XNAS:DISCK Discovery Communications Inc Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2012
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: 001-34177
 
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)
Not Applicable
(Former name, former address and former fiscal year, if changed since last report.)
 
 
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ý    No  o
Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files).    Yes  ý    No  ¨
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
ý
Accelerated filer
¨
Non-accelerated filer
o  (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  ý
Total number of shares outstanding of each class of the Registrant’s common stock as of July 23, 2012:
Series A Common Stock, par value $0.01 per share
145,848,504

Series B Common Stock, par value $0.01 per share
6,570,067

Series C Common Stock, par value $0.01 per share
94,731,733

 
 
 
 
 




DISCOVERY COMMUNICATIONS, INC.
FORM 10-Q
TABLE OF CONTENTS

 
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


3


PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements.

DISCOVERY COMMUNICATIONS, INC.
CONSOLIDATED BALANCE SHEETS
(unaudited; in millions, except par value) 
 
 
June 30, 2012
 
December 31, 2011
ASSETS
 
 
 
 
Current assets:
 
 
 
 
Cash and cash equivalents
 
$
1,698

 
$
1,048

Receivables, net
 
1,155

 
1,042

Content rights, net
 
110

 
93

Deferred income taxes
 
77

 
73

Prepaid expenses and other current assets
 
174

 
175

Total current assets
 
3,214

 
2,431

Noncurrent content rights, net
 
1,404

 
1,302

Property and equipment, net
 
368

 
379

Goodwill
 
6,312

 
6,291

Intangible assets, net
 
560

 
571

Equity method investments
 
817

 
807

Other noncurrent assets
 
135

 
132

Total assets
 
$
12,810

 
$
11,913

LIABILITIES AND EQUITY
 
 
 
 
Current liabilities:
 
 
 
 
Accounts payable
 
$
56

 
$
53

Accrued expenses and other current liabilities
 
583

 
554

Deferred revenues
 
98

 
113

Current portion of long-term debt
 
20

 
26

Total current liabilities
 
757

 
746

Long-term debt
 
5,206

 
4,219

Deferred income taxes
 
263

 
337

Other noncurrent liabilities
 
111

 
92

Total liabilities
 
6,337

 
5,394

Commitments and contingencies (Note 13)
 


 


Equity:
 
 
 
 
Discovery Communications, Inc. stockholders’ equity:
 
 
 
 
Series A convertible preferred stock: $0.01 par value; 75 shares authorized; 71 shares issued
 
1

 
1

Series C convertible preferred stock: $0.01 par value; 75 shares authorized; 57 shares issued
 
1

 
1

Series A common stock: $0.01 par value; 1,700 shares authorized; 146 and 142 shares issued
 
1

 
1

Series B convertible common stock: $0.01 par value; 100 shares authorized; 7 shares issued
 

 

Series C common stock: $0.01 par value; 2,000 shares authorized; 142 shares issued
 
2

 
2

Additional paid-in capital
 
6,637

 
6,505

Treasury stock, at cost
 
(1,794
)
 
(1,102
)
Retained earnings
 
1,646

 
1,132

Accumulated other comprehensive loss
 
(23
)
 
(23
)
Total Discovery Communications, Inc. stockholders’ equity
 
6,471

 
6,517

Noncontrolling interests
 
2

 
2

Total equity
 
6,473

 
6,519

Total liabilities and equity
 
$
12,810

 
$
11,913

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

4


DISCOVERY COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited; in millions, except per share amounts)


 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2012
 
2011
 
2012
 
2011
Revenues:
 
 
 
 
 
 
Distribution
 
$
540

 
$
499

 
$
1,116

 
$
983

Advertising
 
534

 
494

 
987

 
886

Other
 
68

 
74

 
142

 
149

Total revenues
 
1,142

 
1,067

 
2,245

 
2,018

Costs and expenses:
 
 
 
 
 
 
 
 
Costs of revenues, excluding depreciation and amortization
 
314

 
288

 
625

 
561

Selling, general and administrative
 
308

 
300

 
623

 
569

Depreciation and amortization
 
31

 
30

 
61

 
60

Restructuring charges
 
2

 
4

 
3

 
5

Gain on disposition
 

 

 

 
(129
)
Total costs and expenses
 
655

 
622

 
1,312

 
1,066

Operating income
 
487

 
445

 
933

 
952

Interest expense
 
(61
)
 
(49
)
 
(116
)
 
(98
)
Other (expense) income, net
 
(6
)
 
2

 
(56
)
 
(5
)
Income before income taxes
 
420

 
398

 
761

 
849

Provision for income taxes
 
(127
)
 
(144
)
 
(246
)
 
(290
)
Net income
 
293

 
254

 
515

 
559

Net income attributable to noncontrolling interests
 

 

 
(1
)
 

Net income available to Discovery Communications, Inc. stockholders
 
$
293

 
$
254

 
$
514

 
$
559

Net income per share available to Discovery Communications, Inc. stockholders:
 
 
 
 
 
 
 
 
Basic
 
$
0.77

 
$
0.63

 
$
1.34

 
$
1.37

Diluted
 
$
0.76

 
$
0.62

 
$
1.33

 
$
1.36

Weighted average shares outstanding:
 
 
 
 
 
 
 
 
Basic
 
381

 
406

 
383

 
407

Diluted
 
384

 
410

 
387

 
412

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

5


DISCOVERY COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(unaudited; in millions)


 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2012
 
2011
 
2012
 
2011
Net income
 
$
293

 
$
254

 
$
515

 
$
559

Other comprehensive (loss) income, net of tax:
 
 
 
 
 
 
 
 
Currency translation adjustments
 
(10
)
 
6

 
1

 
23

Derivative and market value adjustments
 
(1
)
 

 
(1
)
 

Comprehensive income
 
282

 
260

 
515

 
582

Comprehensive income attributable to noncontrolling interests
 

 

 
(1
)
 

Comprehensive income attributable to Discovery Communications, Inc. stockholders
 
$
282

 
$
260

 
$
514

 
$
582

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

6


DISCOVERY COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited; in millions)


 
Six Months Ended June 30,
 
2012
 
2011
Operating Activities
 
 
 
Net income
$
515

 
$
559

Adjustments to reconcile net income to cash provided by operating activities:
 
 
 
Equity-based compensation expense
72

 
49

Depreciation and amortization
61

 
60

Content amortization and impairment expense
421

 
381

Gain on disposition

 
(129
)
Equity in losses and distributions from investee companies
67

 
17

Deferred income tax (benefit) expense
(71
)
 
71

Other, net
18

 
22

Changes in operating assets and liabilities:
 
 
 
Receivables, net
(109
)
 
(31
)
Content rights
(528
)
 
(430
)
Accounts payable and accrued liabilities
(11
)
 
(116
)
Equity-based compensation liabilities
(37
)
 
(92
)
Income tax receivable
19

 
94

Other, net
(28
)
 
(24
)
Cash provided by operating activities
389

 
431

Investing Activities
 
 
 
Purchases of property and equipment
(24
)
 
(27
)
Business acquisition, net of cash acquired
(20
)
 

Distribution from equity method investee
17

 

Investments in and advances to equity method investees
(87
)
 
(82
)
Cash used in investing activities
(114
)
 
(109
)
Financing Activities
 
 
 
Borrowings from long term debt, net of discount and issuance costs
983

 
641

Principal repayments of capital lease obligations
(13
)
 
(13
)
Repurchases of common stock
(692
)
 
(377
)
Proceeds from issuance of common stock in connection with equity-based plans
67

 
38

Excess tax benefits from equity-based compensation
33

 
17

Other financing activities, net
(2
)
 
(7
)
Cash provided by financing activities
376

 
299

Effect of exchange rate changes on cash and cash equivalents
(1
)
 
8

Net change in cash and cash equivalents
650

 
629

Cash and cash equivalents, beginning of period
1,048

 
466

Cash and cash equivalents, end of period
$
1,698

 
$
1,095

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






7


DISCOVERY COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited; in millions)


 
Six Months Ended June 30,
 
2012
 
2011
Supplemental Cash Flow Information
 
 
 
Cash paid for taxes, net
$
(166
)
 
$
(93
)
Cash paid for interest
$
(119
)
 
$
(99
)
Noncash Investing and Financing Transactions
 
 
 
Investment in OWN
$
7

 
$
273

Assets acquired under capital lease arrangements
$
3

 
$

Acquisitions
 
 
 
Fair value of assets
$
32

 
$

Fair value of liabilities
(12
)
 

Cash paid, net of cash acquired
$
20

 
$

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

8


DISCOVERY COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF EQUITY
(unaudited; in millions)


 
 
Three Months Ended June 30, 2012
 
Three Months Ended June 30, 2011
 
 
Discovery
Stockholders
 
Noncontrolling
Interests
 
Total Equity
 
Discovery
Stockholders
 
Noncontrolling
Interests
 
Total Equity
Beginning balance
 
$
6,565

 
$
3

 
$
6,568

 
$
6,408

 
$
3

 
$
6,411

Comprehensive income
 
282

 

 
282

 
260

 

 
260

Equity-based compensation
 
14

 

 
14

 
14

 

 
14

Excess tax benefits from equity-based compensation
 
3

 

 
3

 
13

 

 
13

Issuance of common stock in connection with equity-based plans
 
11

 

 
11

 
28

 

 
28

Repurchases of common stock
 
(404
)
 

 
(404
)
 
(210
)
 

 
(210
)
Cash distributions to noncontrolling interests
 

 
(1
)
 
(1
)
 

 
(2
)
 
(2
)
Ending balance
 
$
6,471

 
$
2

 
$
6,473

 
$
6,513

 
$
1

 
$
6,514

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Six Months Ended June 30, 2012
 
Six Months Ended June 30, 2011
 
 
Discovery
Stockholders
 
Noncontrolling
Interests
 
Total Equity
 
Discovery
Stockholders
 
Noncontrolling
Interests
 
Total Equity
Beginning balance
 
$
6,517

 
$
2

 
$
6,519

 
$
6,225

 
$
8

 
$
6,233

Comprehensive income
 
514

 
1

 
515

 
582

 

 
582

Equity-based compensation
 
32

 

 
32

 
28

 

 
28

Excess tax benefits from equity-based compensation
 
33

 

 
33

 
17

 

 
17

Issuance of common stock in connection with equity-based plans
 
67

 

 
67

 
38

 

 
38

Repurchases of common stock
 
(692
)
 

 
(692
)
 
(377
)
 

 
(377
)
Cash distributions to noncontrolling interests
 

 
(1
)
 
(1
)
 

 
(7
)
 
(7
)
Ending balance
 
$
6,471

 
$
2

 
$
6,473

 
$
6,513

 
$
1

 
$
6,514

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

9

DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)





NOTE 1. DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION
Description of Business
Discovery Communications, Inc. (“Discovery” or the “Company”) is a leading nonfiction media and entertainment company that provides programming across distribution platforms throughout the world and owns and operates a diversified portfolio of website properties. The Company also develops and sells curriculum-based education products and services as well as postproduction audio services. The Company classifies its operations in three segments: U.S. Networks, consisting principally of domestic television networks, websites and other digital media services; International Networks, consisting principally of international television networks and websites; and Education and Other, consisting principally of curriculum-based education product and service offerings and postproduction audio services. Financial information for Discovery’s reportable segments is discussed in Note 14.
Basis of Presentation
The consolidated financial statements include the accounts of Discovery and its majority-owned subsidiaries in which a controlling interest is maintained. Inter-company accounts and transactions between consolidated entities have been eliminated in consolidation.
Reclassifications
Beginning July 1, 2011, the Company expanded the types of revenue included in distribution revenue in its consolidated statements of operations to include fees charged for certain licensing arrangements, including those for digital streaming of library content, and reclassified prior year amounts. Such fees, which totaled $6 million and $10 million for the three and six months ended June 30, 2011, respectively, were previously classified as other revenue and have been reclassified to distribution revenue to conform to the current presentation.
Unaudited Interim Financial Statements
These consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) applicable to interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. These consolidated financial statements are unaudited; however, in the opinion of management, they reflect all adjustments, consisting only of those of a normal recurring nature, necessary to state fairly the financial position, results of operations and cash flows for the periods presented in conformity with GAAP applicable to interim periods. The results of operations for the interim periods presented are not necessarily indicative of results for the full year or future periods. These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in Discovery’s Annual Report on Form 10-K for the year ended December 31, 2011 (the “2011 Form 10-K”).
Use of Estimates
The preparation of financial statements in accordance with GAAP requires management to make estimates, judgments and assumptions that affect the amounts and disclosures reported in the consolidated financial statements and accompanying notes. Management continually re-evaluates its estimates, judgments and assumptions, and management’s assessments could change. Actual results may differ from those estimates and could have a material impact on the consolidated financial statements.
Significant estimates inherent in the preparation of the consolidated financial statements include accounting for asset impairments, revenue recognition, allowances for doubtful accounts, content rights, depreciation and amortization, business combinations, equity-based compensation, income taxes, contingencies, and the determination of whether the Company is the primary beneficiary of entities in which it holds variable interests.
Accounting and Reporting Pronouncements Adopted
Fair Value Measurements
In May 2011, the Financial Accounting Standards Board (“FASB”) and the International Accounting Standards Board (“IASB”) issued guidance that results in a consistent definition between GAAP and International Financial Reporting Standards (“IFRS”) of fair value and common requirements for measurement of and disclosure about fair value. There are several changes

10

DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)




under the new guidance. The highest and best use valuation concepts are relevant only when measuring the fair value of nonfinancial assets. The prohibition of the application of a blockage factor extends to all financial measurements. The Company must disclose quantitative information about unobservable inputs used to assess fair value and provide a qualitative discussion about the sensitivity of the measurements for recurring Level 3 fair value measurements. The Company prospectively adopted the new guidance effective January 1, 2012. The adoption of the new guidance did not have a material impact on the Company's financial statements.
Comprehensive Income
In June 2011, the FASB issued guidance eliminating the option to report other comprehensive income and its components in the statement of changes in equity. Entities may elect to present items of net income and other comprehensive income in one continuous statement or in two separate, but consecutive, statements. Under the new guidance, each component of net income and each component of other comprehensive income, together with totals for comprehensive income and its two parts, net income and other comprehensive income, are required to be disclosed under either alternative. The Company retrospectively adopted the new guidance effective January 1, 2012. The Company elected to present comprehensive income in a separate statement.
Accounting and Reporting Pronouncements Not Yet Adopted
Testing Indefinite-Lived Intangible Assets for Impairment
In July 2012, the FASB issued guidance which is intended to reduce the cost and complexity of the annual impairment test for indefinite-lived intangible assets other than goodwill by providing entities an option to perform a qualitative assessment to determine whether a quantitative impairment test is necessary. The revised standard is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012, but early adoption is permitted. The Company is currently assessing the impact of this guidance on its consolidated financial statements.
Concentrations Risk
Customers
The Company has long-term contracts with distributors around the world, including the largest operators in the U.S. and major international distributors. In the U.S., approximately 90% of distribution revenue comes from the top 10 distributors. Outside of the U.S., approximately 50% of distribution revenue comes from the top 10 distributors. Agreements with the Company’s major cable and satellite customers expire at various times beginning in 2012 through 2020. Failure to secure a renewal or a renewal on less favorable terms may have a material adverse effect on the Company’s results of operations and financial condition. Not only could the Company experience a reduction in affiliate revenue, but it could also experience a reduction in advertising revenue which is impacted by affiliate subscriber levels and viewership.
No individual customer accounted for more than 10% of total consolidated revenues for the three and six months ended June 30, 2012 or 2011. The Company’s trade receivables do not represent a significant concentration of credit risk as of June 30, 2012 or December 31, 2011 due to the wide variety of customers and markets in which the Company operates and their dispersion across many geographic areas.
Financial Institutions
Cash and cash equivalents are maintained with financial institutions such as banks and money market mutual funds. The Company has deposits held with banks that exceed the amount of insurance provided on such deposits. Generally, these deposits may be redeemed on demand and are maintained with financial institutions of reputable credit and, therefore, bear minimal credit risk.
Lender Counterparties
There is a risk that the counterparties associated with the Company’s revolving credit facility will not be available to fund as obligated under the term of the facility. If funding under the revolving credit facility is unavailable, the Company may have to acquire a replacement credit facility from a different counterparty at a higher cost or may be unable to find a suitable replacement. Typically, the Company seeks to manage these exposures by contracting with experienced large financial institutions and monitoring the credit quality of its lenders. As of June 30, 2012, the Company did not anticipate nonperformance by any of its counterparties.


11

DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)




NOTE 2. ACQUISITIONS AND DISPOSITIONS
Acquisitions
During the six months ended June 30, 2012, the Company acquired businesses for total consideration of $31 million, net of cash acquired. Contingent consideration of up to $13 million may be paid if certain performance targets are achieved. The Company recorded $21 million of goodwill in connection with these acquisitions.
Discovery Health Network
On January 1, 2011, the Company contributed the domestic Discovery Health network to OWN LLC in connection with the launch of The Oprah Winfrey Network (“OWN”), which resulted in a pretax gain of $129 million (see Note 3). As the Company continues to be involved in the operations of the Discovery Health network through its ownership interests in OWN LLC, the Company has not presented the financial position, results of operations and cash flows of the Discovery Health network as discontinued operations.
NOTE 3. VARIABLE INTEREST ENTITIES
In the normal course of business, the Company makes investments that support its underlying business strategy and provide it the ability to enter new markets for its brands, develop programming and distribute its existing content. In certain instances, an investment may qualify as a variable interest entity (“VIE”). As of June 30, 2012 and December 31, 2011, the Company’s VIEs primarily consisted of Hub Television Networks LLC and OWN LLC, which operate pay-television networks.
As of June 30, 2012 and December 31, 2011, the Company accounted for its interests in VIEs using the equity method. The aggregate carrying values of these equity method investments were $808 million and $807 million as of June 30, 2012 and December 31, 2011, respectively. During the three and six months ended June 30, 2012, the Company recognized losses of $9 million and $57 million, respectively, for its portion of net losses generated by these VIEs accounted for using the equity method. During the three and six months ended June 30, 2011, the Company recognized earnings of $3 million, and losses of $7 million, respectively, for its portion of net earnings (losses) generated by VIEs accounted for using the equity method. The Company's portion of net earnings (losses) generated by VIEs accounted for using the equity method were recorded in other expense, net in the consolidated statements of operations.
As of June 30, 2012, the Company’s estimated risk of loss for investments in VIEs was approximately $836 million, which includes investment carrying values, unfunded contractual commitments and guarantees made on behalf of equity method investees. Actual amounts funded to OWN LLC have exceeded contractual funding commitments, and the Company intends to continue to fund OWN LLC. The Company has not recorded any obligations for future funding. The estimated risk of loss excludes the Company’s operating performance guarantee for Hub Television Networks LLC disclosed below.
Hub Television Networks LLC
Hub Television Networks LLC operates The Hub, which is a pay-television network that provides children’s and family entertainment and educational programming. The Company is obligated to provide The Hub with funding up to $15 million. The Company also provides services such as distribution, sales and administrative support for a fee (see Note 12). The Company has not provided funding as of June 30, 2012.
Based upon the level of equity investment at risk, The Hub is a VIE. Discovery and its partner, Hasbro Inc. (“Hasbro”), consent to decisions about programming and marketing strategy and thereby direct the activities of The Hub that most significantly impact its economic performance. The partners share equally in voting control and jointly consent to operating, financing and investing decisions. Neither has special governance rights, and both are equally represented on the board of The Hub. The partners also share equally in the profits, losses and funding of The Hub. The Company has determined that it is not the primary beneficiary of The Hub. Accordingly, the Company accounts for its investment in The Hub using the equity method.
Through December 31, 2015, the Company has guaranteed the performance of The Hub and is required to compensate Hasbro to the extent that distribution metrics decline versus levels historically achieved by the Discovery Kids channel. This guarantee extends on a declining basis through the period of guarantee. Upon inception of The Hub on May 22, 2009, the maximum amount potentially due under this guarantee was $300 million. As of June 30, 2012, the maximum amount potentially due under this guarantee was less than $140 million. The maximum exposure to loss is expected to decline to zero during 2015. As The Hub’s distribution is generally provided under long-term contracts with stable subscriber levels, the Company believes the likelihood is remote that the performance levels will not be achieved and, therefore, the performance guarantee is unlikely to have a material adverse impact on the Company. Accordingly, the fair value of the guarantee was not material as of June 30, 2012.

12

DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)




The carrying values of the Company’s investment in The Hub were $324 million and $334 million as of June 30, 2012 and December 31, 2011, respectively. The value of the investment may decline if future results vary negatively from the current long range plan. The Company continues to monitor the valuation of its investment in accordance with GAAP, which requires an impairment charge when there is an other-than-temporary decline in the investment’s value. No impairment was recorded for the six months ended June 30, 2012.

13

DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)




OWN LLC
OWN LLC operates OWN, which is a pay-television network and website that provides adult lifestyle content focused on self-discovery and self-improvement. In connection with the launch of OWN on January 1, 2011, the Company contributed the domestic Discovery Health network to the venture. The contribution did not impact the Company’s ownership interest, voting control or governance rights related to OWN. Subsequent to the contribution, the Company no longer consolidates the domestic Discovery Health network, which was a component of its U.S. Networks segment. The assets of the Discovery Health network included goodwill and other identifiable assets with carrying values of $136 million and $8 million, respectively.
The Company recorded the contribution at fair value, which resulted in a pretax gain of $129 million and tax expense of $27 million. The fair value of the Company’s retained equity interest in OWN was estimated to be $273 million. The gain represents the fair value of the equity investment retained less the carrying values of contributed assets. The fair value of the contribution of the Discovery Health network to OWN was determined utilizing customary valuation methodologies including discounted cash flow valuation models. The underlying assumptions, such as future cash flows, weighted average costs of capital and long-term growth rates were generally not observable in the marketplace and therefore involved significant judgment.
The Company provides OWN funding and services such as distribution, licensing, sales and administrative support for a fee (see Note 12). As of June 30, 2012 and December 31, 2011, the Company’s advances to and note receivable from OWN were $414 million and $317 million, respectively. During the six months ended June 30, 2012, the Company provided OWN with funding of $84 million and accrued interest earned on the note receivable of $13 million. The note receivable is secured by the net assets of OWN. While the Company has no further funding commitments, the Company expects to provide additional funding to OWN and to recoup amounts funded. The funding to OWN accrues interest at 7.5% compounded annually. There can be no event of default on the borrowing until 2023. However, borrowings are scheduled for repayment four years after the borrowing date to the extent that OWN has excess cash to repay the borrowings then due. Following such repayment, OWN’s subsequent cash distributions will be shared equally between the Company and Harpo Inc. (“Harpo”).
Based upon the level of equity investment at risk, OWN is a VIE. While the partners share equally in voting control, power is not shared because certain activities that significantly impact OWN’s economic performance are directed by Harpo. Harpo holds operational rights related to programming and marketing, as well as selection and retention of key management personnel. The Company has determined that it is not the primary beneficiary of OWN because it does not control activities that are critical to OWN’s operating performance and success. Accordingly, the Company accounts for its investment in OWN using the equity method.
In accordance with the venture agreement, losses generated by OWN are generally allocated to both investors based on their proportionate ownership interests which are 50-50 . However, the Company has recorded its portion of OWN’s losses based upon accounting policies for equity method investments. Prior to the contribution of the Discovery Health network to OWN at its launch, the Company recognized $104 million or 100% of OWN’s net losses. During the three months ended March 31, 2012, accumulated operating losses at OWN exceeded the equity contributed to OWN, and Discovery began to record 100% of OWN’s net losses in other expense, net in the consolidated statements of operations. The Company will continue to record 100% of operating losses as long as Discovery provides all funding to OWN and OWN’s accumulated losses continue to exceed the equity contributed. Future net income generated by OWN will initially be allocated 100% to the Company until Discovery recovers losses absorbed in excess of Discovery’s equity ownership interest.
The carrying value of the Company’s investment in OWN, including its equity method investment and note receivable balance, was $452 million and $420 million as of June 30, 2012 and December 31, 2011, respectively. Given that the early results of OWN’s operations have been below its initial business plan, there is a possibility that the results of OWN’s future operations will fall below the revised long-term projections. The Company continues to monitor the financial results of OWN along with other relevant business information to assess the recoverability of the OWN note receivable and determine whether there is impairment of the Company’s equity investment in OWN. No impairment was recorded for the six months ended June 30, 2012.
Harpo has the right to require the Company to purchase all or part of Harpo’s interest in OWN every two and one half years commencing on January 1, 2016 at fair market value up to a maximum put amount. The maximum put amount is a range from $100 million on the first put exercise date up to $400 million on the fourth put exercise date. The Company has recorded no amounts for the put right.


14

DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)




NOTE 4. FAIR VALUE MEASUREMENTS
Fair value is defined as the amount that would be received for selling an asset or paid to transfer a liability in an orderly transaction between market participants. Assets and liabilities carried at fair value are classified in the following three categories: 
Level 1
Quoted prices for identical instruments in active markets.
Level 2
Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets.
Level 3
Valuations derived from valuation techniques in which one or more significant inputs are unobservable.
The table below presents assets and liabilities measured at fair value on a recurring basis (in millions).
 
 
 
 
June 30, 2012
Category
 
Balance Sheet Location
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets:
 
 
 
 
 
 
 
 
 
 
Trading securities:
 
 
 
 
 
 
 
 
 
 
Mutual funds
 
Prepaid expenses and other current assets
 
$
90

 
$

 
$

 
$
90

Available-for-sale securities:
 
 
 
 
 
 
 
 
 
 
Money market mutual funds
 
Cash and cash equivalents
 
317

 

 

 
317

U.S. Treasury securities
 
Cash and cash equivalents
 

 
900

 

 
900

Total assets
 
 
 
$
407

 
$
900

 
$

 
$
1,307

Liabilities:
 
 
 
 
 
 
 
 
 
 
Deferred compensation plan
 
Accrued expenses and other current liabilities
 
$
90

 
$

 
$

 
$
90

Total liabilities
 
 
 
$
90

 
$

 
$

 
$
90

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2011
Category
 
Balance Sheet Location
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets:
 
 
 
 
 
 
 
 
 
 
Trading securities:
 
 
 
 
 
 
 
 
 
 
Mutual funds
 
Prepaid expenses and other current assets
 
$
76

 
$

 
$

 
$
76

Available-for-sale securities:
 
 
 
 
 
 
 
 
 
 
Money market mutual funds
 
Cash and cash equivalents
 
635

 

 

 
635

Total assets
 
 
 
$
711

 
$

 
$

 
$
711

Liabilities:
 
 
 
 
 
 
 
 
 
 
Deferred compensation plan
 
Accrued expenses and other current liabilities
 
$
76

 
$

 
$

 
$
76

Total liabilities
 
 
 
$
76

 
$

 
$

 
$
76

Trading securities are comprised of investments in mutual funds held in a separate trust, which are owned as part of the Company’s deferred compensation plan. The fair value of Level 1 trading securities was determined by reference to the quoted market price per unit in active markets multiplied by the number of units held without consideration of transaction costs. The fair value of the related deferred compensation plan liability was determined based on the fair value of the related investments elected by employees.
Available-for-sale securities represent investments in highly liquid instruments with original maturities of 90 days or less. The fair value of Level 1 available-for-sale securities was determined by reference to the quoted market price per unit in active markets multiplied by the number of units held without consideration of transaction costs. The fair value of Level 2 available for sale securities was determined by reference to quoted market prices in active markets for similar assets.
In addition to the financial instruments listed in the tables above, the Company holds other financial instruments, including cash deposits, accounts receivable, accounts payable and debt. The carrying values for cash, accounts receivable and accounts payable approximated their fair values. The estimated fair value of the Company’s outstanding senior notes using

15

DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)




quoted prices from over the counter markets, considered Level 2 inputs, was $5.8 billion and $4.6 billion as of June 30, 2012 and December 31, 2011, respectively.
NOTE 5. CONTENT RIGHTS
The table below presents the components of content rights (in millions). 
 
 
June 30, 2012
 
December 31, 2011
Produced content rights:
 
 
 
 
Completed
 
$
2,435

 
$
2,257

In-production
 
272

 
221

Coproduced content rights:
 
 
 
 
Completed
 
506

 
491

In-production
 
87

 
80

Licensed content rights:
 
 
 
 
Acquired
 
398

 
346

Prepaid
 
24

 
21

Content rights, at cost
 
3,722

 
3,416

Accumulated amortization
 
(2,208
)
 
(2,021
)
Total content rights, net
 
1,514

 
1,395

Current portion
 
(110
)
 
(93
)
Noncurrent portion
 
$
1,404

 
$
1,302

Content expense, which consists of content amortization, impairments and other production charges included in cost of revenues in the consolidated statements of operations, was $247 million and $224 million for the three months ended June 30, 2012 and 2011, respectively, and $490 million and $436 million for the six months ended June 30, 2012 and 2011, respectively.
NOTE 6. DEBT
The table below presents the components of outstanding debt (in millions).
 
 
June 30, 2012
 
December 31, 2011
3.70% Senior Notes, semi-annual interest, due June 2015
 
$
850

 
$
850

5.625% Senior Notes, semi-annual interest, due August 2019
 
500

 
500

5.05% Senior Notes, semi-annual interest, due June 2020
 
1,300

 
1,300

4.375% Senior Notes, semi-annual interest, due June 2021
 
650

 
650

3.30% Senior Notes, semi-annual interest, due May 2022
 
500

 

6.35% Senior Notes, semi-annual interest, due June 2040
 
850

 
850

4.95% Senior Notes, semi-annual interest, due May 2042
 
500

 

Capital lease obligations
 
94

 
106

Total long-term debt
 
5,244

 
4,256

Unamortized discount
 
(18
)
 
(11
)
Long-term debt, net
 
5,226

 
4,245

Current portion of long-term debt
 
(20
)
 
(26
)
Noncurrent portion of long-term debt
 
$
5,206

 
$
4,219

On May 17, 2012, Discovery Communications, LLC ("DCL"), a wholly-owned subsidiary of the Company, issued $1.0 billion aggregate principal amount of senior notes consisting of $500 million aggregate principal amount of 3.30% Senior Notes due May 15, 2022 and $500 million aggregate principal amount of 4.95% Senior Notes due May 15, 2042 (the "2022 and 2042 Notes"). DCL received net proceeds of approximately $983 million from the offering after the $8 million issuance discount and $9 million of deferred financing costs.

16

DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)




DCL has the option to redeem some or all of the 2022 and 2042 Notes at any time prior to their maturity by paying a make-whole premium plus accrued and unpaid interest, if any, through the date of repurchase. Interest on the 2022 and 2042 Notes is payable on May 15 and November 15 of each year. The 2022 and 2042 Notes are unsecured and rank equally in right of payment with all of DCL's other unsecured senior indebtedness and are fully and unconditionally guaranteed on an unsecured and unsubordinated basis by Discovery.
In addition to the debt instruments listed in the table above, the Company has access to a $1.0 billion revolving credit facility. There were no amounts drawn under the revolving credit facility as of June 30, 2012 or December 31, 2011. If the Company were to draw on the revolving credit facility, outstanding balances would bear interest at a variable rate determined pursuant to the lending agreement. Balances outstanding under the revolving credit facility would be due on the expiration date, which is October 12, 2015.
As of June 30, 2012 and December 31, 2011, the Company was in compliance with all covenants in, and there were no events of default under its revolving credit agreement.
NOTE 7. EQUITY
Stock Repurchase Program
On April 25, 2012, the Company’s Board of Directors approved an additional authorization of $1.0 billion under the stock repurchase program, bringing the total authorization under the stock repurchase program to $3.0 billion. The additional authorization of $1.0 billion will expire on April 25, 2014. Previously authorized amounts have no expiration date. Under the stock repurchase program, management is authorized to purchase shares through open market transactions or privately negotiated transactions at prevailing prices as permitted by securities laws and other legal requirements and subject to stock price, business conditions, market conditions and other factors. As of June 30, 2012, the Company had remaining authorization of $1.2 billion for future repurchases of its common stock under the stock repurchase program.
The stock repurchases are recorded in treasury stock on the consolidated balance sheet. All repurchases during the three and six months ended June 30, 2012 and 2011 were made through open market transactions and were funded using cash on hand. As of June 30, 2012, the Company had repurchased 0.3 million and 45.2 million shares of Series A and Series C common stock over the life of the program for the aggregate purchase price of $15 million and $1.8 billion, respectively. As of December 31, 2011, the Company had repurchased 30.1 million shares of Series C common stock over the life of the program for the aggregate purchase price of $1.1 billion. There were no shares of Series A common stock repurchased as of December 31, 2011.
The table below presents a summary of stock repurchases (in millions).
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2012
 
2011
 
2012
 
2011
Series A Common Stock:
 
 
 
 
 
 
 
Shares repurchased
0.3
 

 
0.3
 

Aggregate purchase price
$
15

 
$

 
$
15

 
$

Series C Common Stock:
 
 
 
 
 
 
 
Shares repurchased
8.2
 
5.6
 
15.1
 
10.4
Aggregate purchase price
$
389

 
$
210

 
$
677

 
$
377

Total shares repurchased
8.5

 
5.6
 
15.4
 
10.4
Total aggregate purchase price
$
404

 
$
210

 
$
692

 
$
377


17

DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)




Other Comprehensive (Loss) Income
The table below presents the tax effects related to the components of other comprehensive (loss) income (in millions).
 
 

Before-tax
Amount
 
Tax
Benefit (Provision)
 

Net-of-tax
Amount
Three Months Ended June 30, 2012:
 
 
 
 
 
 
Currency translation adjustments
 
$
(18
)
 
$
8

 
$
(10
)
Derivative and market value adjustments
 
(2
)
 
1

 
(1
)
Other comprehensive loss
 
$
(20
)
 
$
9

 
$
(11
)
Three Months Ended June 30, 2011:
 
 
 
 
 
 
Currency translation adjustments
 
$
9

 
$
(3
)
 
$
6

Other comprehensive income
 
$
9

 
$
(3
)
 
$
6


 
 

Before-tax
Amount
 
Tax
Benefit (Provision)
 

Net-of-tax
Amount
Six Months Ended June 30, 2012:
 
 
 
 
 
 
Currency translation adjustments
 
$

 
$
1

 
$
1

Derivative and market value adjustments
 
(2
)
 
1

 
(1
)
Other comprehensive loss
 
$
(2
)
 
$
2

 
$

Six Months Ended June 30, 2011:
 
 
 
 
 
 
Currency translation adjustments
 
$
36

 
$
(13
)
 
$
23

Other comprehensive income
 
$
36

 
$
(13
)
 
$
23

The table below presents the changes in the components of other accumulated comprehensive loss, net of taxes (in millions).
 
 
Currency Translation Adjustments
 
Derivative
and Market
Value
Adjustments
 
Accumulated
Other
Comprehensive
Loss
Three Months Ended June 30, 2012
 
 
 
 
 
 
Beginning balance
 
$
(18
)
 
$
6

 
$
(12
)
Current period other comprehensive loss
 
(10
)
 
(1
)
 
(11
)
Ending balance
 
$
(28
)
 
$
5

 
$
(23
)
Three Months Ended June 30, 2011
 
 
 
 
 
 
Beginning balance
 
$
(22
)
 
$
6

 
$
(16
)
Current period other comprehensive income
 
6

 

 
6

Ending balance
 
$
(16
)
 
$
6

 
$
(10
)

18

DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)




 
 
 
Currency Translation Adjustments
 
Derivative
and Market
Value
Adjustments
 
Accumulated
Other
Comprehensive
Loss
Six Months Ended June 30, 2012
 
 
 
 
 
 
Beginning balance
 
$
(29
)
 
$
6

 
$
(23
)
Current period other comprehensive income (loss)
 
1

 
(1
)
 

Ending balance
 
$
(28
)
 
$
5

 
$
(23
)
Six Months Ended June 30, 2011
 
 
 
 
 
 
Beginning balance
 
$
(39
)
 
$
6

 
$
(33
)
Current period other comprehensive income
 
23

 

 
23

Ending balance
 
$
(16
)
 
$
6

 
$
(10
)

NOTE 8. EQUITY-BASED COMPENSATION
The Company has various incentive plans under which unit awards, stock options, performance based restricted stock units (“PRSUs”), time based restricted stock units (“RSUs”) and stock appreciation rights (“SARs”) have been issued. During the six months ended June 30, 2012, the vesting and service requirements of equity-based awards granted were consistent with the arrangements disclosed in the 2011 Form 10-K.
Equity-Based Compensation Expense
The table below presents the components of equity-based compensation expense (in millions).
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2012
 
2011
 
2012
 
2011
Unit awards
 
$
13

 
$
18

 
$
33

 
$
21

Stock options
 
6

 
8

 
17

 
18

PRSUs and RSUs
 
8

 
6

 
15

 
10

SARs
 
4

 

 
7

 

Total equity-based compensation expense
 
$
31

 
$
32

 
$
72

 
$
49

Tax benefit recognized
 
$
12

 
$
12

 
$
27

 
$
18

Compensation expense for all awards was recorded in selling, general and administrative expense in the consolidated statements of operations. As of June 30, 2012 and December 31, 2011, the Company recorded total liabilities for cash-settled awards of $40 million and $37 million, respectively.
Equity-Based Award Activity
Unit Awards
The table below presents unit award activity (in millions, except years and weighted-average grant price).
 
 
Unit Awards
 
Weighted-
Average
Grant
Price
 
Weighted-
Average
Remaining
Contractual
Term
(years)
 
Aggregate
Intrinsic
Value
Outstanding as of December 31, 2011
 
5.5

 
$
31.44

 
 
 
 
Granted
 

 

 
 
 
 
Settled
 
(2.2
)
 
27.70

 
 
 
$
36

Forfeited
 

 

 
 
 
 
Outstanding as of June 30, 2012
 
3.3

 
$
33.90

 
1.16

 
$
63

Vested and expected to vest as of June 30, 2012
 
3.2

 
$
33.89

 
1.16

 
$
60


19

DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)




Unit awards represent the contingent right to receive a cash payment for the amount by which the vesting price exceeds the grant price. Because unit awards are cash-settled, the Company remeasures the fair value and compensation expense of outstanding unit awards each reporting date until settlement. As of June 30, 2012, the weighted-average fair value of unit awards outstanding was $20.14 per unit award. The Company made cash payments to settle vested unit awards totaling $36 million and $91 million during the six months ended June 30, 2012 and 2011, respectively. As of June 30, 2012, there was $32 million of unrecognized compensation cost, net of estimated forfeitures, related to unit awards, which is expected to be recognized over a weighted-average period of 1.75 years.
SARs
There were 2 million and zero SARs outstanding as of June 30, 2012 and December 31, 2011, respectively. As of June 30, 2012, the weighted-average fair value of SARs outstanding was $15.88 per award. The Company made cash payments of $1 million to settle exercised SARs during both the six months ended June 30, 2012 and 2011. As of June 30, 2012, there was $21 million of unrecognized compensation cost, net of estimated forfeitures, related to SARs, which is expected to be recognized over a weighted-average period of 1.98 years.
Stock Options
The table below presents stock option activity (in millions, except years and weighted-average exercise price).
 
 
Stock Options
 
Weighted-
Average
Exercise
Price
 
Weighted-
Average
Remaining
Contractual
Term
(years)
 
Aggregate
Intrinsic
Value
Outstanding as of December 31, 2011
 
12.7

 
$
22.52

 
 
 
 
Granted
 
1.1

 
48.16

 
 
 
 
Exercised
 
(3.9
)
 
17.29

 
 
 
$
120

Forfeited
 
(0.2
)
 
29.66

 
 
 
 
Outstanding as of June 30, 2012
 
9.7

 
$
27.45

 
5.62

 
$
257

Vested and expected to vest as of June 30, 2012
 
9.4

 
$
26.94

 
5.63

 
$
254

Exercisable as of June 30, 2012
 
3.8

 
$
20.85

 
5.22

 
$
124

The Company received cash payments from the exercise of stock options totaling $68 million and $38 million during the six months ended June 30, 2012 and 2011, respectively. The weighted average grant date fair value of stock options granted during the six months ended June 30, 2012 was $16.80 per option. As of June 30, 2012, there was $50 million of unrecognized compensation cost, net of expected forfeitures, related to stock options, which is expected to be recognized over a weighted-average period of 1.58 years. 
PRSUs and RSUs
The table below presents PRSU and RSU activity (in millions, except years and weighted-average grant price).
 
 
 
PRSUs and
RSUs
 
Weighted-Average
Grant
Price
 
Weighted-Average
Remaining
Contractual
Term
(years)
 
Aggregate
Fair
Value
Outstanding as of December 31, 2011
 
2.2

 
$
35.48

 
 
 
 
Granted
 
0.9

 
47.98

 
 
 
 
Converted
 
(0.1
)
 
32.90

 
 
 
$
5

Forfeited
 
(0.1
)
 
35.46

 
 
 
 
Outstanding as of June 30, 2012
 
2.9

 
$
39.61

 
1.87

 
$
156

Vested and expected to vest as of June 30, 2012
 
2.7

 
$
39.55

 
1.85

 
$
145

PRSUs represent the contingent right to receive shares of the Company’s Series A common stock based on continuous service and whether the Company achieves certain operating performance targets. As of June 30, 2012, there were approximately 2 million outstanding PRSUs with a weighted-average grant price of $39.23. As of June 30, 2012, unrecognized

20

DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)




compensation cost, net of expected forfeitures, related to PRSUs was $39 million, which is expected to be recognized over a weighted-average period of 1.54 years.
RSUs represent the contingent right to receive shares of the Company’s Series A common stock based on continuous service. As of June 30, 2012, there were approximately 1 million outstanding RSUs with a weighted-average grant price of $40.59. As of June 30, 2012, there was $22 million of unrecognized compensation cost, net of expected forfeitures, related to RSUs, which is expected to be recognized over a weighted-average period of 2.76 years.
NOTE 9. INCOME TAXES
The Company's provisions for income taxes were $127 million and $144 million, and the effective tax rates were 30% and 36% for the three months ended June 30, 2012 and 2011, respectively. The effective tax rate for the three months ended June 30, 2012 differed from the U.S. federal statutory income tax rate of 35% primarily due to the reorganization of certain operations, production activity deductions and the net tax benefits related to extraterritorial income deductions for prior tax years, which were partially offset by adjustments for incremental U.S. tax expense on the inter-company license fees established as part of the 2011 international reorganization and state income taxes. The effective tax rate for the three months ended June 30, 2011 differed from the U.S. federal statutory income tax rate of 35% due primarily to state taxes partially offset by production activity deductions.
The Company's provisions for income taxes were $246 million and $290 million, and the effective tax rates were 32% and 34% for the six months ended June 30, 2012 and 2011, respectively. The effective tax rate for the six months ended June 30, 2012 differed from the U.S. federal statutory income tax rate of 35% primarily due to the reorganization of certain operations, production activity deductions and the net tax benefits related to extraterritorial income deductions for prior tax years, which were partially offset by adjustments for incremental U.S. tax expense on the inter-company license fees established as part of the 2011 international reorganization and state income taxes. The effective tax rate for the six months ended June 30, 2011 differed from the U.S. federal statutory income tax rate of 35% principally because the Company did not record a deferred tax liability of $21 million with respect to the portion of the outside basis in the OWN venture attributable to the nondeductible goodwill contributed to OWN and production activity deductions.
The Company is currently under examination by the Internal Revenue Service (“IRS”) for its 2009 and 2008 consolidated federal income tax returns. The Company has not been advised of any material adjustments. With few exceptions, the Company is no longer subject to audit by the IRS, state tax authorities, or foreign tax authorities for years prior to 2006.
NOTE 10. NET INCOME PER SHARE
The table below sets forth the computation of the the weighted-average number of shares outstanding utilized in determining basic and diluted net income per share (in millions, except per share amounts).
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2012
 
2011
 
2012
 
2011
Numerator:
 
 
 
 
 
 
 
Net income available to Discovery Communications, Inc. stockholders
$
293

 
$
254

 
$
514

 
$
559

Denominator:
 
 
 
 
 
 
 
Weighted-average shares outstanding — basic
381

 
406

 
383

 
407

Weighted-average dilutive effect of equity awards
3

 
4

 
4

 
5

Weighted-average shares outstanding — diluted
384

 
410

 
387

 
412

Net Income Per Share:
 
 
 
 
 
 
 
Basic
$
0.77

 
$
0.63

 
$
1.34

 
$
1.37

Diluted
$
0.76

 
$
0.62

 
$
1.33

 
$
1.36


21

DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)




The table below presents the details of the equity-based awards and preferred shares that were excluded from the calculation of diluted net income per share (in millions).
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2012
 
2011
 
2012
 
2011
Shares excluded from the dilutive calculation:
 
 
 
 
 
 
 
Anti-dilutive stock options and RSUs
1
 
2
 
1
 
2
PRSUs whose performance targets are not achieved
2
 
1
 
2
 
1
Contingently issuable preferred shares
1
 
1
 
1
 
1
Net income per share is calculated by dividing the applicable net income available to Discovery Communications, Inc. stockholders by the weighted-average number of shares outstanding. Diluted net income per share adjusts basic net income per share for the dilutive effect of the assumed exercise of outstanding stock options and stock-settled SARs, the vesting of outstanding service based RSUs, and the expected shares issued under the Discovery Communications, Inc. 2011 Employee Stock Purchase Plan using the treasury stock method. Diluted net income per share also adjusts basic net income per share for the dilutive effect for the assumed vesting of outstanding PRSUs or other contingently issuable shares that would be issued under the respective arrangements assuming the last day of the most recent fiscal period was the end of the contingency period.
At June 30, 2012 and 2011, the weighted average number of basic and diluted shares outstanding included the Company’s outstanding Series A, Series B and Series C common stock, as well as its outstanding Series A and Series C convertible preferred stock, as the holder of each common and preferred series legally participates equally in any per share distributions.
NOTE 11. SUPPLEMENTAL DISCLOSURES
The table below presents the components of accrued expenses and other current liabilities (in millions).
 
June 30, 2012
 
December 31, 2011
Accrued payroll and related benefits
$
207

 
$
229

Content rights payable
104

 
86

Accrued income taxes
107

 
38

Accrued interest
30

 
25

Current portion of equity-based compensation liabilities
33

 
27

Accrued other
102

 
149

Total accrued expenses and other current liabilities
$
583

 
$
554

The table below presents the components of other expense, net (in millions).
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2012
 
2011
 
2012
 
2011
(Losses) earnings from equity investees, net
$
(6
)
 
$
3

 
$
(54
)
 
$
(8
)
Other, net

 
(1
)
 
(2
)
 
3

Total other (expense) income, net
$
(6
)
 
$
2

 
$
(56
)
 
$
(5
)
NOTE 12. RELATED PARTY TRANSACTIONS
In the normal course of business, the Company enters into transactions with related parties. The following is a description of the Company’s related parties and related party transactions.
Equity Method Investees
The Company provides equity method investees, including unconsolidated VIEs, with content licenses and services such as distribution, sales and administrative support (see Note 3). Transactions for content licenses and services provided to equity method investees totaled $21 million and $48 million for the three and six months ended June 30, 2012, respectively, and $23 million and $44 million for the three and six months ended June 30, 2011, respectively. Of these transactions, the Company provided funding for $8 million and $22 million for the three and six months ended June 30, 2012, respectively, and $8 million and $16 million for the three and six months ended June 30, 2011, respectively. Operating expenses for services acquired from

22

DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)




equity method investees were $2 million and $4 million for the three and six months ended June 30, 2012, respectively, and $2 million and $5 million for the three and six months ended June 30, 2011, respectively.
The Company’s aggregate carrying value of equity method investments as of June 30, 2012 includes advances to and a note receivable from equity method investees of $414 million (see Note 3). The Company records interest earnings from loans to equity method investees as a component of losses from equity method investees, net, which is a component of other expense, net in the consolidated statements of operations. Interest earnings from related parties recorded by the Company totaled $7 million and $13 million for the three and six months ended June 30, 2012, respectively, and $4 million and $8 million for the three and six months ended June 30, 2011, respectively.
Liberty Global
The Company’s other related parties include entities that share common directorship or ownership. The majority of the revenue earned under contractual arrangements with other related parties relates to multi-year network distribution arrangements. Discovery’s Board of Directors includes three members who serve as directors of Liberty Global, Inc. (“Liberty Global”). John C. Malone is Chairman of the Board of Liberty Global and beneficially owns approximately 36% of the aggregate voting power with respect to the election of directors. Revenue from transactions with Liberty Global totaled $6 million and $15 million for the three and six months ended June 30, 2012, respectively, and $9 million and $17 million for the three and six months ended June 30, 2011, respectively. The Company’s receivable balances as of June 30, 2012 and December 31, 2011 from transactions with Liberty Global were not material.
NOTE 13. COMMITMENTS, CONTINGENCIES, AND GUARANTEES
Commitments
In the normal course of business, the Company enters into various commitments, which primarily include programming and talent arrangements, operating and capital leases, employment contracts, sponsorship commitments, arrangements to purchase various goods and services, future funding commitments to equity method investees (see Note 3), and the obligation to issue additional shares of preferred stock under the anti-dilution provisions of its outstanding preferred stock.
Contingencies
Put Right
Harpo has the right to require the Company to purchase its interest in OWN for fair value at various dates (see Note 3). No amounts have been recorded for put right obligations.
Legal Matters
In the normal course of business, the Company experiences routine claims and legal proceedings. It is the opinion of the Company’s management, based on information available at this time, that none of the current claims and proceedings will have a material adverse effect on the Company’s consolidated financial position, results of operations or cash flows.
Guarantees
The Company has guaranteed a certain level of operating performance for The Hub (see Note 3). There were no material amounts recorded for guarantees associated with equity method investees as of June 30, 2012 or December 31, 2011.
The Company may provide indemnities intended to protect others from certain business risks. Similarly, the Company may remain contingently liable for certain obligations in the event that a third party does not fulfill its obligations under an indemnification obligation. The Company records a liability for its indemnification obligations and other contingent liabilities when probable and estimable. There were no material amounts for indemnifications or other contingencies recorded as of June 30, 2012 or December 31, 2011.
NOTE 14. REPORTABLE SEGMENTS
The Company’s reportable segments are determined based on (i) financial information reviewed by its chief operating decision maker (“CODM”), the Chief Executive Officer, (ii) internal management and related reporting structure, and (iii) the basis upon which the CODM makes resource allocation decisions.
The accounting policies of the reportable segments are the same as the Company’s, except that certain inter-segment transactions that are eliminated for consolidation are not eliminated at the segment level. In determining segment performance,

23

DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)




inter-segment transactions are treated as third-party transactions. Inter-segment transactions, which primarily include advertising and content purchases between segments, were not significant for the periods presented.
The Company evaluates the operating performance of its segments based on financial measures such as revenues and adjusted operating income before depreciation and amortization (“Adjusted OIBDA”). Adjusted OIBDA is defined as revenues less costs of revenues and selling, general and administrative expenses excluding: (i) mark-to-market equity-based compensation, (ii) depreciation and amortization, (iii) amortization of deferred launch incentives, (iv) exit and restructuring charges, (v) certain impairment charges, and (vi) gains and losses on business and asset dispositions. The Company uses this measure to assess the operating results and performance of its segments, perform analytical comparisons, identify strategies to improve performance and allocate resources to each segment. The Company believes Adjusted OIBDA is relevant to investors because it allows them to analyze the operating performance of each segment using the same metric management uses. The Company excludes mark-to-market equity-based compensation, exit and restructuring charges, certain impairment charges, and gains and losses on business and asset dispositions from the calculation of Adjusted OIBDA due to their volatility. The Company also excludes depreciation of fixed assets and amortization of intangible assets and deferred launch incentives as these amounts do not represent cash payments in the current reporting period. Adjusted OIBDA should be considered in addition to, but not a substitute for, operating income, net income, and other measures of financial performance reported in accordance with GAAP.
Additionally, certain corporate expenses are excluded from segment results to enable executive management to evaluate segment performance based upon the decisions of segment executives.
The tables below present summarized financial information for each of the Company’s reportable segments (in millions).
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2012
 
2011
 
2012
 
2011
Revenues:
 
 
 
 
 
 
 
U.S. Networks
$
700

 
$
660

 
$
1,381

 
$
1,247

International Networks
405

 
368

 
785

 
691

Education and Other
37

 
39

 
79

 
80

Total revenues
$
1,142

 
$
1,067

 
$
2,245

 
$
2,018

 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2012
 
2011
 
2012
 
2011
Total Adjusted OIBDA:
 
 
 
 
 
 
 
U.S. Networks
$
426

 
$
395

 
$
821

 
$
729

International Networks
176

 
173

 
347

 
317

Education and Other
2

 
5

 
7

 
13

Corporate and inter-segment eliminations
(61
)
 
(63
)
 
(125
)
 
(122
)
Total Adjusted OIBDA
$
543

 
$
510

 
$
1,050

 
$
937

 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2012
 
2011
 
2012
 
2011
Reconciliation of Total Adjusted OIBDA to Operating Income:
 
 
 
 
 
 
 
Total Adjusted OIBDA
$
543

 
$
510

 
$
1,050

 
$
937

Amortization of deferred launch incentives
(5
)
 
(12
)
 
(10
)
 
(26
)
Mark-to-market equity-based compensation
(18
)
 
(19
)
 
(43
)
 
(23
)
Depreciation and amortization
(31
)
 
(30
)
 
(61
)
 
(60
)
Restructuring charges
(2
)
 
(4
)
 
(3
)
 
(5
)
Gain on disposition

 

 

 
129

Operating income
$
487

 
$
445

 
$
933

 
$
952

 

24

DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)




 
June 30, 2012
 
December 31, 2011
Total assets:
 
 
 
U.S. Networks
$
2,886

 
$
2,679

International Networks
1,337

 
1,244

Education and Other
60

 
68

Corporate and inter-segment eliminations
8,527

 
7,922

Total assets
$
12,810

 
$
11,913

Total assets for corporate and inter-segment eliminations include goodwill that is allocated to the Company’s segments to account for goodwill. The presentation of segment assets in the table above is consistent with the financial reports that are reviewed by the Company’s CODM.
NOTE 15. CONDENSED CONSOLIDATING FINANCIAL STATEMENTS
Overview
As of June 30, 2012 and December 31, 2011, the senior notes outstanding (see Note 6) have been issued by DCL, a wholly-owned subsidiary of the Company, pursuant to a Registration Statement on Form S-3 filed with the U.S. Securities and Exchange Commission (the “SEC”) on June 18, 2012 (the “Shelf Registration”). The Company fully and unconditionally guarantees the senior notes on an unsecured basis. The Company, DCL, and/or Discovery Communications Holding, LLC (“DCH”), a wholly-owned subsidiary of the Company (collectively, the “Issuers”), may issue additional debt securities under the Shelf Registration that are fully and unconditionally guaranteed by the other Issuers.
Set forth below are condensed consolidating financial statements presenting the financial position, results of operations and comprehensive income, and cash flows of (i) the Company, (ii) DCH, (iii) DCL, (iv) the non-guarantor subsidiaries of DCL on a combined basis, (v) the other non-guarantor subsidiaries of the Company on a combined basis and (vi) reclassifications and eliminations necessary to arrive at the consolidated financial statement balances for the Company. DCL and the non-guarantor subsidiaries of DCL are the primary operating subsidiaries of the Company. DCL primarily includes Discovery Channel and TLC networks in the U.S. The non-guarantor subsidiaries of DCL include the Company’s other U.S. and international networks, education businesses, and most of the Company’s websites and other digital media services. The non-guarantor subsidiaries of DCL are wholly-owned subsidiaries of DCL with the exception of certain equity method investments. DCL is a wholly-owned subsidiary of DCH. The Company wholly owns DCH through a 33 1/3% direct ownership interest and a 66 2/3% indirect ownership interest through Discovery Holding Company (“DHC”), a wholly-owned subsidiary of the Company. DHC is included in the other non-guarantor subsidiaries of the Company.
Basis of Presentation
Solely for purposes of presenting the condensed consolidating financial statements, investments in the Company’s subsidiaries have been accounted for by their respective parent company using the equity method. Accordingly, in the following condensed consolidating financial statements, the equity method has been applied to (i) the Company’s interests in DCH and the other non-guarantor subsidiaries of the Company, (ii) DCH’s interest in DCL and (iii) DCL’s interests in the non-guarantor subsidiaries of DCL. Inter-company accounts and transactions have been eliminated to arrive at the consolidated financial statement amounts for the Company. The Company’s accounting bases in all subsidiaries, including goodwill and recognized intangible assets, have been “pushed-down” to the applicable subsidiaries.
Prior to the international reorganization that occurred in November 2011, all direct and indirect subsidiaries were included in the Company’s consolidated U.S. income tax return. Effective with the reorganization, the operations of certain of the Company’s international subsidiaries are excluded from the Company’s consolidated U.S. income tax return. Tax expense related to permanent differences has been allocated to the entity that created the difference. Tax expense related to temporary differences has been allocated to the entity that created the difference, where identifiable. The remaining temporary differences are allocated to each entity included in the Company’s consolidated U.S. income tax return based on each entity’s relative pretax income. Deferred taxes have been allocated based upon the temporary differences between the carrying amounts of the respective assets and liabilities of the applicable entities.
The condensed consolidating financial statements should be read in conjunction with the consolidated financial statements of the Company.


25

DISCOVERY COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)




 Condensed Consolidating Balance Sheet
June 30, 2012
(in millions)
 
 
Discovery
 
DCH
 
DCL
 
Non-Guarantor
Subsidiaries of
DCL
 
Other Non-
Guarantor
Subsidiaries of Discovery
 
Reclassifications 
and
Eliminations
 
Discovery and
Subsidiaries
ASSETS
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Current assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$

 
$

 
$
1,592

 
$
105

 
$
1

 
$

 
$
1,698

Receivables, net
 

 

 
440

 
704

 
11

 

 
1,155