Discovery Communications, Inc. — Q3 2017 Form 10-Q
Entity note: The supplied filing is for Discovery Communications, Inc., for the quarter ended September 30, 2017—not a filing under the Warner Bros. Discovery name. Financial figures below are in U.S. dollars; unless stated otherwise, amounts are in millions.
Business context and reporting period
Discovery operated a global media business spanning television networks, digital distribution and licensing, and education products. It reported U.S. Networks, International Networks, and Education and Other. The unaudited filing covers the three and nine months ended September 30, 2017, compared with the same 2016 periods.
Financial and operating metrics
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Revenue | $1,651 | $1,556 | $5,009 | $4,825 |
| Operating income | $433 | $458 | $1,550 | $1,533 |
| Net income | $223 | $225 | $824 | $909 |
| Net income available to Discovery | $218 | $219 | $807 | $890 |
| Diluted EPS available to common stockholders | $0.38 | $0.36 | $1.39 | $1.44 |
| Adjusted OIBDA | $575 | $559 | $1,895 | $1,835 |
- Q3 revenue grew 6%; distribution revenue rose 9%, advertising 5%, while other revenue fell 19%. Nine-month revenue grew 4%, with distribution up 7%, advertising up 1%, and other down 7%.
- Operating margin was approximately 26.2% in Q3 2017 versus 29.4% in Q3 2016; nine-month operating margin was approximately 31.0% versus 31.8%. Adjusted OIBDA margin was approximately 34.8% versus 35.9% in Q3 and 37.8% versus 38.0% for nine months. Adjusted OIBDA is a non-GAAP measure.
- U.S. Networks nine-month revenue increased 3% to $2,542 and Adjusted OIBDA increased 5% to $1,548. International Networks revenue increased 6% to $2,354, while Adjusted OIBDA was broadly flat at $610.
- At September 30, cash and cash equivalents were $6,994, total debt was $14,838 gross and $14,708 net of discounts and issuance costs, and equity was $5,740. Cash included proceeds raised for the proposed Scripps acquisition.
- Nine-month operating cash flow was $1,167, versus $834 in 2016; investing cash outflow was $523, versus $54; financing cash inflow was $5,983, versus a $975 outflow. Cash increased by $6,694 from year-end 2016.
- Current assets were $9,477 and current liabilities $1,615. The company reported $425 drawn on its $2.5 billion revolving facility and $2,074 of unused capacity after borrowings and letters of credit. It reported compliance with credit covenants.
Material changes versus the prior comparable period
- Q3 operating income fell 5% despite revenue growth, as costs of revenue rose 13% and SG&A rose 9%. Higher content spending included U.S. programming and international sports rights and production.
- Nine-month net income available to Discovery declined 9%. Higher interest expense, equity-method investment losses, foreign-exchange and derivative losses, and a $54 debt-extinguishment loss weighed on results. The Q3 tax benefit of $59 included renewable-energy investment tax benefits; the nine-month effective tax rate was 10%, compared with 25% in 2016.
- Distribution growth was supported by affiliate-rate increases and digital/SVOD revenue, but U.S. portfolio subscribers declined 5% for both the quarter and nine-month comparison; subscribers to fully distributed networks declined 3%.
- Cash and debt rose substantially following $6.8 billion of senior-note issuance in September to help finance the planned Scripps transaction. The company held much of the proceeds in short-term investments pending closing.
Outlook, commentary, risks and unusual items
- Discovery expected the approximately $11.5 billion Scripps cash-and-stock acquisition to close by early 2018, subject to shareholder, regulatory, and other customary approvals. It also expected to assume approximately $2.7 billion of Scripps net debt. The filing provides no specific earnings or revenue guidance.
- Approximately $5.9 billion principal amount of acquisition-related notes carried a special mandatory redemption provision: if the deal terminated or did not close by August 30, 2018, redemption would be at 101% of principal plus accrued interest. The company warned it might not have sufficient resources to meet redemption obligations, potentially causing defaults.
- The acquisition remained exposed to closing, integration, financing, and anticipated-synergy risks. Three shareholder lawsuits challenged merger disclosures; one plaintiff voluntarily dismissed its case without prejudice, while the other actions were still pending.
- Other risks cited include declining subscribers and viewing shifts, distributor renewals and concentration, advertising demand, foreign exchange and Brexit uncertainty, substantial debt and access to capital, and performance of equity-method investments. Management said routine legal matters were not expected to materially affect consolidated results or cash flows.
- Unusual charges and items included $62 of Scripps transaction and integration costs in Q3, including a $35 charge for the Advance/Newhouse preferred-stock modification; a $98 loss on interest-rate contracts used to economically hedge note pricing; and $54 of debt-extinguishment loss in the nine-month period.
- Discovery contributed Velocity to the VTEN joint venture and retained 67.5% ownership; the partner held a put right that could require a purchase or IPO process in future years. Harpo also gave notice to put up to $100 of OWN interests, but valuation was unfinished, the notice could be withdrawn, and no liability was recorded at quarter-end.
Important facts for investors to verify
- Whether the Scripps transaction closed on the anticipated timetable, its final consideration and financing, and any subsequent integration results.
- The special mandatory redemption terms, available liquidity to fund any redemption, and leverage and covenant headroom after the acquisition.
- Subscriber trends, distribution renewals, and whether digital/SVOD and advertising gains can offset audience declines and higher programming costs.
- The sustainability of reported cash flow and tax benefits, including renewable-energy investment losses, credits, and funding commitments.
- Developments in the Scripps-related litigation, Harpo’s OWN put valuation, and VTEN’s future put/call obligations.