Warner Bros. Discovery, Inc. quarterly report, Q3 FY2012

Business context and reporting period

This is Discovery Communications, Inc.’s unaudited Form 10-Q for the quarter ended September 30, 2012, covering its U.S. Networks, International Networks, and Education businesses. The filing names Discovery Communications, Inc.—not Warner Bros. Discovery, Inc.—so the requested company identity does not match the filing.

All dollar amounts below are in millions, except per-share amounts and percentages. Comparisons are with the corresponding 2011 period unless noted.

Key financial metrics

• Quarterly revenue mix: distribution $549 (-5%), advertising $468 (+6%), and other $59 (+2%). For nine months, distribution was $1,665 (+7%) and advertising $1,455 (+10%).
• Cash and cash equivalents were $1,553 at September 30, 2012, versus $1,048 at December 31, 2011. The company reported approximately $2,552 of available capital resources, including $999 of unused revolving-facility capacity after letters of credit.
• Total debt was approximately $5,231 net of discount, versus $4,245 at year-end 2011; the balance sheet reported $5,210 of long-term debt plus $21 current. No revolving-credit borrowings were outstanding.
• Nine-month investing cash use was $195 and financing cash use was $72. Repurchases used $1,146; long-term debt borrowing proceeds were $981.
• Content rights, net, increased to $1,589 from $1,395 at year-end. The filing does not provide a consolidated gross-margin figure.

Material changes versus prior periods

• Q3 revenue was essentially unchanged as lower distribution revenue—primarily reflecting a prior-year library-title licensing agreement—offset advertising growth. Nine-month revenue increased on contractual distribution-rate increases, subscriber growth, and stronger advertising.
• Q3 operating income improved modestly, but net income fell as interest expense rose to $68 from $56 and other expense increased to $21 from $5. Equity-method investee losses were a major driver of the increase in other expense.
• Nine-month net income declined despite revenue growth. The 2011 comparison included a $129 pretax gain from contributing Discovery Health to OWN; 2012 also had higher interest expense and investee losses.
• International Networks grew faster than U.S. Networks in Q3: revenue increased 7% and Adjusted OIBDA 11%, while U.S. Networks revenue fell 4% and Adjusted OIBDA rose 2%. Education revenue increased 14% in Q3 but remained a small share of total revenue.
• Cash from operations rose only $11 year over year: improved operating results and lower cash-settled award payments were partly offset by $175 more programming-content investment and $148 more taxes paid. Share repurchases exceeded operating cash flow during the nine-month period.

Outlook, risks, contingencies, and unusual items

• Management said cash on hand, operating cash flow, and available borrowing capacity were expected to meet anticipated operating cash needs for at least the next 12 months. No specific earnings or revenue guidance was provided.
• The company expected to continue funding equity-method investees, including OWN, and to seek to recoup amounts funded. OWN advances and note receivable totaled $450 at September 30; the company said OWN’s early results were below its initial business plan and noted recoverability and investment-impairment uncertainty. No impairment was recorded for the nine months.
• Discovery recognized $81 of losses from variable-interest-entity investees during the first nine months, including OWN and The Hub. Its estimated risk of loss for VIE investments was approximately $839, excluding The Hub performance guarantee.
• The Hub performance guarantee had a maximum potential exposure of less than $125 at September 30, declining toward zero during 2015. Management considered a shortfall unlikely. Harpo also held a future put right relating to its OWN interest; no liability was recorded.
• Distribution revenue is concentrated among major operators: the top 10 U.S. distributors generated approximately 90% of U.S. distribution revenue, and the top 10 outside the U.S. generated approximately 50%. Renewal on less favorable terms or failure to renew could affect distribution and advertising revenue.
• Other risks include advertising and subscriber trends, competition and technology shifts, foreign exchange and political conditions, access to capital, and performance of investees. Management reported no material change in risk factors since year-end 2011 and no expected material adverse effect from routine legal matters.
• Unusual items included the September 2012 sale of the postproduction audio business, reported as discontinued operations, and the 2011 OWN-related gain that benefited the prior-year comparison. The company also issued $1,000 of senior notes in May 2012 and extended its $1,000 revolving facility to October 2017.

Important facts for investors to verify

• Confirm the issuer: this filing is for Discovery Communications, Inc., not Warner Bros. Discovery, Inc.
• Review OWN’s operating performance, ongoing funding, loan recoverability, and the potential future put obligation.
• Assess distributor concentration and upcoming contract renewals, including possible effects on subscriber counts and advertising.
• Reconcile debt growth and cash uses with the substantial share-repurchase program; $752 remained authorized at September 30, 2012.
• Track whether international revenue and Adjusted OIBDA growth can continue while content, personnel, and marketing costs rise.