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EX-10.2 - EX-10.2 - Discovery Communications, Inc.w75884exv10w2.htm
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
     
þ   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2009
OR
     
o   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission File Number: 001-34177
 
DISCOVERY COMMUNICATIONS, INC.
(Exact name of Registrant as specified in its charter)
     
Delaware
(State or other jurisdiction of
incorporation or organization)
  35-2333914
(I.R.S. Employer
Identification No.)
 
One Discovery Place    
Silver Spring, Maryland   20910
(Address of principal executive offices)   (Zip Code)
(240) 662-2000
(Registrant’s telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year, if changed since last report.)
 
     Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
     Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files). Yes þ No o
     Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
             
Large accelerated filer þ   Accelerated filer o   Non-accelerated filer o   Smaller reporting company o
    (Do not check if a smaller reporting company)
     Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
     Total number of shares outstanding of each class of the Registrant’s common stock as of October 26, 2009:
     
Series A Common Stock, $0.01 par value     135,154,668
Series B Common Stock, $0.01 par value   6,598,161
Series C Common Stock, $0.01 par value   141,711,292
 
 

 


 

DISCOVERY COMMUNICATIONS, INC.
INDEX TO FORM 10-Q
         
    Page
    3  
 
       
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    42  
 
       
    65  
 
       
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    69  

2


 

PART I. FINANCIAL INFORMATION
ITEM 1.   Financial Statements.
DISCOVERY COMMUNICATIONS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited; in millions, except par value)
                 
    September 30,     December 31,  
    2009     2008  
            (recast)  
ASSETS
               
Current assets:
               
Cash and cash equivalents
  $ 401     $ 100  
Receivables, net of allowances of $16 and $16, respectively
    775       780  
Content rights, net
    76       73  
Prepaid expenses and other current assets
    165       156  
 
           
Total current assets
    1,417       1,109  
 
               
Noncurrent content rights, net
    1,225       1,163  
Property and equipment, net
    417       395  
Goodwill
    6,438       6,891  
Intangible assets, net
    654       716  
Other noncurrent assets
    590       210  
 
           
Total assets
  $ 10,741     $ 10,484  
 
           
 
LIABILITIES, REDEEMABLE NON-CONTROLLING INTERESTS IN SUBSIDIARIES AND EQUITY
               
Current liabilities:
               
Accounts payable and accrued liabilities
  $ 394     $ 421  
Current portion of long-term debt
    39       458  
Other current liabilities
    329       191  
 
           
Total current liabilities
    762       1,070  
 
               
Long-term debt
    3,472       3,331  
Other noncurrent liabilities
    416       473  
 
           
Total liabilities
    4,650       4,874  
 
               
Commitments and contingencies (Note 18)
               
Redeemable non-controlling interests in subsidiaries
    49       49  
 
               
Equity:
               
Series A preferred stock, $0.01 par value; authorized 75 shares; issued and outstanding 71 shares at September 30, 2009 and 70 shares at December 31, 2008
    1       1  
Series C preferred stock, $0.01 par value; authorized 75 shares; issued and outstanding 71 shares at September 30, 2009 and 70 shares at December 31, 2008
    1       1  
Series A common stock, $0.01 par value; authorized 1,700 shares; issued and outstanding 135 shares at September 30, 2009 and 134 shares at December 31, 2008
    1       1  
Series B common stock, $0.01 par value; authorized 100 shares; issued and outstanding 7 shares at September 30, 2009 and December 31, 2008
           
Series C common stock, $0.01 par value; authorized 2,000 shares; issued and outstanding 142 shares at September 30, 2009 and 141 shares at December 31, 2008
    2       2  
Additional paid-in capital
    6,589       6,545  
Accumulated deficit
    (531 )     (936 )
Accumulated other comprehensive loss
    (35 )     (78 )
 
           
Equity attributable to Discovery Communications, Inc.
    6,028       5,536  
Equity attributable to non-controlling interests
    14       25  
 
           
Total equity
    6,042       5,561  
 
           
Total liabilities, redeemable non-controlling interests in subsidiaries and equity
  $ 10,741     $ 10,484  
 
           
The accompanying notes are an integral part of these condensed consolidated financial statements.

3


 

DISCOVERY COMMUNICATIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited; in millions, except per share amounts)
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2009     2008     2009     2008  
            (recast)             (recast)  
Revenues:
                               
Distribution
  $ 426     $ 419     $ 1,277     $ 1,239  
Advertising
    341       332       1,010       1,014  
Other
    87       94       265       286  
 
                       
Total revenues
    854       845       2,552       2,539  
 
                       
 
                               
Costs of revenues, excluding depreciation and amortization listed below
    257       262       767       758  
Selling, general and administrative
    338       224       929       845  
Depreciation and amortization
    40       50       118       146  
Restructuring and impairment charges
    4       13       47       17  
Gain on business disposition
                (252 )      
 
                       
 
    639       549       1,609       1,766  
 
                       
 
                               
Operating income
    215       296       943       773  
 
                               
Interest expense, net
    (66 )     (61 )     (183 )     (196 )
Other non-operating income (expense), net
    6       (8 )     34       (4 )
 
                       
 
                               
Income from continuing operations before income taxes
    155       227       794       573  
Provision for income taxes
    (54 )     (93 )     (391 )     (285 )
 
                       
 
                               
Income from continuing operations, net of taxes
    101       134       403       288  
Income from discontinued operations, net of taxes
          40             42  
 
                       
 
                               
Net income
    101       174       403       330  
Less net (income) loss attributable to non-controlling interests
          (40 )     2       (119 )
 
                       
Net income attributable to Discovery Communications, Inc.
    101       134       405       211  
 
                               
Stock dividends to preferred interests
    (6 )           (8 )      
 
                       
Net income available to Discovery Communications, Inc. stockholders
  $ 95     $ 134     $ 397     $ 211  
 
                       
 
                               
Amounts available to Discovery Communications, Inc. stockholders:
                               
Income from continuing operations, net of taxes
  $ 95     $ 94     $ 397     $ 169  
Income from discontinued operations, net of taxes
          40             42  
 
                       
Net income
  $ 95     $ 134     $ 397     $ 211  
 
                       
 
                               
Income per share from continuing operations available to Discovery Communications, Inc. stockholders, basic and diluted
  $ 0.22     $ 0.31     $ 0.94     $ 0.59  
 
                               
Income per share from discontinued operations available to Discovery Communications, Inc. stockholders, basic and diluted
          0.13             0.15  
 
                       
 
                               
Net income per share available to Discovery Communications, Inc. stockholders, basic and diluted
  $ 0.22     $ 0.44     $ 0.94     $ 0.74  
 
                       
Weighted average number of shares outstanding:
                               
Basic
    424       302       423       287  
 
                       
Diluted
    427       302       424       287  
 
                       
The accompanying notes are an integral part of these condensed consolidated financial statements.

4


 

DISCOVERY COMMUNICATIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited; in millions)
                 
    Nine Months Ended  
    September 30,  
    2009     2008  
            (recast)  
Operating Activities
               
Net income
  $ 403     $ 330  
Adjustments to reconcile net income to cash provided by operating activities:
               
Share-based compensation expense (benefit)
    196       (47 )
Depreciation and amortization
    118       195  
Asset impairments
    26        
Gains on business dispositions
    (252 )     (67 )
Gains on asset dispositions
          (9 )
Gain on sale of securities
    (13 )      
Deferred income taxes
    (33 )     122  
Other noncash expenses, net
    26       62  
Changes in operating assets and liabilities, net of discontinued operations:
               
Receivables, net
          (29 )
Accounts payable and accrued liabilities
    (21 )     (18 )
Other, net
    (92 )     (116 )
 
           
Cash provided by operating activities
    358       423  
 
               
Investing Activities
               
Purchases of property and equipment
    (43 )     (84 )
Net cash acquired from Newhouse Transaction
          45  
Business acquisitions, net of cash acquired
          (8 )
Proceeds from asset dispositions
          13  
Proceeds from business dispositions
    300       126  
Proceeds from sales of securities
    22       24  
 
           
Cash provided by investing activities
    279       116  
 
               
Financing Activities
               
Ascent Media Corporation spin-off
          (356 )
Net repayments of revolver loans
    (315 )     (89 )
Borrowings from long-term debt, net of discount and issuance costs
    970        
Principal repayments of long-term debt
    (1,007 )     (191 )
Principal repayments of capital lease obligations
    (7 )     (12 )
Cash distribution to non-controlling interest
    (9 )      
Proceeds from stock option exercises
    26        
Other financing activities, net
    (1 )     (10 )
 
           
Cash used in financing activities
    (343 )     (658 )
 
               
Effect of exchange rate changes on cash and cash equivalents
    7       2  
 
           
 
               
Change in cash and cash equivalents
    301       (117 )
Cash and cash equivalents of continuing operations, beginning of period
    100       8  
Cash and cash equivalents of discontinued operations, beginning of period
          201  
 
           
Cash and cash equivalents, end of period
  $ 401     $ 92  
 
           
The accompanying notes are an integral part of these condensed consolidated financial statements.

5


 

DISCOVERY COMMUNICATIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF EQUITY
(unaudited; in millions)
                                                 
    Three Months Ended     Nine Months Ended  
    September 30, 2009     September 30, 2009  
    Discovery     Non-controlling             Discovery     Non-controlling        
    Communications, Inc.     Interests     Total Equity     Communications, Inc.     Interests     Total Equity  
Balance as of beginning of period
  $ 5,903     $ 15     $ 5,918     $ 5,536     $ 25     $ 5,561  
 
                                               
Comprehensive income (loss):
                                               
Net income (loss)
    101             101       405       (2 )     403  
Other comprehensive (loss) income:
                                               
Foreign currency translation adjustments, net
    (5 )           (5 )     24             24  
Unrealized (losses) gains on securities and derivative instruments, net
    (5 )           (5 )     19             19  
 
                                   
Total comprehensive income (loss)
    91             91       448       (2 )     446  
Stock dividends declared to preferred interests
    (6 )           (6 )     (8 )           (8 )
Stock dividends paid to preferred interests
    7             7       7             7  
Cash distribution to non-controlling interest
          (1 )     (1 )           (9 )     (9 )
Share-based compensation
    7             7       19             19  
Issuance of common stock in connection with share-based plans and other
    26             26       26             26  
 
                                   
Balance as of end of period
  $ 6,028     $ 14     $ 6,042     $ 6,028     $ 14     $ 6,042  
 
                                   
                                                 
    Three Months Ended     Nine Months Ended  
    September 30, 2008     September 30, 2008  
    Discovery     Non-controlling             Discovery     Non-controlling        
    Communications, Inc.     Interests     Total Equity     Communications, Inc.     Interests     Total Equity  
    (recast)     (recast)     (recast)     (recast)     (recast)     (recast)  
Balance as of beginning of period
  $ 4,576     $ 88     $ 4,664     $ 4,495     $ 9     $ 4,504  
Comprehensive income:
                                               
Net income
    134       40       174       211       119       330  
Other comprehensive (loss) income:
                                               
Foreign currency translation adjustments, net
    (14 )           (14 )     (10 )           (10 )
Unrealized gains on securities and derivative instruments, net
    2             2       1             1  
 
                                   
Total comprehensive income
    122       40       162       202       119       321  
Share-based compensation
    2             2       3             3  
Ascent Media Corporation spin-off
    (708 )           (708 )     (708 )           (708 )
Issuance of preferred stock
    210       (112 )     98       210       (112 )     98  
Reversal of deferred tax liability related to DHC’s investment in DCH
    1,317             1,317       1,317             1,317  
 
                                   
Balance as of end of period
  $ 5,519     $ 16     $ 5,535     $ 5,519     $ 16     $ 5,535  
 
                                   
The accompanying notes are an integral part of these condensed consolidated financial statements.

6


 

DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION
Description of Business
     Discovery Communications, Inc. (“Discovery” or the “Company”) is a leading global media and entertainment company that provides original and purchased programming across multiple distribution platforms in the United States (U.S.) and approximately 170 other countries, with over 100 television networks offering customized programming in 35 languages. Discovery also develops and sells consumer and educational products and services as well as media sound services in the U.S. and internationally. In addition, the Company owns and operates a diversified portfolio of website properties and other digital services. The Company manages and reports its operations in three segments: U.S. Networks, consisting principally of domestic cable and satellite television network programming, web brands, and other digital services; International Networks, consisting principally of international cable and satellite television network programming; and Commerce, Education, and Other, consisting principally of e-commerce, catalog, sound production, and domestic licensing businesses. Financial information for Discovery’s reportable segments is disclosed in Note 19.
     Discovery was formed in connection with Discovery Holding Company (“DHC”) and Advance/Newhouse Programming Partnership (“Advance/Newhouse”) combining their respective ownership interests in Discovery Communications Holding, LLC (“DCH”) and exchanging those interests with and into Discovery, which was consummated on September 17, 2008 (the “Newhouse Transaction”). Prior to the Newhouse Transaction, DCH was a stand-alone private company, which was owned approximately 66 2/3% by DHC and 33 1/3% by Advance/Newhouse. The Newhouse Transaction was completed as follows:
    On September 17, 2008, DHC completed the spin-off to its shareholders of Ascent Media Corporation (“AMC”), a subsidiary holding the cash and businesses of DHC, except for certain businesses that provide sound, music, mixing, sound effects, and other related services (“Creative Sound Services” or “CSS”) (the “AMC spin-off”). Such businesses remain with the Company following the completion of the Newhouse Transaction. The AMC spin-off was effected as a distribution by DHC to holders of its Series A and Series B common stock. In connection with the AMC spin-off, each holder of DHC Series A common stock received 0.05 of a share of AMC Series A common stock and each holder of DHC Series B common stock received 0.05 of a share of AMC Series B common stock. The AMC spin-off did not involve the payment of any consideration by the holders of DHC common stock and was structured as a tax free transaction under Sections 368(a) and 355 of the Internal Revenue Code of 1986, as amended. There was no gain or loss related to the spin-off. Subsequent to the AMC spin-off, the companies no longer have any ownership interests in each other and operate independently.
 
    On September 17, 2008, immediately following the AMC spin-off, DHC merged with a transitory merger subsidiary of Discovery, with DHC continuing as the surviving entity and as a wholly-owned subsidiary of Discovery. In connection with the merger, each share of DHC Series A common stock was converted into the right to receive 0.50 of a share of Discovery Series A common stock and 0.50 of a share of Discovery Series C common stock. Similarly, each share of DHC Series B common stock was converted into the right to receive 0.50 of a share of Discovery Series B common stock and 0.50 of a share of Discovery Series C common stock.
 
    On September 17, 2008, immediately following the exchange of shares between Discovery and DHC, Advance/Newhouse contributed its ownership interests in DCH and Animal Planet to Discovery in exchange for Discovery Series A and Series C convertible preferred stock. The preferred stock is convertible at any time into Discovery common stock representing 33 1/3% of the Discovery common stock issued in connection with the Newhouse Transaction, subject to certain anti-dilution adjustments.
     As a result of the Newhouse Transaction, DHC and DCH became wholly-owned subsidiaries of Discovery, with Discovery becoming the successor reporting entity to DHC.
Changes in Basis of Presentation — Recast
     As described more fully in Note 2, certain of the 2008 financial information has been recast to reflect the adoption of the statement issued by the Financial Accounting Standards Board (“FASB”) on non-controlling interests in consolidated financial statements.

7


 

DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Basis of Presentation
Newhouse Transaction and AMC Spin-off
     In accordance with FASB Accounting Standards Codification (“ASC”) Topic 810, Consolidation (“ASC 810”), these condensed consolidated financial statements and notes present the Newhouse Transaction as though it was consummated on January 1, 2008. Accordingly, Discovery’s condensed consolidated financial statements and notes include the gross combined financial results of both DHC and DCH since January 1, 2008, as permitted under U.S. generally accepted accounting principles (“GAAP”).
     Prior to the Newhouse Transaction, DHC accounted for its ownership interest in DCH using the equity method. Accordingly, DHC presented its portion of DCH’s earnings in a separate account in its Statements of Operations. Because the Newhouse Transaction is presented as of January 1, 2008, the Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2008 include the gross combined revenues and expenses of both DHC and DCH and do not present the portion of DCH’s earnings previously recorded in DHC’s Statements of Operations as equity investee income during the period January 1, 2008 through September 30, 2008. Additionally, the Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2008 present a portion of DCH’s earnings as being allocated to Advance/Newhouse for the period January 1, 2008 through September 30, 2008 in a separate account titled Net (income) loss attributable to non-controlling interests.
     Pursuant to FASB ASC Topic 805, Business Combinations (“ASC 805”), Discovery accounted for the Newhouse Transaction as a non-substantive merger. Accordingly, the assets and liabilities of DCH and DHC were accounted for at the investors’ historical bases prior to the Newhouse Transaction.
     As a result of the AMC spin-off, the results of operations of AMC are presented as Income from discontinued operations, net of taxes in the Condensed Consolidated Statements of Operations, for the three and nine months ended September 30, 2008. Cash flows from AMC have not been segregated as discontinued operations in the Condensed Consolidated Statements of Cash Flows. Summarized financial information for AMC for the three and nine months ended September 30, 2008 is presented in Note 4.
Unaudited Interim Financial Statements
     The condensed consolidated financial statements have been prepared in accordance with U.S. GAAP applicable to interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. The condensed consolidated financial statements are unaudited; however, in the opinion of management, they reflect all adjustments, consisting of those of a normal recurring nature, necessary to present fairly the financial position, the results of operations, and cash flows for the periods presented in conformity with U.S. GAAP applicable to interim periods. The results of operations for the interim periods presented are not necessarily indicative of results for the full year or future periods. The year-end condensed balance sheet was derived from audited financial statements but does not include all disclosures required by U.S. GAAP.
     The condensed consolidated financial statements should be read in conjunction with the Company’s revised audited consolidated financial statements and notes thereto as of and for the three years ended December 31, 2008, included in Discovery Communications, Inc.’s Current Report on Form 8-K filed with the U.S. Securities and Exchange Commission (“SEC”) on June 16, 2009.
Use of Estimates
     The preparation of the consolidated financial statements in accordance with U.S. GAAP requires management to make estimates, judgments, and assumptions that affect the amounts reported in the consolidated financial statements and notes thereto. Management continually re-evaluates its estimates, judgments, and assumptions and management’s assessments could change. Actual results may differ from those estimates, judgments, and assumptions and could have a material impact on the consolidated financial statements.
     Significant estimates, judgments, and assumptions inherent in the preparation of the consolidated financial statements include consolidation of variable interest entities, accounting for business acquisitions, dispositions, allowances for doubtful accounts, content rights, asset impairments, redeemable interests in subsidiaries, estimating fair value, revenue recognition, depreciation and amortization, share-based compensation, income taxes, and contingencies.
Consolidation and Accounting for Investments
     The condensed consolidated financial statements include the accounts of Discovery, all majority-owned subsidiaries in which a controlling interest is maintained, and variable interest entities (“VIE”) for which the Company is the primary beneficiary. Controlling interest is determined by majority ownership interest and the ability to unilaterally direct or cause the direction of management and policies of an entity after considering any third-party participatory rights. The Company applies the guidelines set forth in ASC 810 in evaluating whether it has interests in VIEs and in determining whether to consolidate any such entities. All significant inter-company accounts and transactions between consolidated companies have been eliminated in consolidation.

8


 

DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
     The Company’s foreign subsidiaries’ assets and liabilities are translated at exchange rates in effect at the balance sheet date, while results of operations are translated at average exchange rates for the respective periods. The resulting asset and liability translation adjustments are included as a separate component of Accumulated other comprehensive loss in the Condensed Consolidated Balance Sheets. Inter-company accounts of a trading nature are revalued at exchange rates in effect at each month-end and are included as part of operating income in the Condensed Consolidated Statements of Operations.
     Investments in entities of 20% to 50%, without a controlling interest, and other investments over which the Company has the ability to exercise significant influence but not control are accounted for using the equity method. Investments in entities of less than 20% over which the Company has no significant influence are accounted for at fair value or using the cost method.
Reclassifications
     Certain reclassifications have been made to the prior year information to conform to the September 30, 2009 presentation.
Subsequent Events
     The Company has evaluated subsequent events through the time of filing this Quarterly Report on Form 10-Q on November 3, 2009. No material subsequent events have occurred since September 30, 2009 that should be recorded or disclosed in the condensed consolidated financial statements.
2. RECENTLY ISSUED ACCOUNTING AND REPORTING PRONOUNCEMENTS
Accounting and Reporting Pronouncements Adopted
The Hierarchy of Generally Accepted Accounting Principles
     In June 2009, the FASB issued a statement that establishes the FASB Accounting Standards Codification (“Codification”) as the source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities in the preparation of financial statements in conformity with U.S. GAAP. The statement modified the GAAP hierarchy to include only two levels of GAAP: authoritative and nonauthoritative. All guidance contained in the Codification carries an equal level of authority. The provisions of this statement allow for rules and interpretive releases of the SEC under authority of federal securities laws to also serve as sources of authoritative GAAP for SEC registrants. The provisions became effective for Discovery on September 30, 2009. The only impact to the Company’s consolidated financial statements was to revise references to accounting pronouncements from those of the precodification standards to the references used in the codified hierarchy of GAAP.
Fair Value Measurements
     In August 2009, the FASB issued Accounting Standards Update (“ASU”) No. 2009-05, Measuring Liabilities at Fair Value (“ASU 2009-05”), which amends the guidance for measuring the fair value of liabilities included in FASB ASC Topic 820, Fair Value Measurements and Disclosure (“ASC 820”). The update reinforces that fair value of a liability is the price that would be paid to transfer the liability in an orderly transaction between market participants at the measurement date. Additionally, the update clarifies how the price of an identical or similar debt security that is traded or the price of the liability when it is traded as an asset should be considered in estimating the fair value of the issuer’s liability and that the reporting entity must consider its own credit risk in measuring the liability’s fair value. Effective September 30, 2009, the Company adopted the provisions of ASU 2009-05 for all liabilities measured at fair value, which are being applied prospectively. The adoption of ASU 2009-05 resulted in changing the priority level of inputs used to measure the fair value of liabilities associated with the Company’s deferred compensation plan from Level 2 to Level 1 within the fair value hierarchy in ASC 820. However, this ASU did not change the Company’s valuation techniques or impact the amounts or classifications recorded in the Company’s condensed consolidated financial statements.
     In September 2006, the FASB issued a statement which establishes the authoritative definition of fair value, sets out a framework for measuring fair value, and expands the required disclosures about fair value measurement. The provisions of the statement related to financial assets and liabilities as well as nonfinancial assets and liabilities carried at fair value on a recurring basis were adopted prospectively on January 1, 2008 and did not have a material impact on the Company’s consolidated financial statements. In February 2008, the FASB delayed the effective date of this statement for non-recurring measurements of non-financial assets and liabilities to fiscal years beginning after November 15, 2008 and interim periods within those fiscal years. Effective January 1, 2009, the Company adopted the provisions of this statement for non-financial assets and liabilities measured at fair value on a non-recurring basis, which are being applied prospectively. The adoption of this statement did not have a material impact on the Company’s consolidated financial statements. The relevant disclosures required by ASC 820 are included in Note 5.

9


 

DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Subsequent Events
     In May 2009, the FASB issued a statement which establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. The provisions of this statement, located within FASB ASC Topic 855, Subsequent Events (“ASC 855”), require disclosure of the date through which an entity has evaluated subsequent events, which for Discovery is the date the financial statements were issued. Effective June 30, 2009, the Company adopted the provisions of this new statement, which are being applied prospectively. The adoption of this statement did not have a material impact on the Company’s consolidated financial statements. The relevant disclosures required by this new statement are included in Note 1.
Interim Disclosures about Fair Value of Financial Instruments
     In April 2009, the FASB issued a statement which requires disclosures about the fair value of financial instruments in interim financial statements in addition to annual financial statements. Effective June 30, 2009, the Company adopted the interim disclosure requirements of the statement, which are being applied prospectively. The adoption of this statement did not have a material impact on the Company’s consolidated financial statements. The relevant disclosures required by FASB ASC Topic 825, Financial Instruments (“ASC 825”), are included in various notes to the consolidated financial statements.
Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities
     In June 2008, the FASB issued a statement on determining whether instruments granted in share-based payment transactions are participating securities. The provisions of the statement, found under FASB ASC Topic 260, Earnings Per Share (“ASC 260”), became effective for the Company on January 1, 2009. The statement provides that all outstanding unvested share-based payment awards that contain rights to non-forfeitable dividends or dividend equivalents (whether paid or unpaid) are considered participating securities. Because such awards are considered participating securities, the issuing entity is required to apply the two-class method of computing basic and diluted earnings per share retrospectively to all prior period earnings per share computations. The adoption of the statement did not impact the Company’s computation of earnings per share for the periods presented.
Determination of the Useful Life of Intangible Assets
     In April 2008, the FASB issued a statement which amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset. Effective January 1, 2009, the Company adopted the provisions of this statement, found under FASB ASC Topic 350, Intangibles- Goodwill and Other (“ASC 350”), which are being applied prospectively to intangible assets acquired on or subsequent to the effective date. The Company’s policy is to expense costs incurred to renew or extend the contractual terms of its intangible assets. The adoption of the statement did not impact the Company’s consolidated financial statements.
Disclosures about Derivative Investments and Hedging Activities
     In March 2008, the FASB issued a statement which requires entities to include information in interim and annual financial statements about how and why an entity uses derivative instruments; how derivative instruments and related hedged items are accounted for; and how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. Effective January 1, 2009, the Company adopted the provisions of this statement, found under FASB ASC Topic 815, Derivatives and Hedging (“ASC 815”), which are being applied prospectively. The adoption of the statement did not have a material impact on the Company’s consolidated financial statements. The relevant disclosures required by the statement are included in Note 9.
Non-controlling Interests
     In December 2007, the FASB issued a statement which establishes accounting and reporting standards for the non-controlling interest in a subsidiary, commonly referred to as minority interest. Among other matters, this statement requires that non-controlling interests be reported within the equity section of the balance sheet and that the amounts of consolidated net income or loss and consolidated comprehensive income or loss attributable to the parent company and the non-controlling interests are clearly presented separately in the consolidated financial statements. Also, pursuant to this statement, where appropriate, losses will be allocated to non-controlling interests even when that allocation may result in a deficit balance. Effective January 1, 2009, the Company adopted the provisions of this statement, found under ASC 810, which are being applied prospectively, except for the presentation and disclosure requirements, which are being applied retrospectively to all periods presented. Upon adoption of this statement, non-controlling interests of $25 million as of December 31, 2008 have been reclassified from Other noncurrent liabilities to Equity attributable to non-controlling interests in the equity section of the Condensed Consolidated Balance Sheets. Additionally, $40 million and $119 million previously recorded as Minority interests, net of tax for the three and nine months ended September 30, 2008 have been reclassified to Net (income) loss attributable to non-controlling interests and excluded from the caption Net income in the Condensed Consolidated Statements of Operations. The computation of earnings per share for all prior periods is not impacted.

10


 

DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Business Combinations
     In December 2007, the FASB issued a statement on business combinations that requires, among other matters, companies expense business acquisition transaction costs; record an asset for in-process research and development; record at fair value amounts for contingencies, including contingent consideration, as of the purchase date with subsequent adjustments recognized in operating results; recognize decreases in valuation allowances on acquired deferred tax assets in operating results, which are considered to be subsequent changes in consideration and are recorded as decreases in goodwill; and measure at fair value any non-controlling interest in the acquired entity. Effective January 1, 2009, the Company adopted the provisions of this statement, FASB ASC Topic 805, Business Combinations (“ASC 805”), which are being applied prospectively to new business combinations consummated on or subsequent to the effective date. While this statement applies to new business acquisitions consummated on or subsequent to the effective date, the amendments to the guidance on accounting for income taxes with respect to deferred tax valuation allowances and liabilities for income tax uncertainties, applies to changes in deferred tax valuation allowances and liabilities for income tax uncertainties recognized in prior business acquisitions. In April 2009, the FASB issued a position which amends and clarifies the accounting, recording and measurement of certain contingent assets acquired and liabilities assumed in a business combination. The provisions of this position, also located within ASC 805, were effective immediately and required to be applied retrospectively to business combinations that occurred on or after January 1, 2009. The initial adoption of the statement and position, effective January 1, 2009, did not impact the Company’s consolidated financial statements. Generally, the impact of ASC 805 will depend on future acquisitions.
Accounting for Collaborative Arrangements
     In December 2007, the Emerging Issues Task Force (“EITF”) issued a statement which defines collaborative arrangements and establishes accounting and reporting requirements for transactions between participants in the arrangement and third parties. A collaborative arrangement is defined as a contractual arrangement that involves a joint operating activity, such as an agreement to co-produce and distribute programming with another media company. Effective January 1, 2009, the Company adopted the provisions of this statement, found under FASB ASC Topic 808, Collaborative Arrangements (“ASC 808”) which are being applied retrospectively to all periods presented for all collaborative arrangements as of the effective date. The adoption of the statement did not have a material impact on the Company’s consolidated financial statements. The relevant disclosures required by ASC 808 are included in Note 6.
Accounting and Reporting Pronouncements Not Yet Adopted
Revenue Recognition for Multiple-Element Revenue Arrangements
     In October 2009, the FASB issued ASU No. 2009-13, Multiple-Deliverable Revenue Arrangements (“ASU 2009-13”), which revises the existing multiple-element revenue arrangements guidance included in FASB ASC Topic 605, Revenue Recognition (“ASC 605”). The revised guidance changes the determination of when the individual deliverables included in a multiple-element revenue arrangement may be treated as separate units of accounting, modifies the manner in which the transaction consideration is allocated across the separately identified deliverables, and expands the disclosures required for multiple-element revenue arrangements. ASU 2009-13 will be effective for Discovery on January 1, 2011, and may be applied retrospectively for all periods presented or prospectively to arrangements entered into or materially modified after the adoption date. The Company is currently evaluating the impact that ASU 2009-13 will have on its consolidated financial statements.
Consolidation of Variable Interest Entities
     In June 2009, the FASB issued a statement which revises the existing accounting guidance for interests in a VIE included in ASC 810. Among other matters, the statement requires a qualitative rather than a quantitative analysis to determine the primary beneficiary of a VIE; amends the consideration of related party relationships in the determination of the primary beneficiary of a VIE; amends certain guidance for determining whether an entity is a VIE, which may change an entity’s assessment of which entities with which it is involved are VIEs; requires continuous assessments of whether an entity is the primary beneficiary of a VIE; and requires enhanced disclosures about an entity’s involvement with a VIE. In general, the disclosure requirements are consistent with the provisions by the FASB on transfers of financial assets and interests in variable interest entities. The provisions of this statement will be effective for Discovery on January 1, 2010, and will be applied retrospectively to all periods presented. The adoption of this statement will result in the Company no longer consolidating the Oprah Winfrey Network and Animal Planet Japan joint ventures effective January 1, 2010. The Company continues to evaluate the impact of deconsolidating the Oprah Winfrey Network and Animal Planet Japan joint ventures and whether the provisions of this statement will further impact its consolidated financial statements.

11


 

DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
3. VARIABLE INTEREST ENTITIES
     Discovery holds investments in multiple ventures, most of which were determined to be variable interest entities. The following table provides a list of investments in variable interest entities as of September 30, 2009 and the method of accounting.
                 
    Percentage of   Accounting
    Ownership   Method
Ventures with the British Broadcasting Corporation:
               
JV Programs, LLC
    50 %   Consolidated
Joint Venture Network, LLC (“JVN”)
    50 %   Consolidated
Animal Planet Europe
    50 %   Consolidated
Animal Planet Latin America
    50 %   Consolidated
People+Arts Latin America
    50 %   Consolidated
Animal Planet Asia
    50 %   Consolidated
Animal Planet Japan
    33 %   Consolidated
 
               
Other ventures:
               
Oprah Winfrey Network
    50 %   Consolidated
DHJV Company LLC (“Hasbro — Discovery Joint Venture”)
    50 %   Equity Method
     For consolidated ventures, $2 million of net losses generated by the ventures was allocated to other venture partners during the nine months ended September 30, 2009. Approximately $9 million of net income generated by the consolidated ventures was allocated to other venture partners during the nine months ended September 30, 2008. Amounts allocated to other venture partners are recorded in Net (income) loss attributable to non-controlling interests in the Condensed Consolidated Statements of Operations.
Ventures with the British Broadcasting Corporation
     The Company and the British Broadcasting Corporation (“BBC”) formed several cable and satellite television network ventures, other than JVN, to produce and acquire factual-based content. The JVN venture was formed to provide debt funding to the other ventures. In addition to its own funding requirements, Discovery has assumed the BBC’s funding requirements, giving the Company preferential cash distribution for these joint ventures. The equity interests of the ventures owned by the BBC are reported as non-controlling interests. No cumulative operating losses generated by the ventures were allocated to the BBC’s non-controlling interests. In accordance with the venture arrangement, no losses can be allocated to the BBC in excess of distributable cash to the BBC for each joint venture.
     Pursuant to the venture agreements, the BBC has the right to require the Company to purchase the BBC’s interests in the People+Arts Latin America venture and the Animal Planet ventures if certain conditions are not met. Additional information regarding the BBC’s put right is disclosed in Note 10.
Oprah Winfrey Network
     Discovery formed a 50-50 joint venture with Oprah Winfrey and Harpo, Inc. (“Harpo”) to rebrand Discovery Health Channel as OWN: The Oprah Winfrey Network (“OWN Network”), which was consummated on July 23, 2008. Pursuant to the arrangement, Discovery will contribute its interest in the Discovery Health Channel and certain DiscoveryHealth.com content and Harpo will contribute the Oprah.com website (which will serve as the platform for the venture website) and certain Oprah.com content. Discovery and Harpo are required to make these contributions on the launch date unless it is mutually agreed that certain contributions will be made prior to the launch date for the benefit of the venture. The equity interests of the OWN Network owned by Harpo are reported as non-controlling interests.
     Pursuant to the venture agreement, Discovery is committed to loan up to $100 million to the venture through September 30, 2011 to fund operations, of which $27 million has been funded through September 30, 2009. To the extent funding the joint venture in excess of $100 million is necessary, the Company may provide additional funds through a member loan or require the venture to seek third party financing. Discovery expects to recoup the entire amount contributed in future periods provided that the joint venture is profitable and has sufficient funds to repay the Company. The parties are currently discussing a number of matters regarding the OWN Network, including digital strategy, the programming and development pipeline, and timing of the launch of the network.
     Pursuant to the venture agreement, Harpo has the right to require the Company to purchase its interest in the OWN Network

12


 

DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
venture if certain conditions are not met. Additional information regarding Harpo’s put right is disclosed in Note 10.
Hasbro-Discovery Joint Venture
     On May 22, 2009, Discovery and Hasbro, Inc. (“Hasbro”) formed a 50-50 joint venture that will operate a television network and website dedicated to children’s and family entertainment and educational programming. Hasbro acquired a 50% ownership interest in the joint venture, which will hold the assets related to the Discovery Kids Network (“Discovery Kids”) in the U.S., for which Discovery received consideration of $300 million and a tax receivables agreement collectible over 20 years valued at $57 million. Upon purchase of its ownership interest, Hasbro received a step-up in tax basis for its portion of the joint venture assets. To the extent Hasbro has the ability to amortize this tax basis, it is contractually obligated to share the tax benefit as part of purchase consideration. As part of the transaction, Discovery provided Hasbro a guarantee of performance valued at less than $1 million. The maximum remaining exposure to loss under this guarantee of performance is below $265 million. The Company believes the likelihood is remote that this performance guarantee could have a material adverse impact on the Company.
     Hasbro and Discovery have equal representation on the joint venture’s board of directors that oversees a management team responsible for programming, scheduling, and operations. Programming for the joint venture will include animation, game shows, and live-action series and specials. The television network and online presence also will include content from Discovery Kids’ existing library. Discovery provides certain advertising sales services, distribution, origination, and other operational requirements for the joint venture, while Hasbro provides studio-produced programming and merchandising for intellectual property associated with the network. Hasbro is providing the joint venture a $125 million licensing revenue guarantee, which is expected to be earned over the licensing term.
     Beginning May 22, 2009, Discovery ceased to consolidate the gross operating results of Discovery Kids. However, as Discovery continues to be involved in the operations of the joint venture, the Company has not presented the financial position, results of operations, and cash flows of Discovery Kids recorded through May 21, 2009 as discontinued operations. The Company’s interest in the joint venture is accounted for using the equity method of accounting, which was initially valued at $357 million. Accordingly, the Company’s consolidated results of operations include the gross operating results of Discovery Kids through May 21, 2009, whereas for subsequent periods Discovery records only its proportionate share of the joint venture’s net operating results.
     In connection with the formation of the joint venture, the Company recognized a gain of $252 million, which included $127 million as a result of “stepping up” its basis for the 50% retained interest in Discovery Kids and $125 million for the sale of 50% of its ownership interest to Hasbro.
4. DISCONTINUED OPERATIONS
     In September 2008, as part of the Newhouse Transaction, DHC completed the spin-off to its shareholders of AMC, a subsidiary holding the cash and businesses of DHC, except for certain businesses that provide sound, music, mixing, sound effects and other related services. The AMC spin-off did not involve the payment of any consideration by the holders of DHC common stock and was structured as a tax free transaction under Sections 368(a) and 355 of the Internal Revenue Code of 1986, as amended. There was no gain or loss related to the spin-off. Subsequent to the AMC spin-off, the companies no longer have any ownership interests in each other and operate independently.
     In September 2008, prior to the Newhouse Transaction, DHC sold its ownership interests in Ascent Media Systems & Technology Services, LLC (“AMSTS”) and Ascent Media CANS (DBA “AccentHealth”) AccentHealth for approximately $7 million and $119 million, respectively, in cash. The sale of these companies resulted in pre-tax gains of $3 million for AMSTS and $64 million for AccentHealth. AMSTS and AccentHealth were components of the AMC business. It was determined that AMSTS and AccentHealth were non-core assets, and the sale of these companies was consistent with DHC’s strategy to divest non-core assets. The Company has no continuing involvement in the operations of AMSTS or AccentHealth.
     In September 2008, prior to the Newhouse Transaction, DHC disposed of certain buildings and equipment for approximately $13 million in cash. DHC recognized a pre-tax gain of approximately $9 million in connection with the asset disposals. The disposed assets were part of the AMC business.
     As there is no continuing involvement in the operations of AMC, AMSTS, or AccentHealth, their results of operations and the gains from the business and asset dispositions are presented as Income from discontinued operations, net of taxes in the Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2008. Cash flows from these entities have not been segregated as discontinued operations in the Condensed Consolidated Statements of Cash Flows.

13


 

DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
     The following table presents summary financial information for discontinued operations for the three and nine months ended September 30, 2008 (amounts in millions, except per share data):
                 
    Three Months Ended   Nine Months Ended
    September 30, 2008   September 30, 2008
Revenues
  $ 134     $ 482  
Loss from the operations of discontinued operations before income taxes
  $ (8 )   $ (6 )
Loss from the operations of discontinued operations, net of taxes
  $ (7 )   $ (5 )
Gains on dispositions, net of taxes
  $ 47     $ 47  
Income from discontinued operations, net of taxes
  $ 40     $ 42  
Income per share from discontinued operations available to Discovery Communications, Inc. stockholders, basic and diluted
  $ 0.13     $ 0.15  
Weighted average number of shares outstanding, basic and diluted
    302       287  
     No interest expense was allocated to discontinued operations as there was no debt specifically attributable to discontinued operations or that was required to be repaid following the dispositions.
5. FAIR VALUE MEASUREMENTS
     In accordance with ASC 820, a fair value measurement is determined based on the assumptions that a market participant would use in pricing an asset or liability. ASC 820 also established a three-tiered hierarchy that draws a distinction between market participant assumptions based on: (i) observable inputs such as quoted prices in active markets (Level 1), (ii) inputs other than quoted prices in active markets that are observable either directly or indirectly (Level 2), and (iii) unobservable inputs that require the Company to use present value and other valuation techniques in the determination of fair value (Level 3).
Assets and Liabilities Measured at Fair Value on a Recurring Basis
     The following tables present information about assets and liabilities measured at fair value on a recurring basis (in millions).
                                 
            Fair Value Measurements  
            as of September 30, 2009 Using:  
            Quoted Market     Significant        
            Prices in Active     Other     Significant  
            Markets for     Observable     Unobservable  
    Total Fair Value as of     Identical Assets     Inputs     Inputs  
    September 30, 2009     (Level 1)     (Level 2)     (Level 3)  
Assets:
                               
Trading securities
  $ 32     $ 32     $     $  
Derivatives (Note 9)
    6             6        
Liabilities:
                               
Derivatives (Note 9)
    (63 )           (63 )      
Deferred compensation plan
    (32 )     (32 )            
HSW International, Inc. liability
    (4 )           (4 )      
Redeemable non-controlling interests in subsidiaries (Note 10)
    (49 )                 (49 )
 
                       
 
  $ (110 )   $     $ (61 )   $ (49 )
 
                       
     As disclosed in Note 2, the adoption of ASU 2009-05 resulted in changing the priority level of inputs used to measure the fair value of liabilities associated with the Company’s deferred compensation plan from Level 2 to Level 1 within the fair value hierarchy in ASC 820 as of September 30, 2009. However, this ASU did not change the Company’s valuation techniques or impact the amounts or classifications recorded in the Company’s consolidated financial statements.

14


 

DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
                                 
            Fair Value Measurements  
            as of December 31, 2008 Using:  
            Quoted Market     Significant        
            Prices in Active     Other     Significant  
            Markets for     Observable     Unobservable  
    Total Fair Value as of     Identical Assets     Inputs     Inputs  
    December 31, 2008     (Level 1)     (Level 2)     (Level 3)  
Assets:
                               
Trading securities
  $ 36     $ 36     $     $  
Available-for-sale securities
    15       15              
Liabilities:
                               
Derivatives
    (112 )           (112 )      
Deferred compensation plan
    (36 )           (36 )      
HSW International, Inc. liability
    (7 )           (7 )      
Redeemable non-controlling interests in subsidiaries
    (49 )                 (49 )
 
                       
 
  $ (153 )   $ 51     $ (155 )   $ (49 )
 
                       
     For assets that are measured using quoted prices in active markets, the total fair value is the published market price per unit in active markets multiplied by the number of units held without consideration of transaction costs.
     The fair value of derivative instruments, which consist of interest rate and foreign currency hedges, is determined using the published market price of similar instruments with similar maturities and characteristics, interest rate yield curves, and measures of interest rate volatility, adjusted for any terms specific to the asset or liability and nonperformance risk. Additional information regarding derivative instruments is available in Note 9.
     The fair value of the deferred compensation plan liability is determined based on the fair value of the related investments elected by employees.
     The Company currently owns approximately 23 million shares (or 43%) of HSW International, Inc. (“HSWI”). The investment is accounted for using the equity method. The Company has agreed to either: (i) distribute approximately 18 million of the HSWI shares to the former shareholders of HowStuffWorks.com, Inc. (“HSW”), or (ii) sell approximately 18 million HSW shares and distribute substantially all proceeds in excess of $0.37 per share to the former shareholders of HSW. Through September 2008, the fair value of the Company’s liability to the former HSW shareholders was determined using a discounted cash flow (“DCF”) analysis. In October 2008, the Company began using a Black-Scholes option pricing model to value the liability.
     The fair value of the redeemable non-controlling interests in subsidiaries is an estimated negotiated value considering the exercise of the BBC put right and an estimate of the proceeds from a hypothetical sale of interests in certain ventures and a distribution of the proceeds to the venture partners based on various rights and preferences. Additional information regarding the redeemable non-controlling interests in subsidiaries is disclosed in Note 10.
     The following table reconciles the beginning and ending balances of Level 3 measurements and identifies the net income the Company recorded (in millions).
                         
    Three Months Ended     Three Months Ended  
    September 30, 2009     September 30, 2008  
    Redeemable             Redeemable  
    Non-controlling             Non-controlling  
    Interests in     HSWI     Interests in  
    Subsidiaries     Liability     Subsidiaries  
Beginning balance
  $ (49 )   $ (43 )   $ (49 )
Total gains (losses):
                       
Included in net income
          8        
Included in other comprehensive income
                 
Purchases, sales, issuances, settlements, net
                 
Transfers (in) and/or out of Level 3
                 
 
                 
Ending balance
  $ (49 )   $ (35 )   $ (49 )
 
                 

15


 

DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
                         
    Nine Months Ended     Nine Months Ended  
    September 30, 2009     September 30, 2008  
    Redeemable             Redeemable  
    Non-controlling             Non-controlling  
    Interests in     HSWI     Interests in  
    Subsidiaries     Liability     Subsidiaries  
Beginning balance
  $ (49 )   $ (54 )   $ (49 )
Total gains (losses):
                       
Included in net income
          19        
Included in other comprehensive income
                 
Purchases, sales, issuances, settlements, net
                 
Transfers (in) and/or out of Level 3
                 
 
                 
Ending balance
  $ (49 )   $ (35 )   $ (49 )
 
                 
     Gains recognized for liabilities valued using significant unobservable inputs were reported as a component of Other non-operating income (expense), net in the Condensed Consolidated Statements of Operations.
Assets and Liabilities Measured at Fair Value on a Non-Recurring Basis
     The majority of the Company’s non-financial instruments, which include goodwill, intangible assets, property and equipment, and equity method investments, are not required to be carried at fair value on a recurring basis but are subject to fair value adjustments only in certain circumstances. If certain triggering events occur such that a non-financial instrument is required to be evaluated for impairment, a resulting asset impairment would require that the non-financial instrument be recorded at the lower of historical cost or its fair value.
     In June 2009 certain intangible assets and capitalized software costs with carrying values of $40 million and $7 million, respectively, were written down to fair values of $17 million and $4 million, respectively, resulting in pretax charges totaling $26 million. A fair value measurement was required due to a decline in expected future operating results. The fair values were determined by the application of a DCF model and market based approach, which used Level 3 inputs. Cash flows were determined based on Company estimates of future operating results and discounted using an internal rate of return consistent with that used by the Company to evaluate cash flows of other assets of a similar nature. The market approach relied on public information related to certain financial measures. Additional information regarding the fair value measurements is disclosed in Note 7.
6. CONTENT RIGHTS
     The following table presents a summary of the components of content rights (in millions).
                 
    September 30,     December 31,  
    2009     2008  
Produced content rights:
               
Completed
  $ 1,753     $ 1,420  
In-production
    219       270  
Co-produced content rights:
               
Completed
    424       462  
In-production
    81       63  
Licensed content rights:
               
Acquired
    279       218  
Prepaid
    15       17  
 
           
Content rights, at cost
    2,771       2,450  
Accumulated amortization
    (1,470 )     (1,214 )
 
           
Content rights, net
    1,301       1,236  
Less: Current portion
    76       73  
 
           
Noncurrent portion
  $ 1,225     $ 1,163  
 
           
     For the three and nine months ended September 30, 2009, the Company recorded amortization expense related to content rights of

16


 

DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
$179 million and $518 million, respectively. Amortization expense related to content rights was $178 million and $495 million for the three and nine months ended September 30, 2008, respectively. Amortization expense was recorded as a component of Costs of revenues in the Condensed Consolidated Statements of Operations. Amortization expense for the three and nine months ended September 30, 2009 included charges of $19 million and $45 million, respectively, related to the decision not to proceed with certain completed and in-process content at the Company’s U.S. Networks and International Networks segments. Amortization expense for the three and nine months ended September 30, 2008 included charges of $25 million and $40 million, respectively, related to the decision not to proceed with certain completed and in-process content at the Company’s U.S. Networks and International Networks segments. The charges were the result of management evaluating the Company’s programming portfolio assets and concluding that certain programming was no longer aligned with the Company’s strategy and would no longer be aired.
     The Company enters into collaborative co-produced content right arrangements (“co-productions”) whereby it obtains certain editorial and distribution rights to content assets in return for funding production costs. The Company’s level of involvement in co-productions ranges from review of the initial production plan to detailed editorial oversight through each stage of the production process. As the Company shares in the variable risks and rewards of content creation, these co-productions are within the scope of ASC 808.
     The Company capitalizes the net cost of co-productions and amortizes them in accordance with its content amortization policy. The Company’s policy is to record cash receipts for distribution, advertising and royalty revenue that result from the use of co-produced content as gross revenue in accordance with FASB ASC Topic 605, Revenue Recognition (“ASC 605”) as it relates to reporting revenue gross as a principal versus net as an agent. The Company generally does not allocate revenue to specific content rights, and there were no royalty revenues or expenses associated with co-production partners during the three and nine month periods ended September 30, 2009 and 2008. For the three and nine month periods ended September 30, 2009, participation costs of $29 million and $88 million were capitalized as part of co-production content, which included payments of $6 million and $20 million to a co-production partner that is consolidated. Participation costs of $27 million and $66 million were capitalized as a component of co-production content for the three and nine month periods ended September 30, 2008, respectively, which include payments of $7 million and $11 million to a consolidated co-production partner.
7. GOODWILL AND INTANGIBLE ASSETS
Goodwill
     The following table presents a summary of the Company’s goodwill by reportable segment (in millions).
                                 
                    Commerce,        
    U. S.     International     Education,        
    Networks     Networks     and Other     Total  
Balance as of December 31, 2008
  $ 5,569     $ 1,273     $ 49     $ 6,891  
Disposition
    (437 )                 (437 )
Purchase accounting adjustment
    (18 )                 (18 )
Foreign currency translation adjustments
          2             2  
 
                       
Balance as of September 30, 2009
  $ 5,114     $ 1,275     $ 49     $ 6,438  
 
                       
     Goodwill decreased $453 million during the nine months ended September 30, 2009. The decrease was primarily attributable to the Discovery Kids disposition and an adjustment to the purchase price for the acquisition of HSW.
     As disclosed in Note 3, in May 2009 Discovery and Hasbro formed a joint venture that will operate a television network and website to deliver children’s and family entertainment and educational programming. In connection with the formation of the joint venture, the Company transferred Discovery Kids to the venture, which was previously a component of the Other U.S. Networks reporting unit. For its contribution, the Company received a 50% ownership interest in the joint venture and Hasbro acquired the remaining 50% ownership interest for $357 million. It was determined that Discovery Kids met the definition of a business under ASC 805 and, therefore, the Company allocated $437 million of the Other U.S. Networks reporting unit goodwill to Discovery Kids pursuant to ASC 350. The allocation of goodwill was based on the relative fair values of Discovery Kids and the portion of the Other U.S. Networks reporting unit that was retained.
     During the nine months ended September 30, 2009, the Company reversed a deferred tax liability for losses incurred for other than temporary declines during 2008 in the value of the equity investment in HSWI, which resulted in an $18 million reduction of goodwill.

17


 

DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Intangible Assets
     The following table presents a list of the gross carrying value of the Company’s intangible assets and related accumulated amortization by major category (in millions, except years).
                                                         
    Weighted Average     September 30, 2009     December 31, 2008  
    Amortization Period             Accumulated                     Accumulated        
    (Years)     Gross     Amortization     Net     Gross     Amortization     Net  
Intangible assets subject to amortization:
                                                       
Trademarks
    6     $ 33     $ (15 )   $ 18     $ 55     $ (23 )   $ 32  
Customer lists
    25       528       (62 )     466       611       (107 )     504  
Other
    5       4       (2 )     2       36       (24 )     12  
 
                                         
Total
            565       (79 )     486       702       (154 )     548  
Intangible assets not subject to amortization:
                                                       
Trademarks
            168             168       168             168  
 
                                         
Total
          $ 733     $ (79 )   $ 654     $ 870     $ (154 )   $ 716  
 
                                         
     Intangible assets, net decreased $62 million during the nine months ended September 30, 2009 due primarily to amortization expense and noncash impairment charges. Excluding impairment charges, amortization expense related to intangible assets was $11 million and $20 million during the three months ended September 30, 2009 and 2008, respectively. During the nine months ended September 30, 2009 and 2008, amortization expense related to intangible assets, excluding impairment charges, was $39 million and $66 million, respectively.
     The following table presents the Company’s estimate of its aggregate annual amortization expense for intangible assets subject to amortization for the remainder of 2009 and each of the succeeding four years based on the amount of intangible assets as of September 30, 2009 (in millions).
                                                 
    October 1, 2009 —                                
    December 31, 2009     2010     2011     2012     2013     Thereafter  
Amortization expense
  $ 10     $ 41     $ 31     $ 28     $ 26     $ 350  
 
                                   
     The amount and timing of the estimated expenses in the above table may vary due to future acquisitions, dispositions, or impairments.
Impairments
     As disclosed in Note 3, Discovery sold a 50% interest in Discovery Kids, which was determined to be a business under ASC 805. As a result, the Company was required to allocate goodwill to Discovery Kids based on the relative fair values of Discovery Kids and the remaining portion of the Other U.S. Networks reporting unit. Additionally, the Company tested goodwill and long lived assets, including definite lived intangible assets, for impairment under ASC 350 and ASC 360, respectively, for the remaining portion of the Other U.S. Networks reporting unit as of June 30, 2009.
     The Company used the purchase consideration provided by Hasbro to determine the fair value of Discovery Kids. In determining the fair value of the portion of the reporting unit remaining, the Company used a DCF model and market based approach. The significant assumptions used in the DCF models to determine the fair value of the remaining components of the Other U.S. Networks reporting unit were generally consistent with those used during 2008, except that the expected cash flows of certain components declined causing long-term growth rates to increase slightly. The market approach relied on public information and involved the exercise of judgment in identifying the relevant comparable company market multiples. The Company multiplied certain financial measures of the Other U.S. Networks reporting unit by the market multiples identified in determining the estimated fair value. Based on a decline in expected future operating performance and market multiples for certain asset groups of the Other U.S. Networks reporting unit, the carrying values of certain definite lived intangible assets and capitalized software exceeded their fair values. Accordingly, the Company recorded impairment charges of $17 million and $3 million related to certain definite lived intangible assets and capitalized software, respectively, of the Other U.S. Networks reporting unit. Despite the decline in fair value of the definite lived intangible assets and capitalized software for certain asset groups, the overall fair value of the Other U.S. Networks reporting unit exceeded its carrying amount and, therefore, goodwill of the reporting unit was not impaired.

18


 

DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
     In addition to the above tests, it was determined that the expected future operating performance for one of the asset groups in the Europe (excluding the United Kingdom), Middle East and Africa (“EMEA”) reporting unit was lower than expected. As a result, the Company tested long lived assets, including definite lived intangible assets, for impairment. The Company used a DCF model to estimate fair value. The DCF model utilized projected financial results, which were generally below those used during 2008. Based on the decline in expected future operating performance, it was determined that the carrying value of certain definite lived intangible assets exceeded their fair values. Accordingly, the Company recorded an impairment charge of $6 million at the EMEA reporting unit. Despite the decline in fair value of the definite lived intangible assets, the overall fair value of the EMEA reporting unit exceeded its carrying amount and, therefore, goodwill of the reporting unit was not impaired.
     Except for the interim impairment tests discussed above, no other interim impairment analyses of the Company’s goodwill or intangible assets have been required in 2009.
8. DEBT
     The following table presents the components of the Company’s outstanding debt by instrument type (in millions).
                 
    September 30,     December 31,  
    2009     2008  
$1.6 billion Revolving Credit Facility, due October 2010
  $     $ 315  
$1.0 billion Term Loan A, due quarterly December 2008 to October 2010
          938  
$1.5 billion Term Loan B, due quarterly September 2007 to May 2014
    1,466       1,478  
$500 million Term Loan C, due quarterly June 2009 to May 2014
    498        
7.45% Senior Notes, semi-annual interest, due September 2009
          55  
8.37% Senior Notes, semi-annual interest, due March 2011
    220       220  
8.13% Senior Notes, semi-annual interest, due September 2012
    235       235  
Floating Rate Senior Notes, semi-annual interest, due December 2012 (1.99% at September 30, 2009 and 3.3% at December 31, 2008)
    90       90  
6.01% Senior Notes, semi-annual interest, due December 2015
    390       390  
5.625% Senior Notes, semi-annual interest, due August 2019
    500        
Other notes payable
    1       1  
Capital lease obligations
    125       67  
 
           
Total long-term debt
    3,525       3,789  
Unamortized discount
    (14 )      
 
           
Long-term debt, net
    3,511       3,789  
Less: Current portion
    39       458  
 
           
Noncurrent portion
  $ 3,472     $ 3,331  
 
           
Term Loans
     On May 14, 2009, Discovery Communications Holding, LLC (“DCH”), a wholly-owned subsidiary of the Company, entered into Amendment No. 1 (the “Amendment”) to its Credit, Pledge and Security Agreement dated as of May 14, 2007 with Bank of America, N.A. (as administrative agent and a lender) and the other lenders named therein (“Term Loan B”). The Amendment revises Term Loan B to permit any indebtedness otherwise permitted to be incurred by any restricted subsidiary, as defined in Term Loan B, or DCH to contain restrictions similar to provisions in DCH’s and its subsidiaries’ existing credit facility and privately placed notes, subject to certain conditions. These provisions include restrictions on limitations on guarantees, liens and restricted payments. Term Loan B was further amended in order to eliminate DCH’s obligation to give existing lenders ten business days to commit to any additional term facility.
     On May 14, 2009, DCH entered into Credit Agreement Supplement No. 1 (“Term Loan C”) to its Term Loan B with Bank of America N.A. (as administrative agent and lender). Pursuant to Term Loan C, DCH incurred $500 million of indebtedness, which matures on May 14, 2014. DCH received net proceeds of $478 million from the borrowing after deducting issuance expenses of $12 million recorded as a discount and $10 million of expenses recorded as deferred financing costs. DCH used the net proceeds of the borrowing to repay $163 million and $315 million of indebtedness outstanding under DCL’s Term Loan A and the revolving credit facility, respectively.
     The Term Loan C indebtedness is repayable in equal quarterly installments of $1.25 million beginning June 30, 2009 through

19


 

DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
March 31, 2014, with the balance due on the maturity date. Term Loan C bears interest at an initial rate of LIBOR plus an applicable margin of 3.25%, with a LIBOR floor of 2.00%, which was 5.25% at September 30, 2009. From May 14, 2009 through September 30, 2009, the weighted average effective interest rate for Term Loan C was 6.03%.
     Term Loan C contains customary representations and warranties, events of default, affirmative covenants and negative covenants (which impose restrictions and limitations on, among other things, dividends, investments, additional indebtedness, asset sales and capital expenditures) and a total leverage ratio financial maintenance covenant, each of which are identical to Term Loan B. DCH is permitted to prepay Term Loan C in whole or in part at any time at its option with prior notice with no prepayment penalty.
     The events of default under Term Loan C are identical to those under Term Loan B. Discovery’s $1.5 billion Term Loan B and $500 million Term Loan C are each secured by the assets of DCH, excluding assets held by DCH’s subsidiaries.
Senior Notes
     On August 19, 2009, Discovery Communications, LLC (“DCL”), a wholly-owned subsidiary of the Company, issued $500 million aggregate principal amount of 5.625% Senior Notes maturing on August 15, 2019 (the “August 2019 Notes”). The August 2019 Notes were issued in an underwritten public offering at a price of 99.428% of the principal amount. DCL received net proceeds of $492 million from the offering after deducting the issuance discount of $3 million and issuance expenses of $5 million recorded as deferred financing costs. DCL used the net proceeds of the offering to repay $428 million of indebtedness outstanding under its Term Loan A, prior to final maturity on October 31, 2010. The remaining proceeds will be used for general corporate purposes.
     DCL may, at its option, redeem some or all of the August 2019 Notes at any time by paying a make-whole premium, plus accrued and unpaid interest, if any, to the date of repurchase. Interest on the August 2019 Notes is payable on August 15 and February 15 of each year, beginning on February 15, 2010. The August 2019 Notes are unsecured and rank equally in right of payment with all of DCL’s other unsecured senior indebtedness. The August 2019 Notes are fully and unconditionally guaranteed on an unsecured and unsubordinated basis by Discovery.
     The August 2019 Notes were issued pursuant to an indenture and a supplemental indenture, dated as of August 19, 2009, among DCL, Discovery and U.S. Bank National Association, as trustee. The indenture and supplemental indenture contain certain covenants and events of default and other customary provisions.
Debt Payments
     The following table presents a summary of scheduled and estimated debt payments, excluding capital lease obligations and other notes payable, for the remainder of 2009 and each of the succeeding four years based on the amount of debt outstanding as of September 30, 2009 (in millions).
                                                 
    October 1, 2009 —                                
    December 31, 2009     2010     2011     2012     2013     Thereafter  
Long-term debt payments
  $ 5     $ 20     $ 240     $ 345     $ 20     $ 2,769  
 
                                   
Covenants
     The term loans, revolving loan, and senior notes contain covenants that require the Company to meet certain financial ratios and place restrictions on the payment of dividends, sale of assets, borrowing level, mergers, and purchases of capital stock, assets, and investments. The Company was compliant with all debt covenants as of September 30, 2009 and December 31, 2008.
Fair Value of Debt
     The fair value of the Company’s borrowings was $3.6 billion and $3.4 billion at September 30, 2009 and December 31, 2008, respectively, which was estimated based on current market rates and credit pricing for similar debt types and maturities.
9. DERIVATIVE FINANCIAL INSTRUMENTS
     The Company uses derivative financial instruments principally to modify its exposure to market risks from changes in interest rates. The Company does not hold or enter into financial instruments for speculative trading purposes.

20


 

DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
     The Company’s interest expense is exposed to movements in short-term interest rates. Derivative instruments, including both fixed to variable and variable to fixed interest rate swaps, are used to modify this exposure. The majority of the Company’s debt is variable rate and the Company uses derivatives to effectively fix the amount of interest paid. The variable to fixed interest rate instruments are based on the three-month LIBOR rate and have a total notional amount of $2.2 billion and a weighted average interest rate of 4.68% at September 30, 2009. The fixed to variable interest rate agreements have a total notional amount of $50 million and a weighted average interest rate of 4.67% at September 30, 2009. In addition, the Company has forward starting variable to fixed interest rate instruments with a total notional amount of $860 million and a weighted average interest rate of 2.60% at September 30, 2009, of which a notional amount of $560 million will become effective in December 2009 and a notional amount of $300 million will become effective in June 2010.
     During the nine months ended September 30, 2009, the Company has entered into forward starting interest rate swaps with a total notional amount of $300 million, starting June 30, 2010 and maturing on March 31, 2014. The swaps have a weighted average fixed pay rate of 2.90%, and the Company is required to make payments at the three-month LIBOR rate. During the nine months ended September 30, 2009, the Company has terminated interest rate swaps with a total notional amount of $75 million and a net fair value in a loss position of $1 million.
     Of the Company’s total notional amount of $3.1 billion in interest rate derivatives, a notional amount of $2.3 billion of these derivative instruments are highly effective cash flow hedges as of September 30, 2009. The change in the fair value of derivatives designated as hedging instruments is reported as a component of Accumulated other comprehensive loss on the Condensed Consolidated Balance Sheets. Should any portion of these instruments become ineffective due to a restructuring in the Company’s debt, the cumulative fair value, which is currently a net loss of $35 million, would be reclassified from Accumulated other comprehensive loss on the Condensed Consolidated Balance Sheets to Other non-operating income (expense), net on the Condensed Consolidated Statements of Operations. In addition, subsequent monthly changes in fair value would be reported as a component of Other non-operating income (expense), net on the Condensed Consolidated Statements of Operations. The Company does not expect material hedge ineffectiveness in the next twelve months. The remaining $810 million in interest rate derivatives have not been designated for hedge accounting under ASC 815. The change in the fair value of derivatives not designated as hedging instruments is reported as a component of Other non-operating income (expense), net on the Condensed Consolidated Statements of Operations. The Company presents all derivative fair values on a gross basis on the Condensed Consolidated Balance Sheets.
     The foreign exchange instruments used to hedge foreign currency fluctuations for the Company’s non-U.S. operations are spot, forward, and option contracts. Additionally, the Company enters into non-designated forward contracts to hedge non-dollar denominated cash flows and foreign currency balances. At September 30, 2009, the notional amount of foreign exchange derivative contracts was $1 million. These derivative instruments have not been designated for hedge accounting under ASC 815.
     The following tables present the notional amount and fair value of the Company’s derivatives as of September 30, 2009 (in millions).
                     
        Asset Derivatives  
    Balance Sheet Location   Notional     Fair Value  
Derivatives designated as hedging instruments:
                   
Interest rate contracts
  Other noncurrent assets   $ 610     $ 3  
 
                   
Derivatives not designated as hedging instruments:
                   
Interest rate contracts
  Other noncurrent assets     50       3  
 
               
Total asset derivatives
      $ 660     $ 6  
 
             
                     
        Liability Derivatives  
    Balance Sheet Location   Notional     Fair Value  
Derivatives designated as hedging instruments:
                   
Interest rate contracts
  Other current liabilities   $ 1,460     $ 38  
Interest rate contracts
  Other noncurrent liabilities     250        
 
               
Total
        1,710       38  
 
                   
Derivatives not designated as hedging instruments:
                   
Foreign exchange contracts
  Other current liabilities     1        
Interest rate contracts
  Other current liabilities     385       5  
Interest rate contracts
  Other noncurrent liabilities     375       20  
 
             
Total
        761       25  
 
             
Total liability derivatives
      $ 2,471     $ 63  
 
             

21


 

DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
     The following table presents the impact of derivative instruments on the Condensed Consolidated Statement of Operations for the Company’s derivatives in cash flow hedging relationships, all of which are interest rate contracts, for the three and nine months ended September 30, 2009 (in millions).
                 
 
  Three Months Ended     Nine Months Ended  
 
  September 30, 2009     September 30, 2009  
 
           
Amount recognized in Other comprehensive (loss) income, gross of tax
  $ (22 )   $ (5 )
Amount reclassified from Accumulated other comprehensive loss into Interest expense, net
  $ (15 )   $ (40 )
Amount excluded from effectiveness testing and recorded as Other non-operating income (expense), net
  $ (1 )   $ (1 )
     Gain (loss) from changes in fair values of derivatives that are not designated as hedges are recognized as a component of Other non-operating income (expense), net. The following table presents the impact of derivative instruments not designated as hedging instruments on the Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2009 (in millions).
                 
    Three Months Ended     Nine Months Ended  
    September 30, 2009     September 30, 2009  
Interest rate contracts
  $ 5     $ 14  
Foreign exchange contracts
           
 
           
Total
  $ 5     $ 14  
 
           
Credit-Risk Related Contingencies
     Certain of the Company’s derivative instruments contain credit-risk related contingent features, such as requirements that the Company comply with its credit agreements and cross-default provisions under which the Company will be in default upon the occurrence of certain cross-default events, such as failure to make payments when due in respect to any indebtedness exceeding certain threshold amounts. If the Company were to trigger any of these provisions, the derivative contracts would be in default and the counterparties could request immediate settlement on all of their outstanding derivative contracts with the Company. As of September 30, 2009, the aggregate fair value of all derivative instruments with credit-risk related contingent features that are in a liability position was $63 million.
10. REDEEMABLE NON-CONTROLLING INTERESTS IN SUBSIDIARIES
People+Arts Latin America and Animal Planet Channel Group
     As disclosed in Note 3, Discovery and the BBC have formed several cable and satellite television network joint ventures to develop and distribute programming content. Under certain terms outlined in the contract, the BBC has the right every three years, commencing December 31, 2002, to put to the Company its interests in (i) People+Arts Latin America, and/or (ii) certain Animal Planet channels outside of the U.S. (the “Channel Groups”), in each case for a value determined by a specified formula. In January 2009, the BBC requested that a determination be made whether such conditions have occurred with respect to both Channel Groups as of December 31, 2008. The contractual redemption value is based upon the exercise of the BBC put right and an estimate of the proceeds from a hypothetical sale of the Channel Groups and a distribution of the proceeds to the venture partners based on various rights and preferences. As the Company has funded all operations from inception of the ventures through December 31, 2008, the Company believes that it has accumulated rights and preferences in excess of the fair market value of the Channel Groups. However, due to the complexities of the redemption formula, the Company has accrued the non-controlling redeemable interests to an estimated negotiated value of $49 million as of both September 30, 2009 and December 31, 2008. Changes in the assumptions used to estimate the redemption value could materially impact current estimates. The Company recorded no accretion to the redemption value during the three and nine months ended September 30, 2009 and 2008.
     The Company and the BBC are currently discussing potential revisions to all of their contractual relationships, including the ownership interests in the Channel Groups. While there can be no assurance that these or other negotiations would result in an definitive agreement, the Company expects that the cost of a negotiated acquisition of the BBC’s interests in the Channel Groups could substantially exceed the value of the put right described above.

22


 

DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
OWN Network
     As disclosed in Note 3, Discovery and Harpo formed a venture to rebrand Discovery Health Channel as OWN: The Oprah Winfrey Network. Pursuant to the venture agreement, Discovery provided a put right to Harpo which is exercisable on four separate put exercise dates within 12.5 years of the venture’s formation date. The put arrangement provides Harpo with the right to require Discovery to purchase its 50% ownership interest at fair market value up to a maximum put amount. The maximum put amount ranges between $100 million on the first put exercise date up to $400 million on the fourth put exercise date. As of September 30, 2009, no amounts have been recorded for this put right as the Company has not yet contributed its interest in Discovery Health Channel and Harpo has not yet contributed the Oprah.com website to the OWN Network venture.
11. OTHER COMPREHENSIVE INCOME (LOSS)
The following tables summarize the tax effects related to each component of Other comprehensive income (loss) (in millions).
                                                 
    Three Months Ended     Three Months Ended  
    September 30, 2009     September 30, 2008  
    Before-tax         Net-of-tax     Before-tax     Tax Benefit     Net-of-tax  
    Amount     Tax Benefit     Amount     Amount     (Expense)     Amount  
Foreign currency translation adjustments
  $ (7 )   $ 2     $ (5 )   $ (23 )   $ 9     $ (14 )
 
                                               
Unrealized (losses) gains on securities
and derivative instruments, net
    (7 )     2       (5 )     5       (3 )     2  
 
                                   
Other comprehensive (loss) income
  $ (14 )   $ 4     $ (10 )   $ (18 )   $ 6     $ (12 )
 
                                   
                                                 
    Nine Months Ended     Nine Months Ended  
    September 30, 2009     September 30, 2008  
    Before-tax         Net-of-tax     Before-tax     Tax Benefit     Net-of-tax  
    Amount     Tax Benefit     Amount     Amount     (Expense)     Amount  
Foreign currency translation adjustments
  $ 38     $ (14 )   $ 24     $ (17 )   $ 7     $ (10 )
 
                                               
Unrealized gains (losses) on securities and derivative instruments, net
    30       (11 )     19       3       (2 )     1  
 
                                   
Other comprehensive income (loss)
  $ 68     $ (25 )   $ 43     $ (14 )   $ 5     $ (9 )
 
                                   
12. SHARE-BASED COMPENSATION
     The Company has various plans it assumed from DHC and DCH in connection with the Newhouse Transaction. Under these plans the Company is authorized to grant share-based awards to employees and nonemployees. Prior to September 18, 2008, DCH maintained the Discovery Appreciation Plan (the “DAP Plan”) and the HowStuffWorks.com Plan (the “HSW Plan”). The DAP Plan is a long-term incentive plan under which eligible employees received cash settled unit awards. The HSW Plan is a long-term incentive plan assumed with the acquisition of HSW for the benefit of the subsidiary’s employees. The DAP Plan and the HSW Plan continue to exist subsequent to the Newhouse Transaction.
     Prior to September 18, 2008, DHC maintained the Discovery Holding Company 2005 Incentive Plan, the Discovery Holding Company 2005 Non-Employee Director Incentive Plan (collectively the “Incentive Plans”), and the Discovery Holding Company Transitional Stock Adjustment Plan (the “Transitional Plan”). There are outstanding awards under the Transitional Plan, but the Company has no ability to issue new awards under this plan. The Company grants awards to its employees and non-employee directors under the Incentive Plans, which may include stock options, restricted shares, restricted stock units, stock appreciation rights (“SARs”), and cash awards that are subject to the provisions of FASB ASC Topic 718, Stock Compensation (“ASC 718”). Most awards previously granted by DHC under these plans that were outstanding at the time of the Newhouse Transaction were fully vested and were converted into securities of Discovery in connection with the Newhouse Transaction. The Incentive Plans and the Transitional Plan continue to exist subsequent to the Newhouse Transaction.

23


 

DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
DAP Plan
     The DAP Plan awards consist of a number of units which represent an equivalent number of shares of common stock with a base price established by the Company. Although the DAP Plan was a DCH plan through September 17, 2008, the value of the unit awards was based on the price of DHC’s Series A common stock. As the unit awards were indexed to the stock of another entity, DCH accounted for the unit awards as derivatives pursuant to ASC 815. Accordingly, DCH remeasured the fair value of outstanding unit awards each reporting period until settlement. Compensation expense, including the change in fair value, was attributed using the straight-line method during the vesting period. Changes in the fair value of the unit awards that occurred subsequent to the vesting period were recorded as adjustments to compensation costs in the period in which the change occurred.
     In connection with the Newhouse Transaction, effective September 18, 2008, the DAP Plan was amended such that outstanding unit awards and new unit awards granted under that plan are based on Discovery’s Series A common stock. Accordingly, beginning on September 18, 2008, outstanding unit awards and new unit awards granted under the DAP Plan have been accounted for pursuant to the provisions of ASC 718. Because the unit awards are cash settled they are considered liability instruments under ASC 718. Therefore, the Company continues to remeasure the fair value of outstanding unit awards each reporting period until settlement. Compensation expense, including the change in fair value, is attributed using the straight-line method during the vesting period. Changes in the fair value of the unit awards that occur subsequent to the vesting period are recorded as adjustments to compensation costs in the period in which the change occurs. The Company does not intend to grant additional cash-settled unit awards, except as may be required by contract or to employees in countries in which stock option awards are not permitted.
     Unit awards vest in 25% increments each year over a four year period from the grant date. Additionally, upon voluntary termination of employment, the Company distributes 100% of vested unit benefits if employees agree to certain contractual provisions.
     The fair value of each unit award granted under the DAP Plan is determined using the Black-Scholes option-pricing model. The following table presents a summary of the weighted average assumptions used to determine the fair value of each unit award as of September 30, 2009 and December 31, 2008.
                 
    September 30,   December 31,
    2009   2008
Risk-free interest rate
    0.47 %     0.56 %
Expected term (years)
    1.01       1.38  
Expected volatility
    55.95 %     37.89 %
Dividend yield
           
     A summary of the unit awards activity for the nine months ended September 30, 2009 is presented below (in millions, except price and years).
                                 
                    Weighted Average    
                    Remaining    
    Unit   Weighted Average   Contractual Life   Aggregate
    Awards   Grant Price   (years)   Intrinsic Value
Outstanding as of December 31, 2008
    20.0     $ 18.95                  
Granted
    1.6     $ 14.46                  
Exercised
    (3.7 )   $ 17.77                  
Forfeited
    (1.0 )   $ 19.56                  
 
                               
Outstanding as of September 30, 2009
    16.9     $ 18.76       1.01     $ 208  
 
                               
Exercisable as of September 30, 2009
    0.1     $ 21.64       1.67     $ 2  
 
                               
     The Company made cash payments totaling $4 million and $20 million, respectively, during the nine months ended September 30, 2009 and 2008 to settle vested unit awards issued under the DAP Plan. On October 1, 2009, 3.4 million unit awards vested requiring a payment of $50 million in the fourth quarter of 2009.
Incentive Plans
Stock Options
     Stock options are granted with exercise prices equal to, or in excess of, the fair market value at the date of grant. Generally, stock options vest either in 33 1/ 3% increments each year over three years or in 25% increments each year over a four year period beginning one year after the grant date and expire three to ten years from the date of grant. Certain stock option awards provide for accelerated vesting upon an election to retire pursuant to the Incentive Plans or after reaching a specified age and years of service.

24


 

DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
     The fair value of each stock option granted under the Incentive Plans is determined using the Black-Scholes option-pricing model. The following table presents a summary of the weighted average assumptions used to determine the grant date fair value of stock options awarded during the nine months ended September 30, 2009.
         
    Nine Months
    Ended
    September 30, 2009
Risk-free interest rate
    1.57 %
Expected term (years)
    3.34  
Expected volatility
    46.43 %
Dividend yield
     
     A summary of option activity for the nine months ended September 30, 2009 is presented below (in millions, except price and years).
                                 
                    Weighted Average    
                    Remaining    
            Weighted Average   Contractual Life   Aggregate
    Options   Exercise Price   (years)   Intrinsic Value
Outstanding as of December 31, 2008
    10.9     $ 14.47                  
Granted
    8.3     $ 15.71                  
Exercised
    (2.6 )   $ 14.11                  
Forfeited
    (0.3 )   $ 14.96                  
 
                               
Outstanding as of September 30, 2009
    16.3     $ 15.15       5.68     $ 224  
 
                               
Exercisable as of September 30, 2009
    1.0     $ 13.94       4.95     $ 14  
 
                               
     The weighted-average fair value of each stock option granted during the nine months ended September 30, 2009 was $5.39 per option.
Stock Appreciation Rights
     SARs are granted with exercise prices equal to the fair market value at the date of grant. SARs entitle the recipient to receive a payment in cash equal to the excess value of the stock over the base price specified in the grant. Most SAR grants consist of two separate vesting tranches with the first tranche that vested 100% on March 15, 2009 and the second tranche vesting 100% on March 15, 2010. The first tranche expires one year after vesting. All SARs in the second tranche will be automatically exercised on March 15, 2010. Upon vesting, grantees may exercise the SARs included in the first tranche at any time prior to March 15, 2010.
     Cash-settled SARs are liability instruments in accordance with ASC 718. Accordingly, the Company remeasures the fair value of outstanding SARs each reporting period until settlement. Compensation expense, including the change in fair value, is attributed using the straight-line method during the vesting period. Changes in the fair value of liability instruments that occur subsequent to the vesting period are recorded as adjustments to compensation costs in the period in which the change occurs.
     The fair value of each SAR granted under the Incentive Plans is determined using the Black-Scholes option-pricing model. The following table presents a summary of the weighted-average assumptions used to determine the fair value of each SAR as of September 30, 2009 and December 31, 2008.
                 
    September 30,   December 31,
    2009   2008
Risk-free interest rate
    0.43 %     0.37 %
Expected term (years)
    0.52       1.20  
Expected volatility
    57.76 %     39.89 %
Dividend yield
           

25


 

DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
A summary of SAR activity for the nine months ended September 30, 2009 is presented below (in millions, except price and years).
                                 
                    Weighted Average    
                    Remaining    
            Weighted Average   Contractual Life   Aggregate
    SARs   Grant Price   (years)   Intrinsic Value
Outstanding as of December 31, 2008
    5.5     $ 14.40                  
Granted
    0.7     $ 14.79                  
Exercised
    (2.2 )   $ 14.42                  
Forfeited
    (0.5 )   $ 14.47                  
 
                               
Outstanding as of September 30, 2009
    3.5     $ 14.46       0.52     $ 50  
 
                               
Exercisable as of September 30, 2009
    0.7     $ 14.44       0.45     $ 11  
 
                               
     The Company made cash payments totaling $17 million during the nine months ended September 30, 2009 to settle vested SARs.
Share-Based Compensation Expense (Benefit)
     The following table presents a summary of shared-based compensation expense and the related tax expense, by award type, recognized by the Company during the three and nine months ended September 30, 2009 and 2008 (in millions).
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2009     2008     2009     2008  
Stock options and restricted stock units
  $ 7     $     $ 19     $ 1  
Stock appreciation rights
    19             52        
HSW Plan
          1       1       7  
DAP unit awards
    72       (66 )     124       (55 )
 
                       
Total share-based compensation expense (benefit)
  $ 98     $ (65 )   $ 196     $ (47 )
 
                       
Tax (benefit) expense recognized
  $ (36 )   $ 23     $ (72 )   $ 17  
 
                       
     Compensation expense associated with all share based awards is recorded as a component of Selling, general and administrative expenses in the Condensed Consolidated Statements of Operations. The Company classifies as a current liability the intrinsic value of DAP unit awards and stock appreciation rights that are vested or will become vested within one year. The intrinsic value of DAP unit awards that were classified as a current liability at September 30, 2009 and December 31, 2008 was $100 million and $4 million, respectively. The intrinsic value of stock appreciation rights that were classified as a current liability at September 30, 2009 and December 31, 2008 was $47 million and $1 million, respectively.
13. EXIT AND RESTRUCTURING CHARGES
     The following table presents a summary of the Company’s exit and restructuring charges expensed, by segment, for the three and nine months ended September 30, 2008 and 2009 (in millions).
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2009     2008     2009     2008  
U.S. Networks
  $ 1     $ 13     $ 8     $ 13  
International Networks
    3             7        
Commerce, Education, and Other
                1       4  
Corporate
                5        
 
                       
Total exit and restructuring charges
  $ 4     $ 13     $ 21     $ 17  
 
                       

26


 

DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
     The following table presents a summary of changes in the Company’s liabilities with respect to exit and restructuring charges during the three and nine months ended September 30, 2009 (in millions).
                         
            Employee        
    Contract     Relocations/        
    Termination Costs     Terminations     Total  
Liabilities as of December 31, 2008
  $ 6     $ 18     $ 24  
Net accruals
          3       3  
Cash paid
    (1 )     (10 )     (11 )
 
                 
Liabilities as of March 31, 2009
  $ 5     $ 11     $ 16  
Net accruals
    2       12       14  
Cash paid
    (1 )     (6 )     (7 )
 
                 
Liabilities as of June 30, 2009
  $ 6     $ 17     $ 23  
Net accruals
          4       4  
Cash paid
    (1 )     (7 )     (8 )
 
                 
Liabilities as of September 30, 2009
  $ 5     $ 14     $ 19  
 
                 
     The Company reorganized portions of its operations to better align its organizational structure with the Company’s strategic priorities and to reduce its cost structure, which resulted in exit and restructuring charges primarily for changes in management structure and employee terminations. As of September 30, 2009, exit and restructuring related accruals expected to be paid within one year totaling $17 million were classified as a component of Accounts payable and accrued liabilities in the Condensed Consolidated Balance Sheets. The Company does not expect to incur a significant amount of additional costs with respect to these particular activities.
14. INCOME TAXES
     The provisions for income taxes were $54 million and $391 million for the three and nine months ended September 30, 2009, respectively, and $93 million and $285 million for the three and nine months ended September 30, 2008, respectively. The effective tax rates were 35% and 49% for the three and nine months ended September 30, 2009, respectively, and 41% and 50% for the three and nine months ended September 30, 2008, respectively. The effective tax rate for the nine months ended September 30, 2009 differed from the federal statutory rate of 35% due primarily to the permanent difference on the $125 million gain from the sale of 50% of the Company’s ownership interest in Discovery Kids and the $127 million gain as a result of “stepping up” the Company’s basis for the 50% retained interest in Discovery Kids in May 2009, and to a lesser extent state income taxes. Discovery did not record a deferred tax liability of $48 million with respect to the portion of the outside basis in the Hasbro-Discovery venture attributable to nondeductible goodwill.
     The effective tax rate for the three and nine months ended September 30, 2008 differed from the federal statutory rate of 35% principally due to the presentation of the Newhouse Transaction as though it was consummated on January 1, 2008 in accordance with ASC 810. Accordingly, Discovery’s condensed consolidated financial statements and notes include the gross combined financial results of both DHC and DCH since January 1, 2008. Prior to the Newhouse Transaction on September 17, 2008, DHC owned 66 2/3% of DCH and, therefore, recognized a portion of DCH’s operating results. As a result, the tax provision for the three and nine months ended September 30, 2008 includes the taxes recognized by both DCH and DHC related to the portion of DCH’s operating results recognized by DHC. DHC recognized $33 million and $85 million of deferred tax expense related to its investment in DCH prior to the Newhouse Transaction for the three and nine months ended September 30, 2008, respectively. The provision for income taxes for the three and nine months ended September 30, 2008 was partially offset by the release of an $18 million valuation allowance for deferred tax assets of CSS and the release of a $10 million valuation allowance for deferred tax assets related to net operating loss carry-forwards for AMC.
     During 2009, the Company reclassified $68 million of deferred tax liabilities to U.S. federal and state taxes payable in order to recapture certain accelerated tax deductions claimed in 2004 through 2008 related to program content that the Company determined would not qualify as accelerated deductions. As a result of the disallowance of these accelerated deductions, the Company incurred interest of $3 million. In June 2009, Discovery also recorded a tax expense of approximately $4 million related to the reversal of accelerated deductions taken on programs that were disposed of by the Company.
     There have been no significant changes to the Company’s reserves for uncertain tax positions since December 31, 2008.

27


 

DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
15. NET INCOME PER SHARE ATTRIBUTABLE TO DISCOVERY COMMUNICATIONS, INC. STOCKHOLDERS
     Basic net income per share is computed by dividing net income available to Discovery Communications, Inc. stockholders by the weighted average number of shares outstanding during the period. The weighted average number of shares outstanding for the three and nine months ended September 30, 2009 and 2008 includes Discovery’s Series A, B, and C common shares, as well as Discovery’s Series A and C convertible preferred shares. All series of our common and preferred shares are included in the weighted average number of shares outstanding when calculating both basic and diluted income per share as the holder of each common and preferred series legally participate equally in any per share distributions whether through dividends or in liquidation.
     The following table presents a reconciliation of the weighted average number of shares outstanding between basic and diluted net income per share.
                                 
    Three Months Ended   Nine Months Ended
    September 30,   September 30,
    2009   2008   2009   2008
Weighted average number of shares outstanding — basic
    424       302       423       287  
Dilutive effect of equity awards
    3             1        
 
                               
Weighted average number of shares outstanding — diluted
    427       302       424       287  
 
                               
     Diluted net income per share adjusts basic net income per share for the dilutive effects of stock options, restricted stock units, and stock settled stock appreciation rights, only in the periods in which such effect is dilutive. For both the three and nine months ended September 30, 2008, options to purchase two million common shares were excluded from the calculation of diluted net income per share because their inclusion would have been anti-dilutive. Additionally, the net income per share calculations for the three and nine months ended September 30, 2009 and 2008 exclude approximately one million of contingently issuable preferred shares placed in escrow for which specific conditions have not yet been met.
16. ADDITIONAL FINANCIAL INFORMATION
Cash Flows
     The following tables present a summary of certain cash payments made and received as well as certain noncash transactions (in millions).
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2009     2008     2009     2008  
Cash payments made for interest expense
  $ 67     $ 63     $ 185     $ 201  
Cash payments received for interest income
                      (1 )
 
                       
Cash interest payments, net
  $ 67     $ 63     $ 185     $ 200  
 
                       
 
                               
Cash payments made for income taxes
  $ 273     $ 41     $ 362     $ 161  
Cash payments received for income tax refunds
                      (17 )
 
                       
Cash tax payments, net
  $ 273     $ 41     $ 362     $ 144  
 
                       
 
                               
Non cash transactions:
                               
Capital leases
  $ 29     $ 17     $ 61     $ 63  
 
                       
Stock dividends to preferred interests
  $ 6     $     $ 8     $  
 
                       

28


 

DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Other Non-Operating Income (Expense), Net
     The following table presents a summary of the components of Other non-operating income (expense), net (in millions).
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2009     2008     2009     2008  
Equity in earnings (losses) of unconsolidated affiliates
  $ 2     $ (1 )   $ 5     $ (2 )
Unrealized gains (losses) on derivative instruments, net
    4       (4 )     19       (2 )
Realized losses on derivative instruments, net
          (2 )     (6 )     (2 )
Realized (losses) gains on securities
          (1 )     13       2  
Other, net
                3        
 
                       
Total other non-operating income (expense), net
  $ 6     $ (8 )   $ 34     $ (4 )
 
                       
     In May 2009, the Company sold securities for $22 million, which resulted in a pretax gain of $13 million. Approximately $6 million of unrealized pretax gains were reclassified from Other comprehensive income. During the nine months ended September 30, 2008, AMC, which is reported as discontinued operations, sold securities for $24 million. There was no gain associated with this sale.
     During the three and nine months ended September 30, 2008, other-than-temporary impairments charges of $8 million and $16 million respectively, related to the investment in HSWI were recorded.
17. RELATED PARTY TRANSACTIONS
     The Company identifies related parties as investors in its consolidated subsidiaries, entities in which the Company’s has an investment accounted for using the equity method, and the Company’s executive management and directors and their respective affiliates. Transactions with related parties typically result from distribution of networks, mainly with the Discovery Japan, Inc. and Discovery Channel Canada joint ventures, production of content primarily with BBC affiliates, and services involving satellite uplink, systems integration, origination and post-production.
     The following table presents a summary of balances related to transactions with related parties during the three and nine months ended September 30, 2009 and 2008 (in millions).
                                 
    Three Months Ended   Nine Months Ended
    September 30,   September 30,
    2009   2008   2009   2008
Revenues
  $ 6     $ 6     $ 18     $ 19  
Operating costs and expenses
  $ 3     $ 19     $ 13     $ 52  
     Revenues for the three and nine months ended September 30, 2008 exclude $15 million and $37 million, respectively, for related party transactions that were recorded by AMC, which was spun-off effective January 1, 2008. Operating costs and expenses for the three and nine months ended September 30, 2008 include disbursements of $14 million and $39 million, respectively, to an entity that is no longer a related party following the Newhouse Transaction.
     The following table presents a summary of outstanding balances from transactions with related parties as of September 30, 2009 and December 31, 2008 (in millions).
                 
    September 30,   December 31,
    2009   2008
Accounts receivable
  $ 5     $ 12  
18. COMMITMENTS AND CONTINGENCIES
     As more fully described in the Company’s 2008 revised consolidated financial statements in the Current Report on Form 8-K filed with the SEC on June 16, 2009, the Company and its subsidiaries lease offices, satellite transponders, and certain equipment under capital and operating lease arrangements. The Company has several investments in joint ventures. From time to time the Company agrees to fund the operations of the ventures on an as needed basis. The Company has long-term noncancelable lease commitments for office space and equipment, studio facilities, transponders, vehicles and operating equipment. Content commitments of the Company not recorded on the balance sheet include obligations relating to programming development, programming production and programming acquisitions and talent contracts. Other commitments include obligations to purchase goods and services, employment contracts, sponsorship agreements and transmission services. A majority of such fees are payable over several years, as part of the normal course of business.

29


 

DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
     In December 2007, Discovery acquired HSW and a 49.5% interest in HSWI. Pursuant to the terms of the arrangement, Discovery has agreed to either: (i) distribute the HSWI stock to the former HSW shareholders, or (ii) sell the HSWI stock and distribute substantially all proceeds in excess of $0.37 per share to the former HSW shareholders. Discovery continues to record a liability of $4 million as of September 30, 2009 for its estimated obligation with respect to the HSWI shares to the former HSW shareholders.
     Pursuant to the OWN venture agreement, Discovery is committed to loan up to $100 million to the venture through September 30, 2011 to fund operations, of which $27 million has been funded through September 30, 2009. To the extent funding the joint venture in excess of $100 million is necessary, the Company may provide additional funds through a member loan or require the venture to seek third party financing. Discovery expects to recoup the entire amount contributed in future periods provided that the joint venture is profitable and has sufficient funds to repay the Company.
     In connection with the Newhouse Transaction, DHC’s outstanding stock options were converted into stock options or stock settled stock appreciation rights of Discovery, in accordance with the terms of the agreements governing the Newhouse Transaction. Additionally, Advance/Newhouse received shares of Discovery’s Series A and Series C convertible preferred stock. In the event that the stock options or stock settled appreciation rights that were converted in connection with the Newhouse Transaction are exercised, Advance/Newhouse is entitled to receive additional shares of the same series of convertible preferred stock. The Company placed approximately 1.6 million shares of preferred stock into an escrow account for this anti-dilution provision. Shares released from escrow to Advance/Newhouse are accounted for as a dividend measured at the fair value of the underlying shares as of the Newhouse Transaction date. During the three and nine months ended September 30, 2009, the Company recognized $6 million and $8 million, respectively, of non-cash stock dividends for the release of approximately 1 million shares of preferred stock from escrow.
     In the normal course of business, the Company has pending claims and legal proceedings. It is the opinion of the Company’s management, based on information available at this time, that none of the other current claims and proceedings will have a material effect on the Company’s consolidated financial statements.
Concentrations of Credit Risk
     Concentrations of credit risk arise when a number of customers and counterparties engage in similar activities or have similar economic characteristics that make them susceptible to similar changes in industry conditions, which could affect their ability to meet their contractual obligations. The increasing consolidation of the financial services industry will increase our concentration risk to counterparties in this industry, and we will become more reliant on a smaller number of institutional counterparties, which both increases our risk exposure to any individual counterparty and decreases our negotiating leverage with these counterparties. Based on our assessment of business conditions that could impact our financial results, we have determined that none of the Company’s customers or counterparties represent significant concentrations of credit risk.
Derivatives Counterparties
     The risk associated with a derivative transaction is that a counterparty will default on payments due to us. If there is a default, we may have to acquire a replacement derivative from a different counterparty at a higher cost or may be unable to find a suitable replacement. Our derivative credit exposure relates principally to interest rate derivative contracts. Typically, we seek to manage these exposures by contracting with experienced counterparties that are investment grade-rated. These counterparties consist of large financial institutions that have a significant presence in the derivatives market.
Lender Counterparties
     The risk associated with a debt transaction is that a counterparty will not be available to fund as obligated under the terms of our revolver facility. If funding under committed lines of credit are unavailable, we may have to acquire a replacement credit facility from a different counterparty at a higher cost or may be unable to find a suitable replacement. Typically, we seek to manage these exposures by contracting with experienced large financial institutions and monitoring the credit quality of our lenders.
     The Company manages its exposure to derivative and lender counterparties by continually monitoring its positions with, and the credit quality of, the financial institutions that are counterparties to its financial instruments and does not anticipate nonperformance by the counterparties.
Customers
     The Company’s trade receivables do not represent a significant concentration of credit risk as of September 30, 2009 due to the

30


 

DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
wide variety of customers and markets in which the Company operates and their dispersion across many geographic areas.
19. REPORTABLE SEGMENTS INFORMATION
     The Company has three reportable segments: U.S. Networks, consisting principally of domestic cable and satellite television network programming, web brands, and other digital services; International Networks, consisting principally of international cable and satellite television network programming; and Commerce, Education, and Other, consisting principally of e-commerce, catalog, sound production, and domestic licensing businesses.
     Prior to the Newhouse Transaction and related AMC spin-off (refer to Note 1), DHC had three reportable segments: Creative Services Group, which provided various technical and creative services necessary to complete principal photography into final products such as films, trailers, shows, and other media; Network Services Group, which provided the facilities and services necessary to assemble and distribute programming content for cable and broadcast networks; and DCH, as a significant equity method investee. In connection with the Newhouse Transaction, DHC spun-off its interest in AMC, which included the Creative Services Group segment, except for CSS, and the Network Services Group segment. The discontinued operations of the Creative Services Group and Network Services Group segments have been excluded from the reportable segment information presented below.
     The CSS business, which remained with Discovery subsequent to the Newhouse Transaction and AMC spin-off, is included in the Commerce, Education, and Other segment. In accordance with ASC 810, the financial results of both DHC and DCH have been combined in Discovery’s financial statements as if the Newhouse Transaction occurred January 1, 2008. Accordingly, the Commerce, Education, and Other segment information for September 30, 2008 includes amounts for CSS since January 1, 2008.
     The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies, except that certain inter-segment transactions that are eliminated at the consolidated level are not eliminated at the segment level as they are treated similar to third-party sales transactions in determining segment performance. Inter-segment transactions primarily include the purchase of advertising and content between segments. Inter-segment transactions are not material to the periods presented. The Company evaluates the operating performance of its segments based on financial measures such as revenues and adjusted operating income before depreciation and amortization (“Adjusted OIBDA”). Adjusted OIBDA is defined as revenues less costs of revenues and selling, general and administrative expenses excluding: (i) mark-to-market share-based compensation, (ii) depreciation and amortization, (iii) amortization of deferred launch incentives, (iv) exit and restructuring charges, (v) impairment charges, and (vi) gains (losses) on business and asset dispositions. The Company uses this measure to assess operating results and performance of its segments, perform analytical comparisons, identify strategies to improve performance and allocate resources to each segment. The Company believes Adjusted OIBDA is relevant to investors because it allows them to analyze the operating performance of each segment using the same metric management uses and also provides investors a measure to analyze the operating performance of each segment against historical data. The Company excludes mark-to-market share-based compensation, exit and restructuring charges, impairment charges, and gains (losses) on business and asset dispositions from the calculation of Adjusted OIBDA due to their volatility or non-recurring nature. The Company also excludes the amortization of deferred launch incentive payments because these payments are infrequent and the amortization does not represent cash payments in the current reporting period. Because Adjusted OIBDA is a non-GAAP measure, it should be considered in addition to, but not a substitute for, operating income, net income, cash flow provided by operating activities and other measures of financial performance reported in accordance with U.S. GAAP.
     The Company’s reportable segments are determined based on (i) financial information reviewed by the chief operating decision maker (“CODM”), the Chief Executive Officer, (ii) internal management and related reporting structure, and (iii) the basis upon which the CODM makes resource allocation decisions.
     The following tables present summarized financial information for each of the Company’s reportable segments (in millions).
Revenues by Segment
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2009     2008     2009     2008  
U.S. Networks
  $ 522     $ 498     $ 1,588     $ 1,526  
International Networks
    293       300       831       864  
Commerce, Education, and Other
    38       45       127       126  
Corporate and inter-segment eliminations
    1       2       6       23  
 
                       
Total revenues
  $ 854     $ 845     $ 2,552     $ 2,539  
 
                       

31


 

DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Adjusted OIBDA by Segment
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2009     2008     2009     2008  
U.S. Networks
  $ 302     $ 257     $ 907     $ 811  
International Networks
    110       103       298       280  
Commerce, Education, and Other
    2       5       13       2  
Corporate and inter-segment eliminations
    (50 )     (54 )     (144 )     (145 )
 
                       
Total Adjusted OIBDA
  $ 364     $ 311     $ 1,074     $ 948  
 
                       
Reconciliation of Total Adjusted OIBDA to Total Operating Income
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2009     2008     2009     2008  
Total Adjusted OIBDA
  $ 364     $ 311     $ 1,074     $ 948  
Mark-to-market share-based compensation (expense) benefit
    (91 )     65       (177 )     47  
Depreciation and amortization
    (40 )     (50 )     (118 )     (146 )
Amortization of deferred launch incentives
    (14 )     (17 )     (41 )     (59 )
Restructuring and impairment charges
    (4 )     (13 )     (47 )     (17 )
Gain on business disposition
                252        
 
                       
Total operating income
  $ 215     $ 296     $ 943     $ 773  
 
                       
Total Assets by Segment (in millions)
                 
    September 30,     December 31,  
    2009     2008  
U.S. Networks
  $ 2,093     $ 1,840  
International Networks
    1,107       1,043  
Commerce, Education, and Other
    101       115  
Corporate
    7,440       7,486  
 
           
Total assets
  $ 10,741     $ 10,484  
 
           
     Total assets allocated to “Corporate” in the above table include the Company’s goodwill balance as the financial reports reviewed by the Company’s CODM do not include an allocation of goodwill to each reportable segment. Goodwill by reportable segment is disclosed in Note 7.
20. CONDENSED CONSOLIDATING FINANCIAL INFORMATION
     On August 12, 2009, Discovery Communications, LLC (“DCL”) issued debt securities that are fully and unconditionally guaranteed by the Company. The securities were issued under a Registration Statement on Form S-3 with the SEC (the “shelf registration”) to register certain securities, including debt securities of DCL and DCH that may be issued in the future with full and unconditional guarantees by the Company. DCL or DCH may in the future issue additional securities that are fully and unconditionally guaranteed by the Company under the shelf registration. Accordingly, set forth below is condensed consolidating financial information presenting the financial position, results of operations, and cash flows of (i) the Company, (ii) DCL, (iii) DCH, (iv) non-guarantor subsidiaries of DCL on a combined basis, (v) other non-guarantor subsidiaries of the Company on a combined basis, and (vi) the eliminations and reclassifications necessary to arrive at the information for the Company on a consolidated basis.
     DCL and the non-guarantor subsidiaries of DCL are the primary operating subsidiaries of the Company. DCL’s primary operations are the Discovery Channel and TLC in the U.S. The non-guarantor subsidiaries of DCL include most of the other U.S. networks and the international networks along with the commerce and education businesses.
     The non-guarantor subsidiaries of DCL are wholly owned subsidiaries of DCL with the exception of certain joint ventures and equity method investments. DCL is a wholly owned subsidiary of DCH. The Company wholly owns DCH through a 33 1/3% direct ownership interest and a 66 2/3% ownership interest through DHC. DHC is included in other non-guarantor subsidiaries of the Company. CSS is a wholly owned subsidiary of DHC.

32


 

DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
     Prior to the Newhouse Transaction, Advance/Newhouse owned 33 1/3% of DCH which is reported as a reduction of DHC’s Equity in earnings of subsidiaries in the Condensed Consolidating Statements of Operations for the three and nine months ended September 30, 2008.
     The supplemental condensed consolidating financial information should be read in conjunction with the consolidated financial statements of the Company.
     The existing indebtedness of DCL and DCH comprises substantially all of the indebtedness of the Company. The financial covenants of the respective debt agreements limit DCL and DCH from making distributions to the Company. The terms of DCL’s private senior notes restrict the cumulative payment of dividends over the life of the senior notes to an amount calculated based on the cumulative equity contributions and net income of DCL less the cumulative distributions to DCL’s owners. In addition, the terms of the DCH’s Term Loan B and Term Loan C allow DCH to pay dividends to the Company to the extent that DCH’s leverage ratio does not exceed 5 to 1 based upon defined measures of cash flows and indebtedness.
Basis of Presentation
     In accordance with the rules and regulations of the SEC, the equity method has been applied to (i) the Company’s interest in DCH and other non-guarantor subsidiaries, (ii) DCH’s interest in DCL, and (iii) DCL’s interest in non-guarantor subsidiaries. All intercompany balances and transactions have been eliminated. The Company’s bases in all subsidiaries, including goodwill and recognized intangible assets, have been “pushed-down” to the applicable subsidiaries.

33


 

DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
CONDENSED CONSOLIDATING BALANCE SHEET
September 30, 2009
(unaudited; in millions)
                                                         
                            Non-Guarantor                    
                            Subsidiaries of     Other Non-Guarantor           Discovery  
        Discovery         Discovery     Subsidiaries of     Reclassifications     Communications,  
    Discovery     Communications     Discovery     Communications,     Discovery     and     Inc. and  
    Communications, Inc.     Holdings, LLC     Communications, LLC     LLC     Communications, Inc.     Eliminations     Subsidiaries  
ASSETS
                                                       
Current assets:
                                                       
Cash and cash equivalents
  $     $     $ 305     $ 95     $ 1     $     $ 401  
Receivables, net
                360       402       14       (1 )     775  
Content rights, net
                15       61                   76  
Prepaid expenses and other current assets
    1             68       94       2             165  
 
                                         
Total current assets
    1             748       652       17       (1 )     1,417  
 
                                                       
Investment in and advances to subsidiaries
    8,483       8,006       4,166             6,455       (27,110 )      
Noncurrent content rights, net
                548       692             (15 )     1,225  
Property and equipment, net
                89       322       6             417  
Goodwill
                3,876       2,551       11             6,438  
Intangible assets, net
                385       268       1             654  
Other noncurrent assets
          49       438       277             (174 )     590  
 
                                         
Total assets
  $ 8,484     $ 8,055     $ 10,250     $ 4,762     $ 6,490     $ (27,300 )   $ 10,741  
 
                                         
 
                                                       
LIABILITIES, REDEEMABLE NON-CONTROLLING INTERESTS IN SUBSIDIARIES AND EQUITY        
Current liabilities:
                                                       
Accounts payable and accrued liabilities
  $ 41     $ 1     $ 159     $ 198     $ 8     $ (13 )   $ 394  
Current portion of long-term debt
          20       5       14                   39  
Other current liabilities
          38       116       175                   329  
 
                                         
Total current liabilities
    41       59       280       387       8       (13 )     762  
 
                                                       
Long-term debt
          1,933       1,460       79                   3,472  
Other noncurrent liabilities
                504       67       19       (174 )     416  
 
                                         
Total liabilities
    41       1,992       2,244       533       27       (187 )     4,650  
 
                                                       
Redeemable non-controlling interests in subsidiaries
                      49                   49  
 
                                                       
Intercompany contributions and advances between Discovery Communications, Inc. and subsidiaries
    2,415       2,552       2,680       5,154       1,650       (14,451 )      
Equity attributable to Discovery Communications, Inc.
    6,028       3,511       5,326       (982 )     4,813       (12,668 )     6,028  
 
                                         
Equity and advances attributable to Discovery Communications, Inc.
    8,443       6,063       8,006       4,172       6,463       (27,119 )     6,028  
Equity attributable to non-controlling interests
                      8             6       14  
 
                                         
Total equity
    8,443       6,063       8,006       4,180       6,463       (27,113 )     6,042  
 
                                         
Total liabilities, redeemable non-controlling interests in subsidiaries and equity
  $ 8,484     $ 8,055     $ 10,250     $ 4,762     $ 6,490     $ (27,300 )   $ 10,741  
 
                                         

34


 

DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
CONDENSED CONSOLIDATING BALANCE SHEET
December 31, 2008
(unaudited; in millions)
                                                         
                            Non-Guarantor                    
                            Subsidiaries of     Other Non-Guarantor           Discovery  
        Discovery         Discovery     Subsidiaries of     Reclassifications     Communications,  
    Discovery     Communications     Discovery     Communications,     Discovery     and     Inc. and  
    Communications, Inc.     Holdings, LLC     Communications, LLC     LLC     Communications, Inc.     Eliminations     Subsidiaries  
ASSETS
                                                       
Current assets:
                                                       
Cash and cash equivalents
  $     $     $ 13     $ 84     $ 3     $     $ 100  
Receivables, net
                369       415       12       (16 )     780  
Content rights, net
                13       60                   73  
Prepaid expenses and other current assets
    13       12       58       93             (20 )     156  
 
                                         
Total current assets
    13       12       453       652       15       (36 )     1,109  
 
                                                       
Investment in and advances to subsidiaries
    7,989       7,006       4,372             6,144       (25,511 )      
Noncurrent content rights, net
                533       640             (10 )     1,163  
Property and equipment, net
                90       301       4             395  
Goodwill
                4,142       2,738       11             6,891  
Intangible assets, net
                394       321       1             716  
Other noncurrent assets
          50       35       225       1       (101 )     210  
 
                                         
Total assets
  $ 8,002     $ 7,068     $ 10,019     $ 4,877     $ 6,176     $ (25,658 )   $ 10,484  
 
                                         
 
                                                       
LIABILITIES, REDEEMABLE NON-CONTROLLING INTERESTS IN SUBSIDIARIES AND EQUITY        
Current liabilities:
                                                       
Accounts payable and accrued liabilities
  $     $ 4     $ 242     $ 214     $     $ (39 )   $ 421  
Current portion of long-term debt
          15       431       12                   458  
Other current liabilities
          16       61       114       7       (7 )     191  
 
                                         
Total current liabilities
          35       734       340       7       (46 )     1,070  
 
                                                       
Long-term debt
          1,463       1,835       33                   3,331  
Other noncurrent liabilities
          53       444       58       19       (101 )     473  
 
                                         
Total liabilities
          1,551       3,013       431       26       (147 )     4,874  
 
                                                       
Redeemable non-controlling interests in subsidiaries
                      49                   49  
 
                                                       
Intercompany contributions and advances between Discovery Communications, Inc. and subsidiaries
    2,466       2,459       2,398       5,470       1,635       (14,428 )      
Equity attributable to Discovery Communications, Inc.
    5,536       3,058       4,608       (1,082 )     4,515       (11,099 )     5,536  
 
                                         
Equity and advances attributable to Discovery Communications, Inc.
    8,002       5,517       7,006       4,388       6,150       (25,527 )     5,536  
Equity attributable to non-controlling interests
                      9             16       25  
 
                                         
Total equity
    8,002       5,517       7,006       4,397       6,150       (25,511 )     5,561  
 
                                         
 
                                                       
Total liabilities, redeemable non-controlling interests in subsidiaries and equity
  $ 8,002     $ 7,068     $ 10,019     $ 4,877     $ 6,176     $ (25,658 )   $ 10,484  
 
                                         

35


 

DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
For the Three Months Ended September 30, 2009
(unaudited; in millions)
                                                         
                            Non-Guarantor                    
                            Subsidiaries of     Other Non-Guarantor           Discovery  
        Discovery         Discovery     Subsidiaries of     Reclassifications     Communications,  
    Discovery     Communications     Discovery     Communications,     Discovery     and     Inc. and  
    Communications, Inc.     Holdings, LLC     Communications, LLC     LLC     Communications, Inc.     Eliminations     Subsidiaries  
Revenues:
                                                       
Distribution
  $     $     $ 173     $ 253     $     $     $ 426  
Advertising
                187       154                   341  
Other
                22       52       17       (4 )     87  
 
                                         
Total revenues
                382       459       17       (4 )     854  
 
                                         
 
                                                       
Costs of revenues, excluding depreciation and amortization listed below
                80       164       15       (2 )     257  
Selling, general and administrative
    3             100       235       2       (2 )     338  
Depreciation and amortization
                13       26       1             40  
Restructuring and impairment charges
                      4                   4  
 
                                         
 
    3             193       429       18       (4 )     639  
 
                                         
 
                                                       
Operating (loss) income
    (3 )           189       30       (1 )           215  
 
                                                       
Equity in earnings of subsidiaries
    102       124       16             68       (310 )      
Interest expense, net
          (34 )     (31 )     (1 )                 (66 )
Other non-operating income (expense), net
                7       (1 )                 6  
 
                                         
 
                                                       
Income before income taxes
    99       90       181       28       67       (310 )     155  
Benefit from (provision for) income taxes
    2       12       (57 )     (12 )     1             (54 )
 
                                         
 
                                                       
Net income
    101       102       124       16       68       (310 )     101  
 
                                                       
Less net income attributable to non-controlling interests
                      (3 )           3        
 
                                         
Net income attributable to Discovery Communications, Inc.
    101       102       124       13       68       (307 )     101  
 
Stock dividends to preferred interests
    (6 )                                   (6 )
 
                                         
Net income available to Discovery Communications, Inc.
  $ 95     $ 102     $ 124     $ 13     $ 68     $ (307 )   $ 95  
 
                                         

36


 

DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
For the Three Months Ended September 30, 2008
(unaudited; in millions)
                                                         
                            Non-Guarantor                    
                            Subsidiaries of     Other Non-Guarantor           Discovery  
        Discovery         Discovery     Subsidiaries of     Reclassifications     Communications,  
    Discovery     Communications     Discovery     Communications,     Discovery     and     Inc. and  
    Communications, Inc.     Holdings, LLC     Communications, LLC     LLC     Communications, Inc.     Eliminations     Subsidiaries  
Revenues:
                                                       
Distribution
  $     $     $ 173     $ 246     $     $     $ 419  
Advertising
                176       158             (2 )     332  
Other
                19       59       19       (3 )     94  
 
                                         
Total revenues
                368       463       19       (5 )     845  
 
                                         
 
                                                       
Costs of revenues, excluding depreciation and amortization listed below
                97       153       14       (2 )     262  
Selling, general and administrative
                58       162       7       (3 )     224  
Depreciation and amortization
                16       35       (1 )           50  
Restructuring and impairment charges
                13                         13  
 
                                         
 
                184       350       20       (5 )     549  
 
                                         
 
                                                       
Operating income (loss)
                184       113       (1 )           296  
 
                                                       
Equity in earnings of subsidiaries
    134       156       61             55       (406 )      
Interest expense, net
          (26 )     (34 )     (1 )                 (61 )
Other non-operating (expense) income, net
                (6 )     (3 )     1             (8 )
 
                                         
 
Income from continuing operations before income taxes
    134       130       205       109       55       (406 )     227  
Benefit from (provision for) income taxes
          11       (49 )     (47 )     (8 )           (93 )
 
                                         
 
                                                       
Income from continuing operations, net of taxes
    134       141       156       62       47       (406 )     134  
Income from discontinued operations, net of taxes
                            40             40  
 
                                         
 
                                                       
Net income
    134       141       156       62       87       (406 )     174  
Less net income attributable to non-controlling interests
                                  (40 )     (40 )
 
                                         
Net income attributable to Discovery Communications, Inc.
  $ 134     $ 141     $ 156     $ 62     $ 87     $ (446 )   $ 134  
 
                                         

37


 

DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
For the Nine Months Ended September 30, 2009
(unaudited; in millions)
                                                         
                            Non-Guarantor                    
                            Subsidiaries of     Other Non-Guarantor           Discovery  
        Discovery         Discovery     Subsidiaries of     Reclassifications     Communications,  
    Discovery     Communications     Discovery     Communications,     Discovery     and     Inc. and  
    Communications, Inc.     Holdings, LLC     Communications, LLC     LLC     Communications, Inc.     Eliminations     Subsidiaries  
Revenues:
                                                       
Distribution
  $     $     $ 534     $ 743     $     $     $ 1,277  
Advertising
                569       442             (1 )     1,010  
Other
                63       160       53       (11 )     265  
 
                                         
Total revenues
                1,166       1,345       53       (12 )     2,552  
 
                                         
 
                                                       
Costs of revenues, excluding depreciation and amortization listed below
                260       469       44       (6 )     767  
Selling, general and administrative
    7             291       628       9       (6 )     929  
Depreciation and amortization
                38       80                   118  
Restructuring and impairment charges
                5       42                   47  
Gain on business disposition
                (252 )                       (252 )
 
                                         
 
    7             342       1,219       53       (12 )     1,609  
 
                                         
 
                                                       
Operating (loss) income
    (7 )           824       126                   943  
 
                                                       
Equity in earnings of subsidiaries
    409       466       89             273       (1,237 )      
Interest expense, net
          (90 )     (89 )     (4 )                 (183 )
Other non-operating income, net
                32       2                   34  
 
                                         
 
Income before income taxes
    402       376       856       124       273       (1,237 )     794  
Benefit from (provision for) income taxes
    3       33       (390 )     (37 )                 (391 )
 
                                         
 
                                                       
Net income
    405       409       466       87       273       (1,237 )     403  
Less net (income) loss attributable to non-controlling interests
                      (8 )           10       2  
 
                                         
Net income attributable to Discovery Communications, Inc.
    405       409       466       79       273       (1,227 )     405  
 
                                                       
Stock dividends to preferred interests
    (8 )                                   (8 )
 
                                         
Net income available to Discovery Communications Inc.
  $ 397     $ 409     $ 466     $ 79     $ 273     $ (1,227 )   $ 397  
 
                                         

38


 

DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
For the Nine Months Ended September 30, 2008
(unaudited; in millions)
                                                         
                            Non-Guarantor                      
                            Subsidiaries of     Other Non-Guarantor             Discovery  
        Discovery         Discovery     Subsidiaries of     Reclassifications     Communications,  
    Discovery     Communications     Discovery     Communications,     Discovery     and     Inc. and  
    Communications, Inc.     Holdings, LLC     Communications, LLC     LLC     Communications, Inc.     Eliminations     Subsidiaries  
Revenues:
                                                       
Distribution
  $     $     $ 523     $ 716     $     $     $ 1,239  
Advertising
                562       454             (2 )     1,014  
Other
                45       200       55       (14 )     286  
 
                                         
Total revenues
                1,130       1,370       55       (16 )     2,539  
 
                                         
 
                                                       
Costs of revenues, excluding depreciation and amortization listed below
                258       465       41       (6 )     758  
Selling, general and administrative
                248       585       22       (10 )     845  
Depreciation and amortization
                40       105       1             146  
Restructuring and impairment charges
                13       4                   17  
 
                                         
 
                559       1,159       64       (16 )     1,766  
 
                                         
 
                                                       
Operating income (loss)
                571       211       (9 )           773  
 
                                                       
Equity in earnings of subsidiaries
    211       399       101             125       (836 )      
Interest expense, net
          (77 )     (112 )     (7 )                 (196 )
Other non-operating expense, net
                      (4 )                 (4 )
 
                                         
 
Income from continuing operations before income taxes
    211       322       560       200       116       (836 )     573  
Benefit from (provision for) income taxes
          30       (161 )     (90 )     (64 )           (285 )
 
                                         
 
                                                       
Income from continuing operations, net of taxes
    211       352       399       110       52       (836 )     288  
Income from discontinued operations, net of taxes
                            42             42  
 
                                         
 
                                                       
Net income
    211       352       399       110       94       (836 )     330  
Less net income attributable to non-controlling interests
                                  (119 )     (119 )
 
                                         
Net income attributable to Discovery Communications, Inc.
  $ 211     $ 352     $ 399     $ 110     $ 94     $ (955 )   $ 211  
 
                                         

39


 

DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
For the Nine Months Ended September 30, 2009
(unaudited; in millions)
                                                         
                            Non-Guarantor                      
                            Subsidiaries of     Other Non-Guarantor             Discovery  
        Discovery         Discovery     Subsidiaries of             Communications,  
    Discovery     Communications     Discovery     Communications,     Discovery             Inc. and  
    Communications, Inc.     Holdings, LLC     Communications, LLC     LLC     Communications, Inc.     Eliminations     Subsidiaries  
Operating Activities
                                                       
Net income
  $ 405     $ 409     $ 466     $ 87     $ 273     $ (1,237 )   $ 403  
Adjustments to reconcile net income to cash provided by (used in) operating activities:
                                                       
Share-based compensation expense
    1             92       103                   196  
Depreciation and amortization
                38       80                   118  
Asset impairments
                26                         26  
Gain on business disposition
                (252 )                       (252 )
Gain on sale of securities
                (13 )                       (13 )
Equity in earnings of subsidiaries
    (409 )     (466 )     (89 )           (273 )     1,237        
Deferred income taxes
          (1 )     (30 )     (2 )                 (33 )
Other noncash expenses (income), net
          3       (63 )     86                   26  
Changes in operating assets and liabilities:
                                                       
Receivables, net
                10       (9 )     (1 )            
Accounts payable and accrued liabilities
    53       (4 )     (100 )     22       8             (21 )
Other, net
          12       (45 )     (50 )     (9 )           (92 )
 
                                         
Cash provided by (used in) operating activities
    50       (47 )     40       317       (2 )           358  
 
                                                       
Investing Activities
                                                       
Purchases of property and equipment
                (23 )     (18 )     (2 )           (43 )
Proceeds from business disposition
                300                         300  
Proceeds from sale of securities
                22                         22  
 
                                         
Cash provided by (used in) investing activities
                299       (18 )     (2 )           279  
 
Financing Activities
                                                       
Net repayments of revolver loans
                (315 )                       (315 )
Borrowings from long-term debt, net of discount and issuance costs
          478       492                         970  
Principal repayments of long-term debt
          (14 )     (993 )                       (1,007 )
Principal repayments of capital lease obligations
                (4 )     (3 )                 (7 )
Cash distribution to non-controlling interest
                      (9 )                 (9 )
Proceeds from stock option exercises
    26                                     26  
Intercompany (distributions) contributions
    (76 )     (417 )     773       (282 )     2              
Other financing activities, net
                      (1 )                 (1 )
 
                                         
Cash (used in) provided by financing activities
    (50 )     47       (47 )     (295 )     2             (343 )
Effect of exchange rate changes on cash and cash equivalents
                      7                   7  
 
                                         
Change in cash and cash equivalents
                292       11       (2 )           301  
Cash and cash equivalents, beginning of period
                13       84       3             100  
 
                                         
Cash and cash equivalents, end of period
  $     $     $ 305     $ 95     $ 1     $     $ 401  
 
                                         

40


 

DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
For the Nine Months Ended September 30, 2008
(unaudited; in millions)
                                                         
                            Non-Guarantor                      
                            Subsidiaries of     Other Non-Guarantor             Discovery  
        Discovery         Discovery     Subsidiaries of             Communications,  
    Discovery     Communications     Discovery     Communications,     Discovery             Inc. and  
    Communications, Inc.     Holdings, LLC     Communications, LLC     LLC     Communications, Inc.     Eliminations     Subsidiaries  
Operating Activities
                                                       
Net income
  $ 211     $ 352     $ 399     $ 110     $ 94     $ (836 )   $ 330  
Adjustments to reconcile net income to cash (used in) provided by operating activities:
                                                       
Share-based compensation benefit
                (18 )     (29 )                 (47 )
Depreciation and amortization
                40       106       49             195  
Gains on business dispositions
                            (67 )           (67 )
Gains on asset dispositions
                            (9 )           (9 )
Equity in earnings of subsidiaries
    (211 )     (399 )     (101 )           (125 )     836        
Deferred income taxes
          8       30       20       64             122  
Other noncash (income) expenses, net
          (1 )     (90 )     153                   62  
Changes in operating assets and liabilities, net of discontinued operations:
                                                       
Receivables, net
                4       (17 )     (16 )           (29 )
Accounts payable and accrued liabilities
          (14 )     (28 )     (21 )     45             (18 )
Other, net
                3       (103 )     (16 )           (116 )
 
                                         
Cash (used in) provided by operating activities
          (54 )     239       219       19             423  
 
                                                       
Investing Activities
                                                       
Purchases of property and equipment
                (19 )     (30 )     (35 )           (84 )
Net cash acquired from Newhouse Transaction
                      45                   45  
Business acquisitions, net of cash acquired
                      (8 )                 (8 )
Proceeds from asset dispositions
                            13             13  
Proceeds from business dispositions
                            126             126  
Proceeds from sales of securities
                            24             24  
 
                                         
Cash (used in) provided by investing activities
                (19 )     7       128             116  
 
                                                       
Financing Activities
                                                       
Ascent Media Corporation spin-off
                            (356 )           (356 )
Net borrowings from (repayments of) revolver loans
                2       (91 )                 (89 )
Principal repayments of long-term debt
          (11 )     (180 )                       (191 )
Principal repayments of capital lease obligations
                      (12 )                 (12 )
Intercompany contributions (distributions)
          65       (28 )     (37 )                  
Other financing activities, net
                (9 )     (1 )                 (10 )
 
                                         
Cash provided by (used in) financing activities
          54       (215 )     (141 )     (356 )           (658 )
Effect of exchange rate changes on cash and cash equivalents
                      2                   2  
Change in cash and cash equivalents
                5       87       (209 )           (117 )
Cash and cash equivalents of continuing operations, beginning of period
                            8             8  
Cash and cash equivalents of discontinued operations, beginning of period
                            201             201  
 
                                         
Cash and cash equivalents, end of period
  $     $     $ 5     $ 87     $     $     $ 92  
 
                                         

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ITEM 2. Management’s Discussion and Analysis of Results of Operations and Financial Condition.
     Management’s discussion and analysis of results of operations and financial condition is a supplement to and should be read in conjunction with the accompanying condensed consolidated financial statements and related notes. This information provides additional information regarding Discovery Communications, Inc.’s (“Discovery,” “Company,” “we,” “us,” or “our”) businesses, recent developments, results of operations, cash flows, financial condition, and critical accounting policies. Additional context can also be found in our Annual Report on Form 10-K for the year ended December 31, 2008 filed with the United States (“U.S.”) Securities and Exchange Commission (“SEC”) on February 26, 2009, as revised by the Current Report on Form 8-K filed with the SEC on June 16, 2009 (collectively, the “2008 Reports”).
CAUTIONARY NOTE CONCERNING FORWARD-LOOKING STATEMENTS
     Certain statements in this Quarterly Report on Form 10-Q constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including statements regarding our business, marketing and operating strategies, integration of acquired businesses, new service offerings, financial prospects, and anticipated sources and uses of capital. Words such as “anticipates,” “estimates,” “expects,” “projects,” “intends,” “plans,” “believes” and words and terms of similar substance used in connection with any discussion of future operating or financial performance identify forward-looking statements. Where, in any forward-looking statement, we express an expectation or belief as to future results or events, such expectation or belief is expressed in good faith and believed to have a reasonable basis, but there can be no assurance that the expectation or belief will result or be achieved or accomplished. The following include some but not all of the factors that could cause actual results or events to differ materially from those anticipated: continued deterioration in the macroeconomic environment; the inability of advertisers or affiliates to remit payment to us in a timely manner or at all; general economic and business conditions and industry trends including the timing of, and spending on, feature film, television and television commercial production; spending on domestic and foreign television advertising and spending on domestic and foreign first-run and existing content libraries; the regulatory and competitive environment of the industries in which we, and the entities in which we have interests, operate; continued consolidation of the broadband distribution and movie studio industries; uncertainties inherent in the development of new business lines and business strategies; integration of acquired operations; uncertainties associated with product and service development and market acceptance, including the development and provision of programming for new television and telecommunications technologies; changes in the distribution and viewing of television programming, including the expanded deployment of personal video recorders, video on demand and IP television and their impact on television advertising revenue; rapid technological changes; future financial performance, including availability, terms and deployment of capital; fluctuations in foreign currency exchange rates and political unrest in international markets; the ability of suppliers and vendors to deliver products, equipment, software and services; the outcome of any pending or threatened litigation; availability of qualified personnel; the possibility of an industry-wide strike or other job action affecting a major entertainment industry union, or the duration of any existing strike or job action; changes in, or failure or inability to comply with, government regulations, including, without limitation, regulations of the Federal Communications Commission, and adverse outcomes from regulatory proceedings; changes in the nature of key strategic relationships with partners and joint venturers; competitor responses to our products and services, and the products and services of the entities in which we have interests; threatened terrorist attacks and ongoing military action in the Middle East and other parts of the world; reduced access to capital markets or significant increases in costs to borrow; and a failure to secure affiliate agreements or renewal of such agreements on less favorable terms. For additional risk factors, refer to PART I., ITEM 1A. Risk Factors in our 2008 Reports. These forward-looking statements and such risks, uncertainties, and other factors speak only as of the date of this Quarterly Report, and we expressly disclaim any obligation or undertaking to disseminate any updates or revisions to any forward-looking statement contained herein, to reflect any change in our expectations with regard thereto, or any other change in events, conditions or circumstances on which any such statement is based.
BUSINESS OVERVIEW
     This section provides a general description of our business and business segments, as well as recent developments we believe are important in understanding our results of operations and financial condition or in understanding anticipated future trends.
     We are a leading global media and entertainment company that provides original and purchased programming across multiple distribution platforms in the U.S. and approximately 170 other countries, including television networks offering customized programming in 35 languages. Our strategy is to optimize the distribution, ratings and profit potential of each of our branded channels. Additionally, we own and operate a diversified portfolio of website properties and other digital services and develop and sell consumer and educational products as well as media sound services in the U.S. and internationally.
     Our media content is designed to target key audience demographics and the popularity of our programming creates a reason for advertisers to purchase commercial time on our channels. Audience ratings are a key driver in generating advertising revenue and creating demand on the part of cable television operators, direct-to-home (“DTH”) satellite operators and other content distributors to deliver our programming to their customers.
     In addition to growing distribution and advertising revenue for our branded channels, we are focused on growing revenue across new distribution platforms, including brand-aligned web properties, mobile devices, video-on-demand and broadband channels, which serve as additional outlets for advertising and affiliate sales, and provide promotional platforms for our programming. We also operate internet sites, such as HowStuffWorks.com, providing supplemental news, information and entertainment content that are aligned with our television programming.

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     We manage and report our operations in three segments: U.S. Networks; International Networks; and Commerce, Education, and Other.
U.S. Networks
     U.S. Networks is our largest segment, which owns and operates 11 cable and satellite channels, including Discovery Channel, TLC, and Animal Planet, as well as a portfolio of website properties and other digital services. U.S. Networks also provides distribution and advertising sales services for Travel Channel and distribution services for BBC America. U.S. Networks derives revenues primarily from distribution fees and advertising sales, which comprised 46% and 50%, respectively, of revenues for this segment for both the three and nine months ended September 30, 2009. During the three and nine months ended September 30, 2009, Discovery Channel, TLC, and Animal Planet collectively generated 78% and 77%, respectively, of U.S. Networks’ total revenues. U.S. Networks earns distribution fees under multi-year affiliation agreements with cable operators, DTH operators, and other distributors of television programming. Distribution fees are based on the number of subscribers receiving programming. Upon the launch of a new channel, we may initially pay distributors to carry such channel (such payments are referred to as “launch incentives”), or may provide the channel to the distributor for free for a predetermined length of time. Launch incentives are amortized on a straight-line basis as a reduction of revenues over the term of the affiliation agreement. U.S. Networks generates advertising revenues by selling commercial time on our networks and websites. The number of subscribers to our channels, the popularity of our programming, and our ability to sell commercial time over a group of channels are key drivers of advertising revenue.
     Several of our domestic networks, including Discovery Channel, TLC, and Animal Planet, are currently distributed to substantially all of the cable television and direct broadcast satellite homes in the U.S. Accordingly, the rate of growth in U.S. distribution revenue in future periods is expected to be less than historical rates. Our other U.S. Networks are distributed primarily on the digital tier of cable systems and equivalent tiers on DTH platforms and have been successful in maximizing their distribution within this more limited universe. There is, however, no guarantee that these digital networks will ever be able to gain the distribution levels or advertising rates of our major networks. Our contractual arrangements with U.S. distributors are renewed or renegotiated from time to time in the ordinary course of business.
     U.S. Networks’ largest single cost is the cost of programming, including production costs for original programming. U.S. Networks amortizes the cost of original or purchased programming based on the expected realization of revenue resulting in an accelerated amortization for Discovery Channel, TLC, and Animal Planet and straight-line amortization over three to five years for the remaining networks.
International Networks
     International Networks manages a portfolio of channels, led by the Discovery Channel and Animal Planet brands that are distributed in virtually every pay-television market in the world through an infrastructure that includes major operational centers in London, Singapore, and Miami. International Networks’ regional operations cover most major markets and are organized into four locally-managed regional operations: the United Kingdom (“U.K.”); Europe (excluding the U.K.), Middle East and Africa (“EMEA”); Asia-Pacific; and Latin America. International Networks currently operates over 100 unique distribution feeds in 35 languages with channel feeds customized according to language needs and advertising sales opportunities. Most of the segment’s channels are wholly-owned with the exception of the international Animal Planet channels, which are generally joint ventures in which the British Broadcasting Corporation (“BBC”) owns 50%, People+Arts, which operates in Latin America and Iberia as a 50-50 joint venture with the BBC, and several channels in Japan and Canada, which operate as joint ventures with strategically important local partners.
     International Networks’ strategies include maintaining a leadership position in nonfiction and certain fictional entertainment in international markets and continuing to grow and improve the performance of the international operations. These strategies will be achieved through increasing distribution, expanding local advertising sales capabilities, creating licensing and digital growth opportunities, and improving operating efficiencies by strengthening programming and promotional collaboration between U.S. Networks’ and International Networks’ groups.
     Similar to U.S. Networks, the primary sources of revenues for International Networks are distribution fees and advertising sales, and the primary cost is programming. International Networks executes a localization strategy by offering high quality shared programming with U.S. Networks, customized content, and localized schedules via our distribution feeds. For the three and nine months ended September 30, 2009, distribution revenues represented approximately 63% and 65% of the segment’s operating revenues, respectively.
     Advertising sales remain important to the segment’s financial success, representing 27% and 26% of the segment’s total revenues for the three and nine months ended September 30, 2009, respectively. International television markets vary in their stages of development. Some, notably the U.K., are more advanced digital multi-channel television markets, while others remain in the analog environment with varying degrees of investment from operators in expanding channel capacity or converting to digital.

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In developing pay television markets, we expect advertising revenue growth will result from subscriber growth, our localization strategy, and the shift of advertising spending from broadcast to pay television. In relatively mature markets, such as the U.K., the growth dynamic is changing. Increased market penetration and distribution are unlikely to drive rapid growth in those markets. Instead, growth in advertising sales will come from increasing viewership and advertising pricing on our existing pay television networks and launching new services, either in pay television or free television environments.
Commerce, Education, and Other
     Our commerce business engages with licensees, manufacturers, publishers and retailers to design, develop, publish, promote and sell a wide variety of products based on our intellectual property. We primarily engage in catalog sales and online distribution of products through DiscoveryStore.com. In April 2009, we changed our commerce business to a licensing model by outsourcing the commerce direct-to-consumer operations including our commerce website, related marketing, product development, and fulfillment to a third party in exchange for royalties. The new structure for our commerce business enables us to continue offering high quality DVD programming as well as many merchandise categories leveraging both licensed and make and sell products. Although we expect this new structure to facilitate growth in operating income, thereby providing for growth in profitability and reducing the financial risk of holding significant product inventories, we expect a reduction in top-line revenue contribution, as well as a reduction in direct operating expenses in 2009. Commerce will continue to grow our established brand and home video licensing businesses to further expand our national presence in key retailers.
     Our education business is focused on our domestic and international direct-to-school K-12 online streaming distribution subscription services, as well as our professional development services for teachers, benchmark student assessment services, and publishing hardcopy content through a network of distribution channels including online, catalog and dealers. Our education business also participates in a growing sponsorship, global brand, and content licensing business with leading non-profits, foundations, trade associations, and Fortune 500 companies.
     Other businesses primarily include sound, music, mixing sound effects, and other related services to major motion picture studios, independent producers, broadcast networks, cable channels, advertising agencies, and interactive producers.
Changes in Business
Newhouse Transaction
     Discovery was formed in connection with Discovery Holding Company (“DHC”) and Advance/Newhouse Programming Partnership (“Advance/Newhouse”) combining their respective ownership interests in Discovery Communications Holding, LLC (“DCH”) and exchanging those interests with and into Discovery, which was consummated on September 17, 2008 (the “Newhouse Transaction”). Prior to the Newhouse Transaction, DCH was a stand-alone private company, which was owned approximately 66 2/3% by DHC and 33 1/3% by Advance/Newhouse. The Newhouse Transaction was completed as follows:
  On September 17, 2008, DHC completed the spin-off to its shareholders of Ascent Media Corporation (“AMC”), a subsidiary holding the cash and businesses of DHC except for certain businesses that provide sound, music, mixing, sound effects, and other related services (the “AMC spin-off”). Such businesses remain with us following the completion of the Newhouse Transaction.
 
  On September 17, 2008, immediately following the AMC spin-off, DHC merged with a transitory merger subsidiary of Discovery, with DHC’s existing shareholders receiving common stock of Discovery; and
 
  On September 17, 2008, immediately following the exchange of shares between Discovery and DHC, Advance/Newhouse contributed its interests in DCH and Animal Planet to Discovery in exchange for shares of Discovery’s Series A and Series C convertible preferred stock that are convertible at any time into our common stock, which at the transaction date represented one-third of the outstanding shares of our common stock.
     As a result of the Newhouse Transaction, DHC and DCH became wholly-owned subsidiaries of Discovery, with Discovery becoming the successor reporting entity to DHC under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Because Advance/Newhouse was a one-third owner of DCH prior to the completion of the Newhouse Transaction and is a one-third owner of us immediately following completion of the Newhouse Transaction, there was no effective change in ownership. Our convertible preferred stock does not have any special dividend rights and only a de minimis liquidation preference. Additionally, Advance/Newhouse retains significant participatory special class voting rights with respect to certain matters that could be submitted to stockholder vote. Pursuant to guidance from the Financial Accounting Standards Board (“FASB”) on issues relating to accounting for business combinations, for accounting purposes the Newhouse Transaction was treated as a non-substantive merger, and therefore, the Newhouse Transaction was recorded at the investors’ historical bases. Refer to Note 1 to the accompanying condensed consolidated financial statements for further description of the Newhouse Transaction.
Hasbro-Discovery Joint Venture
     On May 22, 2009, we formed a 50-50 joint venture with Hasbro, Inc. (“Hasbro”) that will operate a television network and website

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dedicated to high-quality children’s and family entertainment and educational programming. In connection with the arrangement, Discovery contributed the Discovery Kids Network (“Discovery Kids”) to the joint venture. Additionally, Hasbro acquired a 50% ownership interest in the joint venture for a cash payment of $300 million and a tax receivables agreement collectible over 20 years valued at $57 million, which resulted in a total gain of $252 million. The rebranded network is scheduled to premiere in late 2010. Additional information regarding the joint venture is disclosed in Note 3 to the accompanying condensed consolidated financial statements.
RESULTS OF OPERATIONS
     This section provides an analysis of our results of operations for the three and nine months ended September 30, 2009 as compared to the three and nine months ended September 30, 2008. This analysis is provided on both a consolidated and segment basis. Additionally, we provide a brief description of significant transactions and events that impact the comparability of the results of operations being analyzed.
Changes in Basis of Presentation
     As described more fully in Note 2 to the accompanying condensed consolidated financial statements, certain of the 2008 financial information has been recast to reflect the adoption of the statement issued by the FASB on non-controlling interests in consolidated financial statements.
Items Impacting Comparability
     Beginning May 22, 2009, we ceased to consolidate the gross operating results of Discovery Kids. However, as we continue to be involved in the operations of the joint venture, we have not presented the financial position, results of operations, and cash flows of Discovery Kids recorded through May 21, 2009 as discontinued operations. Our interest in the joint venture is accounted for using the equity method of accounting. Accordingly, our consolidated results of operations include the gross operating results of Discovery Kids through May 21, 2009, whereas for subsequent periods we record only our proportionate share of the joint venture’s net operating results. Similarly, the results of operations for the U.S. Networks segment include the gross revenues and expenses of Discovery Kids through May 21, 2009, whereas for subsequent periods the segment’s results do not include the operating results for Discovery Kids. The following table presents total revenues and operating expenses recognized by Discovery for Discovery Kids prior to deconsolidation (in millions).
                         
    January 1, 2009   Three Months   Nine months
    through   ended   ended
    May 21, 2009   September 30, 2008   September 30, 2008
Revenues
  $ 19     $ 11     $ 31  
Operating costs and expenses
  $ 7     $ 6     $ 18  
     Our results of operations were also impacted by the effects of consolidating OWN, beginning in July 2008, and to a lesser extent the change in our commerce business model to a licensing model in April 2009. For the three and nine months ended September 30, 2009, OWN incurred operating expenses of $6 million and $19 million, respectively.

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Consolidated Results of Operations
     The following table presents our consolidated results of operations (in millions).
                                                 
    Three Months Ended             Nine Months Ended        
    September 30,             September 30,        
    2009     2008     % Change     2009     2008     % Change  
            (recast)                     (recast)          
Revenues:
                                               
Distribution
  $ 426     $ 419       2 %   $ 1,277     $ 1,239       3 %
Advertising
    341       332       3 %     1,010       1,014        
Other
    87       94       (7 )%     265       286       (7 )%
 
                                       
Total revenues
    854       845       1 %     2,552       2,539       1 %
 
                                       
 
                                               
Costs of revenues, excluding depreciation and amortization listed below
    257       262       (2 )%     767       758       1 %
Selling, general and administrative
    338       224       51 %     929       845       10 %
Depreciation and amortization
    40       50       (20 )%     118       146       (19 )%
Restructuring and impairment charges
    4       13       (69 )%     47       17     NM  
Gain on business disposition
              NM       (252 )         NM  
 
                                       
 
    639       549       16 %     1,609       1,766       (9 )%
 
                                       
 
                                               
Operating income
    215       296       (27 )%     943       773       22 %
 
                                               
Interest expense, net
    (66 )     (61 )     8 %     (183 )     (196 )     (7 )%
Other non-operating income (expense), net
    6       (8 )   NM       34       (4 )   NM  
 
                                       
 
                                               
Income from continuing operations before income taxes
    155       227       (32 )%     794       573       39 %
Provision for income taxes
    (54 )     (93 )     (42 )%     (391 )     (285 )     37 %
 
                                       
 
                                               
Income from continuing operations, net of taxes
    101       134       (25 )%     403       288       40 %
Income from discontinued operations, net of taxes
          40     NM             42     NM  
 
                                       
 
                                               
Net income
    101       174       (42 )%     403       330       22 %
Less net (income) loss attributable to non-controlling interests
          (40 )   NM       2       (119 )   NM  
 
                                       
Net income attributable to Discovery Communications, Inc.
    101       134       (25 )%     405       211       92 %
 
                                               
Stock dividends to preferred interests
    (6 )         NM       (8 )         NM  
 
                                       
Net income available to Discovery Communications, Inc. stockholders
  $ 95     $ 134       (29 )%   $ 397     $ 211       88 %
 
                                       
Amounts available to Discovery Communications, Inc. stockholders:
                                               
Income from continuing operations, net of taxes
  $ 95     $ 94       1 %   $ 397     $ 169     NM  
Income from discontinued operations, net of taxes
          40     NM             42     NM  
 
                                       
Net income
  $ 95     $ 134       (29 )%   $ 397     $ 211       88 %
 
                                       
 
                                               
Income per share from continuing operations available to Discovery Communications, Inc. stockholders, basic and diluted
  $ 0.22     $ 0.31             $ 0.94     $ 0.59          
 
                                               
Income per share from discontinued operations available to Discovery Communications, Inc. stockholders, basic and diluted
          0.13                     0.15          
 
                                       
 
Net income per share available to Discovery Communications, Inc. stockholders, basic and diluted
  $ 0.22     $ 0.44             $ 0.94     $ 0.74          
 
                                       
 
                                               
Weighted average number of shares outstanding:
                                               
Basic
    424       302               423       287          
 
                                       
Diluted
    427       302               424       287          
 
                                       
 
NM = not meaningful

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Revenues
     Distribution revenues increased $7 million and $38 million for the three and nine months ended September 30, 2009, respectively, as compared to distribution revenues for the corresponding periods in 2008. Increased distribution revenues were due primarily to higher revenues at the U.S. Networks segment, which were partially offset by decreases at the International Networks segment. The decreases at the International Networks segment were attributable to unfavorable impacts of foreign currency exchange rates of $12 million and $46 million for the three and nine months ended September 30, 2009, respectively, which were partially offset by an increase in paying subscribers.
     Advertising revenues increased $9 million for the three months ended September 30, 2009 as compared to advertising revenues for the same period in 2008. The increase in advertising revenues was principally due to an increase at the U.S. Networks segment, partially offset by a decrease at the International Networks segment. Advertising revenues decreased $4 million for the nine months ended September 30, 2009 as compared to advertising revenues for the same period in 2008. The decrease in advertising revenues was driven by a decrease at the International Networks segment, partially offset by an increase at the U.S. Networks segment.
     Other revenues, which primarily consist of sales of DVDs, merchandise, educational services and content, and sound and music services, decreased $7 million and $21 million for the three and nine months ended September 30, 2009, respectively, as compared with other revenues for the corresponding periods in 2008. The decrease in other revenues for the three months ended September 30, 2009 is primarily due to the conversion of our commerce business to a licensing model and declines in sales of hardcopy content in our education business, partially offset by an increase in online streaming distribution revenues in our education business. The decrease in other revenues for the nine months ended September 30, 2009 is principally from a decline in sales of the Planet Earth DVD series, which was partially offset by an increase from the online streaming distribution revenues in our education business.
Costs of Revenues
     Costs of revenues, which consist primarily of content amortization expense, production costs, and distribution costs, decreased $5 million and increased $9 million for the three and nine months ended September 30, 2009, respectively, when compared to the corresponding periods in 2008. The decrease for the three months ended September 30, 2009 was primarily due to $17 million of content impairment charges for TLC programs in the third quarter of 2008 and favorable impact of foreign currency exchange rates of $6 million, partially offset by higher content amortization expense due to a higher content asset base, reflecting our continued investment in content. The increase for the nine months ended September 30, 2009 was primarily due to higher content amortization expense, partially offset by a $34 million favorable impact from foreign currency exchange rates combined with the impact of the TLC content impairment in the third quarter of 2008.
Selling, General and Administrative
     Selling, general and administrative expenses, which are principally comprised of employee costs, marketing costs, occupancy, and back office support fees, increased $114 million and $84 million for the three and nine months ended September 30, 2009, respectively, as compared to the same periods in 2008. The increases for the three and nine month periods were due primarily to increased employee costs related to share-based compensation programs and the impact of consolidating OWN beginning in July 2008, which increased costs by $4 million and $17 million for the three and nine month periods, respectively. The increases were partially offset by lower marketing costs, consulting fees, and non-share-based employee costs, reflecting cost savings initiatives and improvements in operating efficiencies, combined with favorable impacts of foreign currency exchange rates of $15 million and $39 million for the three and nine month periods, respectively.
     Employee costs include share-based compensation expense arising from equity awards to employees under our incentive plans. Total share-based compensation expense was $98 million and $196 million for the three and nine months ended September 30, 2009, respectively, as compared to benefits of $65 million and $47 million for the corresponding periods in 2008. The increase in share-based compensation for the three and nine month periods primarily reflects an increase in the fair value of outstanding cash settled equity awards and to a lesser extent an increase in stock options outstanding. A portion of our equity awards are cash settled and, therefore, the value of such awards outstanding must be remeasured at fair value each reporting date based on changes in the price of our Series A common stock. Compensation expense for cash settled equity awards, including changes in fair value, was $91 million and $177 million for the three and nine months ended September 30, 2009, respectively, as compared to benefits of $65 million and $48 million for the similar periods in 2008. Increased compensation expense for cash settled awards for the three and nine month periods were due to an increase in fair value. Increases in fair value of cash settled awards were attributable to an increase in the price of our Series A common stock of 28% and 104% during the three and nine months ended September 30, 2009, respectively. We do not intend to grant additional cash-settled equity awards, except as may be required by contract or to employees in countries in which stock option awards are not permitted. We are evaluating our equity-based compensation program and considering changing our current mix of awards to include performance-based restricted stock unit grants.

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Depreciation and Amortization
     Depreciation and amortization expense decreased $10 million and $28 million for the three and nine months ended September 30, 2009, respectively, as compared to the depreciation and amortization expense for the corresponding periods in 2008. The decreases were due to a decline in amortization expense resulting from lower intangible asset balances in 2009 compared to the same periods in 2008.
Restructuring and Impairment Charges
     We recorded $26 million of impairment charges related to intangible assets and capitalized software during the nine months ended September 30, 2009, primarily for certain asset groups at our Other U.S. Networks reporting unit due to declines in expected operating performance. We also recorded exit and restructuring charges of $4 million and $21 million for the three and nine months ended September 30, 2009, respectively, in connection with a reorganization of portions of our operations to reduce our cost structure. The charges were primarily incurred by our International Networks and U.S. Networks segments as well as our corporate operations. The charges for the nine months ended September 30, 2009 include $19 million of severance costs and $2 million of contract termination costs. We expect the majority of these charges to be paid within the next year. We do not expect material future charges associated with these restructuring programs.
Gain on Business Disposition
     In connection with the formation of the Hasbro-Discovery Joint Venture, we recorded a $252 million gain, which included $127 million as a result of “stepping up” our basis for the 50% retained interest in Discovery Kids and $125 million for the sale of 50% of our ownership interest to Hasbro.
Interest Expense, Net
     Interest expense increased $5 million for the three months ended September 30, 2009 when compared to the same period in 2008 primarily due to an increase in the average effective interest rate on our borrowings. Interest expense decreased $13 million for the nine months ended September 30, 2009 when compared with the same period in 2008 primarily due to a decrease in average debt outstanding.
Other Non-Operating Income (Expense), Net
     Other non-operating income (expense), net includes our realized and unrealized gains and losses from derivative transactions that are not accounted for as hedging instruments, realized gains and losses from sale of available-for-sale securities, and other non-operating expenses net of non-operating income. We recognized other non-operating income (expense), net of $6 million and $34 million for the three and nine months ended September 30, 2009, respectively, and $(8) and $(4) million for the three and nine months ended September 30, 2008, respectively. We recognized net realized and unrealized gains on derivatives that are not designated as hedging instruments of $4 million and $13 million during the three and nine months ended September 30, 2009, respectively, and net realized and unrealized losses of $6 million and $4 million during the three and nine months ended September 30, 2008, respectively. In addition, during the nine month period we sold securities for $22 million, which resulted in a pre-tax gain of $13 million.
Provision for Income Taxes
     The provisions for income taxes were $54 million and $391 million for the three and nine months ended September 30, 2009, respectively, and $93 million and $285 million for the three and nine months ended September 30, 2008, respectively. The effective tax rates were 35% and 49% for the three and nine months ended September 30, 2009, respectively, and 41% and 50% for the three and nine months ended September 30, 2008. The effective tax rate for the nine months ended September 30, 2009 differed from the federal statutory rate of 35% due primarily to the permanent difference on the $125 million gain from the sale of 50% of our ownership interest in Discovery Kids and the $127 million gain as a result of “stepping up” our basis for the 50% retained interest in Discovery Kids in May 2009, and to a lesser extent state income taxes. We did not record a deferred tax liability of $48 million with respect to the portion of the outside basis in the Hasbro-Discovery venture attributable to nondeductible goodwill.
     The effective tax rate for the three and nine months ended September 30, 2008 differed from the federal statutory rate of 35% principally due to the presentation of the Newhouse Transaction as though it was consummated on January 1, 2008 in accordance with ASC 810. Accordingly, our condensed consolidated financial statements and notes include the gross combined financial results of both DHC and DCH since January 1, 2008. Prior to the Newhouse Transaction on September 17, 2008, DHC owned 66 2/3% of DCH and, therefore, recognized a portion of DCH’s operating results. As a result, the tax provision for the three and nine months ended September 30, 2008 includes the taxes recognized by both DCH and DHC related to the portion of DCH’s operating results recognized by DHC. DHC recognized $33 million and $85 million of deferred tax expense related to its investment in DCH prior to the Newhouse Transaction for the three and nine months ended September 30, 2008, respectively. The provision for income taxes for the three and nine months ended September 30, 2008 was partially offset by the release of an $18 million valuation allowance for deferred tax assets of CSS and the release of a $10 million valuation allowance for deferred tax assets related to net operating loss carry-forwards for AMC.

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Net (Income) Loss Attributable to Non-Controlling Interests
     Net (income) loss attributable to non-controlling interests represents the portion of net operating results allocable to the non-controlling partners, which was $2 million for the nine months ended September 30, 2009 and $(40) million and $(119) million for the three and nine months ended September 30, 2008, respectively. The amount for the three months ended September 30, 2009 was not significant. The decrease in net (income) loss attributable to non-controlling interests for 2009 is primarily a result of allocating a portion of DCH’s profits to Advance/Newhouse for its ownership interest in DCH for periods prior to the Newhouse Transaction.
Stock Dividends to Preferred Interests
     The Company recognized $6 million and $8 million of non-cash stock dividends for the release of preferred stock from escrow for the three and nine months ended September 30, 2009, respectively.
Income from Discontinued Operations, Net of Taxes
     In September 2008, as part of the Newhouse Transaction, DHC completed the spin-off to its shareholders of AMC, a subsidiary holding the cash and businesses of DHC, except for certain businesses that provide sound, music, mixing, sound effects and other related services. The AMC spin-off did not involve the payment of any consideration by the holders of DHC common stock and was structured as a tax free transaction. There was no gain or loss related to the spin-off.
     In September 2008, prior to the Newhouse Transaction, DHC sold its ownership interests in AMSTS and AccentHealth for approximately $7 million and $119 million, respectively, in cash. The sale of these companies resulted in pre-tax gains of $3 million for AMSTS and $64 million for AccentHealth. AMSTS and AccentHealth were components of the AMC business. It was determined that AMSTS and AccentHealth were non-core assets, and the sale of these companies was consistent with DHC’s strategy to divest non-core assets.
     In September 2008, prior to the Newhouse Transaction, DHC disposed of certain buildings and equipment for approximately $13 million in cash. DHC recognized a pre-tax gain of approximately $9 million in connection with the asset disposals. The disposed assets were part of the AMC business.
     As there is no continuing involvement in the operations of AMC, AMSTS, or AccentHealth, their results of operations and the gains from the business and asset dispositions are presented as Income from discontinued operations, net of taxes in the Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2008.
     The following table presents summary financial information for discontinued operations for the three and nine months ended September 30, 2008 (amounts in millions):
                 
    Three Months Ended   Nine Months Ended
    September 30,   September 30,
    2008   2008
Revenues
  $ 134     $ 482  
Loss from the operations of discontinued operations before income taxes
  $ (8 )   $ (6 )
Loss from the operations of discontinued operations, net of taxes
  $ (7 )   $ (5 )
Gains on dispositions, net of taxes
  $ 47     $ 47  
Income from discontinued operations, net of taxes
  $ 40     $ 42  
Segment Results of Operations
     We manage and report our operations in three segments: U.S. Networks; International Networks; and Commerce, Education, and Other. Corporate primarily consists of corporate functions, executive management, administrative support services, and ancillary revenues and expenses from a consolidated joint venture. Corporate expenses are excluded from segment results to enable executive management to evaluate segment performance based upon decisions made directly by segment executives. Operating results exclude mark-to-market share-based compensation, restructuring and impairment charges, and gains (losses) on asset dispositions, consistent with our segment reporting. Refer to Note 19 to the accompanying condensed consolidated financial statements for additional information related to our segments.

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     We evaluate the operating performance of our segments based on financial measures such as revenues and adjusted operating income before depreciation and amortization (“Adjusted OIBDA”). Adjusted OIBDA is defined as revenues less costs of revenues and selling, general and administrative expenses excluding: (i) mark-to-market share-based compensation, (ii) depreciation and amortization, (iii) amortization of deferred launch incentives, (iv) exit and restructuring charges, (v) impairment charges, and (vi) gains (losses) on business and asset dispositions. We use this measure to assess operating results and performance of our segments, perform analytical comparisons, identify strategies to improve performance and allocate resources to each segment. We believe Adjusted OIBDA is relevant to investors because it allows them to analyze the operating performance of each segment using the same metric management uses and also provides investors a measure to analyze the operating performance of each segment against historical data. We exclude mark-to-market share-based compensation, exit and restructuring charges, impairment charges, and gains (losses) on business and asset dispositions from the calculation of Adjusted OIBDA due to their volatility or non-recurring nature. We also exclude the amortization of deferred launch incentive payments because these payments are infrequent and the amortization does not represent cash payments in the current reporting period. Because Adjusted OIBDA is a non-GAAP measure, it should be considered in addition to, but not a substitute for, operating income, net income, cash flow provided by operating activities and other measures of financial performance reported in accordance with U.S. GAAP.
     The following table presents our revenues by segment and certain consolidated operating expenses, contra revenue amounts, and Adjusted OIBDA (in millions).
                                                 
    Three Months Ended             Nine Months Ended        
    September 30,             September 30,        
    2009     2008     % Change     2009     2008     % Change  
Revenues:
                                               
U.S. Networks
  $ 522     $ 498       5 %   $ 1,588     $ 1,526       4 %
International Networks
    293       300       (2 )%     831       864       (4 )%
Commerce, Education, and Other
    38       45       (16 )%     127       126       1 %
Corporate and intersegment eliminations
    1       2       (50 )%     6       23       (74 )%
 
                                       
Total revenues
    854       845       1 %     2,552       2,539       1 %
Costs of revenues (1)
    (257 )     (262 )     (2 )%     (767 )     (758 )     1 %
Selling, general and administrative (1)
    (247 )     (289 )     (15 )%     (752 )     (892 )     (16 )%
Add: Amortization of deferred launch incentives (2)
    14       17       (18 )%     41       59       (31 )%
 
                                       
Total Adjusted OIBDA
  $ 364     $ 311       17 %   $ 1,074     $ 948       13 %
 
                                       
 
(1)   Costs of revenues and selling, general and administrative expenses exclude depreciation and amortization, mark-to-market share-based compensation, exit and restructuring charges, gain on business dispositions, and impairments of intangible assets and capitalized software costs.
 
(2)   Amortization of deferred launch incentives are included in distribution revenues for U.S. GAAP reporting, but are excluded from Adjusted OIBDA.

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     The following table presents our Adjusted OIBDA by segment with a reconciliation of Adjusted OIBDA to consolidated operating income (in millions).
                                                 
    Three Months Ended             Nine Months Ended        
    September 30,             September 30,        
    2009     2008     % Change     2009     2008     % Change  
Adjusted OIBDA:
                                               
U.S. Networks
  $ 302     $ 257       18 %   $ 907     $ 811       12 %
International Networks
    110       103       7 %     298       280       6 %
Commerce, Education, and Other
    2       5       (60 )%     13       2     NM  
Corporate and intersegment eliminations
    (50 )     (54 )     7 %     (144 )     (145 )     1 %
 
                                       
Total adjusted OIBDA
    364       311       17 %     1,074       948       13 %
Gain on business disposition
              NM       252           NM  
Restructuring and impairment charges
    (4 )     (13 )     (69 )%     (47 )     (17 )   NM  
Mark-to-market share-based compensation (expense) benefit
    (91 )     65     NM       (177 )     47     NM  
Depreciation and amortization
    (40 )     (50 )     (20 )%     (118 )     (146 )     (19 )%
Amortization of deferred launch incentives
    (14 )     (17 )     (18 )%     (41 )     (59 )     (31 )%
 
                                       
Total operating income
  $ 215     $ 296       (27 )%   $ 943     $ 773       22 %
 
                                       
 
NM = not meaningful
U.S. Networks
     The following table presents, for our U.S. Networks segment, revenues by type, certain operating expenses, contra revenue amounts, Adjusted OIBDA, and a reconciliation of Adjusted OIBDA to operating income (in millions).
                                                 
    Three Months Ended             Nine Months Ended        
    September 30,             September 30,        
    2009     2008     % Change     2009     2008     % Change  
Revenues:
                                               
Distribution
  $ 242     $ 231       5 %   $ 737     $ 691       7 %
Advertising
    261       249       5 %     795       776       2 %
Other
    19       18       6 %     56       59       (5 )%
 
                                       
Total revenues
    522       498       5 %     1,588       1,526       4 %
Costs of revenues
    (125 )     (140 )     (11 )%     (382 )     (380 )     1 %
Selling, general and administrative
    (100 )     (107 )     (7 )%     (315 )     (361 )     (13 )%
Add: Amortization of deferred launch incentives
    5       6       (17 )%     16       26       (38 )%
 
                                       
Adjusted OIBDA
    302       257       18 %     907       811       12 %
Mark-to-market share-based compensation expense
          (1 )   NM       (1 )     (7 )     (86 )%
Restructuring and impairment charges
    (1 )     (13 )     (92 )%     (28 )     (13 )   NM  
Depreciation and amortization
    (7 )     (12 )     (42 )%     (23 )     (40 )     (43 )%
Gain on business disposition
              NM       252           NM  
Amortization of deferred launch incentives
    (5 )     (6 )     (17 )%     (16 )     (26 )     (38 )%
 
                                       
Operating income
  $ 289     $ 225       28 %   $ 1,091     $ 725       50 %
 
                                       
 
NM = not meaningful
Revenues
     Total revenues for the three and nine months ended September 30, 2009 increased $24 million and $62 million, respectively, as compared to total revenues for the corresponding periods in 2008. For the three and nine months ended September 30, 2009, the increases in total revenues were due primarily to increases in distribution revenues of $11 million and $46 million, respectively, and increases in advertising revenues of $12 million and $19 million, respectively. Other revenues for the three months ended September 30, 2009 increased $1 million while other revenues for the nine months ended September 30, 2009 decreased $3 million.
     Increased distribution revenues for the three month period were due to annual contractual rate increases and an increase in paying subscribers, principally for networks carried on the digital tier. These increases were partially offset by the effect of deconsolidating Discovery Kids in May 2009, which resulted in a decline of $10 million. Increased distribution revenues for the nine month period were due to annual contractual rate increases, an increase in paying subscribers, principally for networks carried on the digital tier, and

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a decline of $9 million for the amortization of launch incentives, excluding Discovery Kids. These revenue increases were partially offset by the effect of deconsolidating Discovery Kids in May 2009, which resulted in a decline of $10 million, and the absence of a one-time revenue correction recorded during the second quarter of 2008 that increased revenues $8 million.
     Advertising revenues for the three and nine month periods increased as a result of higher ratings. Also contributing to the increase for the nine month period was increased pricing. The increases for the three and nine month periods were partially offset by lower cash sellouts.
Costs of Revenues
     Costs of revenues, which consist primarily of content amortization expense, production costs, and distribution costs, decreased $15 million for the three months ended September 30, 2009 as compared to costs of revenues for the corresponding period in 2008. The decrease in costs of revenues was due principally to $17 million of content impairment charges recorded during the third quarter of 2008 related to the decision not to proceed with certain TLC programs following a change in management and strategy and a reduction of $4 million due to the effect of deconsolidating Discovery Kids. These decreases were partially offset by content impairments of $9 million in the third quarter of 2009 related to decisions not to proceed with certain content and an increase of $3 million in content amortization expense due to a higher content asset balance, reflecting our continued investment in content.
     Costs of revenues for the nine months ended September 30, 2009 increased $2 million as compared to costs of revenues for the same period in 2008. The increase in costs of revenues reflects an increase of $26 million in content amortization expense due to a higher content asset balance, reflecting our continued investment in content, partially offset by the $17 million of content impairment charges for TLC programs recorded during the third quarter of 2008 and a reduction of $7 million due to the effect of deconsolidating Discovery Kids.
Selling, General and Administrative
     Selling, general and administrative expenses, which are principally comprised of employee costs, marketing costs, research costs, and occupancy and back office support fees, decreased $7 million and $46 million for the three and nine months ended September 30, 2009, respectively, when compared to selling, general and administrative expenses for the similar periods in 2008. The decreases were attributable primarily to lower marketing costs and to a lesser extent overhead costs. Also contributing to the decline was the effect of deconsolidating Discovery Kids in May 2009, which resulted in declines of $2 million and $4 million for the three and nine months ended September 30, 2009, respectively. These decreases were partially offset by increased costs related to OWN, which is consolidated beginning in July 2008. Costs incurred related to OWN increased $4 million and $17 million for the three and nine months ended September 30, 2009, respectively.
Adjusted OIBDA
     Adjusted OIBDA increased $45 million for the three months ended September 30, 2009 as compared to Adjusted OIBDA for the corresponding period in 2008. The improved performance was primarily due to higher distribution and advertising revenues and lower costs of revenues and selling, general and administrative expenses.
     Adjusted OIBDA increased $96 million for the nine months ended September 30, 2009 as compared to Adjusted OIBDA for the corresponding period in 2008. The improvement in performance was primarily due to higher distribution and advertising revenues and lower selling, general and administrative expenses.
International Networks
     The following table presents, for our International Networks segment, revenues by type, certain operating expenses, contra revenue amounts, Adjusted OIBDA, and a reconciliation of Adjusted OIBDA to operating income (in millions).

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    Three Months Ended             Nine Months Ended        
    September 30,             September 30,        
    2009     2008     % Change     2009     2008     % Change  
Revenues:
                                               
Distribution
  $ 184     $ 188       (2 )%   $ 540     $ 548       (1 )%
Advertising
    80       83       (4 )%     215       238       (10 )%
Other
    29       29             76       78       (3 )%
 
                                   
Total revenues
    293       300       (2 )%     831       864       (4 )%
Costs of revenues
    (108 )     (95 )     14 %     (308 )     (292 )     5 %
Selling, general and administrative
    (84 )     (113 )     (26 )%     (250 )     (325 )     (23 )%
Add: Amortization of deferred launch incentives
    9       11       (18 )%     25       33       (24 )%
 
                                   
Adjusted OIBDA
    110       103       7 %     298       280       6 %
Restructuring and impairment charges
    (3 )         NM       (13 )         NM  
Depreciation and amortization
    (11 )     (12 )     (8 )%     (32 )     (32 )      
Amortization of deferred launch incentives
    (9 )     (11 )     (18 )%     (25 )     (33 )     (24 )%
 
                                   
Operating income
  $ 87     $ 80       9 %   $ 228     $ 215       6 %
 
                                   
 
NM = not meaningful
Revenues
     Total revenues for the three and nine months ended September 30, 2009 decreased $7 million and $33 million, respectively, as compared to total revenues for the corresponding periods in 2008. The decrease in total revenues was due primarily to unfavorable impacts of foreign currency exchange rates of $22 million and $88 million for the three and nine month periods, respectively. Excluding the unfavorable impacts of foreign currency exchange rates, total revenues increased 6% or $15 million and 7% or $55 million for the three and nine month periods, respectively.
     Distribution revenues decreased $4 million and $8 million for the three and nine months ended September 30, 2009, respectively, as compared to distribution revenues for the corresponding periods in 2008. The declines in distribution revenues were driven by unfavorable impacts of foreign currency exchange rates of $12 million and $46 million for the three and nine month periods, respectively. Excluding the unfavorable impacts of foreign currency exchange rates, distribution revenues increased 5% or $8 million and 8% or $38 million for the three and nine month periods, respectively. These increases were attributable to an increase in paying subscribers in Latin America and Asia-Pacific, which reflect the growth in pay television services in these regions. Additionally, the increase in distribution revenues for the nine month period was also attributable to an increase in paying subscribers in EMEA.
     Advertising revenues decreased $3 million and $23 million for the three and nine months ended September 30, 2009, respectively, as compared to advertising revenues for the corresponding periods in 2008. Decreased advertising revenues were due to unfavorable impacts of foreign currency exchange rates of $9 million and $35 million for the three and nine month periods, respectively. Excluding the unfavorable impacts of foreign currency exchange rates, advertising revenues increased 9% or $6 million and 6% or $12 million for the three and nine month periods, respectively. The increases were primarily due to growth in EMEA and Latin America, which reflects higher viewership combined with an increased subscriber base. In October 2009 we renewed an agreement with our advertising sales representative in the U.K., resulting in our ability to increase the monetization of our audience on a go-forward basis.
Costs of Revenues
     Costs of revenues, which consist primarily of content amortization expense, production costs, and distribution costs, increased $13 million and $16 million for the three and nine months ended September 30, 2009, respectively, as compared to costs of revenues for the corresponding periods in 2008. The increases in costs of revenues were net of favorable impacts of foreign currency exchange rates of $6 million and $34 million for the three and nine month periods, respectively. Excluding the favorable impacts of foreign currency exchange rates, costs of revenues increased 23% or $19 million and 20% or $50 million for the three and nine month periods, respectively. The increases were due primarily to higher content amortization expense and increased distribution costs, partially offset by a $6 million reduction in our music rights accrual related to a change in estimate in the third quarter of 2009. For the three and nine month periods, content amortization expense increased 8% or $4 million and 9% or $14 million, respectively, due to a higher content asset balance, reflecting our continued investment in original content production and language customization to support additional local feeds for growth in local advertising sales. Also contributing to higher content amortization expense for the three and nine month periods were increases of $7 million and $20 million, respectively, in impairment charges related to the decision not to proceed with certain content.
Selling, General and Administrative
     Selling, general and administrative expenses, which are principally comprised of employee costs, marketing costs, occupancy and back office support fees, decreased $29 million and $75 million for the three and nine months ended September 30, 2009, respectively, when compared to selling, general, and administrative expenses for the similar periods in 2008. For the three and nine month periods, there were favorable impacts of foreign currency exchange rates of $15 million and $39 million, respectively. Excluding the favorable impacts of foreign currency exchange rates, selling, general and administrative expenses declined 14% or $14 million and 13% or $36

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million for the three and nine month periods, respectively, due primarily to lower marketing and employee costs as a result of cost saving initiatives and improvements in operating efficiencies.
Adjusted OIBDA
     Adjusted OIBDA increased $7 million and $18 million for the three and nine months ended September 30, 2009, respectively, as compared to Adjusted OIBDA for the corresponding periods in 2008. Excluding the impacts of foreign exchange rate fluctuations, Adjusted OIBDA increased 10% or $9 million and 16% or $39 million, respectively. The improvement in performance reflects growth in distribution and advertising revenues and a decline in selling, general and administrative expenses, which were partially offset by increases in costs of revenues.
Commerce, Education, and Other
     The following table presents, for our Commerce, Education, and Other segment, revenues, certain operating expenses, Adjusted OIBDA, and a reconciliation of Adjusted OIBDA to operating income (loss) (in millions).
                                                 
    Three Months Ended             Nine Months Ended        
    September 30,             September 30,        
    2009     2008     % Change     2009     2008     % Change  
Revenues:
                                               
Other
  $ 38     $ 45       (16 )%   $ 127     $ 126       1 %
 
                                   
Total revenues
    38       45       (16 )%     127       126       1 %
Costs of revenues
    (24 )     (26 )     (8 )%     (76 )     (77 )     (1 )%
Selling, general and administrative
    (12 )     (14 )     (14 )%     (38 )     (47 )     (19 )%
 
                                   
Adjusted OIBDA
    2       5       (60 )%     13       2     NM  
Depreciation and amortization
    (2 )     (2 )           (4 )     (7 )     (43 )%
Restructuring charges
              NM       (1 )     (4 )     (75 )%
 
                                   
Operating income (loss)
  $     $ 3     NM     $ 8     $ (9 )   NM  
 
                                   
Revenues
     Total revenues for the three months ended September 30, 2009 decreased $7 million as compared to total revenues for the corresponding period in 2008 due to a $5 million decrease in commerce sales, reflecting the transition of our commerce business to a licensing model, a decrease in sound services, and a decline in sales of hardcopy education content. These decreases were partially offset by a $2 million increase in online streaming distribution revenues as a result of the continued migration from hardcopy to online distribution of our education content. Total revenues for the nine months ended September 30, 2009 increased $1 million as compared to total revenues for the same period in 2008 principally due to growth in online streaming distribution revenues, which was partially offset by a decrease in commerce sales, due to the transition of our commerce business to a licensing model, a decrease in sound services, and a decline in sales of hardcopy education content. We expect the transition of our commerce business to a licensing model will result in a reduction in our commerce revenues and direct operating expenses for the remainder of 2009.
Costs of Revenues
     Costs of revenues, which consist principally of content amortization expense, production costs, and royalty payments, decreased $2 million and $1 million for the three and nine months ended September 30, 2009, respectively, as compared to costs of revenues for the corresponding periods in 2008 primarily due to a reduction in direct operating costs as a result of the transition of our commerce business to a licensing model in the first quarter of 2009.
Selling, General and Administrative Expenses
     Selling, general and administrative expenses, which are principally comprised of employee costs, occupancy and back office support fees, decreased $2 million and $9 million for the three and nine months ended September 30, 2009, respectively, when compared to selling, general and administrative expenses for the corresponding periods in 2008 primarily due to cost reductions in the commerce business. The declines in expenses at the commerce business were attributable to lower employee costs as a result of the transition to a licensing model.
Adjusted OIBDA
     Adjusted OIBDA for the three months ended September 30, 2009 decreased $3 million as compared to Adjusted OIBDA for the corresponding period in 2008. The decrease primarily reflects lower results in sound services, partially offset by cost reductions from the transition of our commerce business to a licensing model.

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     Adjusted OIBDA for the nine months ended September 30, 2009 increased $11 million as compared to Adjusted OIBDA for the same period in 2008. The increase principally reflects higher results from the online streaming distribution revenues and cost reductions from the transition of our commerce business to a licensing model, partially offset by a decrease from the sound services business.
Corporate and Intersegment Eliminations
     The following table presents, for our unallocated corporate amounts, revenues, certain operating expenses, Adjusted OIBDA, and a reconciliation of Adjusted OIBDA to operating loss (in millions).
                                                 
    Three Months Ended             Nine Months Ended        
    September 30,             September 30,        
    2009     2008     % Change     2009     2008     % Change  
Revenues:
                                               
Other
  $ 1     $ 2       (50 )%   $ 6     $ 23       (74 )%
 
                                   
Total revenues
    1       2       (50 )%     6       23       (74 )%
Costs of revenues
          (1 )   NM       (1 )     (9 )     (89 )%
Selling, general and administrative
    (51 )     (55 )     (7 )%     (149 )     (159 )     (6 )%
 
                                   
Adjusted OIBDA
    (50 )     (54 )     7 %     (144 )     (145 )     1 %
Mark-to-market share-based compensation (expense) benefit
    (91 )     66     NM       (176 )     54     NM  
Depreciation and amortization
    (20 )     (24 )     (17 )%     (59 )     (67 )     (12 )%
Restructuring charges
              NM       (5 )         NM  
 
                                   
Operating loss
  $ (161 )   $ (12 )   NM     $ (384 )   $ (158 )   NM  
 
                                   
 
NM = not meaningful
     Corporate primarily consists of corporate functions, executive management, administrative support services, and ancillary revenues and expenses from a consolidated joint venture. Consistent with our segment reporting, corporate expenses are excluded from segment results to enable executive management to evaluate business segment performance based upon decisions made directly by business segment executives.
     Corporate revenues for the three and nine months ended September 30, 2009 decreased $1 million and $17 million, respectively, when compared with the corresponding periods in 2008, primarily due to decreased ancillary revenues from a consolidated joint venture, whose primary sales were of the Planet Earth DVD. Corporate selling, general and administrative expenses decreased $4 million and $10 million for the three and nine months ended September 30, 2009, respectively, driven by lower consulting costs.
LIQUIDITY AND CAPITAL RESOURCES
     This section provides a description of our primary sources and uses of cash, as well as significant transactions affecting liquidity, for the nine months ended September 30, 2009 as compared to the nine months ended September 30, 2008.
Sources of Cash
     Our principal sources of liquidity are cash and cash equivalents on hand, cash flows from operations, proceeds from business dispositions, available borrowing capacity under our revolving credit facility, and access to capital markets. We anticipate that our existing cash and cash equivalents on hand and cash generated by or available to the Company should be sufficient to meet our anticipated cash requirements for at least the next twelve months.
     As of September 30, 2009, we had approximately $2.0 billion of total liquidity, comprised of $401 million of cash and cash equivalents on hand and the ability to borrow approximately $1.6 billion under our revolving credit facility.
Operating Activities
     For the nine months ended September 30, 2009, our cash provided by operating activities was $358 million, as compared to $423 million for the same period in 2008, driven by a decrease in cash provided by working capital primarily due to cash paid for income taxes of $362 million and $144 million for the nine months ended September 30, 2009 and 2008, respectively. The increase for the nine months ended September 30, 2009 was primarily due to higher operating income and $81 million in taxes paid related to the sale of our 50% interest in Discovery Kids. Cash taxes are expected to be approximately $475 million for 2009.

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Investing Activities
     Cash provided by investing activities for the nine months ended September 30, 2009 was $279 million compared to $116 million during the corresponding period in 2008. The increase primarily reflects $300 million we received from Hasbro in exchange for a 50% ownership interest in a new joint venture that operates the Discovery Kids business and a decrease in capital expenditures of $41 million.
Financing Activities
     At September 30, 2009, our committed debt facilities included two term loans, a revolving credit facility, and various senior notes. Total commitments under these facilities were $5.0 billion at September 30, 2009, of which $3.4 billion of indebtedness was outstanding under these facilities at September 30, 2009, providing additional borrowing capacity of $1.6 billion.
     On August 19, 2009, DCL issued $500 million aggregate principal amount of 5.625% Senior Notes maturing on August 15, 2019 (the “August 2019 Notes”). The August 2019 Notes were issued in an underwritten public offering at a price of 99.428% of the principal amount. DCL received net proceeds of $492 million from the offering after deducting the issuance discount of $3 million and issuance expenses of $5 million recorded as deferred financing costs. DCL used the net proceeds of the offering to repay $428 million of indebtedness outstanding under its Term Loan A, prior to final maturity on October 31, 2010. The remaining proceeds will be used for general corporate purposes.
     DCL may, at its option, redeem some or all of the August 2019 Notes at any time by paying a make-whole premium, plus accrued and unpaid interest, if any, to the date of repurchase. Interest on the August 2019 Notes is payable on August 15 and February 15 of each year, beginning on February 15, 2010. The August 2019 Notes are unsecured and rank equally in right of payment with all of DCL’s other unsecured senior indebtedness. The August 2019 Notes are fully and unconditionally guaranteed on an unsecured and unsubordinated basis by Discovery.
     On May 14, 2009, DCH entered into Credit Agreement Supplement No. 1 (“Term Loan C”) to its Term Loan B with Bank of America N.A. (as administrative agent and lender). Pursuant to Term Loan C, DCH incurred $500 million of indebtedness, which matures on May 14, 2014. DCH received net proceeds of $478 million from the borrowing after deducting issuance expenses of $12 million recorded as a discount and $10 million of expenses recorded as deferred financing costs. DCH used the net proceeds of the borrowing to repay $163 million and $315 million of indebtedness outstanding under DCL’s Term Loan A and the revolving credit facility, respectively.
     The Term Loan C indebtedness is repayable in equal quarterly installments of $1.25 million beginning June 30, 2009 through March 31, 2014, with the balance due on the maturity date. Term Loan C bears interest at an initial rate of LIBOR plus an applicable margin of 3.25%, with a LIBOR floor of 2.00%, which was 5.25% at September 30, 2009. From May 14, 2009 through September 30, 2009, the weighted average effective interest rate for Term Loan C was 6.03%.
     We currently hold fixed rate swaps that economically hedge the interest rate risk on all of our outstanding variable rate debt. The anticipated interest payments, together with the scheduled principal payments, due over the next year are within the available capacity on our committed facilities. Although we have adequate liquidity to fund our operations and to meet our debt service obligations over the next twelve months, we may seek to arrange new financing.
     Term Loan B and Term Loan C are secured by DCH’s assets, excluding assets held by its subsidiaries. The revolving credit facility and senior notes are unsecured. The debt facilities contain covenants that require the respective borrowers to meet certain financial ratios and place restrictions on the payment of dividends, sale of assets, additional borrowings, mergers, and purchases of capital stock, assets and investments. We were compliant with all debt covenants as of September 30, 2009 and have sufficient excess capacity to draw on existing debt commitments or incur additional debt.
Uses of Cash
     Our primary uses of cash include the creation and acquisition of new content, commitments to equity affiliates, and debt and related interest payments. We expect our cash used to acquire content to continue to increase as we continue to invest in high quality programming.
Financing Activities
     During the nine months ended September 30, 2009, $343 million of cash was used in financing activities as compared to $658 million used during the similar period in 2008. Our primary use of cash for financing activities during 2009 was principal payments under our debt facilities totaling $1.3 billion. This outflow was partially offset by $970 million in net cash proceeds from Term Loan C and the August 2019 Notes discussed previously. During the nine months ended September 30, 2008, our primary uses of cash for financing activities were $356 million in cash dispersed in connection with the spinoff of Ascent Media Corporation and principal repayments of $280 million under our debt facilities.

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     In 2009, we expect our uses of cash to include a minimum of $1.3 billion for debt repayments, between $240 million and $260 million for interest expense, and $50 million to $55 million for capital expenditures. Additionally, we expect to make approximately $80 million in payments to settle vested employee cash settled equity awards. Actual amounts expensed and payable for cash settled equity awards are dependent on future calculations of fair value which are primarily affected by changes in our stock price, changes in the number of awards outstanding, and changes to the plan.
     On July 23, 2008, we formed a 50-50 joint venture with Oprah Winfrey and Harpo, Inc. Pursuant to the venture agreement, Discovery is committed to loan up to $100 million to the venture through September 30, 2011 to fund operations, of which $27 million has been funded as of September 30, 2009. We anticipate that approximately one-third of the funding obligation will be paid in 2009. To the extent that funding the joint venture in excess of $100 million is necessary, we may provide additional funds through a member loan or require the joint venture to seek third party financing. We expect to recoup the entire amount contributed in future periods provided that the joint venture is profitable and has sufficient funds to repay us. We are currently discussing with Harpo a number of matters regarding OWN Network, including digital strategy, the programming and development pipeline, and timing of the launch of the network.
Factors Affecting Liquidity and Capital Resources
     If we were to experience a significant decline in operating performance, or have to meet an unanticipated need for additional liquidity beyond our available commitments, there is no certainty that we would be able to access the needed liquidity. While we have established relationships with U.S. and international banks and investors which continue to participate in our various credit agreements, the current state of the credit markets may cause some lenders to have to reduce or withdraw their commitments if we were to seek to negotiate a refinancing or an increase in our total commitments. Covenants in existing debt agreements may constrain our capacity for additional debt or there may be significant increases in costs to refinance existing debt to access additional liquidity. As a public company, we may have access to other sources of capital such as the public bond and equity markets. However, access to sufficient liquidity in these markets is not assured given our substantial debt outstanding and the continued volatility in the equity markets and further tightening in the credit markets.
     On June 17, 2009, we filed a Registration Statement on Form S-3 (“shelf registration”) with the SEC in which we registered securities, including debt securities, common stock, and preferred stock. The August 2019 Notes were issued under this shelf registration. While we are not required to issue additional securities under this shelf registration, we may issue additional securities at a future date.
     Our access to capital markets can be affected by factors outside of our control. In addition, our cost to borrow is impacted by market conditions and our financial performance as measured by certain credit metrics defined in our credit agreements, including interest coverage and leverage ratios.
     We and the BBC have formed several cable and satellite television network joint ventures to develop and distribute programming content. Under the terms of our agreements with the BBC, it has the right, every three years starting December 31, 2002, to require us to purchase its ownership interests in those joint ventures. Due to the complexities of the redemption formula, we have accrued the value of the redemption, or put right, at approximately $49 million. We are currently discussing with the BBC potential revisions to all of our contractual relationships, including the ownership of the joint ventures. While there can be no assurance that these or other negotiations would result in a definitive agreement, we expect that the cost of a negotiated acquisition of the BBC’s interests in the joint ventures could substantially exceed the value of the put right.
     We expect to have sufficient cash flow from operations through the remainder of 2009, combined with $401 million of cash on hand at September 30, 2009, to meet remaining mandatory principal repayments of $5 million, interest payments, expected capital expenditures, and approximately $60 million in payments to settle vested employee cash settled equity awards. In addition, we have $1.6 billion of available capacity on our existing revolving credit facility if our cash flow from operations is less than anticipated.
     We are compliant with all debt covenants and have sufficient excess capacity to draw on existing debt commitments or incur additional debt. We have no indication that any of our lenders would be unable to perform under the requirements of our credit agreements should we seek additional funding. Although our leverage and interest coverage covenants limit the total amount of debt we might incur relative to our operating cash flow, we expect we would continue to maintain compliance with our debt covenants with a 50% reduction in our current operating performance.
     Capital expenditures of $102 million for the year ended December 31, 2008 included the investment in building improvements,

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broadcast equipment, computer hardware/software, and office furniture/equipment, including $35 million related to AMC, which was spun off in September 2008. Therefore, capital expenditures of continuing operations in 2008 were $67 million. We expect capital expenditures to be between $50 million and $55 million during 2009.
Contractual Obligations
     We have agreements for leases of satellite transponders, facilities and equipment. These agreements expire at various dates through 2028. We are obligated to license programming under agreements with content suppliers that expire over various dates. We also have other contractual commitments arising in the ordinary course of business.
Off-Balance Sheet Arrangements
     We have no material off-balance sheet arrangements, as defined in Item 303(a)(4) of Regulation S-K, that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
     The preparation of our financial statements in conformity with U.S. GAAP requires management to make estimates, judgments and assumptions that affect the amounts reported in the condensed consolidated financial statements and accompanying notes. On an ongoing basis, we evaluate estimates, which are based on historical experience and on various other assumptions believed reasonable under the circumstances. The results of these evaluations form the basis for making judgments about the carrying values of assets and liabilities and the reported amount of expenses that are not readily apparent from other