Warner Bros. Discovery, Inc. quarterly report, Q2 FY2021

Business context and reporting period

Registrant: Discovery, Inc. (the filing predates the proposed WarnerMedia combination). This unaudited Form 10-Q covers the quarter and six months ended June 30, 2021, compared with the corresponding 2020 periods. Discovery operated U.S. Networks and International Networks, including its newly launched discovery+ service.

Financial performance

Q2 revenue rose 21% (18% excluding foreign-exchange effects); six-month revenue rose 12% (10% ex-FX). Advertising revenue increased 29% in Q2 and 14% for the half, reflecting recovering international ad markets. Distribution revenue rose 12% and 9%, respectively, supported by discovery+ and higher U.S. affiliate rates, partly offset by linear subscriber declines. Q2 Adjusted OIBDA was nearly flat; six-month Adjusted OIBDA fell 13%. These are non-GAAP measures and should be considered alongside GAAP results.

Profit comparisons were affected by unusual items. Q2 included a $72M gain on sale of Great American Country, $106M of other income (including investment valuation gains), and just $2M of income tax expense. The six-month tax expense of $108M included a $162M deferred tax benefit related to the UK Finance Act 2021. Operating income declined 21% for the half despite higher revenue, as costs and expenses grew 26%; discovery+ launch marketing and content investment, and returning European sports schedules, contributed to higher costs. Six-month operating cash flow also declined.

Cash flow, debt and liquidity

• Six-month operating cash flow: $1.103B, down from $1.326B. Management attributed the decrease primarily to unfavorable working-capital movements.
• Investing cash flow: $196M provided, versus $154M used in the prior-year half. Financing cash flow: $538M used, versus $998M used.
• Cash: $2.834B at June 30, 2021, up from $2.091B at December 31, 2020. Current assets were $6.728B and current liabilities $3.565B.
• Debt: $15.484B principal outstanding ($15.047B net of discounts, premiums and issuance costs), versus $15.848B principal at year-end 2020. Debt maturities ran from 2022 to 2055; $357M of notes were due in March 2022. No revolver or commercial-paper borrowings were outstanding, and the company reported compliance with credit-facility covenants.
• Management expected cash, operating cash generation and available credit to cover needs for the next 12 months. The $2.5B revolving facility could potentially expand to $6B upon completion of the WarnerMedia transaction.

Material changes, outlook and risks

• WarnerMedia combination: Discovery agreed to combine with AT&T’s WarnerMedia assets through a Reverse Morris Trust transaction, then anticipated to close in mid-2022 subject to Discovery shareholder and regulatory approvals and other conditions. AT&T was to receive $43B, subject to adjustment, in cash, debt securities and retained debt; AT&T shareholders were expected to own 71% and Discovery shareholders 29% of the combined company. Discovery disclosed potential termination fees of $720M payable by Discovery or $1.8B payable by AT&T in specified circumstances.
• The company warned that transaction restrictions, execution and integration costs, regulatory conditions, disruption to business relationships, and failure to realize synergies could adversely affect results. It expected substantially higher indebtedness after closing; its filing cited up to $43B of additional debt assumed or incurred.
• COVID-19 and programming: Management did not expect the pandemic to significantly affect 2021 demand, but said impacts remained uncertain. Rescheduled Tokyo Olympics deferred both related revenues and significant expenses into 2021. Cost-saving initiatives, including personnel reductions and restructurings, were expected to continue, with future amounts not yet reasonably estimable.
• Streaming and linear trends: Discovery reported 17M paid DTC subscribers at June 30. It continued to invest in discovery+, while U.S. linear subscribers were down 7% year over year (3% excluding the sold Great American Country network). Risks included streaming acceptance, advertising-market conditions, affiliate renewals, competition, technology changes and international regulation, including proposed Polish ownership restrictions affecting TVN.
• Other exposures: Put rights held by certain subsidiary noncontrolling interests could be exercised in 2021. Uncertain tax-position reserves were $383M, with up to $75M potentially decreasing within 12 months. Management said routine litigation was not expected to have a material adverse effect. The filing also described substantial share-price volatility during the period, including selling pressure reportedly associated with Archegos-related hedge unwinding.

Most important facts for investors to verify

1. Whether the WarnerMedia transaction closed on the anticipated terms and timing, and the resulting ownership, debt, financing and integration costs.
2. Whether discovery+ subscriber growth and monetization justify elevated content and marketing spending, while linear subscriber losses continue.
3. Whether operating cash flow and margins recover, given the six-month decline in Adjusted OIBDA and operating income.
4. The timing and cash impact of near-term debt maturities, subsidiary put rights and other contractual commitments.
5. Whether the UK tax benefit, investment revaluations and asset-sale gain distort the sustainability of reported net income.