Business context and reporting period
The supplied filing is Discovery Communications, Inc.’s unaudited Form 10-Q for the quarter and six months ended June 30, 2012—not a filing by Warner Bros. Discovery, Inc. Discovery operated U.S. Networks, International Networks, and Education and Other businesses, including television networks, digital properties, education products, and audio services. Amounts below are in millions of dollars unless stated otherwise.
Financial performance and position
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Revenue | $1,142 | $1,067 | $2,245 | $2,018 |
| Operating income | $487 | $445 | $933 | $952 |
| Net income attributable to Discovery stockholders | $293 | $254 | $514 | $559 |
| Diluted earnings per share | $0.76 | $0.62 | $1.33 | $1.36 |
| Adjusted OIBDA | $543 | $510 | $1,050 | $937 |
| Cash from operating activities | Not provided separately for the quarter | $389 | $431 |
- Q2 revenue grew 7%; distribution and advertising revenue each increased 8%. Six-month revenue grew 11%, with distribution up 14% and advertising up 11%.
- Q2 operating margin was approximately 42.6% versus 41.7% a year earlier; net margin was approximately 25.7% versus 23.8%. Six-month operating margin was approximately 41.6% versus 47.2%, while net margin was approximately 22.9% versus 27.7%.
- At June 30, cash and cash equivalents were $1,698, total debt net of discount was $5,226, and the company reported approximately $999 of unused revolving-credit capacity. Total available capital resources were approximately $2,697. Current assets were $3,214 and current liabilities $757.
- Six-month free cash flow, calculated as operating cash flow less property and equipment purchases, was approximately $365, compared with $404 in 2011. Investing activities used $114; financing activities provided $376.
- Equity-based compensation expense was $72 for the first six months, compared with $49 a year earlier. Interest expense rose to $116 from $98.
Material changes versus the prior comparable period
- Q2 operating income rose 9%, and net income attributable to stockholders rose 15%. Six-month operating income declined 2% and net income declined 8%.
- The six-month comparison is affected by a $129 gain recorded in 2011 on contributing the Discovery Health network to OWN; excluding that item, the reported 2012 operating-income trend is stronger than the headline comparison suggests.
- Six-month other expense increased to $56 from $5, mainly because of larger equity-method investee losses. Discovery began recognizing 100% of OWN’s incremental losses in 2012 after accumulated losses exceeded contributed equity.
- U.S. Networks six-month revenue increased 11% and Adjusted OIBDA increased 13%; International Networks revenue increased 14% and Adjusted OIBDA increased 9%. Education and Other revenue was nearly flat, while its Adjusted OIBDA declined 46%.
- Cash increased to $1,698 from $1,048 at year-end 2011, while net long-term debt increased to $5,206 from $4,219. The company issued $1.0 billion of senior notes in May and repurchased $692 of common stock during the first half, versus $377 in the prior-year period.
Outlook, management commentary, risks, and unusual items
- Management said available cash, operating cash generation, and borrowing capacity were expected to meet anticipated operating cash requirements for at least the next 12 months. The filing provides no specific earnings or revenue guidance.
- Management cited continued investment in programming, subscriber growth, contractual distribution-rate increases, library-content licensing, advertising pricing, and international expansion as business drivers. Higher content, distribution, personnel, and marketing costs offset some revenue growth.
- OWN presents notable investment risk: Discovery’s advances and note receivable from OWN were $414, and its total carrying value in OWN, including the note, was $452. Discovery said OWN’s early results were below its initial business plan, expected to continue funding the venture, and recorded no impairment for the first half. The note accrues interest at 7.5%; Harpo has future put rights over its OWN interest beginning in 2016.
- Discovery estimated risk of loss on VIE investments at approximately $836, excluding its operating-performance guarantee for The Hub. The maximum potentially payable under that guarantee was less than $140 as of June 30, 2012; the company considered material impact unlikely.
- Distribution revenue is concentrated among major operators: the top 10 U.S. distributors accounted for approximately 90% of U.S. distribution revenue, and the top 10 outside the U.S. accounted for approximately 50%. Major agreements expire at various times from 2012 through 2020; failure to renew, or renewal on worse terms, could affect affiliate and advertising revenue.
- Other risks identified include advertising and affiliate payment or demand changes, technology and viewing-pattern shifts, foreign-exchange and political risks, competition, access to capital, and uncertainty in investee performance. Management stated routine legal matters were not expected to have a material adverse effect; the IRS was examining 2008 and 2009 returns, with no material adjustments advised. Disclosure controls were reported effective.
Important facts for investors to verify
- Confirm the issuer identity: this filing is for Discovery Communications, Inc., notwithstanding the request’s Warner Bros. Discovery, Inc. label.
- Review the trend in OWN’s operating losses, Discovery’s funding and recoverability of the $414 advances/note receivable, and the future put-right terms.
- Assess debt and capital allocation together: debt rose following the May bond issuance, while first-half share repurchases totaled $692 and $1.2 billion of repurchase authorization remained at quarter-end.
- Separate the prior-year $129 disposition gain from recurring performance when comparing first-half operating income and margins.
- Monitor distributor contract renewals, concentration, and the effect of subscriber or viewing changes on both distribution and advertising revenue.
- Review the filing’s non-GAAP Adjusted OIBDA reconciliation and the sustainability of higher content investment and international growth.