Warner Bros. Discovery, Inc. quarterly report, Q3 FY2011

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Business context and reporting period

Issuer identification: The supplied filing is Discovery Communications, Inc.’s Form 10-Q for the quarter ended September 30, 2011, filed November 2, 2011. It is not a Warner Bros. Discovery filing; the request metadata and filing content do not match. Discovery describes its business as global nonfiction media, with U.S. Networks, International Networks, and Education and Other segments. Unless otherwise stated, amounts below are in millions of dollars.

Financial results and condition

  • Third-quarter revenue: $1,095, up 18% from $926. Distribution revenue was $580 (+27%), advertising $442 (+10%), and other revenue $73 (+7%). The filing says distribution growth reflected rate increases, subscriber growth, and expanded digital-library licensing; advertising benefited from improved pricing and sell-through.
  • Third-quarter earnings: Operating income was $426, up 37%; net income attributable to Discovery was $237, up 27%. Diluted EPS was $0.59 versus $0.43. Operating margin was approximately 38.9%, compared with 33.7% a year earlier.
  • Nine-month results: Revenue was $3,113 (+13%), operating income $1,378 (+43%), and net income attributable to Discovery $796 (+72%); diluted EPS was $1.95 versus $1.07. These comparisons include a $129 pretax gain on contributing Discovery Health to OWN in 2011 and a $136 debt-extinguishment loss in 2010.
  • Adjusted OIBDA: $479 in Q3 (+15%) and $1,416 for nine months (+14%). This is a non-GAAP measure; Q3 adjusted OIBDA margin was approximately 43.7%, versus 45.1% in Q3 2010.
  • Cash flow: Nine-month operating cash flow was $760, compared with $445; investing cash outflow was $135 versus $114; financing cash outflow was $55 versus $56 provided in 2010. Ending cash was $1,032, up from $466 at year-end 2010. Operating cash flow benefited from stronger revenue, lower tax payments, and lower cash-settled award payments, partly offset by increased programming investment.
  • Liquidity and debt: Current assets were $2,299 and current liabilities $707 (current ratio approximately 3.25). Long-term debt, net, was $4,249, including $20 current; the $1.0 billion revolving facility was undrawn, with approximately $999 available after letters of credit. Management reported approximately $2.0 billion of available capital resources and said existing cash, operating cash flow, and borrowing capacity should cover anticipated operating needs for at least 12 months. Approximate net debt, using reported cash, was $3.2 billion.
  • Margins and costs: Costs of revenue rose 31% in Q3, primarily from higher content expense; quarterly content impairments were $33 versus $11. SG&A fell 4%, largely because stock-based compensation declined.

Material changes versus comparable periods

  • Q3 revenue growth was led by distribution and advertising. Digital-library license revenue recognized under distribution was $83 in Q3 2011 versus $4 in Q3 2010; the company reclassified such licensing revenue from other to distribution beginning July 2011.
  • International Networks revenue rose 19% in Q3 and 18% for nine months; segment Adjusted OIBDA increased 20% and 23%, respectively. U.S. Networks revenue rose 19% and 11%, while Adjusted OIBDA increased 9% in both periods.
  • Discovery Health was contributed to OWN on January 1, 2011, and is no longer consolidated. The contribution generated the $129 pretax gain and affects year-over-year comparability.
  • Discovery issued $650 of 4.375% senior notes due 2021. Gross debt increased from $3,618 net at December 31, 2010 to $4,249 at September 30, 2011. The revolving facility was amended to extend its maturity to October 2015 and reduce rates and fees.
  • The company repurchased 20 million Series C shares for $732 during the first nine months, funded with cash; $1.2 billion of repurchase authorization remained at quarter-end.

Outlook, commentary, risks, and unusual items

  • No specific revenue, earnings, or EPS guidance is provided. Management identified international expansion, content investment, distribution growth, and extending content to digital platforms as strategic priorities.
  • OWN’s early operating results were below its initial long-term plan. Discovery expected to provide significant additional funding; funding to OWN accrued interest at 7.5%. The company reported $394 of combined OWN investment and note receivable carrying value and estimated total VIE investment-related exposure at approximately $851.
  • Discovery’s operating-performance guarantee for The Hub had a maximum potential payment of less than $175 at September 30, 2011, declining toward zero by 2015. Management considered a material adverse impact unlikely; no material guarantee liability was recorded.
  • Harpo holds a put right to require Discovery to purchase some or all of its OWN interest at specified future dates, beginning in 2016; no liability was recorded. Management also noted that OWN’s results could differ from valuation assumptions and that an other-than-temporary decline could require impairment.
  • Management planned an international legal-entity reorganization before year-end 2011 and warned it could materially change noncash tax expense for Q4; it also expected a benefit from amended foreign tax-credit returns. The company was under IRS examination for 2008 and 2009, with no material adjustments advised.
  • Forward-looking risks include advertising and affiliate payment or renewal terms, economic and competitive conditions, joint-venture performance, technology and viewing changes, international currency and political risks, litigation, regulation, and access to capital. Management said routine legal matters were not expected to have a material adverse effect and reported effective disclosure controls.

Most important facts to verify

  1. Confirm issuer identity and reporting period: this source is Discovery Communications, Inc., not Warner Bros. Discovery.
  2. Assess how much reported growth and nine-month earnings depended on the $129 OWN contribution gain, digital-library licensing timing, and the prior-year debt-extinguishment loss.
  3. Review OWN’s performance against its plan, funding and repayment terms, valuation assumptions, and the potential future put obligation.
  4. Verify debt, covenant compliance, available revolver capacity, and the company’s cash needs alongside ongoing buybacks and joint-venture funding.
  5. Assess content-cost growth and impairments, and the sustainability of advertising, subscriber, and international expansion trends.
  6. Review the potential Q4 tax effect of the planned legal-entity reorganization and amended foreign tax-credit filings.