Business context and reporting period
Filing identity: The supplied 10-Q is for Discovery, Inc. (formerly Discovery Communications, Inc.), for the quarter ended March 31, 2018, filed May 10, 2018. It is not a filing by Warner Bros. Discovery, Inc.; the filing predates that company name.
Discovery operates U.S. and international television networks and digital services, plus education and other businesses. On March 6, 2018, it completed its acquisition of Scripps Networks Interactive for approximately $12.0 billion in consideration, including about $8.8 billion cash and $3.2 billion in stock. The acquired business contributed $380 million of reported quarterly revenue and a $50 million net loss from its acquisition date. Because Scripps was included for only part of the quarter, reported year-over-year comparisons are not like-for-like; management also provides supplemental pro forma comparisons.
Financial performance and position
| Metric | Q1 2018 | Q1 2017 |
|---|---|---|
| Revenue | $2.307 billion | $1.613 billion |
| Operating income | $204 million | $487 million |
| Net income (loss) attributable to Discovery | $(8) million | $215 million |
| Diluted earnings (loss) per share | $(0.01) | $0.37 |
| Adjusted OIBDA | $697 million | $603 million |
| Cash from operations | $160 million | $255 million |
- Revenue rose 43% as reported; on a pro forma combined basis, revenue increased 14% to $2.930 billion from $2.569 billion. Pro forma net income attributable to Discovery was $107 million versus $171 million.
- Operating margin was approximately 8.8%, compared with 30.2% in the prior-year quarter. The reported decline reflects, among other factors, acquisition-related amortization, restructuring charges and Scripps integration costs.
- Reported Adjusted OIBDA increased 16%. U.S. Networks Adjusted OIBDA was $652 million (up 30% reported); International Networks was $137 million (down 29%). Pro forma International Networks Adjusted OIBDA declined 25%.
- Cash used in investing activities was $8.675 billion, mainly for the Scripps acquisition. Financing activities provided $2.019 billion, including $2.0 billion of term-loan borrowings.
- At March 31, cash and equivalents were $812 million, total assets $34.658 billion, and total equity $9.594 billion. Debt was $19.513 billion gross, or $19.367 billion net of unamortized discounts, premiums and issuance costs. Current liabilities were $2.465 billion against current assets of $4.521 billion.
- Cash plus reported unused capacity under the revolving credit facility and program financing line was approximately $2.890 billion. The company said cash, operating cash flow and revolver availability should be sufficient for the next 12 months. It was in compliance with debt covenants at quarter-end.
Material changes and management commentary
- On a pro forma basis, distribution and advertising revenue each increased 8%. Management attributed growth to contractual rate increases, digital activity and international-market performance; reported U.S. Networks subscribers declined 5% overall and 3% for fully distributed networks.
- Pro forma costs of revenue increased 40%, driven substantially by higher content costs, including Olympics and other sports programming. Pro forma International Networks costs of revenue increased 75%, while its Adjusted OIBDA fell 25%.
- Restructuring and other charges were $241 million, versus $24 million a year earlier. These included $164 million of restructuring charges and $77 million of other charges, including Nordics content write-offs. The company expects further restructuring and integration expenses, including employee and contract terminations, relocation and content-related costs.
- Interest expense increased to $177 million from $91 million, primarily reflecting debt issued to finance the acquisition. Senior notes had maturities from 2019 through 2047; approximately $1.8 billion of senior notes were due in 2019.
- The acquisition’s preliminary purchase accounting included $6.003 billion of goodwill and $9.175 billion of acquired intangible assets; valuation remained subject to adjustment. Management cited expected cost, operating and revenue synergies but did not provide a quantified synergy target or financial guidance in the supplied filing text.
- After quarter-end, on April 30, Discovery sold an 87.5% controlling interest in its education business for $120 million, subject to working-capital adjustments, retaining 12.5%. The company also planned to relocate its headquarters from Silver Spring to New York City in 2019.
- Adopted revenue-recognition guidance had an immaterial effect on Q1 revenue and costs; the company recorded a $7 million increase to opening retained earnings. Tax reform and other tax estimates remained subject to analysis; the quarter included a $19 million discrete tax benefit related to film-production deductions.
Risks, contingencies and unusual items
- Distribution agreements with major U.S. and international operators expire at varying times from 2018 through 2024. Management warned that nonrenewal, disruption or less favorable terms could reduce both distribution and advertising revenue. More than 95% of U.S. Networks distribution revenue came from its 10 largest U.S. distributors.
- The filing identifies cord-cutting, changing viewing and distribution platforms, advertising demand, customer consolidation, foreign exchange, international political and regulatory conditions, acquisition integration, and the company’s significant debt as risks. It also warns that access to capital markets is not assured.
- Contractual commitments totaled $5.742 billion, including $4.055 billion for content. Redeemable noncontrolling interests were $419 million and include put rights that could require cash payments. Maximum exposure for unconsolidated variable-interest entities was approximately $737 million.
- Management said routine legal claims were not expected to have a material adverse effect. Tax reserves for uncertain positions were $379 million at quarter-end; IRS audits and other tax matters remained unresolved, and potential reserve reductions were uncertain.
Most important facts for investors to verify
- Confirm the filing issuer and period: this is Discovery, Inc.’s Q1 2018 10-Q, not a Warner Bros. Discovery filing.
- Separate reported results from pro forma results and assess the effects of Scripps’s partial-quarter consolidation and preliminary purchase accounting.
- Track whether acquisition integration produces expected synergies and whether additional restructuring, integration and content charges persist.
- Monitor leverage, 2019 maturities, interest costs, covenant headroom and the company’s stated liquidity sources.
- Verify subscriber trends, distribution renewals, advertising performance and the sustainability of international revenue growth against content and sports-rights costs.
- Review the final Scripps purchase-price allocation, education-sale proceeds and retained interest, and the cash implications of noncontrolling-interest put rights.