock | (266 | ) | — | (266 | ) | — | — | — | ||||||||||||||||
Repurchases of preferred stock | — | — | — | (256 | ) | — | (256 | ) | ||||||||||||||||
Redeemable noncontrolling interest adjustments to redemption value | 1 | — | 1 | 2 | — | 2 | ||||||||||||||||||
Ending balance | $ | 6,180 | $ | 1 | $ | 6,181 | $ | 6,240 | $ | 2 | $ | 6,242 | ||||||||||||
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 global media company that provides content across multiple distribution platforms throughout the world, and through digital distribution arrangements. The Company also has a diversified portfolio of web-native networks and other digital media services and 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 and websites; International Networks, consisting principally of international television networks, radio stations and websites; and Education, consisting of educational curriculum-based product and service offerings. Financial information for Discovery’s reportable segments is discussed in Note 16.
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.
Reclassifications
Transactions denominated in currencies other than subsidiaries' functional currencies are recorded based on exchange rates at the time such transactions arise. Changes in exchange rates with respect to amounts recorded in the consolidated balance sheets related to these items will result in unrealized foreign currency transaction gains and losses based upon period-end exchange rates. The Company also records realized foreign currency transaction gains and losses upon settlement of the transactions. Beginning January 1, 2014, the Company reclassified foreign currency losses, net as described above from selling, general and administrative expense to other (expense) income, net on the consolidated statements of operations for all periods presented. For the three months ended March 31, 2013, foreign currency losses of $2 million were reclassified from selling, general and administrative expense to other (expense) income, net to conform to the current year presentation.
Unaudited Interim Financial Statements
These consolidated financial statements are unaudited; however, in the opinion of management, they reflect all adjustments consisting only of normal recurring adjustments 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, 2013 (the “2013 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 materially from those estimates.
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, other financial instruments, 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
Presentation of Unrecognized Tax Benefits
In July 2013, the Financial Accounting Standards Board ("FASB") issued guidance stating that a liability related to an unrecognized tax benefit should be presented as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carry forward to the extent such deferred tax asset is available at the reporting date to settle any additional income taxes that would result from the disallowance of a tax position. The Company prospectively adopted the new
10
DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
guidance effective January 1, 2014 and reclassified $11 million in liabilities related to unrecognized tax benefits from other noncurrent liabilities to noncurrent deferred income tax liabilities on the consolidated balance sheet as of March 31, 2014.
Accounting and Reporting Pronouncements Not Yet Adopted
Reporting Discontinued Operations
In April 2014, the FASB issued guidance that changes the criteria for reporting a discontinued operation. Under the new pronouncement, disposal of a component of an entity representing a strategic shift with major effect on its operations and financial results is a discontinued operation. The Company is required to adopt the guidance prospectively for all disposals or components of its business classified as held for sale during fiscal periods beginning after December 15, 2014 and is currently evaluating what impact, if any, the adoption will have to the presentation of its consolidated financial statements.
Concentrations Risk
Customers
The Company has long-term contracts with distributors around the world, including the largest distributors in the U.S. and major international distributors. In the U.S., approximately 90% of distribution revenues come from the top 10 distributors. Outside of the U.S., approximately 50% of distribution revenue comes from the top 10 distributors. Agreements in place with the major cable and satellite operators in the U.S. expire at various times beginning in 2014 through 2020. Failure to secure a renewal or a renewal on less favorable terms may have a material adverse effect on the Company’s financial condition and results of operations. Not only could the Company experience a reduction in affiliate revenue, but it could also experience a reduction in advertising revenue which is impacted by affiliate subscriber levels and viewership.
No individual customer accounted for more than 10% of total consolidated revenues for the three months ended March 31, 2014 or 2013. As of March 31, 2014 and December 31, 2013, the Company’s trade receivables do not represent a significant concentration of credit risk as the customers and markets in which the Company operates are varied and dispersed across many geographic areas.
Financial Institutions
Cash and cash equivalents are maintained with several financial institutions. The Company has deposits held with banks that exceed the amount of insurance provided on such deposits. Generally, these deposits may be redeemed upon demand and 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 different counterparties 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 March 31, 2014, the Company did not anticipate nonperformance by any of its counterparties.
NOTE 2. ACQUISITIONS AND DISPOSITIONS
Acquisitions
Eurosport
On January 21, 2014, the Company entered into an agreement with TF1 to acquire a controlling interest in Eurosport International ("Eurosport"), a leading pan-European sports media platform, by increasing Discovery’s ownership stake from 20% to 51% for cash of approximately €253 million ($343 million) subject to working capital adjustments. The Company expects the acquisition to close in the second quarter of 2014 subject to the receipt of necessary regulatory approvals. Due to regulatory constraints the acquisition initially excludes Eurosport France, a subsidiary of Eurosport. The Company will retain a 20% equity interest in Eurosport France and a commitment to acquire another 31% ownership interest beginning in 2015, contingent upon resolution of all regulatory matters. The flagship Eurosport network focuses on regionally popular sports, such as tennis, skiing, cycling and motor sports. Eurosport’s brands and platforms also include Eurosport HD (high definition simulcast), Eurosport 2, Eurosport 2 HD (high definition simulcast), Eurosport Asia-Pacific, and Eurosportnews. The acquisition is intended to increase the growth of Eurosport and enhance the Company's pay television offerings in Europe. TF1 will have the right to put the entirety of its remaining 49% non-controlling interest to the Company during two windows for two and a ha
11
DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
lf years after completion of this acquisition. If the put is exercised during the first 90 day window beginning July 1, 2015, it has a floor value equal to the fair value per share of Eurosport on the closing date of the Company's acquisition of the controlling interest. If the put is exercised during the second 90 day window beginning July 1, 2016, it is priced at the then-current fair value per share of Eurosport, or as may be agreed between the Company and TF1. (See Note 7.)
SBS Nordic
On April 9, 2013, the Company acquired the general entertainment television and radio business operations ("SBS Nordic") of Prosiebensat.1 Media AG for cash of approximately €1.4 billion ($1.8 billion) including closing purchase price adjustments. SBS Nordic has operations in Sweden, Norway, Denmark, Finland and England. The acquisition of SBS Nordic supports the Company’s strategic priority of increasing its presence in key international markets and is a component of the Company's International Networks segment.
The Company used discounted cash flow ("DCF") analyses, which represent Level 3 fair value measurements, to assess the components of its purchase price allocation. The table below presents the fair value allocation of the purchase price to the assets and liabilities acquired (in millions).
April 9, 2013 | ||||
Goodwill | $ | 779 | ||
Intangible assets | 1,001 | |||
Content | 248 | |||
Other assets acquired | 212 | |||
Cash | 106 | |||
Liabilities assumed | (278 | ) | ||
Deferred tax liabilities | (243 | ) | ||
Redeemable noncontrolling interest | (6 | ) | ||
Net assets acquired | $ | 1,819 | ||
The goodwill reflects the workforce, synergies and increased Nordic region market penetration expected from combining the operations of SBS Nordic and the Company. The goodwill recorded as part of this acquisition is not amortizable for tax purposes. Intangible assets primarily consist of broadcast licenses, distribution and advertising customer relationships, advertiser backlog and trademarks with a weighted average estimated useful life of 8 years.
Discovery Japan
On January 10, 2013, the Company purchased an additional 30% of Discovery Japan for $53 million. Discovery Japan operates Discovery Channel and Animal Planet in Japan. As of December 31, 2012, Discovery and Jupiter Telecommunications Co., Ltd ("J:COM") each owned a 50% interest in Discovery Japan, and Discovery accounted for its 50% interest using the equity method of accounting. Discovery consolidated Discovery Japan on January 10, 2013 and recognized a gain of $92 million to account for the difference between the carrying value and the fair value of the previously held 50% equity interest. The gain is included in other (expense) income, net in the Company's consolidated statements of operations (see Note 13). The Company used a combination of a DCF analysis and market-based valuation methodologies, which represent Level 3 fair value measurements, to measure the fair value of Discovery Japan and to perform its purchase price allocation.
12
DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
The table below presents the allocation of the purchase price to the assets and liabilities acquired (in millions).
January 10, 2013 | ||||
Goodwill | $ | 103 | ||
Intangible assets | 100 | |||
Other assets acquired | 25 | |||
Currency translation adjustment | 6 | |||
Cash | 4 | |||
Remeasurement gain on previously held equity interest | (92 | ) | ||
Liabilities assumed | (55 | ) | ||
Redeemable noncontrolling interest | (35 | ) | ||
Carrying value of previously held equity interest | (3 | ) | ||
Net assets acquired | $ | 53 | ||
The terms of the agreement provide J:COM with a right to put its 20% noncontrolling interest to Discovery for cash at any time and Discovery with the right to call J:COM's 20% noncontrolling interest beginning January 2018. As J:COM's put right is outside the control of the Company, J:COM's 20% noncontrolling interest is presented as redeemable noncontrolling interest outside of stockholders' equity on the Company's consolidated balance sheet (see Note 8).
The goodwill reflects the synergies and increased regional flexibility expected from controlling the operations of Discovery Japan and is included in the International Networks segment. The goodwill recorded as part of this acquisition is not amortizable for tax purposes. Intangible assets are primarily distribution customer relationships.
Other
On February 28, 2014, the Company acquired a factual entertainment production company in the U.K. for total consideration of £12 million ($20 million), including accrued purchase liabilities and net of cash acquired. The acquisition helps to strengthen the Company's content sourcing capabilities. As part of the acquisition, the Company recognized $28 million of goodwill.
In 2013, the Company acquired several other unrelated businesses for total consideration of $88 million, net of cash acquired. The Company recorded $67 million and $24 million of goodwill and intangible assets, respectively, in connection with these acquisitions. The acquisitions included a television station in Sweden and an education business in the U.K. The goodwill reflects the synergies and market expansion expected from combining the operations of these acquisitions with the Company.
The operations of acquisitions are included in the Company's consolidated financial statements as of their respective acquisition dates.
Consolidation of Business Combinations
The operations of each of the business combinations discussed above were included in the consolidated financial statements as of each of their respective acquisition dates. The following table presents the revenue and earnings of the businesses acquired after March 31, 2013 as reported within the consolidated financial statements for the three months ended March 31, 2014 (in millions).
Three Months Ended March 31, | ||||
2014 | ||||
Revenue | $ | 184 | ||
Net loss | $ | (20 | ) | |
Disposition
HSW
On April 18, 2014, Discovery entered into a definitive agreement to sell HowStuffWorks, LLC, a commercial website which uses various media to explain complex concepts, terminology and mechanisms, to Blucora, Inc. (“Blucora”). Blucora will pay Discovery $45 million and Discovery expects to recognize a pretax gain of approximately $30 million upon
13
DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
completion of the sale. The transaction is expected to close in the second quarter of 2014, subject to the satisfaction or waiver of customary closing conditions.
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 March 31, 2014 and December 31, 2013, the Company’s VIEs primarily consisted of Hub Television Networks LLC and OWN LLC, which operate pay television networks in the U.S.
The Company accounted for its interests in VIEs using the equity method, as the Company is not the primary beneficiary. The aggregate carrying values of these equity method investments were $786 million and $789 million as of March 31, 2014 and December 31, 2013, respectively. The Company recognized $16 million in income and $1 million in losses for its portion of net income and losses generated by VIEs of during the three months ended March 31, 2014 and 2013, respectively.
As of March 31, 2014, the Company’s estimated risk of loss for investment carrying values, unfunded contractual commitments and guarantees made on behalf of VIEs was approximately $849 million. The estimated risk of loss excludes the Company’s expected non-contractual future funding of OWN and its operating performance guarantee for Hub Television Networks LLC, which are discussed below.
Hub Television Networks LLC
Hub Television Networks LLC operates the Hub Network, which is a pay television network that provides children’s and family entertainment and educational programming. The Company is obligated to provide the Hub Network with funding up to $15 million; the Company has not provided any funding as of March 31, 2014. The Company also provides services such as distribution, sales and administrative support services for a fee (see Note 14).
Based upon the level of equity investment at risk, the Hub Network 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 Network that most significantly impact its economic performance. Neither has special governance rights, and both are equally represented on the board of the Hub Network. The partners also share equally in the profits, losses and funding of the Hub Network. The Company has determined that it is not the primary beneficiary of the Hub Network. Accordingly, the Company accounts for its investment in the Hub Network using the equity method.
Through December 31, 2015, the Company has guaranteed the performance of the Hub Network 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 Network on May 22, 2009, the maximum amount potentially due under this guarantee was $300 million. As of March 31, 2014, the maximum amount potentially due under this guarantee was less than $40 million. As the Hub Network’s distribution is obtained 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 value of the Company’s investment in the Hub Network was $313 million and $312 million as of March 31, 2014 and December 31, 2013, respectively. The Company regularly monitors 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. The Company primarily uses a discounted cash flow model to monitor the value of its investment. The Hub Network’s projected financial results and associated cash flows are key assumptions used in estimating the value of our investment. While the Hub Network is currently generating cash flow from operations, the network has not yet achieved the level of profitability and associated cash flows anticipated in the original long range plan. Management has recently implemented and continues to consider a number of initiatives, including changes to its programing strategy designed to improve the Hub Network’s financial performance by reducing costs, improving viewership and increasing revenues. The Company will continue to assess the carrying value of its investment in the Hub Network taking into account the outcome of the above initiatives. If the outcome of the above initiatives is not successful, the financial results of the Hub Network will vary negatively from the long range plan and, as a result, the carrying value of Discovery's equity investment, or underlying Hub Network assets, may be impaired. No impairment was recorded during the three months ended March 31, 2014.
OWN LLC
OWN LLC operates OWN, which is a pay television network and website that provides adult lifestyle content, which is focused on self-discovery, self-improvement and entertainment. Based upon the level of equity investment at risk, OWN is a
14
DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
VIE. While the Company and Harpo, Inc. ("Harpo") are partners who share equally in voting control, power is not shared because Harpo holds operational rights related to programming and marketing, as well as selection and retention of key management personnel that significantly impact OWN’s economic performance. 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. However, the Company provides OWN funding, content licenses, and services such as distribution, sales and administrative support for a fee (see Note 14).
The Company's combined advances to and note receivable from OWN, including accrued interest, were $473 million and $483 million, as of March 31, 2014 and December 31, 2013, respectively. During the three months ended March 31, 2014, the Company received net repayments of $19 million from OWN and accrued interest on the note receivable of $9 million. During the three months ended March 31, 2013, the Company provided OWN with funding of $14 million and accrued interest on the note receivable of $9 million. The note receivable is secured by the net assets of OWN. While the Company has no further funding commitments, the Company will provide additional funding to OWN, if necessary, and expects 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. OWN began repaying amounts owed to the Company during 2013.
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. Although OWN has become profitable, the Company will record 100% of any net losses resulting from OWN's operations as long as Discovery provides all funding to OWN and OWN’s accumulated losses continue to exceed the equity contributed. All of OWN's future net income will initially be recorded by the Company until the Company recovers losses absorbed in excess of the Company's equity ownership interest.
The carrying value of the Company’s investment in OWN of $443 million and $449 million as of March 31, 2014 and December 31, 2013, respectively, includes a note receivable balance and accumulated investment losses. 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. No impairment was recorded during the three months ended March 31, 2014.
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 a half years commencing January 1, 2016. The maximum put amount ranges from $100 million on the first put exercise date up to a cumulative cap of $400 million on the fourth put exercise date. The Company has recorded no amounts for the put right.
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 techniques in which one or more significant inputs are unobservable. |
15
DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
The tables below present assets and liabilities measured at fair value on a recurring basis (in millions).
March 31, 2014 | ||||||||||||||||||
Category | Balance Sheet Location | Level 1 | Level 2 | Level 3 | Total | |||||||||||||
Assets: | ||||||||||||||||||
Trading securities: | ||||||||||||||||||
Mutual funds | Prepaid expenses and other current assets | $ | 138 | $ | — | $ | — | $ | 138 | |||||||||
Available-for-sale securities: | ||||||||||||||||||
Common stock | Other noncurrent assets | 4 | — | — | 4 | |||||||||||||
Derivatives: | ||||||||||||||||||
Foreign exchange | Prepaid expenses and other current assets | — | 4 | — | 4 | |||||||||||||
Foreign exchange | Other noncurrent assets | — | 8 | — | 8 | |||||||||||||
Total assets | $ | 142 | $ | 12 | $ | — | $ | 154 | ||||||||||
Liabilities: | ||||||||||||||||||
Deferred compensation plan | Accrued liabilities | $ | 138 | $ | — | $ | — | $ | 138 | |||||||||
Derivatives: | ||||||||||||||||||
Foreign exchange | Accrued liabilities | — | 3 | — | 3 | |||||||||||||
TF1 put right | Accrued liabilities | — | — | 27 | 27 | |||||||||||||
Total liabilities | $ | 138 | $ | 3 | $ | 27 | $ | 168 | ||||||||||
December 31, 2013 | ||||||||||||||||||
Category | Balance Sheet Location | Level 1 | Level 2 | Level 3 | Total | |||||||||||||
Assets: | ||||||||||||||||||
Trading securities: | ||||||||||||||||||
Mutual funds | Prepaid expenses and other current assets | $ | 129 | $ | — | $ | — | $ | 129 | |||||||||
Available-for-sale securities: | ||||||||||||||||||
Common stock | Other noncurrent assets | 4 | — | — | 4 | |||||||||||||
Derivatives: | ||||||||||||||||||
Foreign exchange | Prepaid expenses and other current assets | — | 4 | — | 4 | |||||||||||||
Foreign exchange | Other noncurrent assets | — | 9 | — | 9 | |||||||||||||
Total assets | $ | 133 | $ | 13 | $ | — | $ | 146 | ||||||||||
Liabilities: | ||||||||||||||||||
Deferred compensation plan | Accrued liabilities | $ | 129 | $ | — | $ | — | $ | 129 | |||||||||
Derivatives: | ||||||||||||||||||
Foreign exchange | Accrued liabilities | — | 1 | — | 1 | |||||||||||||
TF1 put right | Accrued liabilities | — | — | 20 | 20 | |||||||||||||
Total liabilities | $ | 129 | $ | 1 | $ | 20 | $ | 150 | ||||||||||
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 equity investments in highly liquid instruments. 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.
Derivative financial instruments are comprised of foreign exchange contracts used by the Company to modify its exposure to market risks from foreign exchange rates. The fair value of Level 2 derivative financial instruments was determined using a market-based approach.
16
DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
TF1 has the conditional right to require the Company to purchase its remaining shares in Eurosport at various dates should Discovery complete its planned acquisition of a controlling interest in Eurosport. Written puts that do not qualify for equity classification are reported at fair value and subsequently marked to fair value through earnings regardless of associated contingencies. The fair value measurement of the TF1 put was determined through the use of a Monte Carlo simulation model. The Monte Carlo model simulates the various sources of uncertainty impacting the value of a financial instrument and uses those simulations to develop an estimated fair value for the instrument. The valuation methodology for the TF1 put is based on unobservable estimates and judgments, and therefore represents a Level 3 fair value measurement. At March 31, 2014 and December 31, 2013, the estimated fair value of the TF1 put was $27 million and $20 million, respectively. There were no changes to the valuation methodology used to estimate the fair value of the TF1 put during the three months ended March 31, 2014. (See Note 2.)
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 each approximated their fair values other than debt. The estimated fair value of the Company’s outstanding senior notes using quoted prices from over the counter markets, considered Level 2 inputs, was $7.3 billion and $6.6 billion as of March 31, 2014 and December 31, 2013, respectively.
NOTE 5. CONTENT RIGHTS
The table below presents the components of content rights (in millions).
March 31, 2014 | December 31, 2013 | |||||||
Produced content rights: | ||||||||
Completed | $ | 3,761 | $ | 3,566 | ||||
In-production | 318 | 334 | ||||||
Coproduced content rights: | ||||||||
Completed | 653 | 637 | ||||||
In-production | 85 | 84 | ||||||
Licensed content rights: | ||||||||
Acquired | 927 | 880 | ||||||
Prepaid | 58 | 48 | ||||||
Content rights, at cost | 5,802 | 5,549 | ||||||
Accumulated amortization | (3,593 | ) | (3,389 | ) | ||||
Total content rights, net | 2,209 | 2,160 | ||||||
Current portion | (307 | ) | (277 | ) | ||||
Noncurrent portion | $ | 1,902 | $ | 1,883 | ||||
Content expense, which consists of content amortization, impairments and other production charges, is included in cost of revenues on the consolidated statements of operations. Content expense was $377 million and $256 million for the three months ended March 31, 2014 and 2013, respectively. Content impairments were $6 million and $4 million for the three months ended March 31, 2014 and 2013, respectively.
17
DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
NOTE 6. DEBT
The table below presents the components of outstanding debt (in millions).
March 31, 2014 | December 31, 2013 | |||||||
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 | ||||||
2.375% Senior Notes, euro denominated, annual interest, due March 2022(a) | 412 | — | ||||||
3.30% Senior Notes, semi-annual interest, due May 2022 | 500 | 500 | ||||||
3.25% Senior Notes, semi-annual interest, due April 2023 | 350 | 350 | ||||||
6.35% Senior Notes, semi-annual interest, due June 2040 | 850 | 850 | ||||||
4.95% Senior Notes, semi-annual interest, due May 2042 | 500 | 500 | ||||||
4.875% Senior Notes, semi-annual interest, due April 2043 | 850 | 850 | ||||||
Capital lease obligations | 175 | 165 | ||||||
Total debt | 6,937 | 6,515 | ||||||
Unamortized discount | (19 | ) | (16 | ) | ||||
Debt, net | 6,918 | 6,499 | ||||||
Current portion of debt | (18 | ) | (17 | ) | ||||
Noncurrent portion of debt | $ | 6,900 | $ | 6,482 | ||||
(a) Remeasurement from euro using the exchange rate of €1.00 = $1.37 on March 31, 2014.
On March 7, 2014, Discovery Communications, LLC ("DCL"), a wholly-owned subsidiary of the Company, issued €300 million principal amount ($417 million, at issuance based on the exchange rate of $1.39 per euro at March 7, 2014) of 2.375% Senior Notes due March 7, 2022 (the "2014 Notes"). The proceeds received by DCL from the offering were net of a $3 million issuance discount and $2 million of deferred financing costs.
DCL has the option to redeem some or all of the 2014 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 2014 Notes is payable annually on March 7 of each year. The 2014 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. The outstanding senior notes contain certain nonfinancial covenants, events of default and other customary provisions. The Company was in compliance with all covenants and customary provisions and there were no events of default as of March 31, 2014.
The 2014 Notes are denominated in euro and expose Discovery to fluctuations in foreign exchange rates in that currency. Discovery has reported the change in fair value for these 2014 Notes in earnings.
In addition to the debt instruments listed in the table above, the Company also has access to a $1.0 billion revolving credit facility. There were no amounts drawn under the revolving credit facility as of March 31, 2014 or December 31, 2013. 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. Balances outstanding under the revolving credit facility would be due on the expiration date which is October 12, 2017.
The revolving credit facility contains affirmative and negative covenants, including an interest coverage ratio and leverage ratio, events of default and other customary provisions. The Company was in compliance with all covenants and there were no events of default as of March 31, 2014 and December 31, 2013.
NOTE 7. DERIVATIVE FINANCIAL INSTRUMENTS
The Company may use derivative financial instruments to modify its exposure to market risks from changes in interest rates and foreign exchange rates. The Company does not enter into or hold derivative financial instruments for speculative trading purposes.
18
DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
During the three months ended March 31, 2014 and 2013, the Company designated foreign currency forward contracts used to hedge anticipated distribution revenue as cash flow hedges. The Company also designated interest rate contracts used to hedge the pricing for certain senior notes as cash flow hedges. Gains and losses on the effective portion of designated cash flow hedges are initially recorded in accumulated other comprehensive income on the consolidated balance sheet and reclassified to the statement of operations when the hedged item is recognized.
During the three months ended March 31, 2013, the Company entered into foreign exchange contracts in connection with the planned acquisition of SBS Nordic (see Note 2). These derivatives, which economically hedged the Company's exposure to fluctuations in certain foreign currency exchange rates, did not qualify for hedge accounting and realized and unrealized losses resulting thereon were reflected in the consolidated statements of operations. There were no unsettled foreign exchange contracts held by the Company in connection with potential business combinations as of March 31, 2014 and December 31, 2013. The Company also acquired foreign currency forward contracts in its business combinations that did not qualify for hedge accounting. Gains and losses on these foreign currency forward contracts are reflected in other (expense) income, net on the consolidated statements of operations.
TF1 has the conditional right to require the Company to purchase its remaining shares in Eurosport. Written puts that do not qualify for equity classification are reported at fair value and subsequently marked to fair value through earnings regardless of associated contingencies. (See Note 4.)
The Company records all unsettled derivative contracts on the consolidated balance sheet at fair value (see Note 4); derivatives in an asset position are classified as assets, and derivatives in a liability position are classified as liabilities. The Company's master netting agreements allow the Company to settle derivative contracts denominated in the same currency with a single counterparty on the same day on a net basis. There were no amounts eligible to be offset under master netting agreements as of March 31, 2014 and December 31, 2013.
The following table summarizes the notional amount and fair value of the Company's derivative positions (in millions).
March 31, 2014 | December 31, 2013 | |||||||||||||||||
Balance Sheet Location | Notional | Fair Value | Notional | Fair Value | ||||||||||||||
Derivatives designated as hedges: | ||||||||||||||||||
Foreign exchange | Prepaid expenses and other current assets | $ | 31 | $ | 4 | $ | 16 | $ | 4 | |||||||||
Foreign exchange | Other noncurrent assets | $ | 47 | $ | 8 | $ | 36 | $ | 9 | |||||||||
Interest rate | Other noncurrent assets | $ | 100 | $ | — | $ | — | $ | — | |||||||||
Foreign exchange | Accrued liabilities | $ | 87 | $ | 2 | $ | — | $ | — | |||||||||
Derivatives not designated as hedges: | ||||||||||||||||||
Foreign exchange | Accrued liabilities | $ | 7 | $ | 1 | $ | 4 | $ | 1 | |||||||||
TF1 put right | Accrued liabilities | $ | 573 | $ | 27 | $ | 574 | $ | 20 | |||||||||
Foreign exchange | Other noncurrent liabilities | $ | 3 | $ | — | $ | 3 | $ | — | |||||||||
The following table presents the pretax impact of derivatives designated as cash flow hedges on income and other comprehensive income (loss) (in millions).
Three Months Ended March 31, | ||||||||
2014 | 2013 | |||||||
Foreign exchange | ||||||||
(Losses) gains recognized in accumulated other comprehensive income | $ | (2 | ) | $ | 5 | |||
Gains reclassified from accumulated other comprehensive income into other (expense) income, net (effective portion) | $ | 1 | $ | — | ||||
19
DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
The following table presents the pretax losses on derivatives not designated as hedges recognized in other (expense) income, net in the consolidated statement of operations (in millions).
Three Months Ended March 31, | ||||||||
2014 | 2013 | |||||||
Foreign exchange | $ | — | $ | (59 | ) | |||
TF1 put right | (7 | ) | — | |||||
Total | $ | (7 | ) | $ | (59 | ) | ||
NOTE 8. REDEEMABLE NONCONTROLLING INTERESTS
In connection with the acquisition of Discovery Japan on January 10, 2013, the Company recognized $35 million for the fair value of J:COM's noncontrolling interest (see Note 2). The terms of the agreement provide J:COM with a right to put all, but not less than all, of its 20% noncontrolling interest to Discovery at any time for cash. For the first four years, the redemption value is the January 10, 2013 fair value denominated in Japanese yen; thereafter, the redemption value is the greater of the then current fair value or the January 10, 2013 fair value denominated in Japanese yen.
In connection with the acquisition of SBS Nordic on April 9, 2013, the Company recognized an additional $6 million for the fair value of a noncontrolling interest in one of its Danish subsidiaries (see Note 2). The noncontrolling interest holder has a conditional right from November 20, 2014 through May 31, 2015 to put its 20% ownership interest to SBS. The redemption value is denominated in Danish kroner.
Because exercise of these put rights is outside the Company's control, the noncontrolling interests are presented as redeemable noncontrolling interests outside of stockholders' equity on the Company's consolidated balance sheet. Redeemable noncontrolling interests reflected as of the balance sheet date are the greater of the noncontrolling interest balances adjusted for comprehensive income items or the redemption values remeasured at the period end foreign exchange rates (i.e. the "floor"). Adjustments to the carrying amount of redeemable noncontrolling interests to redemption value as a result of changes in exchange rates are reflected in currency translation adjustments, a component of other comprehensive income (loss); however, such currency translation adjustments to redemption value are allocated to Discovery stockholders only. Redeemable noncontrolling interest adjustments of redemption value to the floor are reflected in retained earnings and as an adjustment to income from continuing operations available to Discovery Communications, Inc. stockholders in the calculation of earnings per share. (See Note 12.)
The table below presents the reconciliation of changes in redeemable noncontrolling interests (in millions).
Three Months Ended March 31, | ||||||||
2014 | 2013 | |||||||
Beginning balance | $ | 36 | $ | — | ||||
Initial fair value of redeemable noncontrolling interests of acquired businesses | — | 35 | ||||||
Comprehensive income adjustments: | ||||||||
Net income attributable to redeemable noncontrolling interests | 1 | — | ||||||
Currency translation on redemption values | 1 | — | ||||||
Retained earnings adjustments: | ||||||||
Adjustments to redemption value | (1 | ) | (2 | ) | ||||
Ending balance | $ | 37 | $ | 33 | ||||
20
DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
NOTE 9. EQUITY
Stock Repurchase Program
Under the Company's stock repurchase program, management is authorized to purchase shares of the Company's common stock from time to time through open market purchases or privately negotiated transactions at prevailing prices or pursuant to one or more accelerated stock repurchase agreements or other derivative arrangement as permitted by securities laws and other legal requirements, and subject to stock price, business and market conditions and other factors. The total authorization under the stock repurchase program is $5.5 billion. As of March 31, 2014, the Company had remaining authorization of $1.7 billion for future repurchases under the stock repurchase program, of which $204 million and $1.5 billion will expire on December 11, 2014 and February 3, 2016, respectively.
Repurchased stock is recorded in treasury stock on the consolidated balance sheet. During the three months ended March 31, 2014 the Company repurchased 3.4 million Series C common shares for $266 million through open market transactions using cash on hand. The Company made no stock repurchases during the three months ended March 31, 2013. As of March 31, 2014, the Company had repurchased over the life of the program 2.8 million and 73.4 million shares of Series A and Series C common stock for the aggregate purchase price of $171 million and $3.6 billion, respectively.
Common Stock
On February 13, 2014, John C. Malone, a member of Discovery’s Board of Directors entered into an agreement granting David Zaslav, the Company’s President and Chief Executive Officer, certain voting and purchase rights with respect to the approximately 5.9 million shares of the Company’s Series B common stock owned by Dr. Malone. The agreement gives Mr. Zaslav the right to vote the Series B shares if Dr. Malone is not otherwise voting or directing the vote of those shares. The agreement also provides that if Dr. Malone proposes to sell the Series B shares, Mr. Zaslav will have the first right to negotiate for the purchase of the shares. If that negotiation is not successful and Dr. Malone proposed to sell the Series B shares to a third party, Mr. Zaslav will have the exclusive right to match that offer. The rights granted under the agreement will remain in effect for as long as Mr. Zaslav is either employed as a principal executive officer of the Company or serving on its Board of Directors.
Preferred Stock Repurchase
On March 6, 2013, the Company agreed to repurchase and retire 4 million shares of its Series C convertible preferred stock from Advance Programming Holdings, LLC for an aggregate purchase price of $256 million, which was recorded as a decrease of par value of preferred stock and retained earnings. The repurchase was made outside of the Company's publicly announced stock repurchase program. The share repurchase was completed on April 5, 2013 using cash on hand. There were no preferred stock repurchases during the three months ended March 31, 2014.
Other Comprehensive Income (Loss)
The table below presents the tax effects related to each component of other comprehensive income (loss) and reclassifications made into the consolidated statements of operations (in millions).
Three Months Ended March 31, 2014 | Three Months Ended March 31, 2013 | ||||||||||||||||||||||
Pretax | Tax Provision | Net-of-tax | Pretax | Tax Provision | Net-of-tax | ||||||||||||||||||
Currency translation adjustments: | |||||||||||||||||||||||
Unrealized gains / (losses) | $ | 2 | $ | (1 | ) | $ | 1 | $ | (64 | ) | $ | 11 | $ | (53 | ) | ||||||||
Reclassification to other (expense) income, net | — | — | — | (9 | ) | 3 | (6 | ) | |||||||||||||||
Derivative and market value adjustments: | |||||||||||||||||||||||
Unrealized (losses) gains | (1 | ) | 1 | — | 7 | (3 | ) | 4 | |||||||||||||||
Reclassifications to other (expense) income, net | (1 | ) | — | (1 | ) | — | — | — | |||||||||||||||
Other comprehensive income (loss) | $ | — | $ | — | $ | — | $ | (66 | ) | $ | 11 | $ | (55 | ) | |||||||||
21
DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Accumulated Other Comprehensive Income
The table below presents the changes in the components of accumulated other comprehensive income, net of taxes (in millions).
Three Months Ended March 31, 2014 | Three Months Ended March 31, 2013 | ||||||||||||||||||||||
Currency Translation Adjustments | Derivative and Market Value Adjustments | Accumulated Other Comprehensive Income | Currency Translation Adjustments | Derivative and Market Value Adjustments | Accumulated Other Comprehensive Income (Loss) | ||||||||||||||||||
Beginning balance | $ | (8 | ) | $ | 12 | $ | 4 | $ | (1 | ) | $ | 5 | $ | 4 | |||||||||
Other comprehensive income (loss) before reclassifications | 1 | — | 1 | (53 | ) | 4 | (49 | ) | |||||||||||||||
Reclassifications from accumulated other comprehensive income to net income | — | (1 | ) | (1 | ) | (6 | ) | — | (6 | ) | |||||||||||||
Ending balance | $ | (7 | ) | $ | 11 | $ | 4 | $ | (60 | ) | $ | 9 | $ | (51 | ) | ||||||||
NOTE 10. EQUITY-BASED COMPENSATION
The Company has various incentive plans under which performance-based restricted stock units ("PRSUs"), time-based restricted stock units ("RSUs"), stock options, unit awards and stock appreciation rights ("SARs") have been issued. As of March 31, 2014, the Company has reserved a total of 72 million shares of its Series A and Series C common stock for future exercises of outstanding and future grants of stock options and future vesting of outstanding and future grants of PRSUs and RSUs. Upon exercise of stock options or vesting of PRSUs and RSUs, the Company issues new shares from its existing authorized but unissued shares. There were 62 million shares of common stock in reserves that were available for future grant under incentive plans as of March 31, 2014.
During the three months ended March 31, 2014, the vesting and service requirements of equity-based awards granted were consistent with the arrangements disclosed in the 2013 Form 10-K.
Equity-Based Compensation Expense
The table below presents the components of equity-based compensation expense (in millions).
Three Months Ended March 31, | ||||||||
2014 | 2013 | |||||||
PRSUs and RSUs | $ | 11 | $ | 12 | ||||
Stock options | 9 | 8 | ||||||
Unit awards | 1 | 24 | ||||||
SARs | (2 | ) | 16 | |||||
Total equity-based compensation expense | $ | 19 | $ | 60 | ||||
Tax benefit recognized | $ | 7 | $ | 14 | ||||
Compensation expense for all awards is recorded in selling, general and administrative expense in the consolidated statements of operations. As of March 31, 2014 and December 31, 2013, the Company recorded total liabilities for cash-settled awards of $55 million and $138 million, respectively. The current portion of the liability for cash-settled awards was $35 million and $85 million as of March 31, 2014 and December 31, 2013, respectively.
22
DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Equity-Based Award Activity
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, 2013 | 2.4 | $ | 46.00 | ||||||||||
Granted | 1.6 | 83.32 | |||||||||||
Converted | (0.7 | ) | 38.55 | $ | 58 | ||||||||
Forfeited | (0.1 | ) | 78.88 | ||||||||||
Outstanding as of March 31, 2014 | 3.2 | $ | 65.15 | 1.5 | $ | 267 | |||||||
Vested and expected to vest as of March 31, 2014 | 3.1 | $ | 64.88 | 1.4 | $ | 258 | |||||||
PRSUs represent the contingent right to receive shares of the Company’s Series A common stock based on continuous service and the Company's achievement of certain operating performance targets. As of March 31, 2014, there were approximately 2 million outstanding PRSUs with a weighted-average grant price of $64.20. As of March 31, 2014, unrecognized compensation cost, net of expected forfeitures, related to PRSUs was $108 million, which is expected to be recognized over a weighted-average period of 1.2 years.
RSUs represent the contingent right to receive shares of the Company’s Series A common stock based on continuous service. As of March 31, 2014, there were slightly less than 1 million outstanding RSUs with a weighted-average grant price of $67.75. As of March 31, 2014, unrecognized compensation cost, net of expected forfeitures, related to RSUs was $43 million, which is expected to be recognized over a weighted-average period of 3.0 years.
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, 2013 | 7.6 | $ | 36.47 | ||||||||||
Granted | 0.9 | 83.30 | |||||||||||
Exercised | (0.3 | ) | 28.63 | $ | 15 | ||||||||
Outstanding as of March 31, 2014 | 8.2 | $ | 41.71 | 4.5 | $ | 335 | |||||||
Vested and expected to vest as of March 31, 2014 | 8.0 | $ | 41.00 | 4.5 | $ | 333 | |||||||
Exercisable as of March 31, 2014 | 5.4 | $ | 29.71 | 4.0 | $ | 283 | |||||||
The Company received cash payments from the exercise of stock options totaling $8 million and $15 million during the three months ended March 31, 2014 and 2013, respectively. The weighted average grant date fair value of stock options granted during the three months ended March 31, 2014 was $21.85 per option. As of March 31, 2014, there was $38 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 1.8 years.
23
DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
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, 2013 | 1.6 | $ | 38.46 | ||||||||||
Settled | (1.0 | ) | 36.96 | $ | 52 | ||||||||
Outstanding as of March 31, 2014 | 0.6 | $ | 41.17 | 0.8 | $ | 24 | |||||||
Vested and expected to vest as of March 31, 2014 | 0.6 | $ | 41.17 | 0.8 | $ | 24 | |||||||
Unit awards represent the contingent right to receive a cash payment for the amount by which the vesting price of Company stock 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 March 31, 2014, the weighted-average fair value of unit awards outstanding was $41.98 per unit award. The Company made cash payments to settle vested unit awards totaling $52 million and $49 million during the three months ended March 31, 2014 and 2013, respectively. As of March 31, 2014, there was $12 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 0.8 years.
SARs
The table below presents SAR award activity (in millions, except years and weighted-average grant price).
SARs | Weighted- Average Grant Price | Weighted- Average Remaining Contractual Term (years) | Aggregate Intrinsic Value | ||||||||||
Outstanding as of December 31, 2013 | 3.2 | $ | 55.20 | ||||||||||
Granted | 3.7 | 86.51 | |||||||||||
Settled | (0.9 | ) | 53.65 | $ | 29 | ||||||||
Outstanding as of March 31, 2014 | 6.0 | $ | 74.71 | 2.0 | $ | 62 | |||||||
Vested and expected to vest as of March 31, 2014 | 6.0 | $ | 74.71 | 2.0 | $ | 62 | |||||||
As of March 31, 2014, the weighted-average fair value of SARs outstanding was $17.66 per award. The Company made cash payments of $29 million and $10 million to settle exercised SARs during the three months ended March 31, 2014 and 2013, respectively. As of March 31, 2014, there was $64 million of unrecognized compensation cost, net of estimated forfeitures, related to SARs, which is expected to be recognized over a weighted-average period of 2.0 years.
Employee Stock Purchase Plan
The Discovery Communications, Inc. 2011 Employee Stock Purchase Plan (the "DESPP") enables eligible employees to purchase shares of the Company’s common stock through payroll deductions or other permitted means. During the three months ended March 31, 2014 and 2013, the Company issued 21 thousand and 17 thousand shares under the DESPP and received cash totaling $2 million and $1 million, respectively.
NOTE 11. INCOME TAXES
The Company's provisions for income taxes on income from continuing operations were $118 million and $146 million, and effective income tax rates were 34% and 39% for the three months ended March 31, 2014 and 2013, respectively.
24
DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
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 March 31, | ||||||
2014 | 2013 | |||||
U.S. federal statutory income tax rate | 35 | % | 35 | % | ||
State and local income taxes, net of federal tax benefit | 3 | % | 3 | % | ||
Effect of foreign operations | (1 | )% | 1 | % | ||
Domestic production activity deductions | (3 | )% | 1 | % | ||
Change in uncertain tax positions | (2 | )% | — | % | ||
Remeasurement gain on previously held equity interest | — | % | (2 | )% | ||
Other, net | 2 | % | 1 | % | ||
Effective income tax rate | 34 | % | 39 | % | ||
The Company and its subsidiaries file income tax returns in the U.S. and various state and foreign jurisdictions. The Company is currently under examination by the IRS for its 2011 and 2010 consolidated federal income tax returns. The Company does not anticipate any material adjustments. With few exceptions, the Company is no longer subject to audit by any jurisdiction for years prior to 2006.
The Company's reserves for uncertain tax positions at March 31, 2014 and December 31, 2013 totaled $181 million and $185 million, respectively. It is reasonably possible that the total amount of unrecognized tax benefits related to certain of the Company's uncertain tax positions could decrease as much as $22 million within the next twelve months as a result of ongoing audits, lapses of statutes of limitations or regulatory developments.
As of March 31, 2014 and December 31, 2013, the Company had accrued approximately $14 million and $11 million, respectively, of total interest and penalties payable related to unrecognized tax benefits. The Company recognizes interest and penalties related to unrecognized tax benefits as a component of income tax expense.
25
DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
NOTE 12. EARNINGS PER SHARE
The table below sets forth the computation of the weighted average number of shares outstanding utilized in determining basic and diluted earnings per share (in millions, except per share amounts).
Three Months Ended March 31, | ||||||||
2014 | 2013 | |||||||
Numerator: | ||||||||
Net income | $ | 231 | $ | 231 | ||||
Less: | ||||||||
Net income attributable to redeemable noncontrolling interests | (1 | ) | — | |||||
Redeemable noncontrolling interest adjustments to redemption value | 1 | 2 | ||||||
Net income available to Discovery Communications, Inc. stockholders | $ | 231 | $ | 233 | ||||
Denominator: | ||||||||
Weighted average shares outstanding — basic | 348 | 363 | ||||||
Weighted average dilutive effect of equity awards | 4 | 4 | ||||||
Weighted average shares outstanding — diluted | 352 | 367 | ||||||
Income per share: | ||||||||
Net income per share available to Discovery Communications, Inc. stockholders: | ||||||||
Basic | $ | 0.66 | $ | 0.64 | ||||
Diluted | $ | 0.66 | $ | 0.63 | ||||
Earnings per share is calculated by dividing the applicable income available to Discovery Communications, Inc. stockholders from continuing operations by the weighted average number of shares outstanding. The Company applies the two-class method for calculating earnings per share. The two-class method calculates earnings per share by distinguishing between the classes of securities based on the proportionate participation rights of each award type in the Company's undistributed income. Adjustments to the carrying amount of redeemable noncontrolling interests to redemption value, excluding currency translation adjustments, are reflected in earnings per share using the two-class method, similar to the treatment of a dividend.
At March 31, 2014 and 2013, 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. Diluted earnings per share adjusts basic earnings per share for the dilutive effect of the assumed exercise of outstanding equity awards using the treasury stock method. Only outstanding PRSUs whose performance targets have been achieved as of the last day of the most recent period are included in the dilutive effect calculation.
The table below presents the details of the equity-based awards that were excluded from the calculation of diluted earnings per share (in millions).
Three Months Ended March 31, | ||||||
2014 | 2013 | |||||
Anti-dilutive stock options, PRSUs and RSUs | 1 | — | ||||
PRSUs whose performance targets have not been achieved | 2 | 1 | ||||
26
DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
NOTE 13. SUPPLEMENTAL DISCLOSURES
Accrued Liabilities
Accrued liabilities consisted of the following (in millions).
March 31, 2014 | December 31, 2013 | |||||||
Accrued payroll and related benefits | $ | 284 | $ | 373 | ||||
Content rights payable | 184 | 212 | ||||||
Accrued income taxes | 121 | 71 | ||||||
Accrued interest | 105 | 43 | ||||||
Current portion of equity-based compensation liabilities | 35 | 85 | ||||||
Other accrued liabilities | 218 | 208 | ||||||
Total accrued liabilities | $ | 947 | $ | 992 | ||||
Other (Expense) Income, Net
Other (expense) income, net consisted of the following (in millions).
Three Months Ended March 31, | ||||||||
2014 | 2013 | |||||||
Foreign currency losses, net | $ | (11 | ) | $ | (2 | ) | ||
Loss on derivative instruments | (7 | ) | (59 | ) | ||||
Remeasurement gain on previously held equity interest | — | 92 | ||||||
Other income, net | 1 | — | ||||||
Total other (expense) income, net | $ | (17 | ) | $ | 31 | |||
Cash Proceeds from Equity-Based Plans, Net
Cash proceeds from equity-based plans, net consisted of the following (in millions).
Three Months Ended March 31, | ||||||||
2014 | 2013 | |||||||
Tax settlements associated with equity-based plans | $ | (26 | ) | $ | (22 | ) | ||
Excess tax benefits from equity-based compensation | 16 | 13 | ||||||
Proceeds from issuance of common stock for equity-based plans | 10 | 16 | ||||||
Total cash proceeds from equity-based plans, net | $ | — | $ | 7 | ||||
NOTE 14. RELATED PARTY TRANSACTIONS
In the normal course of business, the Company enters into transactions with related parties. Related parties include entities that share common directorship, such as Liberty Global plc (“Liberty Global”), Liberty Media Corporation ("Liberty Media") and their subsidiaries and equity method investees (together the “Liberty Group”). Discovery’s Board of Directors includes Dr. Malone, who is Chairman of the Board of Liberty Global and beneficially owns approximately 27% of the aggregate voting power with respect to the election of directors of Liberty Global. Dr. Malone is Chairman of the Board of Liberty Media and beneficially owns approximately 47% of the aggregate voting power with respect to the election of directors of Liberty Media. The majority of the revenue earned from the Liberty Group relates to multi-year network distribution arrangements. The Company also discloses related party revenues for content and services provided to equity method investees, including unconsolidated VIEs (see Note 3). Other related party revenue and service charges included in the table below primarily consist of distribution revenue from J:COM earned by Discovery Japan. Following the consolidation of Discovery Japan (see Note 2), revenues earned from J:COM are reflected in related party revenues.
27
DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
The table below presents a summary of the transactions with related parties (in millions).
Three Months Ended March 31, | ||||||||
2014 | 2013 | |||||||
Revenues and service charges: | ||||||||
Liberty Group(a) | $ | 38 | $ | 12 | ||||
Equity method investees | 21 | 17 | ||||||
Other | 8 | 5 | ||||||
Total revenues and service charges | $ | 67 | $ | 34 | ||||
Interest income(b) | $ | 9 | $ | 9 | ||||
Expenses | $ | 10 | $ | 7 | ||||
(a) The increase in revenue from transactions with the Liberty Group is primarily attributable to activity with Charter Communications, Inc. ("Charter") and Virgin Media, Inc. ("Virgin Media"). In May 2013 Liberty Media completed its equity method investment in Charter; Dr. Malone is on Charter's board of directors. In June 2013, Liberty Global announced it had completed its acquisition of Virgin Media. Transactions with Charter and Virgin Media have been reported as related party transactions since the date they became related parties.
(b) The Company records interest earnings from loans to equity method investees as a component of earnings (losses) from equity method investees, net, in the consolidated statements of operations.
The table below presents receivables due from related parties (in millions).
March 31, 2014 | December 31, 2013 | |||||||
Receivables | $ | 45 | $ | 41 | ||||
Note receivable (see Note 3) | $ | 473 | $ | 483 | ||||
NOTE 15. 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, 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 Rights
The Company has granted put rights related to certain equity method investments and consolidated subsidiaries: Harpo has the right to require the Company to purchase its interest in OWN for fair value at various dates (see Note 3); TF1 has the right to require the Company to purchase its remaining shares in Eurosport at various dates should Discovery acquire a controlling interest in Eurosport (see Note 4); and noncontrolling interests hold put rights that obligate the Company to purchase redeemable noncontrolling interests in consolidated subsidiaries (see Note 8).
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 Network (see Note 3). There were no amounts recorded for guarantees associated with the Hub Network as of March 31, 2014 and December 31, 2013.
The Company may provide indemnities intended to allocate business transaction risks. Similarly, the Company may remain contingently liable for certain obligations of a divested business in the event that a third party does not fulfill its
28
DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
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 March 31, 2014 and December 31, 2013.
NOTE 16. 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 as they are treated as a third-party sales transactions in determining segment performance. Inter-segment transactions, which primarily include the purchase of advertising and content 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 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, amortization of intangible assets and deferred launch incentives, as these amounts do not represent cash payments in the current reporting period. Certain corporate expenses are excluded from segment results to enable executive management to evaluate segment performance based upon the decisions of segment executives. 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. The tables below present summarized financial information for each of the Company’s reportable segments and corporate and inter-segment eliminations (in millions).
Revenues by Segment
Three Months Ended March 31, | ||||||||
2014 | 2013 | |||||||
U.S. Networks | $ | 708 | $ | 686 | ||||
International Networks | 671 | 444 | ||||||
Education | 32 | 27 | ||||||
Corporate and inter-segment eliminations | — | (1 | ) | |||||
Total revenues | $ | 1,411 | $ | 1,156 | ||||
Adjusted OIBDA by Segment
Three Months Ended March 31, | ||||||||
2014 | 2013 | |||||||
U.S. Networks | $ | 383 | $ | 377 | ||||
International Networks | 221 | 187 | ||||||
Education | 6 | 7 | ||||||
Corporate and inter-segment eliminations | (85 | ) | (71 | ) | ||||
Total Adjusted OIBDA | $ | 525 | $ | 500 | ||||
29
DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Reconciliation of Total Adjusted OIBDA to Total Operating Income
Three Months Ended March 31, | ||||||||
2014 | 2013 | |||||||
Total Adjusted OIBDA | $ | 525 | $ | 500 | ||||
Amortization of deferred launch incentives | (2 | ) | (5 | ) | ||||
Mark-to-market equity-based compensation | (3 | ) | (46 | ) | ||||
Depreciation and amortization | (83 | ) | (32 | ) | ||||
Restructuring charges | (3 | ) | (1 | ) | ||||
Operating income | $ | 434 | $ | 416 | ||||
Total Assets by Segment
March 31, 2014 | December 31, 2013 | |||||||
U.S. Networks | $ | 2,919 | $ | 2,978 | ||||
International Networks | 5,228 | 4,792 | ||||||
Education | 118 | 125 | ||||||
Corporate and inter-segment eliminations | 7,046 | 7,084 | ||||||
Total assets | $ | 15,311 | $ | 14,979 | ||||
Total assets for corporate and inter-segment eliminations include goodwill that is allocated to the Company’s segments to account for goodwill. The presentation of segment assets in the table above is consistent with the financial reports that are reviewed by the Company’s CODM.
NOTE 17. CONDENSED CONSOLIDATING FINANCIAL STATEMENTS
Overview
As of March 31, 2014 and December 31, 2013, the senior notes outstanding (see Note 6) have been issued by DCL, a wholly-owned subsidiary of the Company, pursuant to Registration Statements on Form S-3 filed with the U.S. Securities and Exchange Commission (the “Shelf Registration”). The Company fully and unconditionally guarantees the senior notes on an unsecured basis. The Company, DCL, and/or Discovery Communications Holding, LLC (“DCH”), a wholly-owned subsidiary of the Company (collectively, the “Issuers”), may issue additional debt securities under the Shelf Registration that are fully and unconditionally guaranteed by the other Issuers.
Set forth below are condensed consolidating financial statements presenting the financial position, results of operations and comprehensive income, and cash flows of (i) the Company, (ii) DCH, (iii) DCL, (iv) the non-guarantor subsidiaries of DCL on a combined basis, (v) the other non-guarantor subsidiaries of the Company on a combined basis and (vi) reclassifications and eliminations necessary to arrive at the consolidated financial statement balances for the Company. DCL and the non-guarantor subsidiaries of DCL are the primary operating subsidiaries of the Company. DCL primarily includes Discovery Channel and TLC networks in the U.S. The non-guarantor subsidiaries of DCL include the Company’s other U.S. and international networks, education businesses, and most of the Company’s websites and other digital media services. The non-guarantor subsidiaries of DCL are wholly-owned subsidiaries of DCL with the exception of certain equity method investments. DCL is a wholly-owned subsidiary of DCH. The Company wholly owns DCH through a 33 1/3% direct ownership interest and a 66 2/3% indirect ownership interest through Discovery Holding Company (“DHC”), a wholly-owned subsidiary of the Company. DHC is included in the other non-guarantor subsidiaries of the Company.
Basis of Presentation
Solely for purposes of presenting the condensed consolidating financial statements, investments in the Company’s subsidiaries have been accounted for by their respective parent company using the equity method. Accordingly, in the following condensed consolidating financial statements, the equity method has been applied to (i) the Company’s interests in DCH and the other non-guarantor subsidiaries of the Company, (ii) DCH’s interest in DCL and (iii) DCL’s interests in the non-guarantor subsidiaries of DCL. Inter-company accounts and transactions have been eliminated to arrive at the consolidated financial statement amounts for the Company. The Company’s accounting bases in all subsidiaries, including goodwill and recognized intangible assets, have been “pushed-down” to the applicable subsidiaries.
30
DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
The operations of certain of the Company’s international subsidiaries are excluded from the Company’s consolidated U.S. income tax return. Tax expense related to permanent differences has been allocated to the entity that created the difference. Tax expense related to temporary differences has been allocated to the entity that created the difference, where identifiable. The remaining temporary differences are allocated to each entity included in the Company’s consolidated U.S. income tax return based on each entity’s relative pretax income. Deferred taxes have been allocated based upon the temporary differences between the carrying amounts of the respective assets and liabilities of the applicable entities.
The condensed consolidating financial statements should be read in conjunction with the consolidated financial statements of the Company.
31
DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Condensed Consolidating Balance Sheet
March 31, 2014
(in millions)
Discovery | DCH | DCL | Non-Guarantor Subsidiaries of DCL | Other Non- Guarantor Subsidiaries of Discovery | Reclassifications and Eliminations | Discovery and Subsidiaries | ||||||||||||||||||||||
ASSETS | ||||||||||||||||||||||||||||
Current assets: | ||||||||||||||||||||||||||||
Cash and cash equivalents | $ | — | $ | — | $ | 126 | $ | 631 | $ | — | $ | — | $ | 757 | ||||||||||||||
Receivables, net | — | — | 405 | 936 | — | |||||||||||||||||||||||