Warner Bros. Discovery, Inc. quarterly report, Q2 FY2009

Business context and reporting period

This is Discovery Communications, Inc.’s unaudited Form 10-Q for the quarter and six months ended June 30, 2009, filed August 4, 2009. The filing identifies Discovery Communications, Inc. as the registrant—not Warner Bros. Discovery, Inc.; the company name in the request does not match the filing. Discovery operated U.S. Networks, International Networks, and Commerce, Education, and Other, with television, digital, education, commerce, and related businesses.

Comparative 2008 figures are recast to reflect the Newhouse Transaction as if completed January 1, 2008, exclude businesses later disposed of, and reflect non-controlling-interest presentation changes. The comparisons are therefore not simply to the previously reported standalone results.

Financial performance and position

Amounts below are in millions of dollars, except per-share data and percentages.

• Revenue mix: Q2 distribution revenue rose 2% to $426, while advertising fell 3% to $368 and other revenue fell 2% to $87. For the first half, distribution rose 4% to $851; advertising declined 2% to $669 and other revenue declined 7% to $178.
• Margins: Adjusted OIBDA was approximately 43.2% of Q2 revenue versus 38.0% a year earlier, and 41.8% of first-half revenue versus 37.6%. Reported operating income includes the $252 million Hasbro joint-venture gain, so its margin is not a clean measure of underlying performance.
• Cash flow and liquidity: First-half operating cash flow was $320, investing activities provided $288 (including $300 proceeds from Hasbro), and financing activities used $371. Cash rose to $339 at June 30 from $100 at year-end 2008. Management reported approximately $1.9 billion of total liquidity, including $1.6 billion available under the revolving facility, and expected resources to cover anticipated needs for at least 12 months.
• Debt: Net debt was $3.474 billion, versus $3.789 billion at December 31, 2008; $421 million was current and $3.053 billion long term. The company borrowed $500 million under Term Loan C and used proceeds to repay existing debt. It reported compliance with debt covenants. Approximately $296 million of Term Loan A debt and any remaining revolver borrowings were expected to mature in 2010.
• Taxes: Effective tax rates were 60% for Q2 and 53% for the first half, versus 50% and 55% in 2008. The 2009 rates were affected by the Discovery Kids transaction gain and state taxes.

Material changes versus the prior comparable period

• Revenue was broadly unchanged, as U.S. Networks growth offset weaker International Networks and other revenue. First-half International Networks revenue declined 5%, including unfavorable foreign-exchange effects; management said revenue excluding currency effects increased.
• Adjusted OIBDA increased 13% in Q2 and 11% for the first half. U.S. Networks Adjusted OIBDA rose 11% and 9%, respectively. International Networks Adjusted OIBDA fell 5% in Q2 but rose 6% for the first half; Commerce, Education, and Other improved to positive Adjusted OIBDA.
• Reported operating income and net income benefited substantially from the $252 million gain recognized when Discovery contributed Discovery Kids to a 50-50 Hasbro joint venture. The company retained a 50% interest, accounted for under the equity method, and ceased consolidating Discovery Kids after May 21, 2009.
• First-half selling, general and administrative expense fell 5% to $591, while content costs rose 3% to $510. Share-based compensation expense increased to $98 from $19, including mark-to-market effects on cash-settled awards.
• The company recorded $26 million of asset impairments and $17 million of first-half exit and restructuring charges. Goodwill declined $452 million, principally from allocating goodwill to Discovery Kids upon the transaction and an HSW purchase-accounting adjustment.

Outlook, management commentary, risks, and unusual items

• Management forecast 2009 debt repayments of approximately $1 billion, interest expense of $230–$260 million, and capital expenditures of $50–$60 million. It said it might seek refinancing ahead of the October 2010 facility maturity; refinancing access and cost were subject to credit-market conditions.
• Discovery committed to lend up to $100 million to OWN through September 2011; $18 million had been funded by June 30, and management expected a significant portion of the commitment to be funded in 2009. Repayment depends on OWN becoming profitable and having sufficient funds.
• The Hasbro transaction produced $300 million in cash and a tax receivables agreement valued at $57 million; the filing also describes a performance guarantee with maximum exposure below $300 million and says management considered a material adverse impact remote. Hasbro separately committed a $125 million licensing revenue guarantee to the venture.
• Other notable exposures include the BBC’s put right over certain international joint-venture interests, estimated at $49 million, and a potential Harpo put right related to OWN. The filing says the OWN put had not been recorded because the parties had not yet made their specified contributions.
• Management cited macroeconomic weakness, advertising and affiliate payment risk, foreign-currency movements, competition and distribution changes, refinancing conditions, and regulatory, litigation, partner, and technology risks. It reported no material change in the previously disclosed risk factors, no material off-balance-sheet arrangements, and no pending litigation expected to materially affect results or liquidity.
• The company reclassified $68 million of deferred tax liabilities to taxes payable after determining certain prior accelerated content deductions did not qualify; it also accrued $3 million of related interest for Q2. Management reported effective disclosure controls and no material internal-control changes during the quarter.

Important facts for investors to verify

• Confirm the intended issuer: this filing is for Discovery Communications, Inc., not Warner Bros. Discovery, Inc.
• Separate the $252 million one-time Hasbro gain from recurring operating performance; review the retained joint-venture interest and post-transaction segment comparability.
• Assess whether advertising trends, international currency effects, subscriber growth, and content-cost increases support continued Adjusted OIBDA growth.
• Review debt maturities, covenant headroom, the availability and cost of refinancing, and management’s 2009 repayment and liquidity assumptions.
• Track OWN funding and put-right exposure, the BBC redemption estimate, tax-deduction matters, and impairment sensitivity, including the filing’s warning that assumptions and fair values may change.