WBD

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended September 30, 2008, for Discovery Communications, Inc. (Discovery). The filing reflects the company's status following the "Newhouse Transaction" consummated on September 17, 2008, which combined Discovery Holding Company (DHC) and Advance/Newhouse Programming Partnership. As a result, Discovery became the successor reporting entity, consolidating DHC and Discovery Communications Holding, LLC (DCH) as if the transaction occurred on January 1, 2008. The company operates through three segments: U.S. Networks, International Networks, and Commerce, Education, and Other.

Key Financial Metrics

Note: Nine-month operating cash flow is provided; three-month cash flow is not explicitly detailed in the summary tables.

Material Changes vs. Prior Period

• Revenue Growth: Consolidated revenue increased 11% ($85 million) for the three months and 10% ($239 million) for the nine months ended September 30, 2008, compared to the adjusted prior year periods. This growth was driven by higher advertising pricing in U.S. networks and subscriber growth in International Networks.
• Profitability: Operating income improved significantly to $296 million (three months) and $773 million (nine months) compared to losses or minimal income in the prior year, largely due to the consolidation of DCH operations and a $65 million benefit from long-term incentive plan (LTIP) mark-to-market adjustments.
• Discontinued Operations: The company reported significant net income from discontinued operations ($40 million for the quarter, $42 million for nine months), primarily driven by a $64 million pre-tax gain from the sale of Ascent Media CANS, LLC (AccentHealth) and the spin-off of Ascent Media Corporation (AMC).
• Balance Sheet Expansion: Total assets grew from $5.9 billion (Dec 31, 2007) to $10.4 billion (Sep 30, 2008), reflecting the consolidation of DCH assets, including goodwill increasing from $1.8 billion to $7.1 billion.

Guidance, Outlook, Risks, and Unusual Items

• Unusual Items:
  • LTIP Benefit: A $65 million benefit (three months) and $47 million benefit (nine months) was recorded due to the decrease in the company's stock price, which reduced the liability for cash-settled stock appreciation awards.
  • Content Impairment: The company recorded content impairment charges of approximately $21 million (three months) and $26 million (nine months) related to TLC programming strategy changes.
  • Restructuring: Exit and restructuring costs totaled $13 million (three months) and $17 million (nine months), primarily for employee relocations and terminations.
• Outlook and Liquidity: Management anticipates that cash flows from operations and existing borrowing capacity (approximately $1.6 billion available under revolving credit facilities) are sufficient to meet requirements for the next 12 months. The company expects to use approximately $350 million for debt repayments and $110 million for capital expenditures in 2008.
• Risks:
  • Economic Conditions: Adverse macroeconomic conditions could reduce advertiser spending, directly impacting revenue.
  • Goodwill Impairment: Due to market capitalization declines, the company is monitoring goodwill for potential impairment, with annual testing scheduled for the fourth quarter.
  • Joint Venture Commitments: Discovery has committed up to $100 million to fund the new OWN: The Oprah Winfrey Network joint venture through September 2011.

Investor Verification Checklist

• LTIP Volatility: Verify the sustainability of the $65 million LTIP benefit, as it is highly sensitive to stock price fluctuations and may reverse if the stock price rises.
• Goodwill Valuation: Monitor the fourth-quarter goodwill impairment test, given the significant increase in goodwill ($7.1 billion) and recent market volatility.
• Discontinued Operations: Confirm that the gains from discontinued operations (AccentHealth sale, AMC spin-off) are non-recurring and do not reflect core operating performance.
• Debt Covenants: Review compliance with debt covenants, particularly leverage ratios, given the $3.9 billion total debt outstanding and the current credit market environment.
• Content Strategy: Assess the impact of the TLC rebranding strategy on future content amortization and potential further impairment charges.