Business context and reporting period
Identity note: The supplied filing is Discovery Communications, Inc.’s Form 10-Q for the quarter ended March 31, 2010; it is not a filing under the name Warner Bros. Discovery, Inc. The 2009 comparative figures were recast for changes in joint-venture accounting and segment presentation.
Discovery operated nonfiction television networks and related digital, education, commerce, and post-production businesses. It reported U.S. Networks, International Networks, and Education and Other segments.
Financial results and position
- Revenue: $879 million, up 8% from $815 million. Distribution revenue rose 5% to $445 million; advertising rose 16% to $348 million; other revenue fell 7% to $86 million.
- Profit: Operating income was $283 million, up 14%; net income was $173 million versus $123 million; income attributable to Discovery was $169 million versus $119 million. Diluted EPS increased to $0.39 from $0.28. Operating margin was approximately 32.2%, versus 30.4%.
- Adjusted OIBDA: $367 million, up 10%; approximately 41.8% of revenue versus 41.1%. International Networks led growth, with OIBDA up 29% to $124 million; U.S. Networks rose 4% to $293 million.
- Cash flow: Operating cash flow was $126 million, down from $151 million. Investing used $65 million, including the London uplink acquisition; financing provided $1 million. Cash increased $68 million to $691 million, including $39 million restricted for joint ventures.
- Liquidity and debt: Total liquidity was approximately $2.3 billion, comprising $691 million cash and $1.6 billion available under an undrawn revolver. Net debt was approximately $2.8 billion based on reported debt of $3.491 billion less cash. The revolver expired in October 2010; management was evaluating replacement options. The company reported compliance with debt covenants.
- Balance sheet: Current assets were $1.721 billion and current liabilities $934 million. The current portion of debt rose to $256 million from $38 million, principally reflecting scheduled maturities/reclassification. Total assets were $10.952 billion.
Material changes versus the prior comparable period
- Revenue growth reflected stronger advertising, subscriber growth, contractual distribution-rate increases, and favorable foreign exchange. Management said revenue growth excluding foreign exchange and the Discovery Kids Network deconsolidation was 8%.
- International Networks revenue increased 16% and OIBDA 29%; the OIBDA increase included a $12 million favorable foreign-exchange impact. U.S. Networks revenue increased 5% and OIBDA 4%.
- Cash from operations declined despite higher earnings, mainly because of higher taxes, revenue-share payments, reduced operating liabilities, and cash payments for stock-based awards.
- Comparability is affected by Discovery’s May 2009 deconsolidation of the Discovery Kids Network. The 2009 quarter included its full revenues and expenses; 2010 reflected equity-method accounting. The 2009 statements were also recast for deconsolidation of OWN and Animal Planet Japan under newly adopted VIE guidance and for a segment realignment.
Outlook, commentary, risks, and unusual items
- Management expected cash and operating cash generation to cover anticipated requirements for at least 12 months. For 2010 it estimated at least $20 million of debt repayments, $210–$240 million of interest expense, and approximately $50 million of capital expenditures. It expected content spending to continue increasing.
- The $1.6 billion revolving facility was due to expire in October 2010; refinancing or replacement access and terms were not assured. Management cited potential credit-market disruption, higher borrowing costs, covenant constraints, and capital-market access risk.
- In February 2010, Discovery reversed a $28 million foreign tax reserve after a tax audit concluded certain years would not be adjusted. The reversal contributed to a 21% effective tax rate versus 36% in 2009 and materially benefited the comparison of net income.
- Content amortization included programming write-offs of $24 million, versus $9 million in the 2009 quarter, after decisions not to proceed with certain programs. The London uplink acquisition cost $35 million; purchase accounting included a $4 million charge to settle a pre-existing contract and $13 million goodwill.
- Discovery had funded $49 million of its commitment to lend OWN up to $100 million through September 2011. Discussions with Harpo included possible increases to the funding commitment. The company also accrued $49 million for a BBC joint-venture put right and said a negotiated acquisition of BBC interests could cost substantially more.
- Discovery’s performance guarantee for the Discovery Kids Network had remaining maximum exposure below $245 million; management considered a material adverse outcome remote. Management said current legal proceedings were not expected to materially affect results or financial position.
- Forward-looking risks included advertising and affiliate payment conditions, competition and technology shifts, foreign exchange and political risks, litigation, regulation, joint-venture relationships, and availability and cost of financing. Management reported effective disclosure controls and no material change in internal control during the quarter.
Important facts for investors to verify
- Confirm the issuer and period: this is Discovery Communications, Inc., Q1 2010—not a Warner Bros. Discovery filing.
- Review the tax-reserve reversal and higher programming write-offs when assessing whether earnings growth is repeatable.
- Track renewal or replacement of the revolver before its October 2010 expiration and the near-term debt maturity schedule.
- Assess cash conversion: operating cash flow fell while cash-settled award payments and other working-capital uses increased.
- Monitor OWN’s funding needs and negotiations, the BBC put-right valuation and negotiations, and the Discovery Kids Network guarantee exposure.
- Use the recast comparative statements and account for the Discovery Kids Network deconsolidation when interpreting year-over-year trends.