10-K
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-K

 

 

 

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2009

OR

 

¨ 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: 1-34177

 

 

DISCOVERY COMMUNICATIONS, INC.

(Exact name of Registrant as specified in its charter)

 

 

 

Delaware   35-2333914

(State or other jurisdiction of

incorporation or organization)

 

(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)

 

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of Each Class

  

Name of Each Exchange on Which Registered

Series A Common Stock, $0.01 par value    Nasdaq Global Select Market
Series B Common Stock, $0.01 par value    Nasdaq Global Select Market
Series C Common Stock, $0.01 par value    Nasdaq Global Select Market

Securities registered pursuant to Section 12(g) of the Act:

None

 

 

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  x     No  ¨

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x

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  x    No  ¨

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  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§232.405 of this chapter) is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

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   x    Accelerated filer   ¨
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)    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  ¨    No  x

The aggregate market value of voting and non-voting common stock held by nonaffiliates of the Registrant computed by reference to the last sales price of such stock, as of the last business day of the Registrant’s most recently completed second fiscal quarter, which was June 30, 2009, was approximately $5.7 billion.

The number of shares outstanding of each of the Registrant’s classes of common stock as of February 11, 2010 was:

 

Series A Common Stock, $0.01 par value

   135,226,377

Series B Common Stock, $0.01 par value

   6,589,084

Series C Common Stock, $0.01 par value

   141,711,350

DOCUMENTS INCORPORATED BY REFERENCE

Certain information required in Item 10 through Item 14 of Part III of this Annual Report on Form 10-K is incorporated herein by reference to the Registrant’s definitive Proxy Statement for its 2010 Annual Meeting of Stockholders, which shall be filed with the Securities and Exchange Commission pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended, within 120 days of the Registrant’s fiscal year end.

 

 

 


Table of Contents

DISCOVERY COMMUNICATIONS, INC.

TABLE OF CONTENTS

 

              Page

PART I

  
 

ITEM 1.

   Business    3
 

ITEM 1A.

   Risk Factors    16
 

ITEM 1B.

   Unresolved Staff Comments    23
 

ITEM 2.

   Properties    24
 

ITEM 3.

   Legal Proceedings    24
 

ITEM 4.

   Submission of Matters to a Vote of Security Holders    24

PART II

  
 

ITEM 5.

   Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities    26
 

ITEM 6.

   Selected Financial Data    27
 

ITEM 7.

   Management’s Discussion and Analysis of Results of Operations and Financial Condition    30
 

ITEM 7A.

   Quantitative and Qualitative Disclosures About Market Risk    62
 

ITEM 8.

   Financial Statements and Supplementary Data    63
 

ITEM 9.

   Changes in and Disagreements With Accountants on Accounting and Financial Disclosure    127
 

ITEM 9A.

   Controls and Procedures    127
 

ITEM 9B.

   Other Information    127

PART III

  
 

ITEM 10.

   Directors, Executive Officers and Corporate Governance    127
 

ITEM 11.

   Executive Compensation    128
 

ITEM 12.

   Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters    128
 

ITEM 13.

   Certain Relationships and Related Transactions, and Director Independence    128
 

ITEM 14.

   Principal Accountant Fees and Services    128

PART IV

  
 

ITEM 15.

   Exhibits and Financial Statement Schedules    128

SIGNATURES

   161

 


Table of Contents

PART I

 

ITEM 1. Business.

Overview

Discovery Communications, Inc. (“Discovery”, “we”, “us” or “our”) is a leading global media and entertainment company. We were formed on September 17, 2008, 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. Prior to September 17, 2008, DCH was a stand-alone private company, which was owned approximately 66 2/3% by DHC and 33 1/3% by Advance/Newhouse. As a result of this transaction we became the successor reporting entity to DHC under the Securities Exchange Act of 1934, as amended.

As one of the world’s largest nonfiction media companies, we provide original and purchased programming across multiple distribution platforms in the United States (“U.S.”) and more than 170 other countries. Led by the flagship Discovery Channel, one of the first nonfiction cable networks and our most widely distributed global brand, Discovery enables people to explore the world and satisfy their curiosity through more than 100 worldwide networks offering customized programming in 38 languages. In addition to Discovery Channel, our global portfolio includes prominent television brands such as TLC, Animal Planet, Science Channel, Investigation Discovery, Planet Green, Discovery Travel and Living, Discovery Home and Health and HD Theater, as well as leading consumer and educational products and services, and a diversified portfolio of digital media services including HowStuffWorks.com.

Our media content spans genres including science, exploration, survival, natural history, sustainability of the environment, technology, anthropology, paleontology, history, space, archaeology, health and wellness, engineering, adventure, lifestyles and current events. This type of programming tends to be culturally neutral and maintains its relevance for an extended period of time. As a result, our content translates well across international borders and is made even more accessible through extensive use of dubbing and subtitles in local languages, as well as the creation of local programming tailored to individual market preferences.

Our content is designed to target key audience demographics and the popularity of our programming offers a reason for advertisers to purchase time on our channels. Our 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.

We have an extensive library of programming and footage that provides a source of content for creating new services and launching into new markets and onto new platforms. Generally, we own most or all rights to the majority of this programming and footage, which enables us to exploit our library to launch new brands and services into new markets quickly without significant incremental spending. Our programming can be re-edited and updated in a cost-effective manner to provide topical versions of subject matter that can be utilized around the world.

In addition to growing distribution and advertising revenue for our branded channels, we are focused on extending content distribution across new distribution platforms, including brand-aligned web properties, mobile devices, video-on-demand and broadband channels, which provide promotional platforms for our television programming and serve as additional outlets for advertising and affiliate sales. We also operate internet sites including HowStuffWorks.com, Petfinder.com, and Treehugger.com that provide supplemental news, information and entertainment aligned with our television programming.

We also are utilizing our programming assets to take advantage of the growing demand for high definition (“HD”) programming in the U.S. and throughout the world. In 2009, we provided HD simulcasts of six of our U.S. Networks (Discovery Channel, TLC, Animal Planet, Science Channel, Investigation Discovery and Planet Green), in addition to our stand-alone U.S. HD Theater channel. In 2009, we also expanded our international HD operations to include HD channels (Discovery HD, Animal Planet HD and TLC HD) in 61 markets outside of the U.S., making us one of the leading international providers of HD programming, based on the number of markets we serve. We believe we are well positioned to take advantage of the accelerating growth in sales of HD televisions and the expanding distribution of HD channels around the world. Where we operate HD simulcasts of our networks, we also benefit from the ability to aggregate standard and HD audiences for advertising sales purposes. In January 2010, we announced our intent to form a joint venture with Sony Corporation and IMAX Corporation to launch a 24-hours-a-day, 7-days-a-week, three-dimensional (“3-D”) channel in the U.S., positioning us to capitalize on the recent success of 3-D feature films and projected growth in sales of 3-D television sets.

Our strategy is to deliver sustainable long-term growth through the development of high-quality media brands that build consumer viewership, optimize distribution revenue and capture advertising sales. In addition, we are focused on maximizing the overall efficiency and effectiveness of our global operations through collaboration and innovation across operating units and regions around the world, and across all television and digital media.

 

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In line with this strategy, our specific priorities include:

 

   

Maintaining our focus on creative excellence in nonfiction programming and expanding the portfolio’s brand entitlement by developing compelling content that promotes audience growth, builds advertising relationships and has global utility.

 

   

Leveraging our distribution strength in the U.S. — with three channels each reaching more than 95 million subscribers in the U.S. and Canada and five channels each reaching between 50 million and 75 million subscribers in the U.S. and Canada — to create or reposition additional branded channels and businesses that can sustain long-term growth and occupy a desired programming niche with strong consumer appeal.

 

   

Increasing the value of our distribution strength outside of the U.S. – with at least two channels in more than 170 countries around the world – to maintain a leadership position in nonfiction entertainment in international markets and build additional branded channels and businesses that can sustain long-term growth. This includes expanding local advertising sales capabilities, creating licensing and digital growth opportunities, utilizing broadcast and other additional distribution opportunities in select markets, and leveraging operating efficiencies through development and promotional collaboration between the U.S. Networks and International Networks segments.

 

   

Developing and growing compelling content experiences on new platforms that are aligned with our core branded channels. Specifically, extending ownership of nonfiction entertainment to new platforms and technologies around the world to satisfy viewers’ curiosity and enhance the consumer entertainment experience, provide new cross-platform sales and promotional opportunities with our television networks, and create additional reach for our content by leveraging the economies realized through programs that can be produced once and used often in both long-term and short-term formats.

Recent Developments

Accounting for Variable Interest Entities

Effective January 1, 2010, we adopted the Financial Accounting Standards Board’s (“FASB”) statement amending the accounting for interests in a variable interest entity (“VIE”). Pursuant to the adoption of this statement, beginning January 1, 2010, we will no longer consolidate the Oprah Winfrey Network (“OWN”) and Animal Planet Japan (“APJ”) joint ventures and will account for our interest in these entities under the equity method of accounting. However, we continued to consolidate OWN and APJ through December 31, 2009. Accordingly, the financial information in this Annual Report on Form 10-K includes the financial position and operating results of OWN and APJ for 2009 and 2008. Beginning in 2010, we will apply the provisions of the new statement retrospectively to financial information for all periods presented by recasting prior period results to conform to the new presentation. Additional financial information related to OWN and APJ as well as the impact of adopting the new statement is set forth in Item 7 and Note 2 to the accompanying consolidated financial statements in Item 8 of this Annual Report on Form 10-K.

Reportable Segments

Effective January 1, 2010, we realigned the Discovery Commerce business from the Commerce, Education, and Other reporting segment into the U.S. Networks reporting segment. In connection with this realignment we changed the name of our Commerce, Education, and Other reporting segment to Education and Other. The financial information in this Annual Report on Form 10-K has not been recast to reflect the realignment. Accordingly, the results of operations for the Discovery Commerce business are included in the financial results for the Commerce, Education, and Other segment. Beginning in 2010, we will include the Discovery Commerce business in the financial results for the U.S. Networks segment and will recast prior period results to conform to the new presentation.

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 dedicated to high-quality children’s and family entertainment and educational programming. In connection with the arrangement, Discovery contributed the U.S. 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, the Hub, is scheduled to premiere in late 2010. Additional information regarding the joint venture is set forth in Note 4 to the accompanying consolidated financial statements.

 

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Discovery Commerce Business

In April 2009, we completed the transition of 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.

Segment Information

In 2009, we operated through three segments: (1) U.S. Networks, (2) International Networks, and (3) Commerce, Education, and Other. Financial information related to our operating segments is set forth in Note 23 to our consolidated financial statements found in Item 8 of this Annual Report on Form 10-K.

U.S. Networks

Reaching approximately 724 million cumulative subscribers (defined below) primarily in the U.S. as of December 31, 2009, and having one of the industry’s most widely distributed portfolios of brands, U.S. Networks delivers 11 cable and satellite television channels primarily in the U.S. The portfolio includes three channels that each reach more than 95 million subscribers (defined below) and five channels that each reach between 50 and 75 million subscribers.

Our U.S. networks are wholly-owned except for Discovery Kids, which is operated through a 50-50 joint venture between us and Hasbro. Currently, we own and operate the Discovery Health Channel. However, pursuant to our joint venture arrangement for OWN, we will contribute our interest in the Discovery Health Channel to OWN, which is expected to occur in 2011.

Subscriber numbers set forth in this Annual Report on Form 10-K include both wholly-owned networks and networks operated by joint ventures and are according to The Nielsen Company, except for Discovery Kids, Planet Green, FitTV and HD Theater, where Nielsen data is either not available and/or internal data are used. As used herein, a “subscriber” is a single household that receives the applicable Discovery channel from its cable television operator, DTH satellite operator, or other television provider, including those who receive our networks from pay-television providers without charge pursuant to various pricing plans that include free periods and/or free carriage. The term “cumulative subscribers” refers to the collective sum of the total number of subscribers to each of our channels. By way of example, two households that each receive five of our networks from their television provider represent two subscribers, but 10 cumulative subscribers.

The networks operated by the U.S. Networks segment include:

 

LOGO   

Discovery Channel

 

• Discovery Channel reached approximately 100 million subscribers in the U.S. as of December 31, 2009.

  

 

• Discovery Channel is dedicated to creating high-quality nonfiction content that informs and entertains viewers about the wonder and diversity of the world. The network offers a mix of genres including science and technology, exploration, adventure, history and in-depth, behind-the-scenes glimpses at the people, places and organizations that shape and share our world.

  

• Programming highlights on Discovery Channel include Deadliest Catch, MythBusters, Dirty Jobs, Man Vs. Wild, Storm Chasers, Swamp Loggers, Pitchmen and Colony. Discovery Channel is also home to specials and mini-series, including the critically acclaimed Planet Earth, When We Left Earth: The NASA Missions and Discovering Ardi.

  

• Target viewers are adults ages 25-54, particularly men.

  

• Discovery Channel is simulcast in HD.

LOGO   

TLC

 

• TLC reached approximately 99 million subscribers in the U.S. as of December 31, 2009. TLC also reached approximately 8 million subscribers in Canada, according to internal data.

  

 

• TLC features docu-series and reality-based programming about the lives of real-life extraordinary characters.

 

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•Programming highlights on TLC include Cake Boss, Little Couple, What Not to Wear, Little People, Big World, Police Women of Broward County, Say Yes to the Dress, LA Ink and 18 Kids and Counting.

  

•Target viewers are adults ages 18-49, particularly women.

  

•TLC is simulcast in HD.

 

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LOGO   

Animal Planet

 

• Animal Planet reached approximately 96 million subscribers in the U.S. as of December 31, 2009.

  

 

• Animal Planet provides a full range of programming related to life in the animal kingdom with content that offers animal lovers and pet owners access to a centralized online, television and mobile community for entertainment and information.

  

• Programming highlights on Animal Planet include Whale Wars, River Monsters, I’m Alive, Monsters Inside Me, Pit Bulls and Parolees and Dogs 101.

  

• Target viewers are adults ages 25-54.

  

• Animal Planet is simulcast in HD.

LOGO   

Discovery Health

 

• Discovery Health reached approximately 74 million subscribers in the U.S. as of December 31, 2009.

  

 

• Discovery Health provides information that helps viewers better understand health and wellness issues. From pregnancy and parenting to diet and disease prevention, Discovery Health delivers real-life stories.

LOGO   

• In 2011, Discovery Health will be repositioned as OWN through a 50-50 joint venture between Discovery and Harpo, Inc. OWN will be a multi-platform venture, including the OWN television network and Oprah.com, designed to entertain, inform and inspire people to live their best lives.

  

 

• OWN will build on Discovery Health’s target audience of women ages 25-54.

LOGO   

Discovery Kids

 

• Discovery Kids reached approximately 51 million subscribers in the U.S. as of December 31, 2009.

  

 

• Discovery Kids allows kids of all ages (from preschoolers to ‘tweens and teens) to explore the world from their point of view. The network provides programming that enables kids to learn about science, adventure, exploration and natural history through documentaries, reality shows, scripted dramas and animated stories.

LOGO   

• In late 2010, Discovery Kids will be repositioned as THE HUB through a 50-50 joint venture between Discovery and Hasbro. The network will feature original animation programming, game shows and live-action series and specials, including content drawn from Hasbro’s portfolio of entertainment and educational properties, content from Discovery’s extensive library of award-winning children’s educational programming, and third-party acquisitions.

  

 

• Target viewers are children ages 3-12 and families.

 

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LOGO   

Science Channel

 

•Science Channel reached approximately 62 million subscribers in the U.S. as of December 31, 2009.

  

 

•Science Channel immerses viewers in the possibilities of science, from string theory and futuristic cities to accidental discoveries and outrageous inventions. The network celebrates the trials, errors and moments that change our human experience.

  

 

•Programming highlights on Science Channel include How It’s Made, Space Week, Sci Fi Science: Physics of the Impossible, How Do They Do It?, Build It Bigger, and Punkin Chunkin.

  

•Target viewers are men ages 25-54.

  

•Science Channel is simulcast in HD.

LOGO   

Planet Green

 

•Planet Green reached approximately 48 million subscribers in the U.S. as of December 31, 2009.

  

 

•Planet Green targets viewers who want to understand how humans impact the planet and how to live a more environmentally sustainable lifestyle. The network offers unique, original and insightful content related to how we can evolve to live a better, brighter future.

  

•Programming highlights on Planet Green include Operation Wild, Living with Ed, Conviction Kitchen, Blood, Sweat and Takeaways, Wasted, and the Reel Impact weekly film series.

  

•Target viewers are adults ages 18-54.

  

•Planet Green is simulcast in HD.

LOGO   

Investigation Discovery

 

•Investigation Discovery reached approximately 55 million subscribers in the U.S. as of December 31, 2009.

  

 

•Investigation Discovery is a source for fact-based investigative content about culture, history and the human condition, and provides investigative programming focused on stories of human nature from the past to the present, documentaries, and series that challenge viewers on important issues shaping our culture and defining our world.

  

•Programming highlights on Investigation Discovery include On the Case with Paula Zahn, The Bureau, Disappeared, I (Almost) Got Away With It, and Extreme Forensics.

  

•Target viewers are adults ages 25-54.

  

•Investigation Discovery is simulcast in HD.

LOGO   

Military Channel

 

•Military Channel reached approximately 55 million subscribers in the U.S. as of December 31, 2009.

  

 

•Military Channel brings viewers real-world stories of heroism, military strategy, technological breakthroughs and turning points in history. The network takes viewers “behind the lines” to hear the personal stories of servicemen and women and offers in-depth explorations of military technology, battlefield strategy, aviation and history.

  

•Programming highlights on Military Channel include At Sea, Special Ops Mission, Great Planes, and Top Sniper.

  

•Target viewers are men ages 35-64.

 

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LOGO   

FitTV

 

• FitTV reached approximately 46 million subscribers in the U.S. as of December 31, 2009.

  

 

• FitTV is designed to inspire viewers to improve their fitness and well-being on their terms. FitTV features approachable experts and shows that help real people learn how to incorporate fitness into their busy lives.

  

• Target viewers are adults ages 25-54.

LOGO   

HD Theater

 

• HD Theater reached approximately 30 million subscribers in the U.S. as of December 31, 2009.

  

 

• HD Theater was one of the first nationwide 24-hours-a-day, 7-days-a-week high definition networks in the U.S. offering content in virtually all categories of entertainment from across Discovery’s family of networks. The network showcases programming about adventure, nature, wildlife, history, travel, science and technology, world culture and more.

  

• Programming highlights on HD Theater include World Rally Championship and Mecum Auto Auctions: Muscle Cars.

  

• Target viewers are adults ages 25-54, particularly men.

U.S. Networks also includes our digital media businesses in the United States, which provide cross-platform sales and promotional opportunities with our television networks and additional reach for our content by leveraging the economies realized through programs that can be produced once and used often in both long-term and short-term formats across multiple platforms. Digital media features three main components:

 

   

U.S. brand-aligned channel websites, such as Discovery.com, TLC.com and AnimalPlanet.com, and complementary stand-alone websites: HowStuffWorks.com, an award-winning online source of explanations of how the world actually works; Treehugger.com, an eco-lifestyle website that complements the Planet Green television network; and Petfinder.com, a leading pet adoption destination that provides an additional promotional platform for the Animal Planet brand. Together, these websites attracted an average of more than 36 million cumulative unique monthly visitors in 2009, according to internal data. Discovery also offers content through a variety of online syndication partnerships.

 

   

Discovery Mobile, which offers unique made-for-mobile short-form content and long-form episodes of popular titles through distribution arrangements with the majority of mobile carriers in the U.S., as well as a collection of smartphone applications and direct-to-consumer mobile websites for multiple network brands including Discovery Channel, TLC, and Animal Planet.

 

   

Discovery on-demand, a free video-on-demand service distributed across most major U.S. affiliates, which features full-length programming and short-form content from Discovery’s portfolio of U.S. networks.

International Networks

Reaching approximately 685 million cumulative subscribers (defined below) in more than 170 countries outside the U.S. as of December 31, 2009, International Networks operates one of the largest international multi-channel businesses in the media industry. International Networks distributes a diversified portfolio of 22 brands designed to meet the needs of audiences, affiliates and advertisers across multiple regions and markets. The segment maximizes the use of shared content and our global programming pipeline in order to drive consumer engagement and efficiencies across all core brands, and delivers locally targeted customized programming, on-air content and schedules in 38 languages via more than 100 localized feeds. International Networks encompasses four locally-managed regional operations covering all major foreign pay television markets, including the United Kingdom (“U.K.”), Europe (excluding the U.K.), Middle East and Africa (“EMEA”), Asia-Pacific, and Latin America, and has 29 international offices with regional headquarters located in London, Miami and Singapore.

International subscriber statistics include both wholly-owned networks and networks operated by joint ventures and are derived from internal data coupled with external sources when available. As used herein, an “international subscriber” is a single household that receives the applicable Discovery network or programming service from its cable television operator, DTH satellite operator, or other television provider, including those who receive our networks from pay television providers without charge pursuant to various

 

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pricing plans that include free periods and/or free carriage. The term “cumulative subscribers” outside the U.S. refers to the collective sum of the total number of international subscribers to each of our international channels or programming services outside of the U.S. By way of example, two international households that each receive five of our networks from their television provider represent two subscribers, but 10 cumulative subscribers outside the U.S.

In addition to our cumulative subscribers noted above, we provide branded programming blocks in China, which are generally provided without charge to third-party channels and represented approximately 279 million viewers as of December 31, 2009. Such viewers have been excluded from all subscriber amounts in this Annual Report on Form 10-K.

Our international networks are wholly owned by us except (1) the international Animal Planet channels which are generally 50-50 joint ventures with the British Broadcasting Corporation (“BBC”), (2) People+Arts, which operates in Latin America and Iberia as a 50-50 joint venture with the BBC, and (3) several channels in Canada and Japan, which operate as joint ventures with strategic local partners and which are not consolidated in our financial statements.

International Networks is a leader across international markets in factual multi-channel television. The portfolio consists largely of global brands led by Discovery Channel and Animal Planet, which each reach more than 100 million homes in international markets. Newer global digital brands in the factual portfolio include Discovery Science, which is distributed in more than 90 countries, ID: Investigation Discovery, Discovery Turbo and Discovery World. In addition, International Networks offers HD channels for Discovery, Animal Planet and TLC in 61 international markets and is one of the industry’s leading international providers of HD.

The networks operated by the International Networks segment include:

 

Network Brand

 

Subscribers

 

Network Overview

Discovery Channel   187 million subscribers   Discovery Channel’s international programming includes documentaries, docudramas and reality formats covering topics and themes, including human adventure and exploration, engineering, science, history and world culture.
Animal Planet   141 million subscribers   Animal Planet is the world’s only brand that immerses viewers in content devoted to animals.
Discovery Travel & Living   87 million subscribers   Discovery Travel & Living provides content for adults who want to experience the best the world has to offer by providing an eclectic mix of programming on travel, food, design and décor.
DMAX   43 million subscribers  

In Germany, DMAX targets a younger male audience with a mix of fiction and nonfiction content. It has broad distribution throughout the country’s cable systems, reaching approximately 85% of cable homes, but does not get subscription fees and is therefore wholly dependent on advertising revenue.

 

In the U.K., DMAX is a broad-based service that combines fiction and non-fiction content. It is distributed without a subscription fee by both major distributors in the U.K., but is positioned in the Entertainment section of the electronic program guide of Sky, the largest distributor, and is intended to be a strong advertising sales vehicle because of the concentration of viewership in Entertainment channels.

Discovery Science   41 million subscribers   Discovery Science network features programming that uncovers the impact of science and technology.
Discovery Home & Health   36 million subscribers   Discovery Home & Health targets women who strive to be the very best they can be in all the many demanding roles they play.
Discovery Kids   28 million subscribers   One of the leading channels in Latin America among preschoolers and women, Discovery Kids provides a unique environment that nurtures children’s curiosity and encourages life-long learning.
ID: Investigation Discovery   10 million subscribers   ID: Investigation Discovery offers programming that focuses on the science of forensics and uses dramatic, fact-based storytelling to provide in-depth analysis of investigations.
HD Services   6 million subscribers   One of the leading international providers of HD networks, International Networks offers HD services in 61 international markets including Discovery HD, Animal Planet HD, TLC HD and a Discovery Channel HD simulcast service in Japan and Italy.

 

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International Networks also distributes specialized brands developed for individual regions and markets to 106 million subscribers including Discovery Knowledge, Shed and Quest in the U.K.; Discovery Civilization and People + Arts in Latin America and Iberia; Discovery Real Time in the U.K., Italy and France; and Discovery Historia in Poland. In addition, International Networks distributes two Spanish-language networks, Discovery en Espanol and Discovery Familia, that are distributed to a combined 10 million U.S. subscribers.

International Networks also operates Antenna Audio, which is the leading provider of audio, multimedia and mobile tours for museums, exhibitions, historic sites and visitor attractions around the world. More than 19 million visitors take Antenna Audio tours in various languages at well-known and frequented locations each year, including museums such as the Metropolitan Museum of Art, the Musée du Louvre and Tate; historic and cultural sites including Graceland and Alcatraz; and popular destinations such as the Statue of Liberty and Vatican.

Commerce, Education, and Other

Commerce

Commerce plays an important role in support of our overall strategic objectives by enhancing viewer loyalty through direct interaction with our brands. Commerce is focused on extending our on-air brands and increasing the reach of our products through our e-commerce platform and licensing arrangements. Commerce’s platforms include:

 

   

Direct-to-Consumer: includes a printed catalog and the DiscoveryStore.com e-commerce site where customers can shop for a large assortment of our proprietary merchandise and other products. During the first quarter of 2009, we entered into a licensing agreement with a third party for the direct-to-consumer component of our commerce business that includes a catalog and e-commerce platform. Under the agreement, we receive royalties for merchandise sales and wholesale payments for DVDs sold, while the third party has assumed management and operational responsibility for the DiscoveryStore.com website and product development and fulfillment responsibility for merchandise.

 

   

Domestic Licensing and Merchandising: includes agreements with key manufacturers and retailers, including Merchsource, Trau & Loevner, GAP Adventures, JAKKS, Toys R Us and others to develop long-term, strategic programs that translate our network brands and signature properties into an array of merchandising opportunities. From Animal Planet toy and pet products, Mythbusters books, DVDs and calendars to LA Ink apparel and accessories, domestic licensing develops products that capture the look and feel of our core brands and programs.

Domestic home video/DVD licensing and merchandising also includes a strategic partnership with Gaiam, a video distributor. Gaiam distributes Discovery’s high-quality on-air content in standard and Blu-ray format to mass and niche retailers, including Walmart, Target and Borders.

Education

Education offers a suite of curriculum-based tools designed to foster student achievement, as well as enhancement resources such as student assessment services, professional development and a nationwide educator community that promotes the integration of digital media and technology in the classroom. Education services include:

 

   

Discovery Education Streaming: an online video-on-demand service that features over 10,000 digital videos and over 75,000 content-specific video clips correlated to state K-12 curriculum standards. The service is made available through subscription services to over 55,000 public and private K-12 schools serving teachers nationwide.

 

   

Discovery Education Assessment: a service that enables K-12 educators to measure student progress toward meeting state reading/language arts, math and science standards on an ongoing basis, provide differentiated instruction, predict student performance, and improve student learning.

 

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Education also works with corporate partners to create sponsored supplemental curriculum programs and to support education-based student initiatives, such as the Discovery Education 3M Young Scientist Challenge and the Siemens We Can Change the World Challenge.

Education also publishes and distributes content on DVD and CD-ROM through catalogs, an online teacher store, and a network of distributors, participates in global licensing and sponsorship programs with corporate partners to create supplemental curriculum programs and to support education-based student initiatives and supports our digital initiatives by providing educational content in multiple formats that meet the needs of teachers and students.

Other

Our Creative Sound Services (“CSS”) business provides post-production 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. CSS services are marketed under the brand names Todd-AO, Sound One, Soundelux, POP Sound, Modern Music, Soundelux Design Music Group and The Hollywood Edge, with facilities in Los Angeles, New York and London.

Content Development

Our content development strategy is designed to increase viewership, maintain innovation and quality leadership, and provide value for our distributors and advertising customers. Our production agreements fall into three categories: commissions, co-productions and acquisitions. Commissions refer to programming for which we generally own most or all rights for at least 10 years and, in exchange for paying all production costs, retain all editorial control. Co-productions refer to programs where we retain significant (but more limited) rights to exploit the programs. The rights retained by us are generally in proportion to the total project costs we pay or incur, which generally ranges from 35% to 75% of the total project cost. Co-productions are typically high-cost projects for which neither we nor our co-producers wish to bear the entire cost or productions in which the producer has already taken on an international broadcast partner. Acquisitions are license agreements for films or series that have already been produced.

As network distribution and revenues have grown, our program mix has matured from acquired content to sharing in co-productions to full commissions. To minimize programming expense in the early stages, as an audience base begins to form, we use acquired programming to a greater extent and repeat it frequently. The transition from acquired content provides for more customized use of programming for individual networks and broader rights for re-use on television networks and new platforms.

We source content from a wide range of producers, building long-standing relationships with some of the world’s leading nonfiction production companies, as well as consistently developing and encouraging young independent producers.

The programming schedule on our most widely distributed networks is mostly a mix of high-cost “special event” programming combined with miniseries and regular series. Large-scale programming events such as Planet Earth, When We Left Earth: The NASA Missions, Nefertiti Resurrected, and Walking With Cavemen bring brand prestige, favorable media coverage and substantial cross-promotional opportunities for other content platforms. Given the success of these global programming “tent-poles” we will continue to invest in a mix of programs that have the potential to draw larger audiences while also increasing the investment in regularly scheduled series.

We have an extensive library of programming and footage that provides a high-quality source of programming for debuting new services quickly without significant incremental spending. Programming can be re-edited and updated to provide topical versions of subject matter in a cost-effective manner. Library development also provides a mechanism to share content around the world and repurpose for display on new digital and mobile platforms.

Sources of Revenue

We earn revenue principally from (1) the receipt of affiliate fees from the delivery of nonfiction programming pursuant to affiliation agreements with cable television operators, DTH satellite operators, and other distributors of television programming, (2) advertising sales on our television networks and websites, and (3) product, subscription sales and services in the commerce, education and media sound services businesses. No single customer represented more than 10% of our total consolidated revenues for the year ended December 31, 2009.

 

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Distribution Revenues

Distribution revenues represented 49% of our consolidated total revenues in 2009. Distribution revenue in the U.S. represented 46% of U.S. Networks revenue, and international distribution fees represented 61% of International Networks revenue in 2009. Distribution revenue is generated through affiliation agreements with cable operators, DTH satellite operators, and other television distributors, which typically have a term of three to seven years. These affiliation agreements generally provide for the level of carriage our networks will receive, such as channel placement and package inclusion (whether on more widely distributed, broader packages or lesser-distributed, specialized packages), and for payment of a fee to us based on the numbers of subscribers that receive our networks. 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. We have long-term contracts with distributors representing most cable and satellite operators around the world, including the largest operators in the U.S. and major international distributors. In the U.S., over 90% of distribution revenue comes from the top 10 distributors, with whom we have agreements that expire at various times in 2010 through 2017. Outside of the U.S., less than 50% of distribution revenue comes from the top 10 distributors.

Advertising Revenue

Advertising revenues comprised 41% of our consolidated total revenues in 2009. Advertising revenue in the U.S. represented 51% of U.S. Networks revenue, and international advertising revenue represented 29% of International Networks revenue in 2009. We typically build network brands by securing as broad a subscriber base as possible. After obtaining sufficient distribution to provide an attractive platform for advertising, we increase our investment in programming and marketing to build audience share and drive strong ratings performance in order to increase advertising sales opportunities. Advertising revenue depends on the number of subscribers receiving the service, viewership demographics, the ability to sell commercial time over a group of networks, the brand appeal of the network and ratings as determined by third-party research companies such as The Nielsen Company. Revenue from advertising is subject to seasonality, market-based variations, and general economic conditions. Advertising revenue is typically highest in the second and fourth quarters. Revenue can also fluctuate due to the popularity of particular programs and viewership ratings. In some cases, advertising sales are subject to ratings guarantees that may require us to provide additional advertising time or refunds if the guarantees are not met.

We sell advertising time in both the upfront and scatter markets. In the upfront market, advertisers buy advertising time for the upcoming season, and by purchasing in advance, often receive discounted rates. In the scatter market, advertisers buy advertising time close to the time when the commercials will be run, and often pay a premium. The mix between the upfront and scatter markets is based upon a number of factors such as pricing, demand for advertising time and economic conditions.

Our two largest networks, Discovery Channel and TLC, target key demographics that historically have been considered attractive to advertisers, notably viewers in the 18-54 age range who are viewed as having significant spending power. Discovery Channel’s target audience skews toward male viewers, while TLC targets female viewers, providing a demographic balance in our portfolio for distribution and advertising clients.

We benefit by having a portfolio of networks appealing to a broad range of demographics. This allows us to create advertising packages that exploit the strength of our large networks to benefit smaller niche or targeted networks and networks on digital tiers. Utilizing the strength of our diverse networks, coupled with our online and digital platforms, we seek to create innovative programming initiatives and multifaceted campaigns for the benefit of a wide variety of companies and organizations who desire to reach key audience demographics unique to each network. We deliver customized, integrated marketing campaigns to clients worldwide by catering to the special needs of multi-regional advertisers who are looking for integrated campaigns that move beyond traditional spot advertising to include sponsorships, product placements and other opportunities.

We also generate advertising revenue from our websites. We sell advertising on our websites both on a stand-alone basis and as part of advertising packages with our television networks.

Commerce, Education, and Other Revenue

Commerce, education, and other revenues are principally generated from subscriptions to our educational streaming services, royalty payments on the sale of products online and through catalogs, and other revenue including media sound services and representation services.

Subscription sales to our educational streaming services are primarily sold at the beginning of each school year as school budgets are appropriated and approved. The revenue derived from the subscription agreements is generally recognized ratably over the school year. Sponsored strategic partnership programs are recognized as the campaigns are delivered. Education also provides products that are sold throughout the school year.

        In April 2009, we completed the transition of 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. As a

 

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result, we now receive royalties on merchandise and wholesale payments for DVDs sold based upon a percentage of our licensees’ wholesale revenues, with an advance against future expected royalties. As part of our commerce business, we also have a domestic consumer products licensing business which licenses our brands in connection with merchandise, DVDs, sponsored strategic partnerships, videogames and publishing. E-commerce and catalog sales are highly seasonal with a majority of the sales occurring in the fourth quarter due to the holiday season. Licensing revenue may vary from period to period depending upon the popularity of the properties available for license and the popularity of licensed products in a particular period.

We have agreements to represent third parties for U.S. affiliate and advertising representation services. The fees for these services are recorded as the services are provided.

Operating Expenditures

Our principal operating costs consist of programming expense, personnel costs, sales and marketing expense, and general and administrative expenses. Content expense is our largest expense category, representing 28% of our 2009 consolidated operating expenses, as investment in maintaining high-quality editorial and production values is a key differentiator for our content. In connection with creating original content, we incur production costs associated with acquiring new show concepts and retaining creative talent, including actors, writers and producers. We incur sales and marketing expense to promote brand recognition and to secure quality distribution channels worldwide.

Regulatory Matters

Our businesses are subject to and affected by regulations of U.S. federal, state and local government authorities, and our international operations are subject to laws and regulations of local countries and international bodies such as the European Union. Programming networks, such as those owned by us, are regulated by the Federal Communications Commission (“FCC”) in certain respects if they are affiliated with a cable television operator. Other FCC regulations, although imposed on cable television operators and satellite operators, affect programming networks indirectly. The rules, regulations, policies and procedures affecting our businesses are constantly subject to change. These descriptions are summary in nature and do not purport to describe all present and proposed laws and regulations affecting our businesses.

Program Access

The FCC’s program access rules prevent a satellite cable programming vendor in which a cable operator has an “attributable” ownership interest under FCC rules, such as those owned by us, from entering into exclusive contracts for programming with a cable operator and from discriminating among competing multichannel video programming distributors (“MVPDs”) in the price, terms and conditions for the sale or delivery of programming. These rules also permit MVPDs to initiate complaints to the FCC against program suppliers if an MVPD claims it is unable to obtain rights to programming on nondiscriminatory terms.

Effect of “Must-Carry” Requirements

The Cable Television Consumer Protection and Competition Act of 1992 imposed “must-carry” regulations on cable systems, requiring them to carry the signals of most local broadcast television stations. Direct broadcast satellite (“DBS”) systems are also subject to their own must-carry rules. FCC rules require cable systems to carry the digital signals of local television stations that have must-carry status and to carry the same signal in analog format unless all subscribers have the necessary equipment to view the digital broadcast signal. The FCC’s implementation of these “must-carry” obligations requires cable and DBS operators to give broadcasters preferential access to channel space. This reduces the amount of channel space that is available for carriage of our networks by cable television systems and DBS operators.

Closed Captioning and Advertising Restrictions on Children’s Programming

Certain of our networks must provide closed-captioning of programming for the hearing impaired, and our programming and Internet websites intended primarily for children 12 years of age and under must comply with certain limits on advertising.

Regulation of the Internet

We operate several Internet websites which we use to distribute information about and supplement our programs and to offer consumers the opportunity to purchase consumer products and services. Internet services are now subject to regulation in the U.S. relating to the privacy and security of personally identifiable user information and acquisition of personal information from children under 13, including the federal Child Online Protection Act (COPA) and the federal Controlling the Assault of Non-Solicited

 

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Pornography and Marketing Act (CAN-SPAM). In addition, a majority of states have enacted laws that impose data security and security breach obligations. Additional federal and state laws and regulations may be adopted with respect to the Internet or other online services, covering such issues as user privacy, child safety, data security, advertising, pricing, content, copyrights and trademarks, access by persons with disabilities, distribution, taxation and characteristics and quality of products and services. In addition, to the extent we offer products and services to online consumers outside the U.S., the laws and regulations of foreign jurisdictions, including, without limitation, consumer protection, privacy, advertising, data retention, intellectual property, and content limitations, may impose additional compliance obligations on us.

Competition

Cable and satellite network programming is a highly competitive business in the U.S. and worldwide. Our cable and satellite networks and websites generally compete for advertising revenue with other cable and broadcast television networks, online and mobile outlets, radio programming and print media. Our networks and websites also compete for their target audiences with all forms of programming and other media provided to viewers, including broadcast networks, local over-the-air television stations, competitors’ pay and basic cable television networks, pay-per-view and video-on-demand services, online activities and other forms of news, information and entertainment. Our networks also compete with other television networks for distribution and affiliate fees derived from distribution agreements with cable television operators, satellite operators and other distributors. Our commerce and education divisions also operate in highly competitive industries with our e-commerce and catalogue business competing with brick and mortar and online retailers and our education business competing with other providers of educational products to schools, including providers with long-standing relationships, such as Scholastic.

Employees

As of December 31, 2009, we had approximately 4,400 employees, including full-time and part-time employees of our wholly-owned subsidiaries and consolidated ventures. Approximately 3,200 of our employees were employed in the United States, with the remaining 1,200 employed outside the United States. Over 250 of CSS’ creative and technical personnel are subject to one of CSS’ collective bargaining agreements with the International Alliance of Theatrical Stage Employees. There are no active grievances, strikes or work stoppages and we believe our relations with our union and non-union employees are strong.

Intellectual Property

Our intellectual property assets principally include copyrights in television programming, websites and other content, trademarks in brands, names and logos, domain names and licenses of intellectual property rights of various kinds.

We are fundamentally a content company and the protection of our brands and content are of primary importance. To protect our intellectual property assets, we rely upon a combination of copyright, trademark, unfair competition, trade secret and Internet/domain name statutes and laws and contract provisions. However, there can be no assurance of the degree to which these measures will be successful in any given case. Moreover, effective intellectual property protection may be either unavailable or limited in certain foreign territories. Policing unauthorized use of our products and services and related intellectual property is often difficult and the steps taken may not always prevent the infringement by unauthorized third parties of our intellectual property. We seek to limit that threat through a combination of approaches.

 

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Third parties may challenge the validity or scope of our intellectual property from time to time, and such challenges could result in the limitation or loss of intellectual property rights. Irrespective of their validity, such claims may result in substantial costs and diversion of resources which could have an adverse effect on our operations. In addition, piracy, which encompasses both the theft of our signal and unauthorized use of our programming, including in the digital environment, continues to present a threat to revenues from products and services based on intellectual property.

Financial Information about Segments and Geographic Areas

Financial information for segments and geographic areas in which we do business for the three years ended December 31, 2009 is set forth in Note 23 to our consolidated financial statements found in Item 8 of this Annual Report on Form 10-K.

Available Information

All of our filings with the U.S. Securities and Exchange Commission (the “SEC”), including reports on Form 10-K, Form 10-Q and Form 8-K, and all amendments to those filings are available on our Internet website as soon as reasonably practical after we electronically file such material with the SEC. Our corporate website address is www.discoverycommunications.com.

Our annual report, corporate governance guidelines, code of business conduct and ethics, audit committee charter, compensation committee charter, and nominating and corporate governance committee charter are available on our website. In addition, we will provide a printed copy of any of these documents, free of charge, upon written request or by calling Investor Relations, Discovery Communications, Inc., 850 Third Avenue, 5th Floor, New York, NY 10022-7225, Telephone Number (212) 548-5882.

The information contained on our website is not part of this Annual Report on Form 10-K and is not incorporated by reference herein.

 

ITEM 1A. Risk Factors.

Investing in our securities involves risk. In addition to the other information contained in this report, you should consider the following risk factors before investing in our securities.

Our business would be adversely affected if general economic conditions further weaken.

The current economic downturn in the U.S. and in other regions of the world in which we operate could adversely affect demand for any of our businesses, thus reducing our revenue and earnings. We derive substantial revenues from the sale of advertising on our networks. Expenditures by advertisers tend to be cyclical, reflecting overall economic conditions, as well as budgeting and buying patterns. The current economic conditions and any continuation of these adverse conditions may adversely affect the economic prospects of advertisers and could alter current or prospective advertisers’ spending priorities. A decrease in advertising expenditures would have an adverse effect on our business. The decline in economic conditions has impacted consumer discretionary spending. A continued reduction in consumer spending may impact pay television subscriptions, particularly to the more expensive digital service tiers, which could lead to a decrease in our distribution fees and may reduce the rates we can charge for advertising.

Our success is dependent upon U.S. and foreign audience acceptance of our programming and other entertainment content which is difficult to predict.

The production and distribution of pay television programs and other entertainment content are inherently risky businesses because the revenue we derive and our ability to distribute our content depend primarily on consumer tastes and preferences that often change in unpredictable ways. Our success depends on our ability to consistently create and acquire content and programming that meet the changing preferences of viewers in general, viewers in special interest groups, viewers in specific demographic categories and viewers in various overseas marketplaces. The commercial success of our programming and other content also depends upon the quality and acceptance of competing programs and other content available in the applicable marketplace at the same time. Other factors, including the availability of alternative forms of entertainment and leisure time activities, general economic conditions, piracy, digital and on-demand distribution and growing competition for consumer discretionary spending may also affect the audience for our content. Audience sizes for our media networks are critical factors affecting both (i) the volume and pricing of advertising revenue that we receive, and (ii) the extent of distribution and the license fees we receive under agreements with our distributors. Consequently, reduced public acceptance of our entertainment content may decrease our audience share and adversely affect all of our revenue streams.

 

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The loss of our affiliation agreements, or renewals with less advantageous terms, could cause our revenue to decline.

Because our networks are licensed on a wholesale basis to distributors such as cable and satellite operators which in turn distribute them to consumers, we are dependent upon the maintenance of affiliation agreements with these operators. These affiliation agreements generally provide for the level of carriage our networks will receive, such as channel placement and programming package inclusion (widely distributed, broader programming packages compared to lesser distributed, specialized programming packages), and for payment of a license fee to us based on the numbers of subscribers that receive our networks. These per-subscriber payments represent a significant portion of our revenue. Our affiliation agreements generally have a limited term which varies from market to market and from distributor to distributor, and there can be no assurance that these affiliation agreements will be renewed in the future, or renewed on terms that are as favorable to us as those in effect today. A reduction in the license fees that we receive per subscriber or in the number of subscribers for which we are paid, including as a result of a loss or reduction in carriage for our networks, could adversely affect our distribution revenue. Such a loss or reduction in carriage could also decrease the potential audience for our programs thereby adversely affecting our advertising revenue.

Consolidation among cable and satellite operators has given the largest operators considerable leverage in their relationships with programmers, including us. The two largest U.S. cable television system operators provide service to approximately 39% of U.S. households receiving television programming from a multi-channel provider and the two largest satellite television operators provide service to an additional 32% of such households. In the U.S., over 90% of distribution revenues come from the top 10 distributors. We currently have agreements in place with the major U.S. cable and satellite operators which expire at various times beginning in 2010 through 2017. A failure to secure a renewal or a renewal on less favorable terms may have a material adverse effect on our results of operations and financial position. Our affiliation agreements are complex and individually negotiated. If we were to disagree with one of our counterparties on the interpretation of an affiliation agreement, our relationship with that counterparty could be damaged and our business could be negatively affected. In addition, many of the overseas markets in which we distribute our networks also have a small number of dominant distributors. Continued consolidation within the industry could further reduce the number of distributors available to carry our programming and increase the negotiating leverage of our distributors which could adversely affect our revenue.

We operate in increasingly competitive industries.

The entertainment and media programming industries in which we operate are highly competitive. We compete with other programming networks for distribution, viewers, and advertising. We also compete for viewers with other forms of media entertainment, such as home video, movies, periodicals and online and mobile activities. In particular, websites and search engines have seen significant advertising growth, a portion of which is derived from traditional cable network and satellite advertisers. In addition, there has been consolidation in the media industry and our competitors include market participants with interests in multiple media businesses which are often vertically integrated. Our online businesses compete for users and advertising in the enormously broad and diverse market of free internet-delivered services. Our commerce business competes against a wide range of competitive retailers selling similar products. Our educational video business competes with other providers of educational products to schools. Our ability to compete successfully depends on a number of factors, including our ability to consistently supply high quality and popular content, access our niche viewerships with appealing category-specific programming, adapt to new technologies and distribution platforms and achieve widespread distribution. There can be no assurance that we will be able to compete successfully in the future against existing or new competitors, or that increasing competition will not have a material adverse effect on our business, financial condition or results of operations.

Our business is subject to risks of adverse laws and regulations, both domestic and foreign.

Programming services like ours, and the distributors of our services, including cable operators, satellite operators and other MVPDs, are highly regulated by U.S. federal laws and regulations issued and administered by various federal agencies, including the FCC, as well as by state and local governments, in ways that affect the daily conduct of our video programming business. See discussion under “Business — Regulatory Matters” above. The U.S. Congress, the FCC and the courts currently have under consideration, and may in the future adopt, new laws, regulations and policies regarding a wide variety of matters that could, directly or indirectly, affect the operations of our U.S. media properties or modify the terms under which we offer our services and operate. For example, any changes to the laws and regulations that govern the services or signals that are carried by cable television operators or our other distributors may result in less capacity for other programming services, such as our networks, which could adversely affect our revenue.

Similarly, the foreign jurisdictions in which our networks are offered have, in varying degrees, government laws and regulations governing our businesses. Programming businesses are subject to regulation on a country by country basis. Changes in regulations imposed by foreign governments could also adversely affect our business, results of operations and ability to expand our operations beyond their current scope.

 

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Increased programming production and content costs may adversely affect our results of operations and financial condition.

One of our most significant areas of expense is the production and licensing of content. In connection with creating original content, we incur production costs associated with, among other things, acquiring new show concepts and retaining creative talent, including actors, writers and producers. We also incur higher production costs when filming in HD than standard definition. The costs of producing programming have generally increased in recent years. These costs may continue to increase in the future, which may adversely affect our results of operations and financial condition. We recently entered into a non-binding agreement to develop a dedicated 3-D television network. Costs associated with 3-D programming, both in production and in distribution, are expected to be significantly higher than those for both standard and HD television, which may adversely affect our results of operation and financial condition.

Disruption or failure of satellites and facilities, and disputes over supplier contracts on which we depend to distribute our programming, could adversely affect our business.

We depend on transponders on satellite systems to transmit our media networks to cable television operators and other distributors worldwide. The distribution facilities include uplinks, communications satellites and downlinks. We obtain satellite transponder capacity pursuant to long-term contracts and other arrangements with third-party vendors, which expire at various times through 2022. Even with back-up and redundant systems, transmissions may be disrupted as a result of local disasters or other conditions that may impair on-ground uplinks or downlinks, or as a result of an impairment of a satellite. Currently, there are a limited number of communications satellites available for the transmission of programming. If a disruption or failure occurs, we may not be able to secure alternate distribution facilities in a timely manner, which could have a material adverse effect on our business and results of operations.

We must respond to and capitalize on rapid changes in new technologies and distribution platforms, including their effect on consumer behavior, in order to remain competitive and exploit new opportunities.

Technology in the video, telecommunications and data services industry is changing rapidly. We must adapt to advances in technologies, distribution outlets and content transfer and storage to ensure that our content remains desirable and widely available to our audiences while protecting our intellectual property interests. We may not have the right, and may not be able to secure the right, to distribute some of our licensed content across these, or any other, new platforms and must adapt accordingly. The ability to anticipate and take advantage of new and future sources of revenue from these technological developments will affect our ability to expand our business and increase revenue.

Similarly, we also must adapt to changing consumer behavior driven by technological advances such as video-on-demand and a desire for more user-generated and interactive content. Devices that allow consumers to view our entertainment content from remote locations or on a time-delayed basis and technologies which enable users to fast-forward or skip advertisements may cause changes in audience behavior that could affect the attractiveness of our offerings to advertisers and could therefore adversely affect our revenue. If we cannot ensure that our content is responsive to the viewing preferences of our target audiences and capitalize on technological advances, there could be a negative effect on our business.

We continue to develop new products and services for evolving markets. There can be no assurance of the success of these efforts due to a number of factors, some of which are beyond our control.

There are substantial uncertainties associated with our efforts to develop new products and services for evolving markets, and substantial investments may be required. Initial timetables for the introduction and development of new products and services may not be achieved, and price and profitability targets may not prove feasible. External factors, such as the development of competitive alternatives, rapid technological change, regulatory changes and shifting market preferences, may cause new markets to move in unanticipated directions.

Risks associated with our international operations could harm our financial condition.

Our networks are offered worldwide. Inherent economic risks of doing business in international markets include, among other things, longer payment cycles, foreign taxation and currency exchange risk. As we continue to expand the provision of our products and services to overseas markets, we cannot assure you whether these risks and uncertainties will harm our results of operations.

Our international operations may also be adversely affected by export and import restrictions, other trade barriers and acts of disruptions of services or loss of property or equipment that are critical to overseas businesses due to expropriation, nationalization, war, insurrection, terrorism or general social or political unrest or other hostilities.

 

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The loss of key talent could disrupt our business and adversely affect our revenue.

Our business depends upon the continued efforts, abilities and expertise of our corporate and divisional executive teams and entertainment personalities. We employ or contract with entertainment personalities who may have loyal audiences. These individuals are important to audience endorsement of our programs and other content. There can be no assurance that these individuals will remain with us or retain their current audiences. If we fail to retain these individuals or if our entertainment personalities lose their current audience base, our revenue could be adversely affected.

Piracy of our entertainment content, including digital piracy, may decrease revenue received from our programming and adversely affect our business and profitability.

The success of our business depends in part on our ability to maintain the intellectual property rights to our entertainment content. We are fundamentally a content company and piracy of our brands, DVDs, cable television and other programming, digital content and other intellectual property has the potential to significantly affect us. Piracy is particularly prevalent in many parts of the world that lack copyright and other protections similar to existing law in the U.S. It is also made easier by technological advances allowing the conversion of programming into digital formats, which facilitates the creation, transmission and sharing of high quality unauthorized copies. Unauthorized distribution of copyrighted material over the Internet is a threat to copyright owners’ ability to protect and exploit their property. The proliferation of unauthorized use of our content may have an adverse effect on our business and profitability because it reduces the revenue that we potentially could receive from the legitimate sale and distribution of our content.

Financial market conditions may impede access to or increase the cost of financing our operations and investments.

The recent changes in U.S. and global financial and equity markets, including market disruptions and tightening of the credit markets, may make it more difficult for us to obtain financing for our operations or investments or increase the cost of obtaining financing. In addition, our borrowing costs can be affected by short and long-term debt ratings assigned by independent rating agencies which are based, in significant part, on our performance as measured by credit metrics such as interest coverage and leverage ratios. A low rating could increase our cost of borrowing or make it more difficult for us to obtain future financing.

Substantial leverage and debt service obligations may adversely affect us.

As of December 31, 2009, we had approximately $3.4 billion of consolidated debt, excluding capital leases. Our substantial level of indebtedness increases the possibility that we may be unable to generate cash sufficient to pay when due the principal of, interest on, or other amounts due with respect to our indebtedness. In addition, we have the ability to draw down our revolving credit facility in the ordinary course, which has the effect of increasing our indebtedness. We are also permitted, subject to certain restrictions under our existing indebtedness, to obtain additional long-term debt and working capital lines of credit to meet future financing needs. This would have the effect of increasing our total leverage.

Our substantial leverage could have significant negative consequences on our financial condition and results of operations, including:

 

   

impairing our ability to meet one or more of the financial ratio covenants contained in our debt agreements or to generate cash sufficient to pay interest or principal, which could result in an acceleration of some or all of our outstanding debt in the event that an uncured default occurs;

 

   

increasing our vulnerability to general adverse economic and market conditions;

 

   

limiting our ability to obtain additional debt or equity financing;

 

   

requiring the dedication of a substantial portion of our cash flow from operations to service our debt, thereby reducing the amount of cash flow available for other purposes;

 

   

requiring us to sell debt or equity securities or to sell some of our core assets, possibly on unfavorable terms, to meet payment obligations;

 

   

limiting our flexibility in planning for, or reacting to, changes in our business and the markets in which we compete; and

 

   

placing us at a possible competitive disadvantage with less leveraged competitors and competitors that may have better access to capital resources.

 

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Restrictive covenants in the loan agreements for our revolving credit facility and term loans, and the note purchase agreements governing our private placement notes, could adversely affect our business by limiting flexibility.

The loan agreements for our revolving credit facility and term loans and the note purchase agreements governing the terms of our private placement notes contain restrictive covenants, as well as requirements to comply with certain leverage and other financial maintenance tests. These covenants and requirements limit our ability to take various actions, including incurring additional debt, guaranteeing indebtedness and engaging in various types of transactions, including mergers, acquisitions and sales of assets. These covenants could place us at a disadvantage compared to some of our competitors, who may have fewer restrictive covenants and may not be required to operate under these restrictions. Further, these covenants could have an adverse effect on our business by limiting our ability to take advantage of financing, mergers and acquisitions or other opportunities.

In addition, reporting and information covenants in our loan agreements and note purchase agreements require that we provide financial and operating information within certain time periods. If we are unable to timely provide the required information, we would be in breach of these covenants.

We are a holding company and could be unable in the future to obtain cash in amounts sufficient to service our financial obligations or meet our other commitments.

Our ability to meet our financial obligations and other contractual commitments will depend upon our ability to access cash. We are a holding company, and our sources of cash include our available cash balances, net cash from the operating activities of our subsidiaries, any dividends and interest we may receive from our investments, availability under any credit facilities that we may obtain in the future and proceeds from any asset sales we may undertake in the future. The ability of our operating subsidiaries, including Discovery Communications, LLC, to pay dividends or to make other payments or advances to us will depend on their individual operating results and any statutory, regulatory or contractual restrictions, including restrictions in our credit facility, to which they may be or may become subject.

Our directors overlap with those of Liberty Media Corporation and certain related persons of Advance/Newhouse, which may lead to conflicting interests.

Our eleven-person board of directors includes three persons who are currently members of the board of directors of Liberty Media Corporation (“Liberty”), including John C. Malone, the Chairman of the board of Liberty, three persons who are currently members of the board of directors of Liberty Global, Inc. (“Liberty Global”), also including Mr. Malone, who is Chairman of the board of Liberty Global, and three designees of Advance/Newhouse, including Robert J. Miron, the Chairman of Advance/Newhouse, and Steven A. Miron, the Chief Executive Officer of Advance/Newhouse. Both Liberty and the parent company of Advance/Newhouse own interests in a range of media, communications and entertainment businesses. Liberty does not own any interest in us. Mr. Malone beneficially owns stock of Liberty representing approximately 35% of the aggregate voting power of its outstanding stock, owns shares representing approximately 40% of the aggregate voting power of Liberty Global and owns shares representing approximately 23% of the aggregate voting power (other than with respect to the election of the common stock directors) of our outstanding stock. Mr. Malone controls approximately 32% of our aggregate voting power relating to the election of the eight common stock directors, assuming that the preferred stock awarded by Advance/Newhouse has not been converted into shares of our common stock. Those of our directors who are also directors of Liberty or Liberty Global own Liberty or Liberty Global stock and stock incentives and own our stock and stock incentives. Advance/Newhouse will elect three directors annually for so long as it owns a specified minimum amount of our Series A convertible preferred stock, and two of its directors are Chairman, Robert J. Miron, and its Chief Executive Officer, Steven A. Miron. The Advance/Newhouse Series A convertible preferred stock, which votes with our common stock on all matters other than the election of directors, represents approximately 26% of the voting power of our outstanding shares. The Series A convertible preferred stock also grants Advance/Newhouse consent rights over a range of our corporate actions, including fundamental changes to our business, the issuance of additional capital stock, mergers and business combinations and certain acquisitions and dispositions. These ownership interests and/or business positions could create, or appear to create, potential conflicts of interest when these individuals are faced with decisions that could have different implications for us, Liberty, Liberty Global, and/or Advance/Newhouse. For example, there may be the potential for a conflict of interest when we, on the one hand, or Liberty, Liberty Global, and/or Advance/Newhouse, on the other hand, look at acquisitions and other corporate opportunities that may be suitable for the other.

The members of our board of directors have fiduciary duties to our stockholders. Likewise, those persons who serve in similar capacities at Liberty, Liberty Global, or Advance/Newhouse have fiduciary duties to those companies. Therefore, such persons may have conflicts of interest or the appearance of conflicts of interest with respect to matters involving or affecting both respective companies. Although the terms of any transactions or agreements will be established based upon negotiations between employees of the companies involved, there can be no assurance that the terms of any transactions will be as favorable to us or our subsidiaries as would be the case where the parties are at arms’ length.

 

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We may compete with Liberty for business opportunities.

Liberty owns interests in various U.S. and international programming companies that have subsidiaries that own or operate domestic or foreign programming services that may compete with the programming services we offer. We have no rights in respect of U.S. or international programming opportunities developed by or presented to the subsidiaries or Liberty, and the pursuit of these opportunities by such subsidiaries may adversely affect our interests and those of our stockholders. Because we and Liberty have overlapping directors, the pursuit of business opportunities may serve to intensify the conflicts of interest or appearance of conflicts of interest faced by the respective management teams. Our charter provides that none of our directors or officers will be liable to us or any of our subsidiaries for breach of any fiduciary duty by reason of the fact that such individual directs a corporate opportunity to another person or entity (including Liberty), for which such individual serves as a director or officer, or does not refer or communicate information regarding such corporate opportunity to us or any of our subsidiaries, unless (x) such opportunity was expressly offered to such individual solely in his or her capacity as a director or officer of us or any of our subsidiaries and (y) such opportunity relates to a line of business in which we or any of our subsidiaries is then directly engaged.

The personal educational media, lifelong learning, and travel industry investments by John S. Hendricks, a common stock director and our Founder, may conflict with or compete with our business activities.

Our Founder, John S. Hendricks, manages his non-Discovery, personal business investments through Hendricks Investment Holdings LLC (“HIH”), a Delaware limited liability company of which he is the sole owner and member. HIH owns a travel club and travel-related properties including a resort in Gateway, Colorado with plans to create a learning academy for guests that includes online and advanced media offerings in the area of informal and lifelong learning. Certain video productions and offerings of this academy may compete with our educational media offerings. We and the academy may enter into a business arrangement for the offering of our video products for sale by the academy and/or for the joint-production of new educational media products or co-production agreements for programming to be aired on our networks, such as the Curiosity series.

Through HIH, Mr. Hendricks owns a number of business interests in the automotive field, some of which are involved in programming offered by us, in particular the “Turbo” programming series.

From time to time, HIH or its subsidiaries may enter into transactions with us or our subsidiaries. Although the terms of any such transactions or agreements will be established based upon negotiations between employees of the companies involved, there can be no assurance that the terms of any such transactions will be as favorable to us or our subsidiaries as would be the case where the parties are at arms’ length.

It may be difficult for a third party to acquire us, even if doing so may be beneficial to our stockholders.

Certain provisions of our charter and bylaws may discourage, delay or prevent a change in control that a stockholder may consider favorable. These provisions include the following:

 

   

authorizing a capital structure with multiple series of common stock: a Series B that entitles the holders to ten votes per share, a Series A that entitles the holders to one vote per share and a Series C that, except as otherwise required by applicable law, entitles the holders to no voting rights;

 

   

authorizing the Series A convertible preferred stock with special voting rights, which prohibits us from taking any of the following actions, among others, without the prior approval of the holders of a majority of the outstanding shares of such stock:

 

   

increasing the number of members of the Board of Directors above 11;

 

   

making any material amendment to our charter or bylaws;

 

   

engaging in a merger, consolidation or other business combination with any other entity;

 

   

appointing or removing our Chairman of the Board or our CEO;

 

   

authorizing the issuance of “blank check” preferred stock, which could be issued by our board of directors to increase the number of outstanding shares and thwart a takeover attempt;

 

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classifying our common stock directors with staggered three year terms and having three directors elected by the holders of the Series A convertible preferred stock, which may lengthen the time required to gain control of our board of directors;

 

   

limiting who may call special meetings of stockholders;

 

   

prohibiting stockholder action by written consent (subject to certain exceptions), thereby requiring stockholder action to be taken at a meeting of the stockholders;

 

   

establishing advance notice requirements for nominations of candidates for election to our board of directors or for proposing matters that can be acted upon by stockholders at stockholder meetings;

 

   

requiring stockholder approval by holders of at least 80% of our voting power or the approval by at least 75% of our board of directors with respect to certain extraordinary matters, such as a merger or consolidation, a sale of all or substantially all of our assets or an amendment to our charter;

 

   

requiring the consent of the holders of at least 75% of the outstanding Series B common stock (voting as a separate class) to certain share distributions and other corporate actions in which the voting power of the Series B common stock would be diluted by, for example, issuing shares having multiple votes per share as a dividend to holders of Series A common stock; and

 

   

the existence of authorized and unissued stock which would allow our board of directors to issue shares to persons friendly to current management, thereby protecting the continuity of our management, or which could be used to dilute the stock ownership of persons seeking to obtain control of us.

We have also adopted a shareholder rights plan in order to encourage anyone seeking to acquire us to negotiate with our board of directors prior to attempting a takeover. While the plan is designed to guard against coercive or unfair tactics to gain control of us, the plan may have the effect of making more difficult or delaying any attempts by others to obtain control of us.

Holders of any single series of our common stock may not have any remedies if any action by our directors or officers has an adverse effect on only that series of common stock.

Principles of Delaware law and the provisions of our charter may protect decisions of our board of directors that have a disparate impact upon holders of any single series of our common stock. Under Delaware law, the board of directors has a duty to act with due care and in the best interests of all of our stockholders, including the holders of all series of our common stock. Principles of Delaware law established in cases involving differing treatment of multiple classes or series of stock provide that a board of directors owes an equal duty to all common stockholders regardless of class or series and does not have separate or additional duties to any group of stockholders. As a result, in some circumstances, our directors may be required to make a decision that is adverse to the holders of one series of common stock. Under the principles of Delaware law referred to above, stockholders may not be able to challenge these decisions if our board of directors is disinterested and adequately informed with respect to these decisions and acts in good faith and in the honest belief that it is acting in the best interests of all of our stockholders.

 

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The exercise by Advance/Newhouse of its registration rights could adversely affect the market price of our common stock.

As part of the Newhouse Transaction, Advance/Newhouse has been granted registration rights covering all of the shares of common stock issuable upon conversion of the convertible preferred stock issued to Advance/Newhouse in the Newhouse Transaction. Advance/Newhouse’s preferred stock is convertible into a number of shares equal to one-half of the number of shares of common stock that were issued to former DHC stockholders in the merger, subject to anti-dilution adjustments. The registration rights, which are immediately exercisable, are transferrable with the sale or transfer by Advance/Newhouse of blocks of shares representing 10% or more of the preferred stock it received in the Newhouse Transaction. The exercise of the registration rights, and subsequent sale of possibly large amounts of our common stock in the public market, could materially and adversely affect the market price of our common stock.

John C. Malone and Advance/Newhouse will each have significant voting power with respect to corporate matters considered by our stockholders.

John C. Malone and Advance/Newhouse beneficially own shares of our stock representing approximately 23% and 26%, respectively, of the aggregate voting power represented by our outstanding stock (other than voting power relating to the election of directors). With respect to the election of directors, Mr. Malone is expected to control approximately 32% of the aggregate voting power relating to the election of the eight common stock directors (assuming that the convertible preferred stock owned by Advance/Newhouse (the “A/N Preferred Stock”) has not been converted into shares of our common stock). The A/N Preferred Stock carries with it the right to designate the three preferred stock directors to our board (subject to certain conditions), but will not vote with respect to the election of the eight common stock directors. Also, under the terms of the A/N Preferred Stock, Advance/Newhouse has special voting rights with respect to certain enumerated matters, including material amendments to the restated charter and bylaws, fundamental changes in our business, mergers and other business combinations, certain acquisitions and dispositions and future issuances of capital stock. Although there is no stockholder agreement, voting agreement or any similar arrangement between Mr. Malone and Advance/Newhouse, by virtue of their respective holdings, each of Mr. Malone and Advance/Newhouse likely will have significant influence over the outcome of any corporate transaction or other matter submitted to our stockholders.

 

ITEM 1B. Unresolved Staff Comments.

None.

 

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ITEM 2. Properties.

We own and lease over 1.5 million square feet of building space at more than 40 locations throughout the world, which are utilized in the conduct of our businesses. In the U.S. alone, we own and lease approximately 597,000 and 850,000 square feet of building space, respectively, at 21 locations. Principal locations in the U.S. include: (i) our world headquarters located at One Discovery Place, Silver Spring, Maryland, where approximately 543,000 square feet is used for executive offices and general office space by our U.S. Networks, International Networks, and Commerce, Education, and Other segments, (ii) general office space at 850 Third Avenue, New York, New York, where approximately 132,000 square feet is primarily used for sales by our U.S. Networks operating segment, (iii) general office space and a production and post production facility located at 8045 Kennett Street, Silver Spring, Maryland, where approximately 145,000 square feet is primarily used by our U.S. Networks operating segment, (iv) general office space and a production and post production facility at 1619 Broadway, New York, New York, where approximately 85,000 square is used by our Commerce, Education, and Other operating segment, (v) general office space located at 10100 Santa Monica Boulevard, Los Angeles, California, where approximately 55,000 square feet is primarily used for sales by our U.S. Networks operating segment, (vi) general office space at 6505 Blue Lagoon Drive, Miami, Florida, where approximately 91,000 square feet is primarily used by our International Networks Operating Segment, and (vii) an origination facility at 45580 Terminal Drive, Sterling, Virginia, where approximately 53,000 square feet of space is used to manage the distribution of domestic network television programming by our U.S. Networks operating segment.

We also own and lease over 250,000 square feet of building space at more than 20 locations outside of the U.S. Principal locations outside the U.S. include the U.K., Germany and Singapore.

Each property is considered to be in good condition, adequate for its purpose, and suitably utilized according to the individual nature and requirements of the relevant operations. Our policy is to improve and replace property as considered appropriate to meet the needs of the individual operation.

 

ITEM 3. Legal Proceedings.

We experience routine litigation in the normal course of our business. We believe that none of the pending litigation will have a material adverse effect on our consolidated financial condition, future results of operations, or liquidity.

 

ITEM 4. Submission of Matters to a Vote of Security Holders.

None.

Executive Officers of Discovery Communications, Inc.

Pursuant to General Instruction G(3) to Form 10-K, the information regarding our executive officers required by Item 401(b) of Regulation S-K is hereby included in Part I of this report.

The following table sets forth the name and date of birth of each of our executive officers and the office held by such officer as of February 11, 2010.

 

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Name

  

Position

John S. Hendricks

Born March 29, 1952

   Chairman and a common stock director. Mr. Hendricks is our Founder and has served as Chairman of Discovery since September 1982. Mr. Hendricks served as our Chief Executive Officer from September 1982 to June 2004; and our Interim Chief Executive Officer from December 2006 to January 2007. Mr. Hendricks continues to provide leadership vision for our major content initiatives that reinforce and enhance brand and value, have long shelf life, and have global appeal.

David M. Zaslav

Born January 15, 1960

   President, Chief Executive Officer and a common stock director. Mr. Zaslav has served as our President and Chief Executive Officer since January 2007. Mr. Zaslav served as President, Cable & Domestic Television and New Media Distribution of NBC Universal, Inc., a media and entertainment company (NBC), from May 2006 to December 2006. Mr. Zaslav served as Executive Vice President of NBC, and President of NBC Cable, a division of NBC, from October 1999 to May 2006. Mr. Zaslav is a director of TiVo Inc.

Bradley E. Singer

Born July 11, 1966

   Senior Executive Vice President, Chief Financial Officer and Treasurer. Mr. Singer has served as our Senior Executive Vice President, Chief Financial Officer since July 2008. Mr. Singer served as Chief Financial Officer and Treasurer of American Tower Corporation, a wireless and broadcast communications infrastructure company, from December 2001 to June 2008.

Peter Ligouri

Born July 6, 1960

   Senior Executive Vice President, Chief Operating Officer. Mr. Ligouri joined the Company as Senior Executive Vice President, Chief Operating Officer in January 2010. From March 2009 to December 2009, Mr. Ligouri was a consultant to Comcast Corp. Prior to that, Mr. Ligouri served as Chairman, Entertainment for Fox Broadcasting Company from July 2007 until March 2009 and had served as President, Entertainment for Fox since 2005. Prior to that, Mr. Ligouri served as the President and Chief Executive Officer of FX Networks from 1998 until 2005.

Mark G. Hollinger

Born August 26, 1959

   President and Chief Executive Officer of Discovery Networks International. Mr. Hollinger became President and CEO of Discovery Networks International in December 2009. Prior to that, Mr. Hollinger served as our Chief Operating Officer and Senior Executive Vice President, Corporate Operations from January 2008 through December 2009; and as our Senior Executive Vice President, Corporate Operations from January 2003 through December 2009. Mr. Hollinger served as our General Counsel from 1996 to January 2008, and as President of our Global Businesses and Operations from February 2007 to January 2008.

Joseph A. LaSala, Jr.

Born November 5, 1954

   Senior Executive Vice President, General Counsel and Secretary. Mr. LaSala has served as our Senior Executive Vice President, General Counsel and Secretary since January 2008. Mr. LaSala served as Senior Vice President, General Counsel and Secretary for Novell, Inc., a provider of enterprise software and related services, from January 2003 to January 2008.

Adria Alpert-Romm

Born March 2, 1955

   Senior Executive Vice President, Human Resources. Ms. Romm has served as our Senior Executive Vice President of Human Resources since March 2007. Ms. Romm served as Senior Vice President of Human Resources of NBC from 2004 to 2007. Prior to 2004, Ms. Romm served as a Vice President in Human Resources for the NBC TV network and NBC staff functions.

Bruce L. Campbell

Born November 26, 1967

   President, Digital Media & Corporate Development. Mr. Campbell has served as our President of Digital Media & Corporate Development since March 2007. Mr. Campbell served as Executive Vice President, Business Development of NBC from December 2005 to March 2007, and Senior Vice President, Business Development of NBC from January 2003 to November 2005.

Thomas R. Colan

Born July 21, 1955

   Executive Vice President, Chief Accounting Officer. Mr. Colan has served as our Executive Vice President, Chief Accounting Officer since March 2008. Mr. Colan served as Senior Vice President — Controller and Treasurer at America Online/Time Warner from September 2001 to March 2008.

 

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PART II

 

ITEM 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

Market Information

Our Series A, Series B, and Series C common stock are listed and traded on the Nasdaq Global Select Market under the symbols DISCA, DISCB, and DISCK, respectively. Our common stock began trading on the Nasdaq Global Select Market on September 18, 2008. The following table sets forth, for the periods indicated, the range of high and low daily sales prices per share of our Series A, Series B, and Series C common stock as reported on the Nasdaq Global Select Market.

 

     Series A
Common Stock
   Series B
Common Stock
   Series C
Common Stock
     High    Low    High    Low    High    Low

2009

                 

Fourth quarter

   $ 32.69    $ 26.64    $ 33.99    $ 27.00    $ 28.48    $ 23.33

Third quarter

   $ 29.85    $ 21.42    $ 30.44    $ 20.10    $ 26.75    $ 19.54

Second quarter

   $ 24.08    $ 16.00    $ 25.09    $ 14.37    $ 21.95    $ 14.41

First quarter

   $ 17.29    $ 12.46    $ 18.19    $ 10.11    $ 15.68    $ 12.03

2008

                 

Fourth quarter

   $ 15.29    $ 10.02    $ 20.89    $ 9.50    $ 15.25    $ 8.50

September 18, 2008 through September 30, 2008

   $ 22.75    $ 13.59    $ 31.30    $ 18.96    $ 20.00    $ 12.80

Holders

As of February 11, 2010, there were approximately 2,325, 109, and 2,427 record holders of our Series A, Series B, and Series C common stock, respectively (which amounts do not include the number of shareholders whose shares are held of record by banks, brokerage houses or other institutions, but include each institution as one shareholder).

Dividends

We have not paid any cash dividends on our Series A, Series B, or Series C common stock, and we have no present intention to do so. Payment of cash dividends, if any, in the future will be determined by our Board of Directors in light of our earnings, financial condition, and other relevant considerations. Our credit facility restricts our ability to declare dividends.

 

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Stock Performance Graph

The following graph sets forth the cumulative total shareholder return on our Series A, Series B, and Series C common stock as compared with the cumulative total return of the companies listed in the Standard and Poor’s 500 Stock Index (“S&P 500 Index”) and a peer group of companies comprised of CBS Corporation Class B common stock, News Corporation Class A Common Stock, Scripps Network Interactive, Inc., Time Warner, Inc., Viacom, Inc. Class B common stock, and The Walt Disney Company. The graph assumes $100 originally invested on September 18, 2008 in each of our Series A, Series B, and Series C common stock, the S&P 500 Index, and the stock of our peer group companies, assuming reinvestment of dividends, for each calendar quarter through December 31, 2009.

LOGO

 

     September 18,
2008
   December 31, 
2008
   December 31, 
2009

DISCA

   $ 100.00    $ 102.53    $ 222.09

DISCB

   $ 100.00    $ 78.53    $ 162.82

DISCK

   $ 100.00    $ 83.69    $ 165.75

S&P 500

   $ 100.00    $ 74.86    $ 92.42

Peer Group

   $ 100.00    $ 68.79    $ 100.70

 

ITEM 6. Selected Financial Data.

The table set forth below presents our selected financial information for each of the past five years. The selected statement of operations information for each of the three years during the period ended December 31, 2009 and the selected balance sheet information as of December 31, 2009 and 2008 have been derived from and should be read in conjunction with the audited consolidated financial statements and other financial information included elsewhere in this Annual Report on Form 10-K. The selected statement of operations information for the years ended December 31, 2006 and 2005 and the selected balance sheet information as of December 31, 2007, 2006 and 2005 have been derived from audited consolidated financial statements not included in the Annual Report on Form 10-K.

The selected financial information set forth below reflects the Newhouse Transaction, including the spin-off of Ascent Media Corporation (“AMC”), as though it was consummated on January 1, 2008. Accordingly, the selected financial information includes the results of operations and financial

 

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position of both DHC and DCH since January 1, 2008. The selected financial information for years prior to 2008 reflect only the results of operations and financial position of DHC, as our predecessor. Prior to the Newhouse Transaction, DHC accounted for its ownership interest in DCH using the equity method. Because the Newhouse Transaction is presented as of January 1, 2008, the selected financial information for years prior to 2008 include DCH’s results of operations as a component of Equity in earnings of Discovery Communications Holding, LLC. Information regarding the Newhouse Transaction and DHC’s investment in DCH prior to Newhouse Transaction is disclosed in Note 1 and Note 3, respectively, to the audited consolidated financial statements included in this Annual Report on Form 10-K. The selected financial information also reflects certain reclassifications of each company’s financial information to conform to the combined Company’s financial statement presentation, as follows:

 

   

The consolidated financial statements for 2008 have been adjusted to eliminate the separate presentation of DHC’s investment in DCH and the portion of DCH’s earnings recorded by DHC using the equity method during the period January 1, 2008 through September 17, 2008.

 

   

Advance/Newhouse’s interest in DCH’s earnings for the period January 1, 2008 through September 17, 2008 has been recorded as a component of Net income attributable to non-controlling interests in the Consolidated Statements of Operations.

 

   

All DHC share and per share data have been adjusted for all periods presented to reflect the exchange into our shares.

 

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     Years Ended December 31,  
      2009 (1)(2)(3)        2008 (1)             2007                 2006                 2005        
           (in millions, except per share amounts)        

Selected Statement of Operations Information:

          

Revenues

   $ 3,516      $ 3,443      $ 76      $ 80      $ 82   

Costs of revenues, excluding depreciation and amortization

     1,065        1,024        60        63        64   

Restructuring and impairment charges

     66        61        —          2        —     

Gains on dispositions

     (252     —          (1     —          —     

Operating income (loss)

     1,235        1,057        (8     (11     (8 )

Equity in earnings of Discovery Communications Holding, LLC

     —          —          142        104        80   

Equity in earnings (loss) of unconsolidated affiliates

     8        (61 )     —          —          —     

Income from continuing operations, net of taxes

     559        402        86        52        25   

Income (loss) from discontinued operations, net of taxes

     —          43        (154     (98 )     8   

Net income (loss)

     559        445        (68     (46 )     33   

Less net loss (income) attributable to non-controlling interests

     1        (128 )     —          —          —     

Net income (loss) attributable to Discovery Communications, Inc.

     560        317        (68     (46     33   

Stock dividends to preferred interests (3)

     (8     —          —          —          —     

Net income (loss) available to Discovery Communications, Inc. stockholders

     552        317        (68     (46     33   

Income per share from continuing operations available to Discovery Communications, Inc. stockholders:

          

Basic

   $ 1.30      $ 0.85      $ 0.31      $ 0.19      $ 0.09   

Diluted

   $ 1.30      $ 0.85      $ 0.31      $ 0.19      $ 0.09   

Income (loss) per share from discontinued operations available to Discovery Communications, Inc. stockholders:

          

Basic

   $ —        $ 0.13      $ (0.55   $ (0.35 )   $ 0.03   

Diluted

   $ —        $ 0.13      $ (0.55   $ (0.35 )   $ 0.03   

Net income (loss) per share available to Discovery Communications, Inc. stockholders:

          

Basic

   $ 1.30      $ 0.99      $ (0.24   $ (0.16 )   $ 0.12   

Diluted

   $ 1.30      $ 0.98      $ (0.24   $ (0.16 )   $ 0.12   

Weighted average number of shares outstanding:

          

Basic

     423        321        281        280        280   

Diluted

     425        322        281        280        280   

Selected Balance Sheet Information:

          

Cash and cash equivalents

   $ 623      $ 100      $ 8      $ —        $ 1   

Investment in Discovery Communications Holding, LLC

     —          —          3,272        3,129        3,019   

Goodwill

     6,433        6,891        1,782        1,782        1,782   

Intangible assets, net

     643        716        1        592        592   

Total assets

     10,965        10,484        5,866        5,871        5,819   

Long-term debt:

          

Current portion

     38        458        —          —          —     

Long-term portion

     3,457        3,331        —          —          —     

Total liabilities

     4,697        4,874        1,371        1,322        1,244   

Redeemable non-controlling interests in subsidiaries

     49        49        —          —          —     

Equity attributable to Discovery Communications, Inc.

     6,208        5,536        4,495        4,549        4,575   

Equity attributable to non-controlling interests

     11        25        —          —          —     

Total equity

     6,219        5,561        4,495        4,549        4,575   

 

(1) During fiscal 2008, the Company concluded the spin-off of AMC and as a result reports AMC as discontinued operations for all periods presented. See Note 5 in the accompanying consolidated financial statements for further discussion. In addition, the Discovery Kids network was deconsolidated in May 22, 2009 but the financial position, results of operations, and cash flows of Discovery Kids recorded through May 21, 2009 was not presented as discontinued operations. See Note 4 of the accompanying consolidated financial statements for further discussion.
(2) The fiscal 2009 results include a non-cash gain related to the formation of the Hasbro-Discovery Joint Venture. See Note 4 in the accompanying consolidated financial statements for further discussion.
(3) During fiscal 2009, the Company recognized approximately $8 million of non-cash stock dividends for the release of shares of preferred stock from escrow. Additional information regarding dividends is set forth in Note 13 in the accompanying consolidated financial statements.

 

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ITEM 7. 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 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.

CAUTIONARY NOTE CONCERNING FORWARD-LOOKING STATEMENTS

Certain statements in this Annual Report on Form 10-K 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 Internet protocol 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 FCC, 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 1A. Risk Factors. These forward-looking statements and such risks, uncertainties, and other factors speak only as of the date of this Annual 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

We are a leading global media and entertainment company that provides original and purchased programming across multiple distribution platforms in the U.S. and over 170 other countries, including over 100 television networks offering customized programming in 38 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 extending content distribution across new distribution platforms, including brand-aligned web properties, mobile devices, video-on-demand and broadband channels, which provide promotional platforms for our television programming and serve as additional outlets for advertising and affiliate sales. We also operate websites including HowStuffWorks.com, Petfinder.com and Treehugger.com that provide supplemental news, information and entertainment aligned with our television programming.

 

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We were 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”). 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 consolidated financial statements for further description of the Newhouse Transaction.

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 primarily throughout the U.S. including Discovery Channel, TLC, and Animal Planet, as well as a portfolio of website properties and other digital services. The segment’s channels are wholly-owned except for Discovery Kids, which is operated through a 50-50 joint venture between us and Hasbro, Inc. Currently, we own and operate the Discovery Health Channel. However, pursuant to our joint venture arrangement with Harpo, Inc. for the Oprah Winfrey Network (“OWN”), we will contribute our interest in the Discovery Health Channel to OWN, which is expected to occur in 2011.

U.S. Networks derives revenues primarily from distribution fees and advertising sales, which comprised 46% and 51%, respectively, of revenues for this segment for the year ended December 31, 2009. During the year ended December 31, 2009, Discovery Channel, TLC, and Animal Planet collectively generated 77% of U.S. Networks’ total revenues. U.S. Networks earns distribution fees under multi-year affiliation agreements with cable operators, DTH satellite operators, and other distributors of television programming. Distribution fees are based on the number of subscribers receiving our 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, viewership demographics, the popularity of our programming, and our ability to sell commercial time over a group of channels are key drivers of advertising revenue.

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 method for Discovery Channel, TLC, and Animal Planet content and straight-line amortization method over a maximum of four years for the remaining networks.

 

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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 38 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.

Similar to our U.S. Networks segment, 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 shared programming with U.S. Networks, customized content, and localized schedules via our distribution feeds. For the year ended December 31, 2009, distribution revenues represented approximately 61% of the segment’s operating revenues.

Advertising sales are increasingly important to the segment’s financial success, representing 29% of the segment’s total revenues for the year ended December 31, 2009. 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.

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 completed the transition of 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. We expect a reduction in our year over year top-line revenue contribution, as well as a reduction in direct operating expenses through the first fiscal quarter of 2010.

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.

Recent Developments

Accounting for Variable Interest Entities

Effective January 1, 2010, we adopted the Financial Accounting Standards Board’s (“FASB”) statement amending the accounting for interests in a variable interest entity (“VIE”). Pursuant to the adoption of this statement, beginning January 1, 2010 we will no longer consolidate the Oprah Winfrey Network (“OWN”) and Animal Planet Japan (“APJ”) joint ventures and will account for our interest in these entities under the equity method of accounting. However, we continued to consolidate OWN and APJ through December 31, 2009. Accordingly, for the periods in which we were required to consolidate OWN and APJ under the existing accounting standards, the financial information in this Annual Report on Form 10-K includes the financial position and operating results of these entities. Beginning in 2010, we will apply the provisions of the new statement retrospectively to financial information for all periods presented.

 

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In accordance with the existing accounting guidance that required us to consolidate OWN, half of the operating losses generated during 2009 by OWN were allocated to Harpo, Inc. (“Harpo”), our joint venture partner, as a component of Loss (income) attributable to non-controlling interests. In connection with the change in our method of accounting for our interest in OWN from consolidation to the equity method, because of our obligation to fund OWN’s operations up to $100 million we will absorb all of the joint venture’s losses up to our funding commitment. Similarly, upon adoption we will record $17 million of OWN’s 2009 operating losses that were previously allocated to Harpo as a component of Other non-operating income (expense), net.

Reportable Segments

Effective January 1, 2010, we realigned the Discovery Commerce business from the Commerce, Education, and Other reporting segment into the U.S. Networks reporting segment. In connection with this realignment, we changed the name of our Commerce, Education, and Other reporting segment to Education and Other. The financial information in this Annual Report on Form 10-K has not been recast to reflect the realignment. Accordingly, the results of operations for the Discovery Commerce business are included in the financial results for the Commerce, Education, and Other segment. Beginning in 2010, we will include the Discovery Commerce business in the financial results for the U.S. Networks segment and will recast prior period results to conform to the new presentation.

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 dedicated to high-quality children’s and family entertainment and educational programming. In connection with the arrangement, Discovery contributed the U.S. 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 4 to the accompanying consolidated financial statements.

RESULTS OF OPERATIONS

Items Impacting Comparability

Beginning May 22, 2009, we ceased to consolidate the 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 and our U.S. Networks segment include the 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. The following table presents total revenues and operating expenses recognized by Discovery for Discovery Kids prior to deconsolidation (in millions).

 

        January 1, 2009   
through
May 21, 2009
   Year Ended
 December 31, 2008 

Revenues

   $ 19    $ 42

Operating costs and expenses

   $ 7    $ 24

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 years ended December 31, 2009 and 2008, OWN incurred operating expenses of $26 million and $6 million, respectively.

 

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Results of Operations — 2009 vs. 2008

The following table presents our consolidated results of operation for the years ended December 31, 2009 and 2008 (in millions):

 

     Years Ended   December 31,       % Change
Favorable/
(Unfavorable)
 
             2009                     2008            

Revenues:

      

Distribution

   $ 1,713      $ 1,640      4

Advertising

     1,428        1,396      2

Other

     375        407      (8 )% 
                  

Total revenues

     3,516        3,443      2
                  

Costs of revenues, excluding depreciation and amortization listed below

     1,065        1,024      (4 )% 

Selling, general and administrative

     1,247        1,115      (12 )% 

Depreciation and amortization

     155        186      17

Restructuring and impairment charges

     66        61      (8 )% 

Gains on disposition

     (252     —        —     
                  
     2,281        2,386      4
                  

Operating income

     1,235        1,057      17

Interest expense, net

     (250     (256   2

Other non-operating income (expense), net

     46        (47   NM   
                  

Income from continuing operations before income taxes

     1,031        754      37

Provision for income taxes

     (472     (352   (34 )% 
                  

Income from continuing operations, net of taxes

     559        402      39

Income from discontinued operations, net of taxes

     —          43      (100 )% 
                  

Net income

     559        445      26

Less net loss (income) attributable to non-controlling interests

     1        (128   NM   
                  

Net income attributable to Discovery Communications, Inc.

     560        317      77

Stock dividends to preferred interests

     (8     —        —     
                  

Net income available to Discovery Communications, Inc. stockholders

   $ 552      $ 317      74
                  

NM = not meaningful.

Revenues

Distribution revenues increased $73 million for 2009 as compared to distribution revenues for 2008 due primarily to contractual rate increases, subscriber growth, and a reduction in amortization for launch incentives at our U.S. Networks segment and subscriber growth at our International Networks segment. These increases were partially offset by the deconsolidation of Discovery Kids in May 2009, which resulted in a decline of $20 million, and the absence of a one-time revenue correction recorded in 2008 that increased revenues $8 million. Distribution revenues were also adversely affected by unfavorable impacts of foreign currency exchange rates of $37 million for the year ended December 31, 2009. Excluding the unfavorable impacts of foreign currency exchange rates, the deconsolidation of Discovery Kids, and the one-time revenue correction in 2008, distribution revenues increased 9% or $138 million.

Advertising revenues for 2009 increased $32 million over advertising revenues for 2008. The increase in advertising revenues was principally due to higher ratings and overall price increases at our U.S. Networks segment and increased viewership and subscriber growth at our International Networks segment. Advertising revenues in 2009 also benefited from a $6 million settlement of a prior contract dispute at our U.K. operations. The increases were partially offset by unfavorable impacts of foreign currency exchange rates of $26 million for the year ended December 31, 2009. Excluding the unfavorable impacts of foreign currency exchange rates and the contract dispute settlement, advertising revenues grew 4% or $52 million.

Other revenues, which primarily consist of sales of educational services and content, distribution and advertising sales services, license fees, DVDs, merchandise, and sound and music services, decreased $32 million for 2009 as compared with 2008. The decline

 

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is attributable to decreasing merchandise sales as a result of changing our business model from direct-to-consumer to a licensing model where we receive royalties, lower sales of hard copy educational content as purchasers migrate to online distribution, a decline in sales of the Planet Earth DVD series, and a $6 million unfavorable impact from foreign currency exchange rates. These decreases were partially offset by an increase in online streaming distribution revenues from our education business and $6 million recorded in 2009 in connection with renegotiating our agreements to provide programming to a joint venture. We expect a reduction in our year over year commerce revenues and direct operating costs through the first fiscal quarter of 2010 due to the transition of our commerce business to a licensing model.

Costs of Revenues

Costs of revenues, which consist primarily of content amortization expense, production costs, distribution costs, and sales commissions, increased $41 million for 2009 when compared to costs of revenues for 2008. The increase was primarily due to higher content amortization expense and write-offs primarily at our U.S. Networks and Internal Networks segments as well as higher distribution costs at our International Networks segment. Total content amortization increased $53 million, of which $17 million was attributable to a higher content asset balance while a $36 million was due to an increase in write-offs was due to the decision not to proceed with certain programs or lower than expected revenues. These increases were partially offset by the effect of deconsolidating Discovery Kids, which resulted in a decline of $12 million, a $6 million reduction in our music rights accrual at the International Networks segment, the reduction in costs of goods sold as a result of transitioning our commerce business to a license model, and a $30 million favorable impact from foreign currency exchange rates. Excluding the unfavorable impacts of foreign currency exchange rates, programming write-offs, the deconsolidation of Discovery Kids, and the music rights accrual reduction, costs of revenues increased 6% or $53 million.

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, increased $132 million for 2009 as compared to 2008 due primarily to a $294 million increase in employee costs related to share-based compensation programs and the impact of consolidating OWN beginning in July 2008, which increased costs by $19 million. The increase was partially offset by lower marketing costs, consulting fees, non-share-based employee costs, all of which reflect targeted cost savings initiatives and improvements in operating efficiencies, and a $5 million reduction due to the deconsolidation of Discovery Kids in May 2009. Additionally, selling, general, and administrative expenses were down as a result of favorable impacts of foreign currency exchange rates of $25 million.

Employee costs include share-based compensation expense arising from equity awards to employees under our incentive plans. Total share-based compensation expense was $228 million for 2009 as compared to a net benefit of $66 million for 2008. The increase in share-based compensation 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 $205 million for 2009 as compared to a net benefit of $69 million for 2008. Increased compensation expense for cash-settled awards was due to an increase in fair value, which reflects the increase in the price of our Series A common stock of 117% during the year ended December 31, 2009. 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.

Depreciation and Amortization

Depreciation and amortization expense decreased $31 million for 2009 as compared to the depreciation and amortization expense for 2008. The decrease was due to a decline in amortization expense resulting from lower intangible asset balances in 2009 compared to 2008.

Restructuring and Impairment Charges

Restructuring and impairment charges increased $5 million for 2009 as compared to 2008. We recorded $32 million and $30 million of impairment charges related to intangible assets, goodwill, and capitalized software during 2009 and intangible assets in 2008, respectively, 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 $34 million and $31 million for 2009 and 2008, respectively, in connection with a reorganization of portions of our operations to reduce our cost structure. The charges for 2009 were primarily incurred by our U.S. Networks and International Networks segments as well as our corporate operations and include $29 million of severance costs and $5 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.

 

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The charges incurred in 2008 were primarily related to TLC’s repositioning strategy, the termination of a production group, and the closure of our commerce distribution center and our store headquarters offices along with the transition of the remaining commerce distribution services to third-party service providers.

Gain on Disposition

In connection with the formation of the Hasbro-Discovery joint venture, we recorded a $252 million gain during 2009, 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, net decreased $6 million for 2009 when compared to 2008 primarily due to a decrease in average debt outstanding partially offset by an increase in the average effective interest rate on our borrowings.

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, gains and losses from equity method investments, and other non-operating expenses net of non-operating income. Other non-operating income (expense), net improved $93 million for 2009 as compared to 2008. The improvement was due to the absence of a $57 million charge recorded in 2008 for the other-than-temporary decline in the value of our equity method investment in HSWI, which was partially offset by the absence of a corresponding one-time adjustment of $47 million recorded in 2008 to reduce the liability related to the value of shares in HSWI to be exchanged to its former shareholders. Additionally, we recognized net realized and unrealized gains on derivatives not designated as hedging instruments of $20 million during 2009 as compared to net realized and unrealized losses of $31 million during 2008 due to increased market values. The improvements were also driven by the sale of certain investments in 2009 that resulted in pre-tax gains of $15 million and a net increase of $12 million in income from investments accounted for using the equity method excluding the HSWI impairment.

Provision for Income Taxes

The provision for income taxes was $472 million and $352 million for 2009 and 2008, respectively. The effective tax rates were 46% and 47% for 2009 and 2008. The effective tax rate for 2009 differed from the federal statutory rate of 35% due primarily to a permanent difference on the $252 million gain from the sale of a 50% interest in and deconsolidation of Discovery Kids in May 2009, state income taxes and to a lesser extent, deductions for domestic production activities.

The effective tax rate for 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. Accordingly, our consolidated financial statements 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 year ended December 31, 2008 includes the taxes recognized by both DCH and DHC related to the portion of DCH’s operating results recognized by DHC. DHC recognized $91 million of deferred tax expense related to its investment in DCH prior to the Newhouse Transaction for 2008. The provision for income taxes for 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.

Net Loss (Income) Attributable to Non-Controlling Interests

Net loss (income) attributable to non-controlling interests represents the portion of net operating results allocable to the non-controlling partners, which was $1 million for 2009 and $(128) million for 2008. The change in net loss (income) attributable to non-controlling interests is primarily a result of allocating a portion of DCH’s 2008 profits to Advance/Newhouse for its ownership interest in DCH prior to the Newhouse Transaction.

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, which did not result in a gain or loss.

 

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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, LLC (DBA “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.

Also 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.

The following table presents summary financial information for discontinued operations for the year ended December 31, 2008 (in millions)

 

     Year Ended
December 31, 2008
 

Revenues

   $ 484   

Loss from the operations of discontinued operations before income taxes

   $ (6

Loss from the operations of discontinued operations, net of taxes

   $ (4

Gains on dispositions, net of taxes

   $ 47   

Income from discontinued operations, net of taxes

   $ 43   

Income per share from discontinued operations available to Discovery Communications, Inc. stockholders, basic and diluted

   $ 0.13   

Weighted average number of shares outstanding:

  

Basic

     321   

Diluted

     322   

Stock Dividends to Preferred Interests

During 2009, the Company recognized $8 million for non-cash stock dividends for the release of approximately 500,000 shares of preferred stock from escrow. Additional information regarding the stock dividend is set forth in Note 13 in the accompanying consolidated financial statements.

Segment Results of Operations

As noted above, 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 business and asset dispositions, consistent with our segment reporting. Additional financial information related to our segments is set forth in Note 23 to the accompanying consolidated financial statements in Item 8 of Part II of this Annual Report on Form 10-K.

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 flows provided by operating activities and other measures of financial performance reported in accordance with U.S. GAAP.

 

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The following table presents our revenues by segment and certain consolidated operating expenses, contra revenue amounts, and Adjusted OIBDA (in millions):

 

                % Change  
    Years Ended December 31,     Favorable/  
            2009                     2008             (Unfavorable)  

Revenues:

     

U.S. Networks

  $ 2,142      $ 2,062      4

International Networks

    1,189        1,158      3

Commerce, Education, and Other

    176        196      (10 )% 

Corporate and intersegment eliminations

    9        27      (67 )% 
                 

Total revenues

    3,516        3,443      2
                 

Costs of revenues (1)

    (1,065     (1,024   (4 )% 

Selling, general and administrative (1)

    (1,042     (1,184   12

Add: Amortization of deferred launch incentives (2)

    55        75      (27 )% 
                 

Adjusted OIBDA

  $ 1,464      $ 1,310      12
                 

 

(1)

Costs of revenues and selling, general and administrative expenses exclude mark-to-market share-based compensation, depreciation and amortization, exit and restructuring charges, impairments of intangible assets, goodwill, capitalized software costs, and a gain on a business disposition.

(2)

Amortization of deferred launch incentives are included as a reduction of distribution revenues for U.S. GAAP reporting, but are excluded from Adjusted OIBDA.

The following table presents our Adjusted OIBDA by segment with a reconciliation of Adjusted OIBDA to consolidated operating income (in millions):

 

                % Change  
    Years Ended December 31,     Favorable/  
            2009                     2008             (Unfavorable)  

Adjusted OIBDA:

     

U.S. Networks

  $ 1,196      $ 1,111      8

International Networks

    450        387      16

Commerce, Education, and Other

    22        13      69

Corporate and intersegment eliminations

    (204     (201   (1 )% 
                 

Total Adjusted OIBDA

    1,464        1,310      12
                 

Amortization of deferred launch incentives

    (55     (75   27

Mark-to-market share-based compensation

    (205 )     69      NM   

Depreciation and amortization

    (155     (186   17

Restructuring and impairment charges

    (66     (61   (8 )% 

Gain on disposition

    252        —        —     
                 

Total operating income

  $ 1,235      $ 1,057      17
                 

NM = not meaningful.

 

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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).

 

                % Change  
    Years Ended December 31,     Favorable/  
            2009                     2008             (Unfavorable)  

Revenues:

     

Distribution

  $ 982      $ 927      6

Advertising

    1,082        1,058      2

Other

    78        77      1
                 

Total revenues

    2,142        2,062      4
                 

Costs of revenues

    (533     (509   (5 )% 

Selling, general and administrative

    (434     (476   9

Add: Amortization of deferred launch incentives

    21        34      (38 )% 
                 

Adjusted OIBDA

    1,196        1,111      8
                 

Amortization of deferred launch incentives

    (21     (34   38

Mark-to-market share-based compensation

    (1     (4 )   75

Depreciation and amortization

    (30     (56   46

Restructuring and impairment charges

    (37     (51 )   27

Gain on disposition

    252        —        —     
                 

Operating income

  $ 1,359      $ 966      41
                 

Revenues

Total revenues for 2009 increased $80 million as compared to total revenues for 2008. The increase in total revenues was due primarily to increases in distribution revenues of $55 million and advertising revenues of $24 million.

Increased distribution revenues for 2009 were due to annual contractual rate increases, an increase in paying subscribers, principally for networks carried on the digital tier, and a decline of $13 million for the amortization of launch incentives. These increases were partially offset by the effect of deconsolidating Discovery Kids in May 2009, which resulted in a decline of $20 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 2009 increased as a result of higher ratings and overall increased pricing, which were partially offset by lower cash sellouts due to softness in the economy.

Costs of Revenues

Costs of revenues, which consist primarily of content amortization expense, sales commissions, production costs, and distribution costs, increased $24 million for 2009 as compared to costs of revenues for 2008. The increase in costs of revenues was driven by an increase of $30 million in content amortization expense, of which $18 million was due to a higher content asset balance, reflecting our continued investment in content, and $12 million was attributable to higher write-offs of certain programming costs that are included as content amortization, partially offset by decreases in production and distribution costs. The increase in costs of revenues is net of a $12 million decline 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 $42 million for 2009 when compared to selling, general and administrative expenses for 2008. The decrease was attributable primarily to lower marketing and overhead costs, which reflects our cost reduction efforts. Also contributing to the decline was the effect of deconsolidating Discovery Kids in May 2009, which resulted in a decline of $5 million. These decreases were partially offset by higher employee costs and an additional $19 million of costs related to OWN, which we began consolidating in July 2008.

 

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Adjusted OIBDA

Adjusted OIBDA increased $85 million for 2009 in comparison to Adjusted OIBDA for 2008. The improved performance is primarily due to higher distribution revenues driven by annual contractual rate increases and subscriber growth, an increase in advertising revenues due to increased ratings and overall pricing, and lower marketing and overhead costs. These improvements were partially offset by an increase in content amortization and write-offs and costs associated with OWN.

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).

 

                % Change  
    Years Ended December 31,     Favorable/  
            2009                     2008             (Unfavorable)  

Revenues:

     

Distribution

  $ 731      $ 713      3

Advertising

    345        336      3

Other

    113        109      4
                 

Total revenues

    1,189        1,158      3
                 

Costs of revenues

    (422     (394   (7 )% 

Selling, general and administrative

    (351     (418   16

Add: Amortization of deferred launch incentives

    34        41      (17 )% 
                 

Adjusted OIBDA

    450        387      16
                 

Amortization of deferred launch incentives

    (34     (41   17

Depreciation and amortization

    (41     (43   5

Restructuring and impairment charges

    (22     (2   NM   
                 

Operating income

  $ 353      $ 301      17
                 

NM = not meaningful.

Revenues

Total revenues for 2009 increased $31 million as compared to total revenues for 2008. The increase in total revenues was due primarily to operational increases in distribution revenues and advertising revenues, which were partially offset by unfavorable impacts of foreign currency exchange rates of $69 million. Excluding the unfavorable impacts of foreign currency exchange rates, total revenues increased 10% or $100 million.

Distribution revenues increased $18 million for 2009 when compared to distribution revenues for 2008, net of unfavorable impacts of foreign currency exchange rates of $37 million. Excluding the unfavorable impacts of foreign currency exchange rates, distribution revenues increased 9% or $55 million. The increase in distribution revenues was attributable to growth in the number of paying subscribers in Latin America, EMEA and Asia-Pacific, which reflect the growth in pay television services in these regions.

Advertising revenues increased $9 million for 2009 in comparison to advertising revenues for 2008, including the unfavorable impacts of foreign currency exchange rates of $26 million. Excluding the unfavorable impacts of foreign currency exchange rates, advertising revenues increased 12% or $35 million. Increased advertising revenues was primarily due to growth in the U.K., EMEA, and Latin America, which reflects higher viewership combined with an increased subscriber base. Increased viewership was attributable to growth in pay television in certain markets and expanded distribution of our networks. Advertising revenues in 2009 also benefited from a $6 million settlement of a prior contract dispute at our U.K. operations. 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, primarily on a go-forward basis.

Other revenues for 2009 include $6 million recorded in connection with renegotiating our agreements to provide content to a joint venture.

 

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Costs of Revenues

Costs of revenues, which consist primarily of content amortization expense, distribution costs, sales commissions, and production costs, increased $28 million for 2009 as compared to costs of revenues for 2008. The increase was driven by higher content amortization expense and 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. Content amortization expense increased 8% or $20 million, driven by an increase of $13 million 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, $24 million more in write-offs of programming costs, partially offset by favorable changes in foreign currency exchange rates of $17 million. Distribution costs increased $10 million as a result of expanding the distribution of our networks in certain markets. The increases in costs of revenues were net of favorable impacts of foreign currency exchange rates of $30 million. Excluding the favorable impacts of foreign currency exchange rates, costs of revenues increased 17% or $58 million.

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 $67 million for 2009 when compared to selling, general, and administrative expenses for 2008. The decrease is attributable to lower marketing and employee costs as a result of cost saving initiatives and improvements in operating efficiencies and a $25 million benefit due to favorable impacts of foreign currency exchange rates. Excluding the favorable impacts of foreign currency exchange rates, selling, general and administrative expenses declined 11% or $42 million.

Adjusted OIBDA

Adjusted OIBDA increased $63 million for 2009 as compared to Adjusted OIBDA for 2008. Excluding the impacts of foreign exchange rate fluctuations, Adjusted OIBDA increased 24% or $83 million. The improvement in performance reflects growth in distribution revenues resulting from subscriber growth, an increase in advertising due to higher viewership and subscribers, and a decline in marketing and personnel costs. These increases were partially offset by increases in content amortization and write-offs and distribution costs.

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).

 

                % Change  
    Years Ended December 31,     Favorable/  
            2009                     2008             (Unfavorable)  

Revenues:

     

Advertising

  $ 1      $ —        —     

Other

    175        196      (11 )% 
                 

Total revenues

    176        196      (10 )% 
                 

Costs of revenues

    (103     (116   11

Selling, general and administrative

    (51     (67   24
                 

Adjusted OIBDA

    22        13      69
                 

Depreciation and amortization

    (6     (9   33

Restructuring and impairment charges

    (2     (6   67
                 

Operating income (loss)

  $ 14      $ (2   NM   
                 

NM = not meaningful.

Revenues

Total revenues for 2009 decreased $20 million as compared to total revenues for 2008 principally driven by a decrease of $25 million in commerce sales reflecting the transition of our commerce business to a licensing model in early 2009, a decrease in sound services, and a decline in sales of hardcopy education content. These decreases were partially offset by growth in our education online streaming distribution revenues as a result of the continued migration from hardcopy to online distribution of our education content. We expect the transition of our commerce business to a licensing model will result in a reduction in our year-over-year commerce revenues and direct operating costs through the first fiscal quarter of 2010.

 

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Costs of Revenues

Costs of revenues, which consist principally of production costs, royalty payments, and content amortization expense, decreased $13 million for 2009 as compared to costs of revenues for 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 early 2009 and to a lesser extent reductions in production costs.

Selling, General and Administrative Expenses

Selling, general and administrative expenses, which are principally comprised of employee costs, occupancy expenses, and marketing costs, decreased $16 million for 2009 when compared to selling, general and administrative expenses for 2008 primarily due to cost reductions in the commerce business. The decline in expenses in the commerce business was attributable to lower employee costs as a result of the transition of our commerce business to a licensing model in early 2009.

Adjusted OIBDA

Adjusted OIBDA for 2009 increased $9 million as compared to Adjusted OIBDA for 2008. The increase principally reflects growth in education online streaming distribution revenues as users migrate from hard copy education content 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).

 

    Years Ended December 31,     % Change
Favorable/
 
            2009                     2008             (Unfavorable)  

Revenues:

     

Other

  $ 9      $ 27      (67 )% 
                 

Total revenues

    9        27      (67 )% 
                 

Costs of revenues

    (7     (5   (40 )% 

Selling, general and administrative

    (206     (223   8
                 

Adjusted OIBDA

    (204     (201   (1 )% 
                 

Mark-to-market share-based compensation

    (204 )     73      NM   

Depreciation and amortization

    (78     (78   —     

Restructuring and impairment charges

    (5     (2   NM   
                 

Operating loss

  $ (491   $ (208   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 year ended December 31, 2009 decreased $18 million, when compared with the corresponding period 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 $17 million for 2009 driven by lower personnel and consulting costs as a result of cost savings initiatives.

 

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2008 vs. 2007

Consolidated Results of Operations

The following discussion of our results of operations is presented in three parts to assist the reader in better understanding our operations. The table below reconciles our and DHC’s prior year income statements presented in accordance with U.S. GAAP to the financial information discussed in our adjusted results of operations for the year ended December 31, 2007. The second section is an overall discussion of our consolidated operating results. The third section includes a more detailed discussion of revenue and expense activity of our three operating divisions: U.S. Networks, International Networks, and Commerce, Education, and Other.

The following table represents the year ended December 31, 2007 on an as adjusted basis (in millions). The information in the “DHC Historical” and “DCH Historical” columns is derived from the historical statement of operations of DHC included elsewhere herein (and has been adjusted to conform to Discovery’s presentation) and the historical statement of operations for DHC included in Part IV of the 2008 Form 10-K. The adjustments column reflects specific adjustments required to present the “Discovery As Adjusted” column as if the Newhouse Transaction occurred on January 1, 2007. We believe that the 2007 as adjusted presentation will assist the reader in better understanding our operations as this presentation is on a comparable basis with the 2008 Statement of Operations, therefore operating trends are more clearly presented. However, the actual results of operations for 2007 could have been significantly different than the 2007 as adjusted results had the Newhouse Transaction actually closed on January 1, 2007.

 

    Year Ended December 31, 2007
    Discovery
Holding
       Company (A)        
  Discovery
      Communications   
Holding, LLC
Historical
          Adjustments             Discovery
Communications, Inc.
As Adjusted

Revenues:

       

Distribution

  $ —     $ 1,477   $ —        $ 1,477

Advertising

    —       1,345     —          1,345

Other

    76     305     —          381
                         

Total revenues

    76     3,127     —          3,203
                         

Costs of revenues, excluding depreciation and amortization listed below

    60     1,167     —          1,227

Selling, general and administrative

    22     1,296     —          1,318

Depreciation and amortization

    3     131     —          134

Restructuring and impairment charges

    —       46     —          46

Gains on dispositions

    (1)     (135)     —          (136)
                         
    84     2,505     —          2,589
                         

Operating (loss) income

    (8)     622     —          614

Equity in earnings of Discovery Communications Holding, LLC

    142     —       (142) (B)      —  

Interest expense, net

    —       (249)     —          (249)

Other non-operating income (expense), net

    8     (1)     —          7
                         

Income from continuing operations before income taxes

    142     372     (142)        372

Provision for income taxes

    (56)     (77)     —          (133)
                         

Income from continuing operations, net of taxes

    86     295     (142)        239

Loss from discontinued operations, net of taxes

    (154)     (65)     —          (219)
                         

Net (loss) income

    (68)     230     (142)        20

Less net income attributable to non-controlling interests

    —       (8)     (80) (C)      (88)
                         

Net (loss) income attributable to Discovery Communications, Inc. stockholders

  $ (68)   $ 222   $ (222)      $ (68)
                         

 

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(A) Amounts in this column represent DHC’s results of operations for the year ended December 31, 2007, recast to reflect the operating results of Ascent Media Corporation, Ascent Media CANS, LLC and Ascent Media Sytems & Technology Services, LLC as discontinued operations.

The continuing operations of DHC represent corporate costs and the operating results of Creative Sound Services.

(B) Represents the elimination of the portion of DCH’s earnings allocated to and recognized by DHC under the equity of accounting for the year ended December 31, 2007.
(C) Represents the allocation of the portion DCH’s earnings not recognized by DHC to non-controlling interests for the year ended December 31, 2007.

The following table presents our operating results for the year ended December 31, 2008 and our adjusted results for the year ended December 31, 2007 (in millions).

 

    Years Ended December 31,     % Change
Favorable/
  (Unfavorable)  
 
              2008               2007
As Adjusted (D)
   

Revenues:

     

Distribution

  $ 1,640      $ 1,477      11

Advertising

    1,396        1,345      4

Other

    407        381      7
                 

Total revenues

    3,443        3,203      7
                 

Costs of revenues, excluding depreciation and amortization listed below

    1,024        1,227      17

Selling, general and administrative

    1,115        1,318      15

Depreciation and amortization

    186        134      (39 )% 

Restructuring and impairment charges

    61        46      (33 )% 

Gains on dispositions

    —          (136   (100 )%
                 
    2,386        2,589      8
                 

Operating income

    1,057        614      72

Interest expense, net

    (256     (249   (3 )% 

Other non-operating (expense) income, net

    (47     7      NM   
                 

Income from continuing operations before income taxes

    754        372      NM   

Provision for income taxes

    (352     (133   NM   
                 

Income from continuing operations, net of taxes

    402        239      68

Income (loss) from discontinued operations, net of taxes

    43        (219   NM   
                 

Net income

    445        20      NM   

Less net income attributable to non-controlling interests

    (128     (88   (45 )% 
                 

Net income (loss) attributable to Discovery Communications, Inc. stockholders

  $ 317      $ (68   NM   
                 

NM = not meaningful.

 

(D) In order to enhance comparability, unaudited adjusted financial information for the year ended December 31, 2007 is provided as if the Newhouse Transaction had occurred on January 1, 2007.

 

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Revenues

Our consolidated revenues increased $240 million for the year ended December 31, 2008 when compared with 2007, as adjusted. Distribution revenues increased $163 million during the year primarily due to International Networks subscriber growth combined with annual contract increases for the fully distributed U.S. Networks, offset by the disposition of Travel Channel. Advertising revenues increased $51 million for the period, and is primarily attributed to higher pricing and cash sellout rates in U.S. Networks. Other revenues increased $26 million for the year ended December 31, 2008 when compared with 2007, as adjusted, primarily due to an increase in licensing revenues in the International Networks, increase in sales of the Planet Earth DVD through a joint venture, and increases in revenues from our representation of the Travel Channel through our U.S. Networks segment, offset by a decline in revenues from the direct to consumer business in our Commerce, Education, and Other business segment.

Costs of Revenues

Costs of revenues, which includes content amortization and other production related expenses in addition to distribution and merchandising costs, decreased $203 million for the year ended December 31, 2008 when compared to 2007, as adjusted. The decrease in costs of revenues was primarily due to the effect of content impairment charges in the fourth quarter 2007 of $139 million primarily in U.S. Networks coupled with a $76 million decrease in related amortization expense. These decreases were partially offset by increases in costs of revenue in the International Networks and content impairment related to TLC.

Selling, General and Administrative

Selling, general and administrative expenses, which include certain personnel, marketing and other general and administrative expenses, decreased $203 million for the year ended December 31, 2008 from 2007, as adjusted, primarily attributable to a $210 million decrease in expenses arising from long-term incentive plans, which were partially offset by slight increases in costs incurred in conjunction with DCH preparing to become a consolidated subsidiary of ours as a result of the Newhouse Transaction and an increase in personnel costs in International Networks. Expenses arising from long-term incentive plans are largely related to DCH’s unit-based, long-term incentive plan, the Discovery Appreciation Plan or the “DAP”, or “LTIP”, which was modified to reflect our capital structure following the Newhouse Transaction. Prior to the Newhouse Transaction, the value of units in the LTIP was indexed to the value of DHC Series A common stock. After the Newhouse Transaction, the units remained outstanding and were converted at the effective time of the Newhouse Transaction to track changes in the value of our Series A common stock. The change in unit value of LTIP awards outstanding is recorded as expenses arising from long-term incentive plans over the period outstanding. Primarily due to the decrease in both the DHC Series A common stock and our Series A common stock price during the year ended December 31, 2008, we recorded a benefit of $69 million to expenses arising from long-term incentive plans in 2008 compared to expenses arising from long-term incentive plans of $141 million for the year ended December 31, 2007, as adjusted. In the fourth quarter 2008, eligible new hires and promoted employees received stock options that vest in four equal installments, and those employees with LTIP units that vest between September 18, 2008 and March 14, 2009 will receive cash-settled stock appreciation awards that expire in March 2010. We do not intend to make additional cash-settled stock appreciation awards, except as may be required by contract or to employees in countries where stock option awards are not permitted.

Depreciation and Amortization

The increase in depreciation and amortization for the year ended December 31, 2008 is due to an increase in intangible assets resulting from the reclassification of DHC intangibles following the Newhouse Transaction and the HowStuffWorks.com acquisition.

Restructuring and Impairment Charges

During the year ended December 31, 2008, we recorded $31 million in restructuring charges, of which $11 million relates to the relocation and severance costs related to TLC’s repositioning strategy, $6 million for the termination of a production group, and $6 million due to the closure of our commerce distribution center and our store headquarters offices along with the transition of the remaining commerce distribution services to third-party service providers. During the year ended December 31, 2007, we recorded restructuring charges of $20 million related to a number of organizational and strategic adjustments. The purpose of these adjustments was to better align our organizational structure with our new strategic priorities and to respond to continuing changes within the media industry.

During the fourth quarter of 2008, we recorded a write-off of intangible assets of $30 million related to our HowStuffWorks.com business. This write-off of intangible assets was due to the decline in the cash flows projected to be generated by the HowStuffWorks.com business. During the second quarter of 2007, DCH recorded an asset impairment of $26 million which represents write-offs of intangible assets related to the education business.

 

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Gains on Dispositions

In 2007, we exchanged the capital stock of a subsidiary that held the Travel Channel and travelchannel.com (collectively, the “Travel Business”) for Cox Communications Holdings, Inc.’s 25% ownership interest in us and $1.3 billion in cash. The distribution of the Travel Business, which was valued at $575 million, resulted in a $135 million tax-free gain.

Interest Expense, Net

On May 14, 2007, we entered into a $1.5 billion term loan in conjunction with the transaction with Cox Communications Holdings, Inc., offset by a $180 million payment for a senior note that matured. The increase in interest expense for the year ended December 31, 2008 when compared with 2007, as adjusted, is primarily a result of the term loan.

Other Non-Operating (Expense) Income, Net

Other non-operating (expense) income, net includes our equity in the operating results of unconsolidated affiliates, other non-operating income net of non-operating expenses, as well as unrealized losses from derivative instruments. Equity in loss of unconsolidated affiliates in 2008 consisted primarily of a $57 million other-than-temporary decline in the value of our equity method investment in HSWi, coupled with $13 million in equity losses recorded during 2008, which is offset by equity in income from our joint ventures in Canada and Japan. In 2007, we recognized $9 million of equity in income primarily from our joint ventures in Canada and Japan.

Other non-operating income consisted of a $47 million reduction of a liability related to the value of shares in HSWi to be exchanged to its former shareholders, which was recorded in December 2008. Offsetting this non-operating income is unrealized losses from derivative transactions. Unrealized losses from derivative transactions relate primarily to our use of derivative instruments to modify our exposure to interest rate fluctuations on our debt. These instruments include a combination of swaps, caps, collars and other structured instruments. As a result of unrealized mark to market adjustments, we recognized unrealized losses of $31 million and $9 million during the years ended December 31, 2008 and 2007, respectively. The foreign exchange hedging instruments used by us are spot, forward and option contracts. Additionally, we enter into non-designated forward contracts to hedge non-dollar denominated cash flows and foreign currency balances.

Provision for Income Taxes

Our effective tax rate was 47% and 36% for the years ended December 31, 2008 and 2007, as adjusted, respectively. Our effective tax rate for the year ended December 31, 2008 differed from the federal income tax rate of 35% primarily due to DHC’s recognition of deferred tax expense related to its investment in DCH (net of tax benefit from intangible amortization related to the spin-off of the Travel Channel in 2007), which is partially offset by the release of a valuation allowance on deferred tax assets of Ascent Media Sound, Inc. Other items impacting the effective tax rate include the following: our conversion from deducting foreign taxes to claiming foreign tax credits, foreign unrecognized tax positions, and other miscellaneous items. Our effective tax rate for the year ended December 31, 2007, as adjusted, was not materially different than the federal income tax rate of 35%. However, during this period we benefited from the tax-free treatment of the gain recognized on the disposition of the Travel Channel and the release of Travel Channel deferred tax liabilities, offset by the tax impact of discontinued operations.

Income (Loss) from Discontinued Operations, Net of Taxes

Summarized financial information included in discontinued operations is set forth in the following table (in millions).

 

    Years Ended December 31,  
            2008             2007
 As Adjusted 
 

Revenues

  $ 484      $ 689   

Loss from the operations of discontinued operations before income taxes

  $ (6   $ (250

Loss from the operations of discontinued operations, net of taxes

  $ (4   $ (219

Gains on dispositions, net of taxes

  $ 47      $ —     

Income (loss) from discontinued operations, net of taxes

  $ 43      $ (219

Income (loss) per share from discontinued operations available to Discovery Communications, Inc. stockholders, basic and diluted

  $ 0.13      $ (0.78

Weighted average number of shares outstanding:

   

Basic

    321        281   

Diluted

    322        281   

 

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On September 17, 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 CSS, which provides sound, music, mixing, sound effects and other related services under brand names such as Sound One, POP Sound, Soundelux and Todd A-O (which businesses remained with us following the completion of the Newhouse Transaction). The AMC spin-off was structured such that there was no gain or loss related to the transaction.

Just prior to the Newhouse Transaction, DHC sold its ownership interests in Ascent Media CANS, LLC (D/B/A AccentHealth) to AccentHealth Holdings LLC, an unaffiliated third party, for approximately $119 million in cash. It was determined that AccentHealth was a non-core asset, and the sale of AccentHealth was consistent with DHC’s strategy to divest non-core assets. DHC recognized a pre-tax gain of approximately $64 million in connection with the sale of AccentHealth, which is recorded as a component of discontinued operations. As there is no continuing involvement in the operations of AMC or AccentHealth, the financial results of their operations have been presented as discontinued operations for the years ended December 31, 2008 and 2007.

Following a comprehensive strategic review of our businesses, we closed 103 mall-based and stand-alone Discovery Stores in the third quarter of 2007. As there is no continuing involvement in the retail stores or significant migration of retail customers to e-commerce, the results of the Retail business are accounted for as discontinued operations in the as-adjusted results of operations for the year ended December 31, 2007.

Net Loss (Income) Attributable to Non-Controlling Interests

Non-controlling interests primarily represent our and consolidated entities’ portion of earnings which are allocable to the non-controlling partners. The increase in net income attributable to non-controlling interests during the year ended December 31, 2008 is primarily a result of our increased profits allocated to non-controlling partners prior to the Newhouse Transaction and reporting of our financial results in accordance with FASB Accounting Standards Codification Topic 810, Consolidations (“ASC 810”).

Segment Results of Operations

 

    Years Ended December 31,     % Change
Favorable/
(Unfavorable)
 
            2008             2007
 As Adjusted 
   

Revenues:

     

U.S. Networks

  $ 2,062      $ 1,941      6

International Networks

    1,158        1,030      12

Commerce, Education, and Other

    196        225      (13 )% 

Corporate and intersegment eliminations

    27        7      NM   
                 

Total revenues

    3,443        3,203      7
                 

Costs of revenues (1) 

    (1,024     (1,227   17

Selling, general and administrative (1) 

    (1,184     (1,177   (1 )% 

Add: Amortization of deferred launch incentives

    75        100      (25 )% 
                 

Adjusted OIBDA

  $ 1,310      $ 899      46
                 
     

NM = not meaningful.

 

(1)

Costs of revenue and selling, general and administrative expenses exclude depreciation and amortization, income (expense) arising from long-term incentive plan awards (mark-to-market), gains on dispositions, exit and restructuring charges, and intangible asset impairments.

 

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    Years Ended December 31,     % Change
Favorable/
 (Unfavorable)
 
             2008             2007
  As Adjusted  
   

Adjusted OIBDA:

     

U.S. Networks

  $ 1,111      $ 830      34

International Networks

    387        254      52

Commerce, Education, and Other

    13        4      NM   

Corporate and intersegment eliminations

    (201     (189   (6 )% 
                 

Total Adjusted OIBDA

    1,310        899      46
                 

Amortization of deferred launch incentives

    (75     (100   25

Mark-to-market share-based compensation

    69        (141   NM   

Depreciation and amortization

    (186     (134   (39 )% 

Restructuring and impairment charges

    (61     (46   (33 )% 

Gains on dispositions

    —          136      (100 )% 
                 

Total operating income

  $ 1,057     $ 614     72
                 

NM = not meaningful.

U.S. Networks

 

    Years Ended December 31,     % Change
Favorable/
(Unfavorable)
 
    2008     2007
As Adjusted
   

Revenues:

     

Distribution

  $ 927      $ 862      8

Advertising

    1,058        1,015      4

Other

    77        64      20
                 

Total revenues

             2,062                 1,941      6
                 

Costs of revenues

    (509     (699   27

Selling, general and administrative

    (476     (468   (2 )% 

Add: Amortization of deferred launch incentives

    34        56      (39 )% 
                 

Adjusted OIBDA

    1,111        830      34
                 

Amortization of deferred launch incentives

    (34     (56   39

Mark-to-market share-based compensation

    (4     —                      —     

Depreciation and amortization

    (56     (28   (100 )% 

Restructuring and impairment charges

    (51     —        —     
                 

Operating income

  $ 966      $ 746      29
                 

As noted above, in May 2007, we exchanged our subsidiary holding the Travel Channel, travelchannel.com and approximately $1.3 billion in cash for Cox’s interest in DCH. Accordingly, DCH’s 2007 results of operations do not include Travel Channel after May 14, 2007. The disposal of Travel Channel does not meet the requirements for discontinued operations presentation. The following table represents U.S. Networks results of operations excluding Travel Channel for all periods. Although this presentation is not in accordance with U.S. GAAP, we believe this presentation provides a more meaningful comparison of the U.S. Networks results of operations and allows the reader to better understand the U.S. Networks ongoing operations.

 

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U.S. Networks without Travel Channel

 

    Years Ended December 31,     % Change
Favorable/
 (Unfavorable)
 
            2008              2007
  As Adjusted  
   

Revenues:

   

Distribution

  $ 927      $ 840      10

Advertising

    1,058        975      9

Other

    77        64      20
                 

Total revenues

    2,062        1,879      10
                 

Costs of revenues

    (509     (673   24

Selling, general and administrative

    (476     (447   (6 )% 

Add: Amortization of deferred launch incentives

    34        51      (33 )% 
                 

Adjusted OIBDA

    1,111        810      37
                 

Amortization of deferred launch incentives

    (34     (51   33

Mark-to-market share-based compensation

    (4     —        —     

Depreciation and amortization

    (56     (28   (100 )% 

Restructuring and impairment charges

    (51     —        —     
                 

Operating income

  $ 966      $ 731      32
                 

Since the disposal of Travel Channel in 2007 did not meet the requirements of discontinued operations presentation, and the results of Travel Channel are not consolidated with DCH post transaction, the following discussion excludes the results of Travel Channel for all periods so as to facilitate comparability of the U.S. Networks segment data.

Revenues

Total revenues increased $183 million for the year ended December 31, 2008, when compared with 2007. Distribution revenue increased $87 million over the period, driven by annual contractual rate increases for fully distributed networks combined with subscription units, principally from networks carried on the digital tier. Distribution revenue includes a one-time $8 million adjustment resulting from improvements in our methodology of estimating accrued revenue for certain distribution operators. The adjustment was recorded in its entirety in the second quarter of 2008 and is not material to the current or prior periods. Contra revenue items included in distribution revenue, such as launch amortization and marketing consideration, decreased $19 million for the year ended December 31, 2008 when compared with 2007. This decrease includes $3 million for replacement decoder boxes to support the digitization of an analog transponder recorded as contra revenue in the second quarter of 2007.

Advertising revenue increased $83 million for the year ended December 31, 2008, when compared with the prior year, primarily due to higher pricing in the up-front and scatter markets, as well as higher cash sellouts, which were partially offset by under-delivery of committed audience levels, when compared with the corresponding prior year periods.

Other revenue increased $13 million for the year ended December 31, 2008, primarily from our representation of the Travel Channel, which increased $11 million during the period, coupled with an increase of $5 million in revenue from How Stuff Works, which was acquired in December 2007. These increases were partially offset by a decrease of $6 million of international program sales revenue, which is now reported in the International Networks segment.

Costs of Revenues

For the year ended December 31, 2008, costs of revenues decreased $164 million when compared with 2007, primarily due to a decrease in content amortization expense of $156 million. The decrease in content amortization expense was primarily a result of the effect of the $129 million content impairment charge recorded in 2007 following a change in management and related changes in strategy. This charge coupled with the related $76 million decrease in content amortization expense was offset by $17 million of content impairment charges for TLC programs following a change in management and related changes in strategy in the second half of 2008, and content amortization expense for new programming on Discovery Channel, TLC, Planet Green and Science Channel.

Selling, General and Administrative

Total selling, general and administrative expenses increased $29 million for the year ended December 31, 2008, when compared with 2007, which was primarily a result of a $34 million increase in personnel costs, primarily driven by continued investment in digital media, including acquisitions made during the third and fourth quarters of 2007. This increase was partially offset by decreased marketing expense of $12 million for the year ended December 31, 2008 when compared with the corresponding prior year period.

 

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Adjusted OIBDA

The U.S. Networks segment’s operating performance improved as reflected by an increase in adjusted OIBDA of $301 million for the year ended December 31, 2008 when compared with 2007. The improved performance is primarily due to revenue growth driven by subscriber growth coupled with higher pricing and lower costs of revenue due to declines in content amortization expense.

International Networks

 

    Years Ended December 31,     % Change
Favorable/
 (Unfavorable)
 
             2008             2007
  As Adjusted  
   

Revenues:

     

Distribution

  $ 713      $ 615      16

Advertising

    336        330      2

Other

    109        85      28
                 

Total revenues

    1,158        1,030      12
                 

Costs of revenues

    (394     (373   (6 )% 

Selling, general and administrative

    (418     (447   6

Add: Amortization of deferred launch incentives

    41        44      (7 )% 
                 

Adjusted OIBDA

    387        254      52
                 

Amortization of deferred launch incentives

    (41     (44   7

Depreciation and amortization

    (43     (36   (19 )% 

Restructuring and impairment charges

    (2     (2   —     
                 

Operating income

  $ 301      $ 172      75
                 

Revenues

Total revenues increased $128 million for the year ended December 31, 2008, when compared with 2007, driven by an increase in distribution revenue of $98 million. Distribution revenue increased $76 million in EMEA, Latin America, and Asia-Pacific primarily as a result of a 16% increase in average paying subscription units. In addition, foreign exchange had a favorable impact of $13 million on distribution revenues for the year ended December 31, 2008 when compared with 2007.

Advertising revenue increased $6 million for the year ended December 31, 2008, when compared with 2007. Advertising revenue increased $42 million in EMEA and Latin America primarily due to higher viewership combined with an increased subscriber base in most markets worldwide. These increases were offset by a $35 million decrease in the U.K. due to an interpretation of a contract provision resulting in a limitation in our ability to monetize our audience in the U.K., as well as a deterioration in market conditions. Advertising revenue decreased $4 million due to the impact of unfavorable foreign exchange.

Other revenue increased $24 million mainly due to improvement in licensing and sales of programs primarily in the U.K. offset by a $2 million unfavorable foreign exchange impact.

Costs of Revenues

Costs of revenues increased $21 million for the year ended December 31, 2008, when compared with 2007, driven by a $40 million increase in content amortization expense due to continued investment in original productions and language customization to support additional local feeds for growth in local ad sales partially offset by favorable foreign exchange of $10 million and a reduction in sales commissions of $5 million.

Selling, General and Administrative

Selling, general and administrative expenses decreased $29 million for the year ended December 31, 2008, when compared with 2007. This decrease was driven by a $26 million reduction in marketing expenditures coupled with the favorable impact of $3 million from foreign exchange.

 

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Adjusted OIBDA

The International Networks segment’s operating performance improved as reflected in an increase in adjusted OIBDA of $133 million for the year ended December 31, 2008, when compared with 2007. The improved performance reflects revenue growth driven by subscription growth in EMEA, Latin America and Asia-Pacific and a reduction in marketing expenditures, partially offset by increased content amortization expense due to continued investment in original productions and language customization.

Commerce, Education, and Other

 

    Years Ended December 31,     % Change
Favorable/
(Unfavorable)
 
            2008             2007
  As Adjusted  
   

Revenues:

     

Other

  $ 196      $ 225      (13 )% 
                 

Total revenues

    196        225      (13 )% 
                 

Costs of revenues

    (116     (151   23

Selling, general and administrative

    (67     (70   4
                 

Adjusted OIBDA

    13        4      NM   
                 

Depreciation and amortization

    (9     (17   47

Restructuring and impairment charges

    (6     (27   78
                 

Operating loss

  $ (2   $ (40   95
                 

NM = not meaningful.

Revenues

Commerce, Education, and Other total revenues decreased $29 million for the year ended 2008 when compared with the prior year. A challenging retail environment in 2008 coupled with the success of the Planet Earth DVD in 2007 contributed to a year over year decline of 48% in revenue from the direct to consumer business, which was partially offset by higher licensing revenue. Education revenue increased by $6 million as the core streaming business continued to grow. New revenue streams in licensing and sponsorships were slightly offset by the decline in the hardcopy business as customers shifted to our digital services. Revenues generated by the CSS business were relatively flat compared with 2007.

Costs of Revenues

Costs of revenues decreased $35 million for the year ended December 31, 2008, commensurate with the decrease in Commerce’s product revenue coupled with a decrease in Education’s content amortization, which resulted from the fourth quarter 2007 write-off of capitalized content costs that were not aligned with Education’s product offerings.

Selling, General and Administrative

Selling, general and administrative expenses decreased $3 million for the year ended December 31, 2008. The decrease was primarily due to lower personnel and marketing costs incurred in Commerce and Education coupled with a $2 million legal expense in 2007 for a legal settlement. These decreases were partially offset by a slight increase in selling, general and administrative expense from the CSS business.

Adjusted OIBDA

Adjusted OIBDA increased $9 million for the year ended December 31, 2008, when compared to 2007, which reflects our efforts to reduce costs in response to the challenging retail environment during the year, reflected by a decline in revenue.

 

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Corporate and Intersegment Eliminations

 

    Years Ended December 31,     % Change
Favorable/
(Unfavorable)
 
            2008             2007
 As Adjusted 
   

Revenues:

     

Other

  $ 27      $ 7      NM   
                 

Total revenues

    27        7      NM   
                 

Costs of revenues

    (5     (4   (25 )% 

Selling, general and administrative

    (223     (192   (16 )% 
                 

Adjusted OIBDA

    (201     (189   (6 )% 
                 

Market-to-market share-based compensation

    73        (141   NM   

Depreciation and amortization

    (78 )     (53 )   (47 )% 

Restructuring and impairment charges

    (2     (17   88

Gains on dispositions

    —          136      (100 )% 
                 

Operating loss

  $ (208   $ (264   21
                 

NM = not meaningful.

Corporate is mainly comprised of ancillary revenue and expenses from a joint venture, corporate functions, executive management and administrative support services. 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 increased $20 million for the year ended December 31, 2008, when compared with 2007, primarily due to increased ancillary revenue from a joint venture, whose primary sales were of the Planet Earth DVD; current sales volume is not expected to continue. Corporate costs increased $32 million, for the year ended December 31, 2008, driven by increased costs incurred in conjunction with our preparing to become a public entity as a result of the Newhouse Transaction and costs related to the start-up of OWN.

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 year ended December 31, 2009 as compared to the years ended December 31, 2008 and 2007.

The following table represents a comparison of the components of the statement of cash flows, as reported for the years ended December 31, 2009, 2008, and 2007 with a reconciliation of historical DCH statement of cash flows for the year ended December 31, 2007 (in millions).

 

    Years Ended December 31,  
        2009           2008 (2)       2007 (1)(2)  

Cash provided by operating activities

  $ 608      $ 569      $ 300   

Cash provided by (used in) investing activities

  $ 266      $ 98      $ (446

Cash (used in) provided by financing activities

  $ (356 )   $ (774   $ 187   

 

(1) The 2007 amounts reflect the gross combined cash flow activities of both DHC and DCH as though the Newhouse Transaction was completed January 1, 2007. The 2007 amounts include net operating cash inflows of $58 million and $242 million from DHC and DCH, respectively, investing cash outflows of ($15) million and ($431) million from DHC and DCH, respectively, and financing cash inflows of $12 million for DHC and $175 million for DCH.
(2)

The cash flow activity also includes cash flows for AMC for both the years ended December 31, 2008 and 2007, including cash provided by operating activities of $28 million, cash provided by investing activities of $128 million, and cash used in financing

 

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activities of $2 million for the year ended December 31, 2008. AMC cash provided by operating activities was $61 million, cash used in investing activities was $15 million, and cash provided by financing activities was $2 million for the year ended December 31, 2007.

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 December 31, 2009, we had approximately $2.2 billion of total liquidity, comprised of $623 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 year ended December 31, 2009, our cash provided by operating activities was $608 million, as compared to $569 million and $300 million for the years ended December 31, 2008 and 2007, respectively, driven by a decrease in cash provided by working capital primarily due to cash paid for income taxes of $444 million, $194 million, and $75 million for the years ended December 31, 2009, 2008, and 2007, respectively. The increase for the year ended December 31, 2009 was primarily due to higher operating income and $108 million in taxes paid related to the sale of our 50% interest in Discovery Kids. The amount for the year ended December 31, 2008 includes $17 million for taxes paid by discontinued operations.

Investing Activities

Cash provided by (used in) investing activities for the year ended December 31, 2009 was $266 million compared to $98 million and $(446) million during the corresponding periods in 2008 and 2007, respectively. 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 $45 million and $71 million for the year ended December 31, 2009 as compared to 2008 and 2007, respectively.

Financing Activities

At December 31, 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 December 31, 2009, of which $3.4 billion of indebtedness was outstanding under these facilities at December 31, 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”). DCL received net proceeds of $492 million from the offering after deducting the issuance 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 are for general corporate purposes.

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. 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 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 a rate of LIBOR plus an applicable margin of 3.25%, with a LIBOR floor of 2.00%, which was 5.25% at December 31, 2009. From May 14, 2009 through December 31, 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.

 

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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 December 31, 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.

Investing Activities

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 as of December 31, 2009. 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.

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 $35 million has been funded as of December 31, 2009. We anticipate that sufficient funds will be available to meet funding needs under our obligation in 2010. 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 the OWN Network, including digital strategy, the programming and development pipeline, and increases in our funding commitment, which is currently $100 million.

Financing Activities

During the year ended December 31, 2009, $356 million of cash was used in financing activities as compared to $774 million used for the year ended December 31, 2008 and $187 million provided by financing activities during the year ended December 31, 2007. 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 year ended December 31, 2008, our primary uses of cash for financing activities were $356 million in cash disbursed in connection with the spinoff of Ascent Media Corporation and principal repayments of $382 million under our debt facilities.

In 2010, we expect our uses of cash to include a minimum of $20 million for debt repayments, between $210 million and $240 million for interest expense, and approximately $50 million for capital expenditures. Additionally, we expect to make 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. The current portion accrued for these cash-settled awards was $117 million as of December 31, 2009.

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 and 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.

 

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We expect to have sufficient cash flow from operations in 2010, combined with $623 million of cash on hand at December 31, 2009, to meet future needs including mandatory principal repayments of debt, interest payments, expected capital expenditures, and 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. Our revolving credit facility expires in October 2010. We are currently assessing our options to extend or enter into a new facility.

We were compliant with all debt covenants as of December 31, 2009 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.

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.

A summary of all of the expected payments for these commitments as well as future principal payments under the current debt arrangements and minimum payments under capital leases at December 31, 2009 is as follows (in millions).

 

     Payments Due by Period(1)
           Total           Less than 1 
Year
     1-3 Years        3-5 Years       More than 
5 Years

Long-term debt

   $     3,394    $         20    $     585    $     1,899    $     890

Interest payments(2)

     976      205      358      257      156

Capital leases

     153      27      49      27      50

Operating leases

     337      70      105      70      92

Content

     440      287      111      42      —  

Other(3)

     445      128      121      57      139
                                  

Total

   $ 5,745    $ 737    $ 1,329    $ 2,352    $ 1,327
                                  

 

(1) Table does not include certain long-term obligations reflected in our consolidated balance sheet as the timing of the payments cannot be predicted or the amounts will not be settled in cash. The most significant of these obligations include $148 million accrued under our cash-settled equity awards and $71 million related to unrecognized tax benefits.
(2) Amounts (i) are based on our outstanding debt at December 31, 2009, (ii) assume the interest rates on our floating rate debt and associated interest rate swaps remain constant at the December 31, 2009 rates, (iii) assume that our existing debt is repaid at maturity and (iv) excludes interest payments on capital leases which are included in Capital leases.
(3) Represents our obligations to purchase goods and services whereby the underlying agreements are enforceable, legally binding and specify all significant terms. The more significant purchase obligations include: obligations to purchase goods and services, employment contracts, sponsorship agreements and transmission services. Amounts related to employment contracts include base compensation and do not include compensation contingent on future events.

 

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We are subject to a contractual agreement that may require us to acquire the non-controlling interest of certain of our subsidiaries. The amount and timing of such payments are not currently known and, accordingly, are not included in the table above. We have recorded a $49 million liability as of December 31, 2009 for this redemption right. Refer to Note 12 to the consolidated financial statements for additional information.

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 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 sources. Actual results may differ from these estimates under different assumptions. Critical accounting policies impact the presentation of our financial condition and results of operations and require significant judgment and estimates. An appreciation of our critical accounting policies facilitates an understanding of our financial results. Unless otherwise noted, we applied our critical accounting policies and estimates methods consistently in all material respects and for all periods presented. For further information regarding these critical accounting policies and estimates, please see the Notes to our consolidated financial statements.

For financial reporting purposes, we are the successor reporting entity to DHC. Because there is no effective change in ownership, in accordance with ASC 810, both DHC and DCH have been consolidated in our financial statements as if the transaction had occurred January 1, 2008. Our critical accounting policies were adopted from DCH following the Newhouse Transaction. For purposes of analyzing our critical accounting policies, we present associated 2008 financial information consistent with our financial statement presentation and present associated 2007 financial information consistent with the financial statement presentation of DCH.

Revenues

We derive revenues from (i) distribution revenues from cable systems, satellite operators and other distributors, (ii) advertising aired on our networks and websites, and (iii) other, which is largely educational sales, e-commerce sales, and post-production sound and service sales.

Distribution

Distributors generally pay a per-subscriber fee for the right to distribute our programming under the terms of long-term distribution contracts (“distribution revenues”). Distribution revenues are reported net of incentive costs or other consideration, if any, offered to system operators in exchange for long-term distribution contracts. We recognize distribution revenues over the term of the contracts based on contracted monthly license fee provisions and reported subscriber levels. Network incentives have historically included upfront cash incentives referred to as “launch incentive” in connection with the launch of a network by the distributor within certain time frames. Any such amounts are capitalized as assets upon launch of our programming by the distributor and are amortized on a straight-line basis as a reduction of revenue over the terms of the contracts. In instances where the distribution agreement is extended prior to the expiration of the original term, we evaluate the economics of the extended term and, if it is determined that the deferred launch asset continues to benefit us over the extended term, then we will adjust the launch amortization period accordingly. Other incentives are recognized as a reduction of revenue as incurred.

The amount of distribution revenues due to us is reported by distributors based on actual subscriber levels. Such information is generally not received until after the close of the reporting period. Therefore, reported distribution revenues are based upon our estimates of the number of subscribers receiving our programming for the month, plus an adjustment for the prior month estimate. Our subscriber estimates are based on the most recent remittance or confirmation of subscribers received from the distributor.

Advertising

We record advertising revenues net of agency commissions and audience deficiency liabilities in the period advertising spots are broadcast. A substantial portion of the advertising sold in the United States includes guaranteed levels of audience that either the program or the advertisement will reach. Deferred revenue is recorded and adjusted as the guaranteed audience levels are achieved.

 

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Audience guarantees are initially developed by our internal research group and actual audience and delivery information is provided by third party ratings services. In certain instances, the third party ratings information is not received until after the close of the reporting period. In these cases, reported advertising revenues and related deferred revenue are based on our estimates for any under-delivery of contracted advertising ratings based on the most current data available from the third party ratings service. Differences between the estimated under-delivery and the actual under-delivery have historically been insignificant. Online advertising revenues are recognized as impressions are delivered.

Certain of our advertising arrangements include deliverables in addition to commercial time, such as the advertiser’s product integration into the programming, customized vignettes, and billboards. These contracts that include other deliverables are evaluated as multiple element revenue arrangements under FASB ASC Topic 605, Revenue Recognition (“ASC 605”).

Other

Other revenues primarily consist of revenues from our Education, CSS, advertising representation, and Commerce businesses. Educational service sales are generally recognized ratably over the term of the agreement. CSS services revenues are recognized when services are performed. Revenues from post-production, advertising representation, and certain distribution related services are recognized when services are provided. Prepayments received for services to be performed at a later date are deferred. Commerce revenues are recognized upon product shipment, net of estimated returns, which are not material to our consolidated financial statements.

Content Rights

Costs incurred in the direct production, co-production or licensing of content rights are capitalized and stated at the lower of unamortized cost, fair value, or net realizable value. In accordance with FASB’s position on accounting by producers or distributors of films, FASB ASC Topic 926, Entertainment- Films (“ASC 926”), we amortize our content assets based upon the ratio of current revenue to total estimated revenue (“ultimate revenue”). To determine this ratio, we analyze historical and projected usage for similar programming and apply such usage factors to projected revenues by network, adjusted for any future significant programming strategy changes.

The result of this policy is an accelerated amortization pattern for the fully distributed U.S. Networks segment (Discovery Channel, TLC, Animal Planet) and Discovery Channel in the International Networks segment over a period of no more than four years. The accelerated amortization pattern results in the amortization of approximately 40% to 50% of the program cost during the first year. Topical or current events programming is amortized over shorter periods based on the nature of the programming and may be expensed upon its initial airing. All other networks in the U.S. Networks segment and International Networks segment utilize up to a five year useful life. For these networks, with programming investment levels lower than the established networks and higher reuse of programming, straight-line amortization is considered a reasonable estimate of the use of content consistent with the pace of earning ultimate revenue.

Ultimate revenue assessments include advertising and affiliate revenue streams. Ancillary revenue is considered immaterial to the assessment. Changes in management’s assumptions, such as changes in expected use, could significantly alter our estimates for amortization.

On a periodic basis, management evaluates the net realizable value of content in conjunction with our strategic review of the business. If we expect to alter the planned use of programming because of a change in network strategy, the unamortized balance is adjusted to net realizable value when we identify the need to alter the planned use. Changes in management’s assumptions, such as changes in expected use, could significantly alter our estimates for write-offs.

Share-Based Compensation

We have incentive plans under which cash-settled unit awards, stock appreciation rights (“SARs”), stock options, and restricted stock units (“RSUs”) were issued.

We measure the cost of employee services received in exchange for cash-settled unit awards and SARs based on the fair value of the award less estimated forfeitures. Because unit awards and SARs are cash-settled, we remeasure the fair value of outstanding unit awards and SARs each reporting period until settlement. Compensation expense, including changes in fair value, for unit awards and SARs is recognized during the vesting period in proportion to the requisite service that has been rendered at the reporting date. For grants of unit awards with graded vesting, we measure fair value and record compensation expense for the grant as a single award. For grants of SARs with graded vesting, we measure fair value and record compensation expense separately for each tranche. Changes in the fair value of outstanding unit awards and SARs that occur subsequent to the vesting period are recorded as adjustments to compensation costs in the period in which the changes occur.

        We measure the cost of employee services received in exchange for stock options and RSUs based on the fair value of the award on the date of grant less estimated forfeitures. For awards that vest based on service, compensation expense is recognized ratably during the vesting period. Vesting of certain RSUs is also subject to satisfying operating performance conditions. At the time that we determine that it is probable that the performance targets will be achieved, compensation expense is recorded for such awards.

When recording compensation cost for share-based awards, we are required to estimate the number of awards granted that are expected to be forfeited. Forfeitures are estimated on the date of grant based on historical forfeiture rates. On an ongoing basis, we adjust compensation expense based on actual forfeitures and revise the forfeiture rate as necessary.

The fair value of unvested cash-settled unit awards, unvested SARs, and all stock options are estimated using the Black-Scholes option-pricing model. Because the Black-Scholes option-pricing model requires the use of subjective assumptions, changes in these assumptions can materially affect the fair value of awards. The risk-free interest rate is based on U.S. Treasury zero-coupon issues with a remaining term equal to the expected term of the award. For cash-settled award units and RSUs, the expected term is the period from the grant date to the vesting date of the award. For SARs, the expected term is estimated to be the contractual term of the award. For stock options, the expected term is estimated to be the period from the date of grant through the mid-point between the vesting date and the end of the contractual term of the award. Expected volatility is based on a combination of implied volatilities from traded options on our common stock and historical realized volatility of our common stock, and considers other factors deemed relevant. The dividend yield is assumed to be 0% because we have no present intention to pay dividends.

The fair value of RSUs is determined based on the fair value of our common stock as of the grant date.

Share-based compensation expense is recorded as a component of Selling, general and administrative expense. We classify as a current liability the intrinsic value of cash-settled award units and SARs that are vested or will become vested within one year.

Excess tax benefits realized from the exercise of stock options are reported as a financing cash inflow rather than as a reduction of taxes paid in cash flow from operations on the Consolidated Statements of Cash Flows.

 

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Goodwill and Indefinite-lived Intangible Assets

2009 Impairment Testing

The majority of our goodwill balance is the result of the Newhouse Transaction in 2008 and a transaction with Advance/Newhouse and Cox Communications Holdings, Inc. in 2007 (the “Cox Transaction”). As a result of the Newhouse Transaction, we allocated $1.8 billion of goodwill previously allocated to DHC’s equity investment in DCH and $251 million of goodwill for the basis differential between the carrying value of DHC’s and Advance/Newhouse’s investments in DCH to our reporting units. The formation of DCH as part of the Cox Transaction required “pushdown” accounting of each shareholder’s basis in DCH. The result was the pushdown of $4.6 billion of additional goodwill previously recorded on the investors’ books to DCH reporting units.

We performed our annual goodwill impairment testing in accordance with FASB ASC Topic 350, Intangibles—Goodwill and Other (“ASC 350”) on November 30, 2009. Under the guidelines established by FASB ASC Topic 280, Segment Reporting (“ASC 280”), we have aggregated our operating segments into the following three reportable segments: U.S. Networks, International Networks, and Commerce, Education, and Other. However, the goodwill impairment analysis, under the requirements of ASC 350, is performed at the reporting unit level. A reporting unit is the same as, or one level below, an operating segment as defined in ASC 280.

The following table presents our goodwill balances, by reporting unit, as of December 31, 2009 and 2008 (in millions).

 

     As of
December 31,
     2009    2008

Discovery Channel

   $ 2,284    $ 2,284

TLC

     1,551      1,551

Animal Planet

     313      313

Other U.S. Networks

     967      1,421
             

Total U.S. Networks

     5,115      5,569

U.K.

     181      181

EMEA

     695      693

Latin America

     231      230

Asia-Pacific

     164      164

Antenna Audio

     —        5
             

Total International Networks

     1,271      1,273

Commerce

     20      22

Education

     16      16

Creative Sound Services

     11      11
             

Total Commerce, Education, and Other

     47      49
             

Total Goodwill

   $ 6,433    $ 6,891
             

We utilized a discounted cash flow (“DCF”) model and market approach to estimate the fair value of our reporting units. The DCF model utilizes projected financial results for each reporting unit. The projected financial results are created from critical assumptions and estimates which are based on management’s business plans and historical trends. The market approach relies on data from publicly traded guideline companies. Determining fair value requires the exercise of significant judgments, including judgments about appropriate discount rates, perpetual growth rates, the amount and timing of expected future cash flows, and relevant comparable company earnings multiples.

A summary of the critical assumptions utilized for our annual impairment tests in 2009 and 2008 are outlined below. We believe this information coupled with our sensitivity analysis considering reporting units whose fair value would not exceed carrying value following a hypothetical reduction in fair value of 10% and 20% provide relevant information to understand our goodwill impairment testing and evaluate our goodwill balances.

 

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During 2009, we did not change our reporting units. However, Discovery Kids, a component of the Other U.S. Networks reporting unit, was deconsolidated in 2009 and was not included in the 2009 impairment testing. For the annual goodwill impairment test performed on November 30, 2009, we did not significantly change the methodology from 2008 to determine the fair value of our reporting units. Due to the improvement in the global economic environment, we made changes to certain of the assumptions utilized in the DCF model for 2009 compared with the prior year. Generally we decreased discount rates in our 2009 DCF calculations. Our assumed growth rates in 2009 were generally consistent with growth rates used in 2008. The following is a summary analysis of the significant assumptions used in our DCF model, as well as a sensitivity analysis on the impact of changes in certain assumptions to our overall conclusion concerning impairment of our goodwill balances.

Discount rate: The discount rate represents the expected return on capital. Each of the U.S. Networks’ reporting units used a discount rate of 11% for 2009, which represents a decrease from a rate of 12% utilized in 2008. The International Networks’ reporting units’ discount rates were a weighted average of 14% and 16% for the years 2009 and 2008, respectively. For our remaining reporting units, discount rates were a weighted average of 15% for the years 2009 and 2008. We used the average interest rate of a 20-year government security over a one year period to determine the risk free rate in our weighted average cost of capital calculation. The difference between our discount rate and the risk free rate was 7% and 8% in 2009 and 2008, respectively.

Growth assumptions: Projected annual growth is primarily driven by assumed advertising sales and cable subscriber trends offset by expected expenses. Other considerations include historical performance and anticipated economic conditions for the current period and long term.

We use a five year period of assumed cash flows to assess short-term company net free cash flow for our DCF calculation. The projected revenue growth for the U.S. Networks’ reporting units was a weighted average of 5% for both the 2009 and 2008 DCF calculations. U.S. Networks experienced actual revenue growth of 4% and 10% in 2009 and 2008, respectively. The projected expense growth for the U.S. Networks’ reporting units was a weighted average of 1% in 2009, compared with 5% in 2008. The projected revenue growth for the International Networks’ reporting units was a weighted average of 7% for both the 2009 and 2008 DCF calculations. International Networks experienced actual revenue growth of 10% and 12% in 2009 and 2008, respectively, when excluding the impacts of foreign exchange. The projected expense growth for the International Networks’ reporting units was a weighted average of 3% in 2009, compared with 6% in 2008. The projected revenue growth for our other reporting units was a weighted average of 5% for the 2009 DCF calculation, compared with 4% in 2008. Other reporting units experienced actual revenue decreases of 10% and 19% in 2009 and 2008, respectively. The historical revenue declines for our other reporting units are not relevant due to the transition of our commerce business to a licensing model in 2009 and the closure of retail stores in the second half of 2007. The projected expense growth for other reporting units was 2% in 2009, compared with a decrease of 1% in 2008.

We used a weighted average terminal value growth rate of 4% for the U.S. Networks’ reporting units in both our 2009 and 2008 DCF calculations. We used a weighted average terminal value growth rate of 4% and 5% for the International Networks’ reporting units in our 2009 and 2008 DCF calculations, respectively. We used a weighted average terminal value growth rate of 6% and 7% for our other reporting units in our 2009 and 2008 DCF calculations, respectively. The terminal values used in our DCF model are calculated using the dividend discount model. As a result, the terminal values used for our reporting units are a function of their respective discount rates and terminal value growth rates.

Market approach assumptions: We used Earnings Before Interest Depreciation and Amortization (“EBITDA”), revenue, and price per subscriber multiples to estimate fair value using a market approach. The U.S. Networks’ reporting units’ weighted average EBITDA multiples were 13 and 10 in 2009 and 2008, respectively. The International Networks’ reporting units’ weighted average EBITDA multiples were 13 and 12 in 2009 and 2008, respectively.

The U.S. Networks’ reporting units made up 75% of the fair value of our Company in both 2009 and 2008. At the date of impairment testing, the carrying value of our U.S. Networks’ reporting units made up 74% and 77% of the carrying value of net assets allocated for purposes of goodwill impairment testing in 2009 and 2008, respectively. The International Networks’ reporting units made up 24% and 23% of the fair value of our Company in 2009 and 2008, respectively. The carrying value of the International Networks’ reporting units made up 25% and 22% of the carrying value of net assets allocated for purposes of goodwill impairment testing in 2009 and 2008, respectively. The fair value of our other reporting units made up 1% and 2% of the fair value of our Company in 2009 and 2008, respectively. The carrying value of our other reporting units made up 1% of the carrying value of net assets allocated for purposes of goodwill impairment testing in both 2009 and 2008.

Impairment: As of November 30, 2009, the fair value of our CSS and Antenna Audio reporting units did not exceed their carrying values due to declines in operating cash flows as a result of adverse market conditions. We performed the second step of the goodwill impairment test as required by ASC 350, which requires calculation of the reporting units implied goodwill and comparing to the book value of goodwill, and determined that $6 million of goodwill of the Antenna Audio reporting unit was impaired. The change in the goodwill balance from December 31, 2008 to the date of the 2009 impairment test was due to foreign exchange. The impairment was recorded as a component of Restructuring and impairment charges in the Consolidated Statements of Operations.

 

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Sensitivity Analysis: In order to analyze the sensitivity our assumptions have on our overall impairment assessment, we determined the impact that a hypothetical 10% and 20% reduction in fair value would have on our conclusions.

 

   

The fair value of the CSS reporting unit does not exceed its carrying value. After performing the second step of the goodwill impairment test, we did not record an impairment for CSS. However, a further 20% decline in fair value would result in a goodwill impairment. As of December 31, 2009, the carrying value of goodwill for the CSS reporting unit is $11 million.

 

   

There were no other reporting units for which a 20% decline in fair value would result in the reporting unit’s carrying value to be in excess of its fair value.

Reductions of approximately 47% and 51% in the fair value of our largest reporting units, Discovery Channel and TLC, respectively, would result in their carrying values exceeding their fair values. Given the reductions required and the assumptions used in our fair value modeling at the time of our impairment review, there did not appear to be any likely changes or trigger events that would indicate an impairment of these reporting units.

If changes in the fair value of our reporting units caused the carrying value of a reporting unit to exceed its fair value, the second step of the goodwill impairment test would be required to be performed to determine the ultimate amount of impairment loss to record.

2010 Impairment Testing

We will perform our annual impairment testing of goodwill as of November 30, 2010, unless there is a triggering event, which would require the performance of impairment testing before our annual impairment testing date. We monitor our anticipated operating performance to ensure that no event has occurred requiring goodwill impairment testing. As part of our annual impairment testing or any interim impairment test deemed necessary, we will evaluate whether our assumptions and methodologies require changes as a result of the current global economic environment.

The determination of recoverability of goodwill requires significant judgment and estimates regarding future cash flows and fair values. Such estimates are subject to change and could result in impairment losses being recognized in the future. If different reporting units or different valuation methodologies had been used, the impairment test results could have differed.

Long-lived Assets

Long-lived assets (e.g., amortizing trademarks, customer lists, other intangibles and property, plant and equipment) do not require that an annual impairment test be performed; instead, long-lived assets are tested for impairment upon the occurrence of a triggering event. Triggering events include the likely (i.e., more likely than not) disposal of a portion of such assets or the occurrence of an adverse change in the market involving the business employing the related assets. Once a triggering event has occurred, the impairment test employed is based on whether the intent is to hold the asset for continued use or to hold the asset for sale. If the intent is to hold the asset for continued use, the impairment test first requires a comparison of undiscounted future cash flows against the carrying value of the asset. If the carrying value of the asset exceeds the undiscounted cash flows, the asset would be deemed to not be recoverable. Impairment would then be measured as the difference between the fair value of the asset and its carrying value. Fair value is generally determined by discounting the future cash flows associated with that asset. If the intent is to hold the asset for sale and certain other criteria are met (e.g., the asset can be disposed of currently, appropriate levels of authority have approved the sale, and there is an active program to locate a buyer), the impairment test involves comparing the asset’s carrying value to its fair value. To the extent the carrying value is greater than the asset’s fair value, an impairment loss is recognized for the difference.

Significant judgments in this area involve determining whether a triggering event has occurred, determining the future cash flows for the assets involved and determining the proper discount rate to be applied in determining fair value.

During the year ended December 31, 2009, we recorded long-lived asset impairments of $26 million primarily related to our HowStuffWorks.com business, a component of the Other U.S. Networks reporting unit, due to declines in expected operating performance.

The determination of recoverability of long-lived assets requires significant judgment and estimates regarding future cash flows, fair values, and the appropriate grouping of assets. Such estimates are subject to change and could result in impairment losses being recognized in the future. If different asset groupings or different valuation methodologies had been used, the impairment test results could have differed.

 

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Income Taxes

Income taxes are recorded using the asset and liability method of accounting for income taxes. Deferred income taxes reflect the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. A valuation allowance is provided for deferred tax assets if it is more likely than not such assets will be unrealized.

Recently Issued Accounting and Reporting Pronouncements

Refer to Note 2 in the accompanying consolidated financial statements in Item 8 of Part II of this Annual Report on Form 10-K for a discussion of recently issued accounting standards.

 

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ITEM 7A. Quantitative and Qualitative Disclosures about Market Risk.

Our earnings and cash flows are exposed to market risk and can be affected by, among other things, economic conditions, interest rate changes, foreign currency fluctuations, and changes in the market values of investments. We have established policies, procedures and internal processes governing our management of market risks and the use of financial instruments to manage our exposure to such risks. We use derivative financial instruments to modify our exposure to market risks from changes in interest rates and foreign exchange rates. We do not hold or enter into financial instruments for speculative trading purposes.

Interest Rates

The nature and amount of our long-term debt are expected to vary as a result of future requirements, market conditions and other factors. Our interest expense is exposed to movements in short-term interest rates. Of our $3.4 billion of debt excluding capital leases, $2.0 billion was floating rate debt at December 31, 2009. We use derivative instruments, including variable to fixed and fixed to variable interest rate instruments, to modify this exposure. The variable to fixed interest rate instruments had a notional amount of $1.8 billion and $2.3 billion and had a weighted average interest rate of 4.27% and 4.68% at December 31, 2009 and 2008, respectively. The fixed to variable interest rate agreements had a notional amount of $50 million and had a weighted average interest rate of 4.67% and 7.90% at December 31, 2009 and 2008, respectively. As of December 31, 2009, we have a notional amount of $300 million of forward starting variable to fixed interest rate swaps, which will start in June 2010. The fair value of our interest rate derivative contracts, adjusted for our credit risk and our counterparties’ credit risk, aggregate a net loss position of $33 million and $107 million at December 31, 2009 and 2008, respectively.

Of the total notional amount of $2.2 billion in interest rate derivatives, $1.8 billion of these derivative instruments are highly effective cash flow hedges. The fair value of these hedges at December 31, 2009 and 2008 was a net loss position of $17 million and $71 million, respectively, with changes in the mark-to-market value recorded as a component of Other comprehensive income (loss). We do not expect material hedge ineffectiveness in the next twelve months. As of December 31, 2009, a parallel shift in the interest rate yield curve equal to one percentage point would change the fair value of our interest rate derivative portfolio by approximately $40 million. In addition, a change of one percentage point in interest rates on our variable rate debt would impact interest expense by approximately $3 million on an annual basis.

We continually monitor our positions with, and the credit quality of, the financial institutions that are counterparties to our derivative instruments and do not anticipate nonperformance by the counterparties. In addition, we limit the amount of derivative counterparty credit exposure with any one institution.

Refer to Note 11 to the accompanying consolidated financial statements for additional information regarding our interest rate derivative instruments.

Foreign Currency Exchange Rates

We continually monitor our economic exposure to changes in foreign currency exchange rates and may enter into foreign exchange agreements when appropriate. Substantially all of our foreign transactions are denominated in foreign currencies, including the liabilities of our foreign subsidiaries. The majority of our foreign currency exposure is to the British pound and the Euro. Although our foreign transactions are not generally subject to significant foreign exchange transaction gains or losses, the financial statements of our foreign subsidiaries are translated into U.S. dollars as part of our consolidated financial reporting. As a result, fluctuations in exchange rates affect our financial position and results of operations.

Our objective in managing exposure to foreign currency fluctuations is to reduce volatility of earnings and cash flows. Accordingly, we may enter into foreign currency derivative instruments that change in value as foreign exchange rates change. We did not hold significant foreign currency derivative instruments at December 31, 2009. At December 31, 2008, the notional amount of foreign currency derivative instruments was $75 million and the fair value was $5 million.

Refer to Note 11 to the accompanying consolidated financial statements for additional information regarding our foreign currency derivative instruments.

 

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ITEM 8. Financial Statements and Supplementary Data.

Index to consolidated financial statements and supplementary data:

 

     Page

Management’s Report on Internal Control Over Financial Reporting

   64

Report of Independent Registered Public Accounting Firm

   65

Report of Independent Registered Public Accounting Firm

   66

Consolidated Financial Statements of Discovery Communications, Inc.:

  

Consolidated Balance Sheets as of December 31, 2009 and 2008

   67

Consolidated Statements of Operations for the Years Ended December 31, 2009, 2008, and 2007

   68

Consolidated Statements of Cash Flows for the Years Ended December 31, 2009, 2008, and 2007

   69

Consolidated Statements of Equity for the Years Ended December 31, 2009, 2008, and 2007

   70

Notes to Consolidated Financial Statements

   71

Financial Statement Schedules:

  

Consolidated Financial Statements of Discovery Communications Holding, LLC:

  

Report of Independent Registered Public Accounting Firm

   134

Report of Independent Registered Public Accounting Firm

   135

Consolidated Balance Sheet of Discovery Communications Holding, LLC as of December 31, 2007

   136

Consolidated Statement of Operations of Discovery Communications Holding, LLC for the period from May  15, 2007 through December 31, 2007

   137

Consolidated Statement of Operations of Discovery Communications, Inc. (the predecessor entity to Discovery Communications Holding, LLC and not the current registrant) for the period from January 1, 2007 through May 14, 2007

   137

Consolidated Statement of Cash Flows of Discovery Communications Holding, LLC for the period from May  15, 2007 through December 31, 2007

   138

Consolidated Statement of Cash Flows of Discovery Communications, Inc. (the predecessor entity to Discovery Communications Holding, LLC and not the current registrant) for the period from January 1, 2007 through May 14, 2007

   138

Consolidated Statement of Changes in Members’ Equity of Discovery Communications Holding, LLC for the period from May 15, 2007 through December 31, 2007

   139

Consolidated Statement of Stockholders’ Deficit of Discovery Communications, Inc. (the predecessor entity to Discovery Communications Holding, LLC and not the current registrant) for the period from January 1, 2007 through May 14, 2007

   139

Notes to Consolidated Financial Statements

   140

 

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MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

Management of Discovery Communications, Inc. (the “Company”) is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) and Rule 15d-15(f) of the Securities Exchange Act of 1934, as amended. Our internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and disposition of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and provide reasonable assurance that receipts and expenditures of the Company are being made only in accordance with authorizations of management and the directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the consolidated financial statements.

Internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements prepared for external purposes in accordance with generally accepted accounting principles. Because of the inherent limitations in any internal control, no matter how well designed, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

The Company’s management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our system of internal control over financial reporting as of December 31, 2009 based on the framework set forth in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on its evaluation, management concluded that, as of December 31, 2009, the Company’s internal control over financial reporting is effective based on the specified criteria.

The effectiveness of our internal control over financial reporting as of December 31, 2009 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report in Item 8 of Part II of this Annual Report on Form 10-K under the caption “Report of Independent Registered Public Accounting Firm.”

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and

Stockholders of Discovery Communications, Inc.:

In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, of equity and of cash flows present fairly, in all material respects, the financial position of Discovery Communications, Inc. and its subsidiaries at December 31, 2009 and December 31, 2008, and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express opinions on these financial statements, and on the Company’s internal control over financial reporting based on our audits (which was an integrated audit in 2009). We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

As discussed in Note 2 to the consolidated financial statements, the Company changed the manner in which it accounts for non-controlling interests and the manner in which it accounts for collaborative arrangements effective January 1, 2009.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

/s/    PricewaterhouseCoopers LLP
McLean, Virginia
February 19, 2010

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Stockholders

Discovery Holding Company:

We have audited the accompanying consolidated statements of operations, cash flows, and equity of Discovery Holding Company and subsidiaries (DHC) for the year ended December 31, 2007. These consolidated financial statements are the responsibility of DHC’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit. We did not audit the financial statements of Discovery Communications Holding, LLC (a 66 2/3 percent owned investee company as of December 31, 2007). DHC’s equity in the earnings of Discovery Communications Holding, LLC was $141,781,000 for the year ended December 31, 2007. The financial statements of Discovery Communications Holding, LLC and its predecessor were audited by other auditors whose reports have been furnished to us, and our opinion, insofar as it relates to the amounts included for Discovery Communications Holding, LLC, is based solely on the reports of the other auditors.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit and the reports of other auditors provide a reasonable basis for our opinion.

In our opinion, based on our audit and the reports of the other auditors, the consolidated financial statements referred to above present fairly, in all material respects, the results of operations and cash flows of Discovery Holding Company and subsidiaries for the year ended December 31, 2007, in conformity with U.S. generally accepted accounting principles.

 

/s/ KPMG LLP
Denver, Colorado
February 14, 2008, except as to note 25,
which is as of June 11, 2009

 

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DISCOVERY COMMUNICATIONS, INC.

CONSOLIDATED BALANCE SHEETS

(in millions, except par value)

 

     As of December 31,  
     2009     2008  

ASSETS

    

Current assets:

    

Cash and cash equivalents

   $ 623      $ 100   

Receivables, net of allowances of $15 and $16, respectively

     810        780   

Content rights, net

     76        73   

Deferred income taxes

     71        49   

Prepaid expenses and other current assets

     100        107   
                

Total current assets

     1,680        1,109   

Noncurrent content rights, net

     1,217        1,163   

Property and equipment, net

     411        395   

Goodwill

     6,433        6,891   

Intangible assets, net

     643        716   

Other noncurrent assets

     581        210   
                

Total assets

   $ 10,965      $ 10,484   
                

LIABILITIES, REDEEMABLE NON-CONTROLLING INTERESTS IN SUBSIDIARIES AND EQUITY

    

Current liabilities:

    

Accounts payable

   $ 63      $ 71   

Accrued liabilities

     394        350   

Deferred revenues

     91        93   

Current portion of share-based compensation liabilities

     117        8   

Current portion of long-term debt

     38        458   

Other current liabilities

     87        90   
                

Total current liabilities

     790        1,070   

Long-term debt

     3,457        3,331   

Deferred income taxes

     274        246   

Other noncurrent liabilities

     176        227   
                

Total liabilities

     4,697        4,874   

Commitments and contingencies (Note 22)

    

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 December 31, 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 December 31, 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 December 31, 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 December 31, 2009 and 2008

     —          —     

Series C common stock, $0.01 par value; authorized 2,000 shares; issued and outstanding 142 shares at December 31, 2009 and 141 shares at December 31, 2008

     2        2   

Additional paid-in capital

     6,600        6,545   

Accumulated deficit

     (376     (936

Accumulated other comprehensive loss

     (21     (78 )
                

Equity attributable to Discovery Communications, Inc.

     6,208        5,536   

Equity attributable to non-controlling interests

     11        25   
                

Total equity

     6,219        5,561   
                

Total liabilities, redeemable non-controlling interests in subsidiaries and equity

   $ 10,965      $ 10,484   
                

The accompanying notes are an integral part of these consolidated financial statements.

 

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DISCOVERY COMMUNICATIONS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(in millions, except per share amounts)

 

     Years Ended December 31,  
        2009            2008             2007     

Revenues:

      

Distribution

   $ 1,713      $ 1,640      $ —     

Advertising

     1,428        1,396        —     

Other

     375        407        76   
                        

Total revenues

     3,516        3,443        76   
                        

Costs of revenues, excluding depreciation and amortization listed below

     1,065        1,024        60   

Selling, general and administrative

     1,247        1,115        22   

Depreciation and amortization

     155        186        3   

Restructuring and impairment charges

     66        61        —     

Gains on dispositions

     (252     —          (1
                        
     2,281        2,386        84   
                        

Operating income (loss)

     1,235        1,057        (8

Equity in earnings of Discovery Communications Holding, LLC

     —          —          142   

Interest expense, net

     (250     (256     —     

Other non-operating income (expense), net

     46        (47     8   
                        

Income from continuing operations before income taxes

     1,031        754        142   

Provision for income taxes

     (472     (352     (56
                        

Income from continuing operations, net of taxes

     559        402        86   

Income (loss) from discontinued operations, net of taxes

     —          43        (154
                        

Net income (loss)

     559        445        (68

Less net loss (income) attributable to non-controlling interests

     1        (128     —     
                        

Net income (loss) attributable to Discovery Communications, Inc.

     560        317        (68

Stock dividends to preferred interests

     (8     —          —     
                        

Net income (loss) available to Discovery Communications, Inc. stockholders

   $ 552      $ 317      $ (68
                        

Amounts available to Discovery Communications, Inc. stockholders:

      

Income from continuing operations, net of taxes

   $ 552      $ 274      $ 86   

Income (loss) from discontinued operations, net of taxes

     —          43        (154
                        

Net income (loss)

   $ 552      $ 317      $ (68
                        

Income per share from continuing operations available to Discovery Communications, Inc. stockholders:

      

Basic

   $ 1.30      $ 0.85      $ 0.31   
                        

Diluted

   $ 1.30      $ 0.85      $ 0.31   
                        

Income (loss) per share from discontinued operations available to Discovery Communications, Inc. stockholders:

      

Basic

   $ —        $ 0.13      $ (0.55
                        

Diluted

   $ —        $ 0.13      $ (0.55
                        

Net income (loss) per share available to Discovery Communications, Inc. stockholders:

      

Basic

   $ 1.30      $ 0.99      $ (0.24
                        

Diluted

   $ 1.30      $ 0.98      $ (0.24
                        

Weighted average number of shares outstanding:

      

Basic

     423        321        281   
                        

Diluted

     425        322        281   
                        

The accompanying notes are an integral part of these consolidated financial statements.

 

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DISCOVERY COMMUNICATIONS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in millions)

 

<
     Years Ended December 31,  
     2009        2008           2007     

Operating Activities

      

Net income (loss)

   $ 559      $ 445      $ (68

Adjustments to reconcile net income (loss) to cash provided by operating activities:

      

Share-based compensation expense (benefit)

     228        (66     1   

Depreciation and amortization

     155        232        68   

Impairment charges

     32        30        165   

Gains on dispositions

     (252     (76     (1

Gains on sales of investments

     (15     —          —     

Equity in earnings of Discovery Communications Holding, LLC

     —          —          (142

Deferred income taxes

     (7     190        56   

Other noncash expenses (income), net

     32        130        (8

Changes in operating assets and liabilities, net of discontinued operations:

      

Receivables, net

     (37     (45     4   

Content rights, net

     (55     (145     —     

Accounts payable and accrued liabilities

     40        (46     (11

Share-based compensation liabilities

     (81     (49     —     

Other, net

     9        (31     (6
                        

Cash provided by operating activities

     608        569        58   

Investing Activities

      

Purchases of property and equipment

     (57     (102     (47

Net cash acquired from Newhouse Transaction

     —          45        —     

Business acquisitions, net of cash acquired

     —          (8