(12) | | (13) | Stock Options and Other Long-Term Incentive Compensation |
| | | Stock Options On May 4, 2006, each of the non-employee directors of DHC was granted 10,000 options to purchase DHC Series A common stock with an exercise price of $14.48. Such options vest one year from the date of grant, terminate 10 years from the date of grant and had a grant-date fair value of $4.47 per share, as determined by the Black-Scholes Model.
II-32
|
In addition to the Spin Off DHC Awards, shareholders of DHC have approved the Discovery Holding Company 2005 Incentive Plan (the “2005 Incentive Plan”) and the Discovery Holding Company 2005 Nonemployee Director Incentive Plan (the “2005 NDIP”). The 2005 Incentive Plan and the 2005 NDIP provide for the grant of up to 10 million incentive awards and 5 million incentive awards, respectively. On May 4, 2006, each of the non-employee directors of DHC was granted 10,000 options to purchase DHC Series A common stock with an exercise price of $14.48. Such options vested one year from the date of grant, terminate 10 years from the date of grant and had a grant-date fair value of $4.47 per share, as determined using the Black-Scholes Model. On May 16, 2007, each of the non-employee directors of DHC was granted 10,000 options to purchase DHC Series A common stock with an exercise price of $22.90 per share. Such options vest on the date of the 2008 DHC annual stockholder meeting. Also on May 16, 2007, the president of DHC was granted 10,000 options to purchase DHC Series A common stock with an exercise price of $22.90 per share. Such options vest one year from the date of grant. All 40,000 options granted on May 16, 2007 terminate 10 years from the date of grant and had a grant-date fair value of $7.74 per share, as determined using the Black-Scholes Model. II-47
DISCOVERY HOLDING COMPANY AND SUBSIDIARIES
Notes to Consolidated financial Statements — (Continued) The following table presents the number and weighted average exercise price (“WAEP”) of options to purchase DHC Series A and Series B common stock. | | | | | | | | | | | | | | | | | | | DHC
| | | | | | DHC
| | | | | | | Series A
| | | | | | Series B
| | | | | | | Common
| | | | | | Common
| | | | | | | Stock | | | WAEP | | | Stock | | | WAEP | | | Outstanding at January 1, 2007 | | | 1,943,804 | | | $ | 15.45 | | | | 2,996,525 | | | $ | 18.87 | | Grants | | | 40,000 | | | $ | 22.90 | | | | — | | | | | | Exercises | | | (828,570 | ) | | $ | 15.94 | | | | — | | | | | | Cancellations | | | (2,942 | ) | | $ | 31.61 | | | | — | | | | | | | | | | | | | | | | | | | | | | | Outstanding at December 31, 2007 | | | 1,152,292 | | | $ | 15.32 | | | | 2,996,525 | | | $ | 18.87 | | | | | | | | | | | | | | | | | | | Exercisable at December 31, 2007 | | | 926,743 | | | $ | 15.47 | | | | 2,936,525 | | | $ | 18.93 | | | | | | | | | | | | | | | | | | |
As of December 31, 2007, the total compensation cost related to unvested equity awards was approximately $540,000. Such amount will be recognized in DHC’s consolidated statements of operations over a weighted average period of approximately 1.2 years. 2006 Ascent Media Long-Term Incentive Plan Effective August 3, 2006, Ascent Media adopted its 2006 Long-Term Incentive Plan (the “2006 Plan”). The 2006 Plan provides the terms and conditions for the grant of, and payment with respect to, Phantom Appreciation Rights (“PARs”) granted to certain officers and other key personnel of Ascent Media. The value of a single PAR (“Value”) is calculated as the sum of (i) 6% of cumulative free cash flow (as defined in the 2006 Plan) over a period of up to six years, divided by 500,000 plus (ii) 5% of the increase in the calculated value of Ascent Media over a baseline value determined at the time of grant, divided by 10,000,000. The 2006 Plan is administered by a committee that consists of two individuals appointed by DHC. Grants are determined by the committee, with the first grant occurring on August 3, 2006. The maximum number of PARs that may be granted under the 2006 Plan is 500,000, and there were 438,500 PARs granted as of December 31, 2007. The PARs vest quarterly over a three year period, and are payable on March 31, 2012 (or, if earlier, on the six-month anniversary of a grantee’s termination of employment without cause). Ascent Media records a liability and a charge to expense based on the Value and percent vested at each reporting period. Ascent Media recorded 2006 Plan expense of $276,000 for the year ended December 31, 2007. No expense was recorded for the year ended December 31, 2006. Notes to Consolidated Financial Statements — (Continued)
The following table presents the number and weighted average exercise price (“WAEP”) of options to purchase DHC Series A and Series B common stock.
| | | | | | | | | | | | | | | | | | | DHC
| | | | | | DHC
| | | | | | | Series A
| | | | | | Series B
| | | | | | | Common
| | | | | | Common
| | | | | | | Stock | | | WAEP | | | Stock | | | WAEP | | | Outstanding at January 1, 2006 | | | 1,937,616 | | | $ | 15.43 | | | | 2,996,525 | | | | 18.87 | | Granted | | | 30,000 | | | $ | 14.48 | | | | — | | | | | | Exercises | | | (22,382 | ) | | $ | 12.46 | | | | — | | | | | | Cancellations | | | (1,430 | ) | | $ | 12.10 | | | | — | | | | | | | | | | | | | | | | | | | | | | | Outstanding at December 31, 2006 | | | 1,943,804 | | | $ | 15.45 | | | | 2,996,525 | | | | 18.87 | | | | | | | | | | | | | | | | | | | Exercisable at December 31, 2006 | | | 1,460,415 | | | $ | 16.18 | | | | 2,876,525 | | | | 18.99 | | | | | | | | | | | | | | | | | | |
As of December 31, 2006, the total compensation cost related to unvested equity awards was $1.1 million. Such amount will be recognized in DHC’s consolidated statements of operations through 2009.
2006 Ascent Media Long-Term Incentive Plan
Effective August 3, 2006, Ascent Media adopted its 2006 Long-Term Incentive Plan (the “2006 Plan”). The 2006 Plan provides the terms and conditions for the grant of, and payment with respect to, Phantom Appreciation Rights (“PARs”) granted to certain officers and other key personnel of Ascent Media. The value of a single PAR (“Value”) is calculated as the sum of (i) 6% of cumulative free cash flow (as defined in the 2006 Plan) over a period of up to six years, divided by 500,000 plus (ii) 5% of the increase in the calculated value of Ascent Media over a baseline value determined at the time of grant, divided by 10,000,000. The 2006 Plan is administered by a committee that consists of two individuals appointed by DHC. Grants are determined by the committee, with the first grant occurring on August 3, 2006. The maximum number of PARs that may be granted under the 2006 Plan is 500,000, and there were 398,500 granted PARs as of December 31, 2006. The PARs vest quarterly over a three year period, and are payable on March 31, 2012 (or, if earlier, on the six-month anniversary of a grantee’s termination of employment without cause). Ascent Media will record a liability and a charge to expense based on the Value and percent vested at each reporting period. As of December 31, 2006, the Value of the PARs was $0.
| | (13) (14) | Other Comprehensive Earnings (Loss) Accumulated other comprehensive earnings (loss) included in DHC’s consolidated balance sheets and consolidated statements of stockholders’ equity reflect the aggregate of foreign currency translation adjustments and unrealized holding gains and losses onavailable-for-sale securities.
The change in the components of accumulated other comprehensive earnings (loss), net of taxes, is summarized as follows:
| | | | | | | | | | | | | | | | | | | | | Accumulated
| | | | Foreign
| | | Unrealized
| | | Other
| | | | Currency
| | | Holding
| | | Comprehensive
| | | | Translation
| | | Gains (losses)
| | | Earnings (loss),
| | | | Adjustments | | | on Securities | | | Net of Taxes | | | | amounts in thousands | | | Balance at January 1, 2004 | | $ | 5,236 | | | | 1,439 | | | | 6,675 | | Other comprehensive earnings | | | 6,797 | | | | (1,162 | ) | | | 5,635 | | | | | | | | | | | | | | | Balance at December 31, 2004 | | | 12,033 | | | | 277 | | | | 12,310 | | Other comprehensive loss | | | (14,821 | ) | | | 651 | | | | (14,170 | ) | | | | | | | | | | | | | | Balance at December 31, 2005 | | | (2,788 | ) | | | 928 | | | | (1,860 | ) | Other comprehensive earnings | | | 17,922 | | | | (148 | ) | | | 17,774 | | | | | | | | | | | | | | | Balance at December 31, 2006 | | $ | 15,134 | | | | 780 | | | | 15,914 | | | | | | | | | | | | | | |
II-33
DISCOVERY HOLDING COMPANY AND SUBSIDIARIES
Notes to Consolidated Financial Statements — (Continued)
The components of other comprehensive earnings (loss) are reflected in DHC’s consolidated statements of comprehensive earnings (loss) net of taxes. The following table summarizes the tax effects related to each component of other comprehensive earnings (loss).
| | | | | | | | | | | | | | | | | | Tax
| | | | | | | Before-Tax
| | | (Expense)
| | | Net-of-Tax
| | | | Amount | | | Benefit | | | Amount | | | | amounts in thousands | | | Year ended December 31, 2006: | | | | | | | | | | | | | Foreign currency translation adjustments | | $ | 29,648 | | | | (11,726 | ) | | | 17,922 | | Unrealized holding gains on securities arising during period | | | (245 | ) | | | 97 | | | | (148 | ) | | | | | | | | | | | | | | Other comprehensive earnings | | $ | 29,403 | | | | (11,629 | ) | | | 17,774 | | | | | | | | | | | | | | | Year ended December 31, 2005: | | | | | | | | | | | | | Foreign currency translation adjustments | | $ | (24,518 | ) | | | 9,697 | | | | (14,821 | ) | Unrealized holding gains on securities arising during period | | | 1,077 | | | | (426 | ) | | | 651 | | | | | | | | | | | | | | | Other comprehensive loss | | $ | (23,441 | ) | | | 9,271 | | | | (14,170 | ) | | | | | | | | | | | | | | Year ended December 31, 2004: | | | | | | | | | | | | | Foreign currency translation adjustments | | $ | 11,143 | | | | (4,346 | ) | | | 6,797 | | Unrealized holding losses on securities arising during period | | | (1,905 | ) | | | 743 | | | | (1,162 | ) | | | | | | | | | | | | | | Other comprehensive earnings | | $ | 9,238 | | | | (3,603 | ) | | | 5,635 | | | | | | | | | | | | | | |
|
Accumulated other comprehensive earnings (loss) included in DHC’s consolidated balance sheets and consolidated statements of stockholders’ equity reflect the aggregate of foreign currency translation adjustments, unrealized holding gains and losses on available-for-sale securities and minimum pension liability adjustments. II-48
DISCOVERY HOLDING COMPANY AND SUBSIDIARIES
Notes to Consolidated financial Statements — (Continued) The change in the components of accumulated other comprehensive earnings (loss), net of taxes, is summarized as follows: | | | | | | | | | | | | | | | | | | | | | | | | | | | | Accumulated
| | | | Foreign
| | | Unrealized
| | | Minimum
| | | Other
| | | | Currency
| | | Holding
| | | Pension
| | | Comprehensive
| | | | Translation
| | | Gains (losses)
| | | Liability
| | | Earnings (loss),
| | | | Adjustments | | | on Securities | | | Adjustment | | | Net of Taxes | | | | amounts in thousands | | | Balance at January 1, 2005 | | $ | 12,033 | | | | 277 | | | | — | | | | 12,310 | | Other comprehensive loss | | | (14,821 | ) | | | 651 | | | | — | | | | (14,170 | ) | | | | | | | | | | | | | | | | | | Balance at December 31, 2005 | | | (2,788 | ) | | | 928 | | | | — | | | | (1,860 | ) | Other comprehensive earnings | | | 17,922 | | | | (148 | ) | | | — | | | | 17,774 | | | | | | | | | | | | | | | | | | | Balance at December 31, 2006 | | | 15,134 | | | | 780 | | | | — | | | | 15,914 | | Other comprehensive earnings | | | 7,934 | | | | (6,606 | ) | | | (461 | ) | | | 867 | | | | | | | | | | | | | | | | | | | Balance at December 31, 2007 | | $ | 23,068 | | | | (5,826 | ) | | | (461 | ) | | | 16,781 | | | | | | | | | | | | | | | | | | |
The components of other comprehensive earnings (loss) are reflected in DHC’s consolidated statements of comprehensive earnings (loss) net of taxes. The following table summarizes the tax effects related to each component of other comprehensive earnings (loss). | | | | | | | | | | | | | | | | | | Tax
| | | | | | | Before-tax
| | | (Expense)
| | | Net-of-tax
| | | | Amount | | | Benefit | | | Amount | | | | amounts in thousands | | | Year ended December 31, 2007: | | | | | | | | | | | | | Foreign currency translation adjustments | | $ | 13,125 | | | | (5,191 | ) | | | 7,934 | | Unrealized holding losses on securities arising during period | | | (10,928 | ) | | | 4,322 | | | | (6,606 | ) | Minimum pension liability adjustment | | | (763 | ) | | | 302 | | | | (461 | ) | | | | | | | | | | | | | | Other comprehensive earnings | | $ | 1,434 | | | | (567 | ) | | | 867 | | | | | | | | | | | | | | | Year ended December 31, 2006: | | | | | | | | | | | | | Foreign currency translation adjustments | | $ | 29,648 | | | | (11,726 | ) | | | 17,922 | | Unrealized holding losses on securities arising during period | | | (245 | ) | | | 97 | | | | (148 | ) | | | | | | | | | | | | | | Other comprehensive earnings | | $ | 29,403 | | | | (11,629 | ) | | | 17,774 | | | | | | | | | | | | | | | Year ended December 31, 2005: | | | | | | | | | | | | | Foreign currency translation adjustments | | $ | (24,518 | ) | | | 9,697 | | | | (14,821 | ) | Unrealized holding gains on securities arising during period | | | 1,077 | | | | (426 | ) | | | 651 | | | | | | | | | | | | | | | Other comprehensive loss | | $ | (23,441 | ) | | | 9,271 | | | | (14,170 | ) | | | | | | | | | | | | | |
| | (14) (15) | Employee Benefit Plans |
Ascent Media offers a 401(k) defined contribution plan covering most of its full-time domestic employees who are not eligible to participate in the Motion Picture Industry Pension and Health Plan (MPIPHP), a multi-employer defined benefit pension plan. Contributions to the MPIPHP are determined in accordance with the provisions of negotiated labor contracts and generally are based on the number of hours worked. Ascent Media also sponsors a pension plan for eligible employees of its foreign subsidiaries. Employer contributions are determined by Ascent Media’s board of directors. The plans are funded by employee and employer contributions. Total pension plan II-49
DISCOVERY HOLDING COMPANY AND SUBSIDIARIES
Notes to Consolidated financial Statements — (Continued) expenses for the years ended December 31, 2007, 2006 and 2005 were $8,263,000, $7,868,000 and Health Plan (MPIPHP), a multi-employer defined benefit pension plan. Contributions to the MPIPHP are determined in accordance with the provisions of negotiated labor contracts and generally are based on the number of hours worked. Ascent Media also sponsors a pension plan for eligible employees of its foreign subsidiaries. Employer contributions are determined by Ascent Media’s board of directors. The plans are funded by employee and employer contributions. Total pension plan expenses for the years ended December 31, 2006, 2005 and 2004 were $7,868,000, $7,109,000, and $6,485,000, respectively. | | (15) (16) | Commitments and Contingencies Future minimum lease payments under scheduled operating leases, which are primarily for buildings, equipment and real estate, having initial or remaining noncancelable terms in excess of one year are as follows (in thousands):
| | | | | Year ended December 31: | | | | | 2007 | | $ | 32,058 | | 2008 | | $ | 29,156 | | 2009 | | $ | 27,645 | | 2010 | | $ | 24,590 | | 2011 | | $ | 19,436 | | Thereafter | | $ | 59,144 | |
Rent expense for noncancelable operating leases for real property and equipment was $31,355,000, $31,643,000 and $26,487,000 for the years ended December 31, 2006, 2005 and 2004, respectively. Various lease arrangements contain options to extend terms and are subject to escalation clauses.
At December 31, 2006, the Company is committed to compensation under long-term employment agreements with its certain executive officers of Ascent Media as follows: 2007, $1,815,000; 2008, $1,760,000; and 2009, $1,565,000.
On December 31, 2003, Ascent Media acquired the operations of Sony Electronic’s systems integration center business and related assets, which we refer to as SIC. In exchange, Sony received the right to be paid in 2008 an amount equal to 20% of the value of the combined business of Ascent Media’s wholly owned subsidiary, AF Associates, Inc. and
II-34
DISCOVERY HOLDING COMPANY AND SUBSIDIARIES
Notes to Consolidated Financial Statements — (Continued)
SIC. The value of 20% of the combined business of AF Associates and SIC is estimated at $6,100,000.
|
Future minimum lease payments under scheduled operating leases, which are primarily for buildings, equipment and real estate, having initial or remaining noncancelable terms in excess of one year are as follows (in thousands): | | | | | Year ended December 31: | | | | | 2008 | | $ | 31,374 | | 2009 | | $ | 30,964 | | 2010 | | $ | 27,709 | | 2011 | | $ | 22,362 | | 2012 | | $ | 16,954 | | Thereafter | | $ | 62,080 | |
Rent expense for noncancelable operating leases for real property and equipment was $31,539,000, $31,355,000 and $31,643,000 for the years ended December 31, 2007, 2006 and 2005, respectively. Various lease arrangements contain options to extend terms and are subject to escalation clauses. On December 31, 2003, Ascent Media acquired the operations of Sony Electronic’s systems integration center business and related assets, which we refer to as SIC. In exchange, Sony received the right to be paid in 2008 an amount equal to 20% of the value of the combined business of Ascent Media’s wholly owned subsidiary, AF Associates, Inc. and SIC. The value of 20% of the combined business of AF Associates and SIC is estimated at $6,100,000, which liability is included in other accrued liabilities in the accompanying consolidated balance sheets. SIC is included in Ascent Media’s network services group. The Company is involved in litigation and similar claims incidental to the conduct of its business. In management’s opinion, none of the pending actions is likely to have a material adverse impact on the Company’s financial position or results of operations. | | (16) (17) | Related Party Transactions Certain third-party general and administrative and spin off related costs were paid by Liberty on behalf of the Company prior to the Spin Off and reflected as expenses in the accompanying consolidated statements of operations. In addition, certain general and administrative expenses are charged by Liberty to DHC pursuant to the Services Agreement. Such expenses aggregated $2,260,000 and $5,948,000
|
Certain third-party general and administrative and spin off related costs were paid by Liberty on behalf of the Company prior to the 2005 Spin Off and reflected as expenses in the accompanying consolidated statements of operations. In addition, certain general and administrative expenses are charged by Liberty to DHC pursuant to the Services Agreement. Such expenses aggregated $2,321,000, $2,260,000 and $5,080,000 for the years ended December 31, 2007, 2006 and 2005, respectively. Ascent Media provides services, such as satellite uplink, systems integration, origination, and post-production, to Discovery. Revenue recorded by Ascent Media for these services for the years ended December 31, 2007, 2006 and 2005 aggregated $41,216,000, $33,741,000 and $34,189,000, respectively. Ascent Media provides services, such as satellite uplink, systems integration, origination, and post-production, to Discovery. Revenue recorded by Ascent Media for these services for the years ended December 31, 2006, 2005 and 2004 aggregated $33,741,000, $34,189,000 and $41,785,000, respectively.
| | (17) (18) | Information About Operating Segments |
The Company’s chief operating decision maker, or his designee (the “CODM”), has identified the Company’s reportable segments based on (i) financial information reviewed by the CODM and (ii) those operating segments that represent more than 10% of the Company’s combined revenue or earnings before taxes. In addition, those equity investments whose share of earnings represent more than 10% of the Company’s earnings before taxes are considered reportable segments. II-50
DISCOVERY HOLDING COMPANY AND SUBSIDIARIES
Notes to Consolidated financial Statements — (Continued) Based on the foregoing criteria, the Company’s business units have been aggregated into three reportable segments: the creative services group and the network services group, which are operating segments of Ascent Media, and Discovery, which is an equity affiliate. Corporate related items and unallocated income and expenses are reflected in the Corporate and other column listed below. The creative services group provides various technical and creative services necessary to complete principal photography into final products, such as feature films, movie trailers, documentaries and independent films, episodic television, TV movies and mini-series, television commercials, music videos, interactive games and new digital media, promotional and identity campaigns and corporate communications. These services are referred to generally in the entertainment industry as “post-production” services. In addition, the creative services group provides a full complement of facilities and services necessary to optimize, archive, manage and repurpose completed media assets for global distribution via freight, satellite, fiber and the Internet. The network services group provides origination, transmission/distribution and technical services to broadcast, cable and satellite programming networks, local television channels, broadcast syndicators, satellite broadcasters and other broadband telecommunications companies and private networks for viewers in North America, Europe, Asia and Latin America. Additionally, the networks services group provides systems integration, design, consulting, engineering and project management services. The accounting policies of the segments that are consolidated entities are the same as those described in the summary of significant accounting policies and are consistent with GAAP. The Company evaluates the performance of these operating segments based on financial measures such as revenue and operating cash flow. The Company defines operating cash flow as revenue less cost of services and selling, general and administrative expenses (excluding stock and other equity-based compensation and accretion expense on asset retirement obligations). The Company believes this is an important indicator of the operational strength and performance of its businesses, including the businesses’ ability to service debt and capital expenditures. In addition, this measure allows management to view operating results and perform analytical comparisons and identify strategies to improve performance. This measure of performance excludes depreciation and amortization, stock and other equity-based compensation, accretion expense on asset retirement obligations and restructuring and impairment charges that are included in the measurement of operating income pursuant to GAAP. Accordingly, operating cash flow should be considered in addition to, but not as a substitute for, operating income, cash flow provided by operating activities and other measures of financial performance prepared in accordance with GAAP. The Company’s reportable segments are strategic business units that offer different products and services. They are managed separately because each segment requires different technologies, distribution channels and marketing strategies. II-51
DISCOVERY HOLDING COMPANY AND SUBSIDIARIES
Notes to Consolidated financial Statements — (Continued) Summarized financial information concerning the Company’s reportable segments is presented in the following tables: | | | | | | | | | | | | | | | | | | | | | | | Consolidated Reportable Segments | | | | | | | Creative
| | | Network
| | | | | | | | | Equity
| | | | Services
| | | Services
| | | Corporate
| | | Consolidated
| | | Affiliate-
| | | | Group | | | Group(1) | | | and Other | | | Total | | | Discovery | | | | amounts in thousands | | | Year ended December 31, 2007 | | | | | | | | | | | | | | | | | | | | | Revenue from external customers | | $ | 420,504 | | | | 286,710 | | | | — | | | | 707,214 | | | | 3,127,333 | | Operating cash flow | | $ | 48,493 | | | | 49,256 | | | | (30,831 | ) | | | 66,918 | | | | 806,180 | | Capital expenditures | | $ | 23,494 | | | | 19,789 | | | | 3,832 | | | | 47,115 | | | | 80,553 | | Depreciation and amortization | | $ | 33,089 | | | | 28,636 | | | | 6,007 | | | | 67,732 | | | | 130,576 | | Total assets | | $ | 369,845 | | | | 257,679 | | | | 5,238,228 | | | | 5,865,752 | | | | 7,960,430 | | Year ended December 31, 2006 | | | | | | | | | | | | | | | | | | | | | Revenue from external customers | | $ | 417,876 | | | | 270,211 | | | | — | | | | 688,087 | | | | 2,883,671 | | Operating cash flow | | $ | 48,035 | | | | 47,005 | | | | (36,311 | ) | | | 58,729 | | | | 746,766 | | Capital expenditures | | $ | 27,126 | | | | 44,331 | | | | 6,084 | | | | 77,541 | | | | 90,138 | | Depreciation and amortization | | $ | 38,661 | | | | 23,055 | | | | 6,213 | | | | 67,929 | | | | 122,037 | | Total assets | | $ | 410,313 | | | | 382,848 | | | | 5,077,821 | | | | 5,870,982 | | | | 3,376,553 | | Year ended December 31, 2005 | | | | | | | | | | | | | | | | | | | | | Revenue from external customers | | $ | 421,797 | | | | 272,712 | | | | — | | | | 694,509 | | | | 2,544,358 | | Operating cash flow | | $ | 65,098 | | | | 52,797 | | | | (39,270 | ) | | | 78,625 | | | | 707,744 | | Capital expenditures | | $ | 47,179 | | | | 38,476 | | | | 4,871 | | | | 90,526 | | | | 99,684 | | Depreciation and amortization | | $ | 38,644 | | | | 27,046 | | | | 10,687 | | | | 76,377 | | | | 112,653 | | Total assets | | $ | 470,213 | | | | 323,558 | | | | 5,025,465 | | | | 5,819,236 | | | | 3,174,620 | |
The Company’s chief operating decision maker, or his designee (the “CODM”), has identified the Company’s reportable segments based on (i) financial information reviewed by the CODM and (ii) those operating segments that represent more than 10% of the Company’s combined revenue or earnings before taxes. In addition, those equity investments whose share of earnings represent more than 10% of the Company’s earnings before taxes are considered reportable segments.
Based on the foregoing criteria, the Company’s business units have been aggregated into three reportable segments: the creative services group and the network services group, which are operating segments of Ascent Media, and Discovery, which is an equity affiliate. Corporate related items and unallocated income and expenses are reflected in the Corporate and other column listed below. As a product of our segment restructuring, the segment presentation for prior periods has been conformed to the current period segment presentation.
The creative services group provides various technical and creative services necessary to complete principal photography into final products, such as feature films, movie trailers, documentaries and independent films, episodic television, TV movies and mini-series, television commercials, music videos, interactive games and new digital media, promotional and identity campaigns and corporate communications. These services are referred to generally in the entertainment industry as “post-production” services. In addition, the creative services group provides a full complement of facilities and services necessary to optimize, archive, manage and repurpose completed media assets for global distribution via freight, satellite, fiber and the Internet. The network services group provides broadcast services, which are comprised of services necessary to assemble and distribute programming for cable and broadcast networks via fiber and satellite to viewers in North America, Europe, Asia and Latin America. Additionally, the networks services group provides systems integration, design, consulting, engineering and project management services.
The accounting policies of the segments that are consolidated entities are the same as those described in the summary of significant accounting policies and are consistent with GAAP.
The Company evaluates the performance of these operating segments based on financial measures such as revenue and operating cash flow. The Company defines operating cash flow as revenue less cost of services and selling, general and administrative expenses (excluding stock and other equity-based compensation and accretion expense on asset retirement obligations). The Company believes this is an important indicator of the operational strength and performance of its businesses, including the businesses’ ability to service debt and capital expenditures. In addition, this measure allows management to view operating results and perform analytical comparisons and identify strategies to improve performance. This measure of performance excludes depreciation and amortization, stock and other equity-based compensation, accretion expense on asset retirement obligations and restructuring and impairment charges that are included in the measurement of operating income pursuant to GAAP. Accordingly, operating cash flow should be considered in addition to, but not as a substitute for, operating income, cash flow provided by operating activities and other measures of financial performance prepared in accordance with GAAP.
II-35
DISCOVERY HOLDING COMPANY AND SUBSIDIARIES
Notes to Consolidated Financial Statements — (Continued)
The Company’s reportable segments are strategic business units that offer different products and services. They are managed separately because each segment requires different technologies, distribution channels and marketing strategies.
Summarized financial information concerning the Company’s reportable segments is presented in the following tables:
| | | | | | | | | | | | | | | | | | | | | | | Consolidated Reportable Segments | | | | | | | Creative
| | | Network
| | | | | | | | | Equity
| | | | Services
| | | Services
| | | Corporate
| | | Consolidated
| | | Affiliate-
| | | | Group | | | Group(1) | | | and Other | | | Total | | | Discovery | | | | amounts in thousands | | | Year ended December 31, 2006 | | | | | | | | | | | | | | | | | | | | | Revenue from external customers | | $ | 417,876 | | | | 270,211 | | | | — | | | | 688,087 | | | | 3,012,988 | | Operating cash flow | | $ | 52,554 | | | | 49,522 | | | | (43,347 | ) | | | 58,729 | | | | 722,424 | | Capital expenditures | | $ | 27,126 | | | | 44,331 | | | | 6,084 | | | | 77,541 | | | | 90,138 | | Depreciation and amortization | | $ | 38,661 | | | | 23,055 | | | | 6,213 | | | | 67,929 | | | | 133,634 | | Total assets | | $ | 410,313 | | | | 382,848 | | | | 5,077,821 | | | | 5,870,982 | | | | 3,376,553 | | Year ended December 31, 2005 | | | | | | | | | | | | | | | | | | | | | Revenue from external customers | | $ | 421,797 | | | | 272,712 | | | | — | | | | 694,509 | | | | 2,671,754 | | Operating cash flow | | $ | 70,708 | | | | 55,877 | | | | (47,960 | ) | | | 78,625 | | | | 686,638 | | Capital expenditures | | $ | 47,179 | | | | 38,476 | | | | 4,871 | | | | 90,526 | | | | 99,684 | | Depreciation and amortization | | $ | 38,644 | | | | 27,046 | | | | 10,687 | | | | 76,377 | | | | 123,209 | | Total assets | | $ | 470,213 | | | | 323,558 | | | | 5,025,465 | | | | 5,819,236 | | | | 3,174,620 | | Year ended December 31, 2004 | | | | | | | | | | | | | | | | | | | | | Revenue from external customers | | $ | 405,026 | | | | 226,189 | | | | — | | | | 631,215 | | | | 2,365,346 | | Operating cash flow | | $ | 72,903 | | | | 62,537 | | | | (37,645 | ) | | | 97,795 | | | | 662,690 | | Capital expenditures | | $ | 22,810 | | | | 23,123 | | | | 3,359 | | | | 49,292 | | | | 88,100 | | Depreciation and amortization | | $ | 38,776 | | | | 27,074 | | | | 11,755 | | | | 77,605 | | | | 129,011 | | Total assets | | $ | 469,930 | | | | 294,599 | | | | 4,800,299 | | | | 5,564,828 | | | | 3,235,686 | |
| | | (1) | | Included in Network Services Group revenue is broadcast services revenue of $158,273,000, $158,151,000 and $149,568,000 and systems integration revenue of $128,437,000, $112,060,000 and $123,144,000 in 2007, 2006 and 2005, respectively. |
The following table provides a reconciliation of segment operating cash flow to earnings (loss) before income taxes. | | | (1) | | Included in Network Services Group revenue is broadcast services revenue of $158,151,000, $149,568,000 and $136,680,000 and systems integration revenue of $112,060,000, $123,144,000 and $89,509,000 in 2006, 2005 and 2004, respectively. |
The following table provides a reconciliation of segment operating cash flow to earnings (loss) before income taxes.
| | | | | | | | | | | | | | | Years Ended December 31, | | | | 2006 | | | 2005 | | | 2004 | | | | amounts in thousands | | | Segment operating cash flow | | $ | 58,729 | | | | 78,625 | | | | 97,795 | | Stock-based compensation | | | (1,817 | ) | | | (4,383 | ) | | | (2,775 | ) | Restructuring and other charges | | | (12,092 | ) | | | (4,112 | ) | | | — | | Depreciation and amortization | | | (67,929 | ) | | | (76,377 | ) | | | (77,605 | ) | Impairment of goodwill | | | (93,402 | ) | | | — | | | | (51 | ) | Share of earnings of Discovery | | | 103,588 | | | | 79,810 | | | | 84,011 | | Other, net | | | 10,855 | | | | 8,549 | | | | (297 | ) | | | | | | | | | | | | | | Earnings (loss) before income taxes | | $ | (2,068 | ) | | | 82,112 | | | | 101,078 | | | | | | | | | | | | | | |
II-36
DISCOVERY HOLDING COMPANY AND SUBSIDIARIES
Notes to Consolidated Financial Statements — (Continued)
Information as to the Company’s operations in different geographic areas is as follows:
| | | | | | | | | | | | | | | Years Ended December 31, | | | | 2006 | | | 2005 | | | 2004 | | | | amounts in thousands | | | Revenue | | | | | | | | | | | | | United States | | $ | 535,792 | | | | 525,288 | | | | 460,070 | | United Kingdom | | | 129,540 | | | | 149,928 | | | | 148,002 | | Other countries | | | 22,755 | | | | 19,293 | | | | 23,143 | | | | | | | | | | | | | | | | | $ | 688,087 | | | | 694,509 | | | | 631,215 | | | | | | | | | | | | | | | Property and equipment, net | | | | | | | | | | | | | United States | | $ | 184,052 | | | | 163,073 | | | | | | United Kingdom | | | 70,363 | | | | 65,017 | | | | | | Other countries | | | 26,360 | | | | 28,155 | | | | | | | | | | | | | | | | | | | | | $ | 280,775 | | | | 256,245 | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | Years Ended December 31, | | | | 2007 | | | 2006 | | | 2005 | | | | amounts in thousands | | | Segment operating cash flow | | $ | 66,918 | | | | 58,729 | | | | 78,625 | | Stock-based compensation | | | (1,129 | ) | | | (1,817 | ) | | | (4,383 | ) | Restructuring and other charges | | | (761 | ) | | | (12,092 | ) | | | (4,112 | ) | Depreciation and amortization | | | (67,732 | ) | | | (67,929 | ) | | | (76,377 | ) | Impairment of goodwill | | | (165,347 | ) | | | (93,402 | ) | | | — | | Share of earnings of Discovery | | | 141,781 | | | | 103,588 | | | | 79,810 | | Other, net | | | 17,035 | | | | 10,855 | | | | 8,549 | | | | | | | | | | | | | | | Earnings (loss) before income taxes | | $ | (9,235 | ) | | | (2,068 | ) | | | 82,112 | | | | | | | | | | | | | | |
II-52
DISCOVERY HOLDING COMPANY AND SUBSIDIARIES
Notes to Consolidated financial Statements — (Continued) Information as to the Company’s operations in different geographic areas is as follows: | | | | | | | | | | | | | | | Years Ended December 31, | | | | 2007 | | | 2006 | | | 2005 | | | | amounts in thousands | | | Revenue | | | | | | | | | | | | | United States | | $ | 561,594 | | | | 535,792 | | | | 525,288 | | United Kingdom | | | 120,821 | | | | 129,540 | | | | 149,928 | | Other countries | | | 24,799 | | | | 22,755 | | | | 19,293 | | | | | | | | | | | | | | | | | $ | 707,214 | | | | 688,087 | | | | 694,509 | | | | | | | | | | | | | | | Property and equipment, net | | | | | | | | | | | | | United States | | $ | 178,299 | | | | 184,052 | | | | | | United Kingdom | | | 68,548 | | | | 70,363 | | | | | | Other countries | | | 22,895 | | | | 26,360 | | | | | | | | | | | | | | | | | | | | | $ | 269,742 | | | | 280,775 | | | | | | | | | | | | | | | | | | |
| | (18) (19) | Quarterly Financial Information (Unaudited) | | | | | | | | | | | | | | | | | | | 1st
| | | 2nd
| | | 3rd
| | | 4th
| | | | Quarter | | | Quarter | | | Quarter | | | Quarter | | | | amounts in thousands, except per share amounts | | | 2006: | | | | | | | | | | | | | | | | | Revenue | | $ | 153,568 | | | | 165,789 | | | | 169,876 | | | | 198,854 | | | | | | | | | | | | | | | | | | | Operating loss | | $ | (2,857 | ) | | | (6,252 | ) | | | (97,350 | ) | | | (8,678 | ) | | | | | | | | | | | | | | | | | | Net earnings (loss) | | $ | 11,615 | | | | 13,734 | | | | (76,633 | ) | | | 5,274 | | | | | | | | | | | | | | | | | | | Basic and diluted net earnings (loss) per common share | | $ | .04 | | | | .05 | | | | (.27 | ) | | | .02 | | | | | | | | | | | | | | | | | | | 2005: | | | | | | | | | | | | | | | | | Revenue | | $ | 174,290 | | | | 178,019 | | | | 167,934 | | | | 174,266 | | | | | | | | | | | | | | | | | | | Operating income (loss) | | $ | 2,877 | | | | (4,982 | ) | | | (1,403 | ) | | | 2,106 | | | | | | | | | | | | | | | | | | | Net earnings | | $ | 16,825 | | | | 4,027 | | | | 1,189 | | | | 11,235 | | | | | | | | | | | | | | | | | | | Basic and diluted net earnings per common share | | $ | .06 | | | | .01 | | | | — | | | | .04 | | | | | | | | | | | | | | | | | | |
II-37
|
| | | | | | | | | | | | | | | | | | | 1st
| | | 2nd
| | | 3rd
| | | 4th
| | | | Quarter | | | Quarter | | | Quarter | | | Quarter | | | | amounts in thousands, except per share amounts | | | 2007: | | | | | | | | | | | | | | | | | Revenue | | $ | 173,882 | | | | 177,220 | | | | 177,913 | | | | 178,199 | | | | | | | | | | | | | | | | | | | Operating income (loss) | | $ | (1,201 | ) | | | (2,929 | ) | | | (1,553 | ) | | | (161,960 | ) | | | | | | | | | | | | | | | | | | Net earnings (loss) | | $ | 20,464 | | | | 74,217 | | | | 7,507 | | | | (170,580 | ) | | | | | | | | | | | | | | | | | | Basic and diluted net earnings (loss) per common share | | $ | .07 | | | | .26 | | | | .03 | | | | (.61 | ) | | | | | | | | | | | | | | | | | | 2006: | | | | | | | | | | | | | | | | | Revenue | | $ | 153,568 | | | | 165,789 | | | | 169,876 | | | | 198,854 | | | | | | | | | | | | | | | | | | | Operating loss | | $ | (2,857 | ) | | | (6,252 | ) | | | (97,350 | ) | | | (8,678 | ) | | | | | | | | | | | | | | | | | | Net earnings (loss) | | $ | 11,615 | | | | 13,734 | | | | (76,633 | ) | | | 5,274 | | | | | | | | | | | | | | | | | | | Basic and diluted net earnings (loss) per common share | | $ | .04 | | | | .05 | | | | (.27 | ) | | | .02 | | | | | | | | | | | | | | | | | | |
II-53
PART III.
The following required information is incorporated by reference to our definitive proxy statement for our 2007 Annual Meeting of Stockholders presently scheduled to be held in the second quarter of 2007:
| | Item 10. | Directors, Executive Officers and Corporate Governance |
| | Item 11. | Executive Compensation |
| | Item 12. | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters |
| | Item 13. | Certain Relationships and Related Transactions, and Director Independence |
| | Item 14. | Principal Accounting Fees and Services |
We will file our definitive proxy statement for our 2007 Annual Meeting of stockholders with the Securities and Exchange Commission on or before April 30, 2007.
III-1
PART IV.
| | Item 15.PART III. The following required information is incorporated by reference to our definitive proxy statement for our 2008 Annual Meeting of Stockholders presently scheduled to be held in the second quarter of 2008: | | Item 10. | Directors, Executive Officers and Corporate Governance | Exhibits and Financial Statement Schedules. |
(a) (1) Financial Statements
| | Item 11. | Executive Compensation |
Included in Part II | | Item 12. | Security Ownership of this Report: | | | | | | | Page No. | | | Discovery Holding Company: | | | | | | | | II-15 | | | | | II-16 | | | | | II-17 | | | | | II-18 | | | | | II-19 | | | | | II-20 | | | | | II-21 | | | | | II-22 | Certain Beneficial Owners and Management and Related Stockholder Matters |
(a) (2) Financial Statement Schedules
| | Item 13. | Certain Relationships and Related Transactions, and Director Independence |
Included in Part IV of this Report:
| | | | (i) | All schedules have been omitted because they are not applicable, not material or the required information is set forth in the financial statements or notes thereto. | | Item 14. | Principal Accounting Fees and Services |
| | | | (ii) | Separate financial statements for Discovery Communications, Inc.:We will file our definitive proxy statement for our 2008 Annual Meeting of stockholders with the Securities and Exchange Commission on or before April 30, 2008. III-1
PART IV. | | Item 15. | Exhibits and Financial Statement Schedules. |
| | | | | | | | IV-3 | | | | | IV-4 | | | | | IV-5 | | | | | IV-6 | | | | | IV-7 | | | | | | | Page No. | | | Discovery Holding Company: | | | | | | | | II-26 | | | | | II-27 | | | | | II-28 | | | | | II-29 | | | | | II-30 | | | | | II-31 | | | | | II-32 | | | | | II-33 | |
(a) (2) Financial Statement Schedules Included in Part IV of this Report: | | | | (i) | All schedules have been omitted because they are not applicable, not material or the required information is set forth in the financial statements or notes thereto. |
| | | | (ii) | Separate financial statements for Discovery Communications Holding, LLC: |
| | | | | | | | IV-3 | | | | | IV-4 | | | | | IV-5 | | | | | IV-6 | | | | | IV-7 | | | | | IV-8 | | | | | IV-9 | |
(a) (3) Exhibits Listed below are the exhibits which are filed as a part of this Report (according to the number assigned to them in Item 601 ofRegulation S-K): | | | | | 2 — Plan of Acquisition, Reorganization, Arrangement, Liquidation or Succession: | | 2.1 | | | Reorganization Agreement among Liberty Media Corporation, Discovery Holding Company (“DHC”) and Ascent Media Group, Inc. (incorporated by reference to Exhibit 2.1 to DHC’s Registration Statement on Form 10, dated July 15, 2005 (FileNo. 000-51205) (the “Form 10”)). | 3 — Articles of Incorporation and Bylaws: | | 3.1 | | | Restated Certificate of Incorporation of DHC (incorporated by reference to Exhibit 3.1 to the Form 10). | | 3.2 | | | Bylaws of DHC (incorporated by reference to Exhibit 3.2 to the Form 10). | 4 — Instruments Defining the Rights of Securities Holders, including Indentures: | | 4.1 | | | Specimen Certificate for shares of the Series A common stock, par value $.01 per share, of DHC (incorporated by reference to Exhibit 4.1 to the Form 10). |
IV-1
| | | | | | 4.2 | | | Specimen Certificate for shares of the Series B common stock, par value $.01 per share, of DHC (incorporated by reference to Exhibit 4.2 to the Form 10). | | 4.3 | | | Rights Agreement between DHC and EquiServe Trust Company, N.A., as Rights Agent (incorporated by reference to Exhibit 4.3 to the Form 10). |
IV-1
10 — Material Contracts: | | 10.1 | | | Amended and Restated Limited Liability Company Agreement of Discovery Communications Holding, LLC, dated as of May 14, 2007, by and among Advance/Newhouse Programming Partnership, LMC Discovery, Inc. and John S. Hendricks, filed herewith. | | 10.2 | | | Form of Tax Sharing Agreement between Liberty Media Corporation and DHC (incorporated by reference to Exhibit 10.6 to the Form 10). | | 10.3 | | | Discovery Holding Company 2005 Incentive Plan (As Amended and Restated Effective August 15, 2007) (incorporated by reference to Exhibit 10.1 to the Quarterly Report onForm 10-Q of Discovery Holding Company for the quarter ended September 30, 2007 (FileNo. 000-51205) as filed on November 7, 2007). | | 10.4 | | | Discovery Holding Company 2005 Non-Employee Director Incentive Plan (As Amended and Restated Effective August 15, 2007) (incorporated by reference to Exhibit 10.2 to the Quarterly Report onForm 10-Q of Discovery Holding Company for the quarter ended September 30, 2007 (FileNo. 000-51205) as filed on November 7, 2007). | | 10.5 | | | Discovery Holding Company Transitional Stock Adjustment Plan (As Amended and Restated Effective August 15, 2007) (incorporated by reference to Exhibit 10.3 to the Quarterly Report onForm 10-Q of Discovery Holding Company for the quarter ended September 30, 2007 (FileNo. 000-51205) as filed on November 7, 2007). | | 10.6 | | | Agreement between DHC and John C. Malone (incorporated by reference to Exhibit 10.10 to the Form 10). | | 10.7 | | | Agreement, dated June 24, 2005, between Discovery and DHC (incorporated by reference to Exhibit 10.11 to the Form 10). | | 10.8 | | | Indemnification Agreement, dated as of June 24, 2005, between Cox and DHC (incorporated by reference to Exhibit 10.12 to the Form 10). | | 10.9 | | | Indemnification Agreement, dated as of June 24, 2005, between NewChannels and DHC (incorporated by reference to Exhibit 10.13 to the Form 10). | | 10.10 | | | Form of Indemnification Agreement with Directors and Executive Officers (incorporated by reference to Exhibit 10.14 to the Form 10). | 21 — Subsidiaries of Discovery Holding Company, filed herewith. | | 23.1 | | | Consent of KPMG LLP, filed herewith. | | 23.2 | | | Consent of PricewaterhouseCoopers LLP, filed herewith. | | 31.1 | | | Rule 13a-14(a)/15d — 14(a) Certification, filed herewith. | | 31.2 | | | Rule 13a-14(a)/15d — 14(a) Certification, filed herewith. | | 31.3 | | | Rule 13a-14(a)/15d — 14(a) Certification, filed herewith. | 32 — Section 1350 Certification, filed herewith. | |
IV-2
| | | | | 10 — Material Contracts: | | 10.1 | | | The Shareholders Agreement, dated as of November 30, 1991 (the “Stockholders’ Agreement”), by and among Discovery Communications, Inc. (“Discovery”), Cox Discovery, Inc. (“Cox”), NewsChannels TDC Investments, Inc. (“NewChannels”), TCI Cable Education, Inc. (“TCID”) and John S. Hendricks (“Hendricks”) (incorporated by referenceReport of Independent Registered Public Accounting Firm To the Board of Directors and Stockholders of Discovery Communications, Inc.: In our opinion, the accompanying consolidated balance sheet and related consolidated statements of operations, of changes in stockholders’ deficit, and of cash flows, present fairly, in all material respects, the financial position of Discovery Communications, Inc. and its subsidiaries at December 31, 2006, and the results of their operations and their cash flows for the period from January 1, 2007 through May 14, 2007, and for each of the two years in the period ended December 31, 2006 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. As discussed in Note 16 to Exhibit 10.1 to the Form 10). | | 10.2 | | | First Amendment to the Stockholders’ Agreement, dated as of December 20, 1996, by and among Discovery, Cox Communications Holdings, Inc. (the successor to Cox), Newhouse Broadcasting Corporation ( the successor to NewChannels), TCID, Hendricks and for the purposes stated therein only, LMC Animal Planet, Inc. (“LMC”) and Liberty Media Corporation, a Colorado corporation (“Liberty”) (incorporated by reference to Exhibit 10.2 to the Form 10). | | 10.3 | | | Second Amendment to the Stockholders’ Agreement, dated as of September 7, 2000, by and among Discovery, Cox Communications Holdings, Inc. (the successor to Cox), Advance/Newhouse Programming Partnership (the successor to NewChannels), LMC Discovery, Inc. (formerly known as TCID) and Hendricks (incorporated by reference to Exhibit 10.3 to the Form 10). | | 10.4 | | | Third Amendment to the Stockholders’ Agreement, dated as of September, 2001, by and among Discovery, Cox, NewChannels, TCID, Hendricks and Advance Programming Holdings Corp. (incorporated by reference to Exhibit 10.4 to the Form 10). | | 10.5 | | | Fourth Amendment to the Stockholders’ Agreement, dated as of June 23, 2003, by and among Discovery, Cox NewChannels, TCID, Liberty Animal, Inc. (the successor in interest to LMC) for the purposes stated in the First Amendment to the Stockholders’ Agreement, and Hendricks (incorporated by reference to Exhibit 10.5 to the Form 10). | | 10.6 | | | Form of Tax Sharing Agreement between Liberty Media Corporation and DHC (incorporated by reference to Exhibit 10.6 to the Form 10). | | 10.7 | | | Discovery Holding Company 2005 Incentive Plan (incorporated by reference to Exhibit 10.7 to the Form 10). | | 10.8 | | | Discovery Holding Company 2005 Non-Employee Director Plan (incorporated by reference to Exhibit 10.8 to the Form 10). | | 10.9 | | | Discovery Holding Company Transitional Stock Adjustment Plan (incorporated by reference to Exhibit 10.9 to the Form 10). | | 10.10 | | | Agreement between DHC and John C. Malone (incorporated by reference to Exhibit 10.10 to the Form 10). | | 10.11 | | | Agreement, dated June 24, 2005, between Discovery and DHC (incorporated by reference to Exhibit 10.11 to the Form 10). | | 10.12 | | | Indemnification Agreement, dated as of June 24, 2005, between Cox and DHC (incorporated by reference to Exhibit 10.12 to the Form 10). | | 10.13 | | | Indemnification Agreement, dated as of June 24, 2005, between NewChannels and DHC (incorporated by reference to Exhibit 10.13 to the Form 10). | | 10.14 | | | Form of Indemnification Agreement with Directors and Executive Officers (incorporated by reference to Exhibit 10.14 to the Form 10). | 21 — Subsidiaries of Discovery Holding Company, filed herewith. | | 23.1 | | | Consent of KPMG LLP, filed herewith. | | 23.2 | | | Consent of PricewaterhouseCoopers LLP, filed herewith. | | 31.1 | | | Rule 13a-14(a)/15d — 14(a) Certification, filed herewith. | | 31.2 | | | Rule 13a-14(a)/15d — 14(a) Certification, filed herewith. | | 31.3 | | | Rule 13a-14(a)/15d — 14(a) Certification, filed herewith. | 32 — Section 1350 Certification, filed herewith. |
IV-2
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 related consolidated statements of operations, of changes in stockholders’ deficit, and of cash flows, present fairly, in all material respects, the consolidated financial position of Discovery Communications, Inc. and its subsidiaries at December 31, 2006 and December 31, 2005, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2006 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
/s/PricewaterhouseCoopers LLP
McLean, Virginia
February 23, 2007
IV-3
DISCOVERY COMMUNICATIONS, INC.
| | | | | | | | | | | December 31, | | | | 2006 | | | 2005 | | | | in thousands,
| | | | except share data | | | ASSETS | Current assets | | | | | | | | | Cash and cash equivalents | | $ | 52,263 | | | | 34,491 | | Accounts receivable, less allowances of $25,175 and $35,079 | | | 657,552 | | | | 565,407 | | Inventories | | | 35,716 | | | | 30,714 | | Deferred income taxes | | | 76,156 | | | | 88,765 | | Content rights, net | | | 64,395 | | | | 55,125 | | Other current assets | | | 84,554 | | | | 56,867 | | | | | | | | | | | Total current assets | | | 970,636 | | | | 831,369 | | | | | | | | | | | Property and equipment, net | | | 424,041 | | | | 397,578 | | Content rights, net, less current portion | | | 1,253,553 | | | | 1,175,988 | | Deferred launch incentives | | | 207,032 | | | | 255,259 | | Goodwill | | | 365,266 | | | | 254,989 | | Intangibles, net | | | 107,673 | | | | 142,938 | | Investments in and advances to unconsolidated affiliates | | | 15,564 | | | | 11,528 | | Deferred income taxes | | | — | | | | 69,316 | | Other assets | | | 32,788 | | | | 35,655 | | | | | | | | | | | TOTAL ASSETS | | $ | 3,376,553 | | | | 3,174,620 | | | | | | | | | | | LIABILITIES AND STOCKHOLDERS’ DEFICIT | Current liabilities | | | | | | | | | Accounts payable and accrued liabilities | | $ | 316,804 | | | | 283,326 | | Accrued payroll and employee benefits | | | 122,431 | | | | 88,000 | | Launch incentives payable | | | 17,978 | | | | 22,655 | | Content rights payable | | | 57,694 | | | | 97,075 | | Current portion of long-term incentive plan liabilities | | | 43,274 | | | | 20,690 | | Current portion of long-term debt | | | 7,546 | | | | 6,470 | | Income taxes payable | | | 55,264 | | | | 51,226 | | Unearned revenue | | | 68,339 | | | | 89,803 | | Other current liabilities | | | 45,194 | | | | 33,220 | | | | | | | | | | | Total current liabilities | | | 734,524 | | | | 692,465 | | | | | | | | | | | Long-term debt, less current portion | | | 2,633,237 | | | | 2,590,440 | | Derivative financial instruments, less current portion | | | 8,282 | | | | 18,592 | | Launch incentives payable, less current portion | | | 10,791 | | | | 21,910 | | Long-term incentive plan liabilities, less current portion | | | 41,186 | | | | 25,380 | | Content rights payable, less current portion | | | 3,846 | | | | 4,380 | | Deferred income taxes | | | 46,289 | | | | — | | Other liabilities | | | 64,861 | | | | 31,309 | | | | | | | | | | | Total liabilities | | | 3,543,016 | | | | 3,384,476 | | | | | | | | | | | Mandatorily redeemable interests in subsidiaries | | | 94,825 | | | | 272,502 | | | | | | | | | | | Commitments and contingencies | | | | | | | | | Stockholders’ deficit | | | | | | | | | Class A common stock; $.01 par value; 100,000 shares authorized; 51,119 shares issued, less 719 shares of treasury stock | | | 1 | | | | 1 | | Class B common stock; $.01 par value; 60,000 shares authorized; 50,615 shares | | | — | | | | — | | issued and held in treasury stock | | | | | | | | | Additional paid-in capital | | | 21,093 | | | | 21,093 | | Accumulated deficit | | | (306,135 | ) | | | (513,311 | ) | Accumulated other comprehensive income | | | 23,753 | | | | 9,859 | | | | | | | | | | | Total stockholders’ deficit | | | (261,288 | ) | | | (482,358 | ) | | | | | | | | | | TOTAL LIABILITIES AND STOCKHOLDERS’ DEFICIT | | $ | 3,376,553 | | | | 3,174,620 | | | | | | | | | | |
The accompanying notes are an integral part of these consolidated financial statements.
IV-4
DISCOVERY COMMUNICATIONS, INC.
| | | | | | | | | | | | | | | Year Ended December 31, | | | | 2006 | | | 2005 | | | 2004 | | | | in thousands | | | OPERATING REVENUE | | | | | | | | | | | | | Advertising | | $ | 1,243,500 | | | | 1,187,823 | | | | 1,133,807 | | Distribution | | | 1,434,901 | | | | 1,198,686 | | | | 976,362 | | Other | | | 334,587 | | | | 285,245 | | | | 255,177 | | | | | | | | | | | | | | | Total operating revenue | | | 3,012,988 | | | | 2,671,754 | | | | 2,365,346 | | | | | | | | | | | | | | | Cost of revenue, exclusive of depreciation shown below | | | 1,120,377 | | | | 979,765 | | | | 846,316 | | Selling, general & administrative | | | 1,209,420 | | | | 1,054,816 | | | | 927,855 | | Depreciation & amortization | | | 133,634 | | | | 123,209 | | | | 129,011 | | Gain on sale of long-lived asset | | | — | | | | — | | | | (22,007 | ) | | | | | | | | | | | | | | Total operating expenses | | | 2,463,431 | | | | 2,157,790 | | | | 1,881,175 | | | | | | | | | | | | | | | INCOME FROM OPERATIONS | | | 549,557 | | | | 513,964 | | | | 484,171 | | | | | | | | | | | | | | | OTHER INCOME (EXPENSE) | | | | | | | | | | | | | Interest, net | | | (194,227 | ) | | | (184,575 | ) | | | (167,420 | ) | Realized and unrealized gains from derivative instruments, net | | | 22,558 | | | | 22,499 | | | | 45,540 | | Minority interests in consolidated subsidiaries | | | (2,451 | ) | | | (43,696 | ) | | | (54,940 | ) | Equity in earnings of unconsolidated affiliates | | | 7,060 | | | | 4,660 | | | | 171 | | Other, net | | | 1,467 | | | | 9,111 | | | | 2,299 | | | | | | | | | | | | | | | Total other expense, net | | | (165,593 | ) | | | (192,001 | ) | | | (174,350 | ) | | | | | | | | | | | | | | INCOME BEFORE INCOME TAXES | | | 383,964 | | | | 321,963 | | | | 309,821 | | | | | | | | | | | | | | | Income tax expense | | | 176,788 | | | | 162,343 | | | | 141,799 | | | | | | | | | | | | | | | NET INCOME | | $ | 207,176 | | | | 159,620 | | | | 168,022 | | | | | | | | | | | | | | |
The accompanying notes are an integral part of these consolidated financial statements.
IV-5
DISCOVERY COMMUNICATIONS, INC.
| | | | | | | | | | | | | | | Year Ended December 31, | | | | 2006 | | | 2005 | | | 2004 | | | | in thousands | | | OPERATING ACTIVITIES | | | | | | | | | | | | | Net income | | $ | 207,176 | | | | 159,620 | | | | 168,022 | | Adjustments to reconcile net income to cash provided by operations | | | | | | | | | | | | | Depreciation and amortization | | | 133,634 | | | | 123,209 | | | | 129,011 | | Amortization of deferred launch incentives and representation rights | | | 77,778 | | | | 83,411 | | | | 107,757 | | Provision for losses on accounts receivable | | | 3,691 | | | | 12,217 | | | | 959 | | Expenses arising from long-term incentive plans | | | 39,233 | | | | 49,465 | | | | 71,515 | | Equity in earnings of unconsolidated affiliates | | | (7,060 | ) | | | (4,660 | ) | | | (171 | ) | Deferred income taxes | | | 108,903 | | | | 109,383 | | | | 105,522 | | Realized and unrealized gains on derivative financial instruments, net | | | (22,558 | ) | | | (22,499 | ) | | | (45,540 | ) | Non-cash minority interest charges | | | 2,451 | | | | 43,696 | | | | 54,940 | | Gain on sale of investments | | | (1,467 | ) | | | (12,793 | ) | | | — | | Gain on sale of long-lived assets | | | — | | | | — | | | | (22,007 | ) | Other non-cash (income) charges | | | 2,447 | | | | 9,675 | | | | (2,681 | ) | Changes in assets and liabilities, net of business combinations | | | | | | | | | | | | | Accounts receivable | | | (84,598 | ) | | | (37,207 | ) | | | (60,841 | ) | Inventories | | | (4,560 | ) | | | 1,853 | | | | 4,555 | | Other assets | | | (7,434 | ) | | | (18,748 | ) | | | (3,711 | ) | Content rights, net of payables | | | (84,377 | ) | | | (108,155 | ) | | | (122,433 | ) | Accounts payable and accrued liabilities | | | 73,646 | | | | 47,913 | | | | 55,734 | | Representation rights | | | 93,233 | | | | (6,000 | ) | | | (479 | ) | Deferred launch incentives | | | (49,386 | ) | | | (35,731 | ) | | | (74,696 | ) | Long-term incentive plan liabilities | | | (841 | ) | | | (325,756 | ) | | | (240,752 | ) | | | | | | | | | | | | | | Cash provided by operations | | | 479,911 | | | | 68,893 | | | | 124,704 | | | | | | | | | | | | | | | INVESTING ACTIVITIES | | | | | | | | | | | | | Acquisition of property and equipment | | | (90,138 | ) | | | (99,684 | ) | | | (88,100 | ) | Business combinations, net of cash acquired | | | (194,905 | ) | | | (400 | ) | | | (17,218 | ) | Purchase of intangibles | | | — | | | | (583 | ) | | | — | | Investments in and advances to unconsolidated affiliates | | | — | | | | (363 | ) | | | (17,433 | ) | Redemption of interests in subsidiaries | | | (180,000 | ) | | | (92,874 | ) | | | (148,880 | ) | Proceeds from sale of investments | | | 1,467 | | | | 14,664 | | | | — | | Proceeds from sale of long-lived assets | | | — | | | | — | | | | 22,007 | | | | | | | | | | | | | | | Cash used by investing activities | | | (463,576 | ) | | | (179,240 | ) | | | (249,624 | ) | | | | | | | | | | | | | | FINANCING ACTIVITIES | | | | | | | | | | | | | Proceeds from issuance of long-term debt | | | 316,813 | | | | 1,785,955 | | | | 1,848,000 | | Principal payments of long-term debt | | | (307,030 | ) | | | (1,697,068 | ) | | | (1,699,215 | ) | Deferred financing fees | | | (1,144 | ) | | | (4,810 | ) | | | (8,499 | ) | Contributions from minority shareholders | | | — | | | | 603 | | | | 3,146 | | Other financing | | | (9,963 | ) | | | 32,153 | | | | (30,840 | ) | | | | | | | | | | | | | | Cash (used) provided by financing activities | | | (1,324 | ) | | | 116,833 | | | | 112,592 | | | | | | | | | | | | | | | Effect of exchange rate changes on cash | | | 2,761 | | | | 3,723 | | | | 2,535 | | CHANGE IN CASH AND CASH EQUIVALENTS | | | 17,772 | | | | 10,209 | | | | (9,793 | ) | Cash and cash equivalents, beginning of year | | | 34,491 | | | | 24,282 | | | | 34,075 | | CASH AND CASH EQUIVALENTS, END OF YEAR | | $ | 52,263 | | | | 34,491 | | | | 24,282 | | | | | | | | | | | | | | |
The accompanying notes are an integral part of these consolidated financial statements.
IV-6
DISCOVERY COMMUNICATIONS, INC.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Other Comprehensive Income (Loss) | | | | | | | | | | | | | Additional
| | | | | | Foreign
| | | Unrealized
| | | Unamortized
| | | | | | | Class A | | | Paid-In
| | | Accumulated
| | | Currency
| | | Gain (Loss) on
| | | Gain on
| | | | | | | At Par | | | Redeemable | | | Capital | | | Deficit | | | Translation | | | Investments | | | Derivatives | | | TOTAL | | | | in thousands | | | Balance, December 31, 2003 | | $ | 1 | | | | — | | | | 21,093 | | | | (840,953 | ) | | | 14,323 | | | | 3,771 | | | | — | | | | (801,765 | ) | Comprehensive income | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Net income | | | | | | | | | | | | | | | 168,022 | | | | | | | | | | | | | | | | | | Foreign currency translation, net of tax of $5.2 million | | | | | | | | | | | | | | | | | | | 8,409 | | | | | | | | | | | | | | Unrealized loss on investments, net of tax of $1.7 million | | | | | | | | | | | | | | | | | | | | | | | (2,592 | ) | | | | | | | | | Total comprehensive income | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 173,839 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Balance, December 31, 2004 | | $ | 1 | | | | — | | | | 21,093 | | | | (672,931 | ) | | | 22,732 | | | | 1,179 | | | | — | | | | (627,926 | ) | Comprehensive income | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Net income | | | | | | | | | | | | | | | 159,620 | | | | | | | | | | | | | | | | | | Foreign currency translation, net of tax of $9.6 million | | | | | | | | | | | | | | | | | | | (16,017 | ) | | | | | | | | | | | | | Unrealized loss on investments, net of tax of $0.1 million | | | | | | | | | | | | | | | | | | | | | | | (101 | ) | | | | | | | | | Unamortized gain on cash flow hedge, net of tax of $1.3 million | | | | | | | | | | | | | | | | | | | | | | | | | | | 2,066 | | | | | | Total comprehensive income | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 145,568 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Balance, December 31, 2005 | | $ | 1 | | | | — | | | | 21,093 | | | | (513,311 | ) | | | 6,715 | | | | 1,078 | | | | 2,066 | | | | (482,358 | ) | Comprehensive income | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Net income | | | | | | | | | | | | | | | 207,176 | | | | | | | | | | | | | | | | | | Foreign currency translation, net of tax of $8.8 million | | | | | | | | | | | | | | | | | | | 14,458 | | | | | | | | | | | | | | Unrealized loss on investments, net of tax of $0.2 million | | | | | | | | | | | | | | | | | | | | | | | (355 | ) | | | | | | | | | Amortization of gain on cash flow hedge, net of tax of $0.1 million | | | | | | | | | | | | | | | | | | | | | | | | | | | (209 | ) | | | | | Total comprehensive income | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 221,070 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Balance, December 31, 2006 | | $ | 1 | | | | — | | | | 21,093 | | | | (306,135 | ) | | | 21,173 | | | | 723 | | | | 1,857 | | | | (261,288 | ) | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
The accompanying notes are an integral part of these consolidated financial statements.
IV-7
DISCOVERY COMMUNICATIONS, INC.
1. Description of Business
Discovery Communications, Inc. (the “Company”) is a privately-held, globally-diversified entertainment company whose operations are organized into four business units: U.S. Networks, International Networks, Commerce and Education. U.S. Networks operates cable and satellite television networks in the United States, including Discovery Channel, TLC, Animal Planet, The Travel Channel and Discovery Health Channel. International Networks operates cable and satellite television networks worldwide, including regional variants of Discovery Channel, Animal Planet, People & Arts, Discovery Travel & Living, and Discovery Real Time. Commerce operates over 100 Discovery Channel retail stores and manages consumer ventures in the United States. Education provides products and services to educational institutions and consumers.
2. Summary of Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include the accounts of all majority-owned and controlled subsidiaries. In addition, the Company evaluates its relationships with other entities to identify whether they are variable interest entities as defined by Financial Accounting Standards Board (“FASB”) Interpretation No. (“FIN”) 46, “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51” as revised in December 2003 (“FIN 46R”) and to assess whether it is the primary beneficiary of such entities. Variable Interest Entities (“VIEs”) are generally entities that lack sufficient equity to finance their activities without additional financial support from other parties or whose equity holders possess rights not proportionate to their ownership. The equity method of accounting is used for affiliates over which the Company exercises significant influence but does not control.
All significant intercompany accounts and transactions have been eliminated in consolidation.
Use of Estimates
The preparation of financial statements in accordance with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting periods. Actual results may differ from those estimates and could have a material impact on the consolidated financial statements.
The Company has issued redeemable interests in a number of its consolidated subsidiaries for which redemption events are outside of the Company’s control. Estimating the redemption value of these interests requires complex contract interpretation and the use of fair value and future performance assumptions. Certain of our ventures with the British Broadcasting Company (“BBC”) are operated under interim or unfinalized agreements, which contribute to the complexity of associated estimates.
Other significant estimates include the amortization method and recoverability of content rights, the valuation and recoverability of intangible assets and other long-lived assets, the valuation of deferred tax assets, the fair value of derivative financial instruments, and the adequacy of reserves associated with accounts receivable and retail inventory.
Recent Accounting Pronouncements
In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109 (“FIN 48”), which clarifies the accounting for uncertainty in income tax positions. This Interpretation requires the Company to recognize in the consolidated financial statements, the impact of a tax position that is more likely than not to be sustained upon examination by the applicable taxing authority based on the technical merits of the position. The provisions of FIN 48 will be effective for the Company as of the beginning of the Company’s 2007 fiscal year, with the cumulative effect of the change in accounting principle recorded as an adjustment to opening retained earnings. The Company is currently evaluating the impact of adopting FIN 48 on the consolidated financial statements.
IV-8
DISCOVERY COMMUNICATIONS, INC.
Notes to Consolidated Financial Statements — (Continued)
Revenue Recognition
The Company derives revenue from four primary sources: (1) advertising revenue for commercial spots aired on the Company’s networks, (2) distribution revenue from cable system and satellite operators (distributors), (3) retail sales of consumer products, and (4) educational product and service sales.
Advertising revenue is recorded net of agency commissions and audience deficiency liabilities in the period advertising spots are broadcast. Distribution revenue is recognized over the service period, net of launch incentives and other vendor consideration. Retail revenues are recognized either at thepoint-of-sale or upon product shipment. Educational service and product sales are generally recognized ratably over the term of the agreement or as the product is delivered.
Advertising Costs
The Company expenses advertising costs as incurred. The Company incurred advertising costs of $207.7 million, $208.6 million and $170.3 million in 2006, 2005 and 2004.
Cash and Cash Equivalents
Highly liquid investments with original maturities of ninety days or less are recorded as cash equivalents. The Company had $7.1 million and $4.5 million in restricted cash included in other current assets as of December 31, 2006 and 2005. Book overdrafts representing outstanding checks in excess of funds on deposit are a component of accounts payable and total $30.9 million and $40.9 million in 2006 and 2005.
Derivative Financial Instruments
Statement of Financial Accounting Standards (“SFAS”) No. 133, “Accounting for Derivative Instruments and Hedging Activities,” requires every derivative instrument to be recorded on the balance sheet at fair value as either an asset or a liability. The statement also requires that changes in the fair value of derivatives be recognized currently in earnings unless specific hedge accounting criteria are met. From time to time, the Company uses financial instruments designated as a cash flow hedge of a forecasted transaction to hedge its exposures to interest rate risks. The effective changes in fair value of derivatives designated as cash flow hedges are recorded in accumulated other comprehensive income (loss). Amounts are reclassified from accumulated other comprehensive income (loss) as interest expense is recorded for debt. None of the Company’s financial instruments were designated as a hedge in 2006 and 2004 and most of the Company’s financial instruments were not designated as a hedge in 2005.
Inventories
Inventories are carried at the lower of cost or market and include inventory acquisition costs. Cost is determined using the weighted average cost method.
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. The Company evaluates the net realizable value of content by considering the fair value of the underlying produced and co-produced content and the net realizable values of the licensed content at least annually.
The costs of produced and co-produced content airing on the Company’s networks are capitalized and amortized based on the expected realization of revenues, resulting in an accelerated basis over four years for developed networks (Discovery Channel, TLC, Animal Planet, and The Travel Channel) in the United States, and a straight-line basis over three to five years for developing networks in the United States and all International networks. The cost of licensed content is capitalized and amortized over the term of the license period based on the expected realization of revenues, resulting in an accelerated basis for developed networks in the United States, and a straight-line basis for all International networks, developing networks in the United States and educational ventures. The costs of content for electronic, video and hardcopy educational supplements and tools for educational ventures are amortized straight-line over a three to seven year period.
IV-9
DISCOVERY COMMUNICATIONS, INC.
Notes to Consolidated Financial Statements — (Continued)
All produced and co-produced content is classified as long-term. The portion of the unamortized licensed content balance that will be amortized within one year is classified as a current asset.
Property and Equipment
Property and equipment are stated at cost less accumulated depreciation. Depreciation is recognized on a straight-line basis over the estimated useful lives of three to seven years for equipment, furniture and fixtures, five to forty years for building structure and construction, and six to thirteen years for satellite transponders. Leasehold improvements are amortized on a straight-line basis over the lesser of their estimated useful lives or the terms of the related leases, beginning on the date the asset is put into use. Equipment under capital lease represents the present value of the minimum lease payments at the inception of the lease, net of accumulated depreciation.
Capitalized Software Costs
All capitalized software costs are for internal use. Capitalization of costs occurs during the application development stage. Costs incurred during the pre and post implementation stages are expensed as incurred. Capitalized costs are amortized on a straight-line basis over their estimated useful lives of one to five years. Unamortized capitalized costs totaled $61.4 million and $59.1 million at December 31, 2006 and 2005. The Company capitalized software costs of $21.6 million, $23.2 million, and $28.6 million in 2006, 2005 and 2004. Amortization of capitalized software costs totaled $18.3 million, $19.3 million, and $18.4 million during 2006, 2005 and 2004. Write-offs of capitalized software totaled $1.0 million and $4.0 million in 2006 and 2004; there were no write-offs for capitalized software costs during 2005.
Recoverability of Long-Lived Assets, Goodwill, and Intangible Assets
The Company annually assesses the carrying value of its acquired intangible assets, including goodwill, and its other long-lived assets, including deferred launch incentives, to determine whether impairment may exist, unless indicators of impairment become evident requiring immediate assessment. Goodwill impairment is identified by comparing the fair value of the reporting unit to its carrying value. If the fair value of the reporting unit is less than its carrying value, an impairment loss is recorded to the extent that the implied fair value of the goodwill within the reporting unit is less than its carrying value. Intangible assets and other long-lived assets are grouped for purposes of evaluating recoverability at the lowest level for which independent cash flows are identifiable. If the carrying amount of an intangible asset, long-lived asset, or asset grouping exceeds its fair value, an impairment loss is recognized. Fair values for reporting units, goodwill and other intangible assets are determined based on discounted cash flows, market multiples, or comparable assets as appropriate.
The determination of recoverability of goodwill and other intangible and 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 reporting units, asset groupings, or different valuation methodologies had been used, the impairment test results could have differed.
Deferred Launch Incentives
Consideration issued to cable and satellite distributors in connection with the execution of long-term network distribution agreements is deferred and amortized on a straight-line basis as a reduction to revenue over the terms of the agreements. Obligations for fixed launch incentives are recorded at the inception of the agreement. Obligations for performance-based arrangements are recorded when performance thresholds have been achieved. Following the renewal of a distribution agreement, the remaining deferred consideration is amortized over the extended period. Amortization of deferred launch incentives and interest on unpaid deferred launch incentives was $79.1 million, $74.1 million and $98.4 million in 2006, 2005 and 2004.
Foreign Currency Translation
The Company’s foreign subsidiaries’ assets and liabilities are translated at exchange rates in effect at the balance sheet date, while results of operations are translated at average exchange rates for the respective periods. The resulting translation adjustments are included as a separate component of stockholders’ deficit in accumulated other comprehensive income (loss).
IV-10
DISCOVERY COMMUNICATIONS, INC.
Notes to Consolidated Financial Statements — (Continued)
Long-term Incentive Plans
Prior to October 2005, the Company maintained two unit-based, cash settled, long-term incentive plans. Under these plans, unit awards, which vest over a period of years, were granted to eligible employees and increased or decreased in value based on a specified formula of Company business metrics. The Company accounted for these units similar to stock appreciation rights and applied the guidance in FASB Interpretation Number 28, “Accounting for Stock Issued to Employees,” (“FIN 28”). Accordingly, the Company adjusted compensation expense for changes in the accrued value of these awards over the period outstanding.
During August 2005, the Company discontinued one of its long-term incentive plans and settled all amounts with cash payments. In October 2005, the Company established a new long-term incentive plan for certain eligible employees. Substantially all participants in the remaining plan redeemed their vested units for cash payment and received units in the new plan.
Under the new plan, eligible employees receive cash settled unit awards indexed to the price of Class A Discovery Holding Company (“DHC”) stock. As the units are indexed to the equity of another entity, the Company treats the units similar to a derivative, by determining their fair value each reporting period. The Company attributes compensation expense for the new awards on a straight-line basis; the Company attributes compensation expense for the initial grant of partially vested units by continuing to apply the FIN 28 model that was utilized over the awards’ original vesting periods. Once units are fully vested, the Company recognizes allmark-to-mark adjustments to fair value in each period as compensation expense. In March 2005, the Securities and Exchange Commission (the “SEC”) issued Staff Accounting Bulletin No. 107 (“SAB 107”) regarding the classification of compensation expense associated with share-based payment awards. The Company has applied the provisions of SAB 107 and has recorded long term incentive compensation expense as a component of selling, general and administrative expenses. Prior year amounts have been reclassified to conform to current year presentation.
The Company classifies as a current liability 75% of the intrinsic value of the units that are vested or will become vested within one year. This amount corresponds to the value potentially payable should all participants separate from the Company. Upon voluntary termination of employment, the Company distributes 75% of unit benefits. The remainder is paid at the one-year anniversary of termination date.
Mandatorily Redeemable Interests in Subsidiaries
Mandatorily redeemable interests in subsidiaries are initially recorded at fair value. For those instruments with an estimated redemption value, the Company accretes or decretes to the estimated redemption value ratably over the period to the redemption date. Accretion and decretion are recorded as a component of minority interest expense. For instruments with a specified rate of return, the Company changed the manner in which it accounts for uncertain tax positions effective January 1, 2007.
McLean, Virginia February 14, 2008 IV-3
Report of Independent Registered Public Accounting Firm To the Board of Directors and Members of Discovery Communications Holding, LLC: In our opinion, the accompanying consolidated balance sheet and related consolidated statements of operations, of changes in members’ equity, and of cash flows, present fairly, in all material respects, the financial position of Discovery Communications Holding, LLC and its subsidiaries at December 31, 2007 and the results of their operations and their cash flows for the period from May 15, 2007 through December 31, 2007 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit of these statements 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. McLean, Virginia February 14, 2008 IV-4
DISCOVERY COMMUNICATIONS HOLDING, LLC
| | | | | | | | | | | | Successor
| | | | Predecessor
| | | | Company | | | | Company | | | | December 31, 2007 | | | | December 31, 2006 | | | | in thousands, except share data | | ASSETS | Current assets | | | | | | | | | | Cash and cash equivalents | | $ | 44,951 | | | | $ | 52,263 | | Accounts receivable, less allowances of $22,419 and $25,175 | | | 741,745 | | | | | 657,552 | | Inventories | | | 10,293 | | | | | 35,716 | | Deferred income taxes | | | 103,723 | | | | | 76,156 | | Content rights, net | | | 79,162 | | | | | 64,395 | | Other current assets | | | 97,359 | | | | | 84,554 | | | | | | | | | | | | Total current assets | | | 1,077,233 | | | | | 970,636 | | | | | | | | | | | | Property and equipment, net | | | 397,430 | | | | | 424,041 | | Content rights, net, less current portion | | | 1,048,193 | | | | | 1,253,553 | | Deferred launch incentives | | | 242,655 | | | | | 207,032 | | Goodwill | | | 4,870,187 | | | | | 365,266 | | Intangibles, net | | | 181,656 | | | | | 107,673 | | Investments in and advances to unconsolidated affiliates | | | 100,724 | | | | | 15,564 | | Other assets | | | 42,352 | | | | | 32,788 | | | | | | | | | | | | TOTAL ASSETS | | $ | 7,960,430 | | | | $ | 3,376,553 | | | | | | | | | | | | | LIABILITIES AND MEMBERS’ EQUITY/STOCKHOLDERS’ DEFICIT | Current liabilities | | | | | | | | | | Accounts payable and accrued liabilities | | $ | 267,818 | | | | $ | 316,804 | | Accrued payroll and employee benefits | | | 183,823 | | | | | 122,431 | | Launch incentives payable | | | 1,544 | | | | | 17,978 | | Content rights payable | | | 56,334 | | | | | 57,694 | | Current portion of long-term incentive plan liabilities | | | 141,562 | | | | | 43,274 | | Current portion of long-term debt | | | 32,006 | | | | | 7,546 | | Income taxes payable | | | 23,629 | | | | | 55,264 | | Unearned revenue | | | 78,155 | | | | | 68,339 | | Other current liabilities | | | 65,624 | | | | | 45,194 | | | | | | | | | | | | Total current liabilities | | | 850,495 | | | | | 734,524 | | | | | | | | | | | | Long-term debt, less current portion | | | 4,109,085 | | | | | 2,633,237 | | Derivative financial instruments, less current portion | | | 49,110 | | | | | 8,282 | | Launch incentives payable, less current portion | | | 6,114 | | | | | 10,791 | | Long-term incentive plan liabilities, less current portion | | | — | | | | | 41,186 | | Content rights payable, less current portion | | | 2,459 | | | | | 3,846 | | Deferred income taxes | | | 10,619 | | | | | 46,289 | | Other liabilities | | | 175,565 | | | | | 64,861 | | | | | | | | | | | | Total liabilities | | | 5,203,447 | | | | | 3,543,016 | | | | | | | | | | | | Mandatorily redeemable interests in subsidiaries | | | 48,721 | | | | | 94,825 | | | | | | | | | | | | Commitments and contingencies | | | | | | | | | | Members’ Equity/Stockholders’ deficit | | | | | | | | | | Class A common stock; $.01 par value; zero shares authorized, issued or outstanding at December 31, 2007; 100,000 shares authorized, 51,119 shares issued, less 719 shares of treasury stock at December 31, 2006 | | | — | | | | | 1 | | Class B common stock; $.01 par value; zero shares authorized, issued or outstanding at December 31, 2007; 60,000 shares authorized, 50,615 shares issued and held in treasury stock at December 31, 2006 | | | — | | | | | — | | Additional paid-in capital | | | — | | | | | 21,093 | | Members’ equity (51,119 member units issued, less 13,319 repurchased and retired) | | | 2,533,694 | | | | | — | | Retained earnings (deficit) | | | 184,712 | | | | | (306,135 | ) | Accumulated other comprehensive (loss) income | | | (10,144 | ) | | | | 23,753 | | | | | | | | | | | | Total members’ equity/stockholders’ deficit | | | 2,708,262 | | | | | (261,288 | ) | | | | | | | | | | | TOTAL LIABILITIES AND MEMBERS’ EQUITY/STOCKHOLDERS’ DEFICIT | | $ | 7,960,430 | | | | $ | 3,376,553 | | | | | | | | | | | |
The accompanying notes are an integral part of these consolidated financial statements. IV-5
DISCOVERY COMMUNICATIONS HOLDING, LLC
| | | | | | | | | | | | | | | | | | | | Successor
| | | | | | | | Company | | | | Predecessor Company | | | | May 15, 2007
| | | | January 1, 2007
| | | Year Ended
| | | Year Ended
| | | | through
| | | | through
| | | December 31,
| | | December 31,
| | | | December 31, 2007 | | | | May 14, 2007 | | | 2006 | | | 2005 | | | | in thousands | | OPERATING REVENUE | | | | | | | | | | | | | | | | | | Advertising | | $ | 874,894 | | | | $ | 470,139 | | | $ | 1,243,500 | | | $ | 1,187,823 | | Distribution | | | 930,386 | | | | | 547,093 | | | | 1,434,901 | | | | 1,198,686 | | Other | | | 222,626 | | | | | 82,195 | | | | 205,270 | | | | 157,849 | | | | | | | | | | | | | | | | | | | | Total operating revenue | | | 2,027,906 | | | | | 1,099,427 | | | | 2,883,671 | | | | 2,544,358 | | | | | | | | | | | | | | | | | | | | OPERATING EXPENSES | | | | | | | | | | | | | | | | | | Cost of revenue, exclusive of depreciation and amortization shown below | | | 799,716 | | | | | 373,191 | | | | 1,032,789 | | | | 907,664 | | Selling, general and administrative | | | 823,918 | | | | | 486,129 | | | | 1,143,349 | | | | 978,415 | | Depreciation and amortization | | | 82,807 | | | | | 73,943 | | | | 122,037 | | | | 112,653 | | Gain from disposition of business | | | (134,671 | ) | | | | — | | | | — | | | | — | | | | | | | | | | | | | | | | | | | | Total operating expenses | | | 1,571,770 | | | | | 933,263 | | | | 2,298,175 | | | | 1,998,732 | | | | | | | | | | | | | | | | | | | | INCOME FROM OPERATIONS | | | 456,136 | | | | | 166,164 | | | | 585,496 | | | | 545,626 | | | | | | | | | | | | | | | | | | | | OTHER INCOME (EXPENSE) | | | | | | | | | | | | | | | | | | Interest, net | | | (180,157 | ) | | | | (68,600 | ) | | | (194,255 | ) | | | (184,585 | ) | Realized and unrealized (losses) gains from non-hedged derivative instruments, net | | | (10,986 | ) | | | | 2,350 | | | | 22,558 | | | | 22,499 | | Minority interests in consolidated subsidiaries | | | (7,133 | ) | | | | (1,133 | ) | | | (2,451 | ) | | | (43,696 | ) | Equity in earnings of unconsolidated affiliates | | | 5,093 | | | | | 3,529 | | | | 7,060 | | | | 4,660 | | Other, net | | | (448 | ) | | | | (335 | ) | | | 1,467 | | | | 9,111 | | | | | | | | | | | | | | | | | | | | Total other expense, net | | | (193,631 | ) | | | | (64,189 | ) | | | (165,621 | ) | | | (192,011 | ) | | | | | | | | | | | | | | | | | | | INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES | | | 262,505 | | | | | 101,975 | | | | 419,875 | | | | 353,615 | | | | | | | | | | | | | | | | | | | | Income tax expense | | | 25,303 | | | | | 52,163 | | | | 190,381 | | | | 173,427 | | | | | | | | | | | | | | | | | | | | INCOME FROM CONTINUING OPERATIONS | | | 237,202 | | | | | 49,812 | | | | 229,494 | | | | 180,188 | | | | | | | | | | | | | | | | | | | | DISCONTINUED OPERATIONS | | | | | | | | | | | | | | | | | | Loss from discontinued operations, net of income tax benefit | | | (52,490 | ) | | | | (12,533 | ) | | | (22,318 | ) | | | (20,568 | ) | | | | | | | | | | | | | | | | | | | LOSS FROM DISCONTINUED OPERATIONS | | | (52,490 | ) | | | | (12,533 | ) | | | (22,318 | ) | | | (20,568 | ) | | | | | | | | | | | | | | | | | | | NET INCOME | | $ | 184,712 | | | | $ | 37,279 | | | $ | 207,176 | | | $ | 159,620 | | | | | | | | | | | | | | | | | | | |
The accompanying notes are an integral part of these consolidated financial statements. IV-6
DISCOVERY COMMUNICATIONS HOLDING, LLC
| | | | | | | | | | | | | | | | | | | | Successor
| | | | | | | | Company | | | | Predecessor Company | | | | May 15, 2007
| | | | January 1, 2007
| | | Year Ended
| | | Year Ended
| | | | through
| | | | through
| | | December 31,
| | | December 31,
| | | | December 31, 2007 | | | | May 14, 2007 | | | 2006 | | | 2005 | | | | in thousands | | OPERATING ACTIVITIES | | | | | | | | | | | | | | | | | | Net income | | $ | 184,712 | | | | $ | 37,279 | | | $ | 207,176 | | | $ | 159,620 | | Adjustments to reconcile net income to cash provided by (used in) operations: | | | | | | | | | | | | | | | | | | Depreciation and amortization | | | 111,208 | | | | | 77,186 | | | | 133,634 | | | | 123,209 | | Amortization of deferred launch incentives and representation rights | | | 58,425 | | | | | 37,158 | | | | 77,778 | | | | 83,411 | | Provision (reversal) for losses on accounts receivable | | | (2 | ) | | | | 1,855 | | | | 3,691 | | | | 12,217 | | Expenses arising from long-term incentive plans | | | 78,527 | | | | | 62,850 | | | | 39,233 | | | | 49,465 | | Equity in earnings of unconsolidated affiliates | | | (5,093 | ) | | | | (3,529 | ) | | | (7,060 | ) | | | (4,660 | ) | Deferred income taxes | | | (70,978 | ) | | | | 10,511 | | | | 108,903 | | | | 109,383 | | Realized and unrealized gains on derivative financial instruments, net | | | 10,986 | | | | | (2,350 | ) | | | (22,558 | ) | | | (22,499 | ) | Gain from disposition of business | | | (134,671 | ) | | | | — | | | | — | | | | — | | Non-cash minority interest charges | | | 7,133 | | | | | 1,133 | | | | 2,451 | | | | 43,696 | | Gain on sale of investments | | | — | | | | | — | | | | (1,467 | ) | | | (12,793 | ) | Other non-cash (income) charges | | | 1,733 | | | | | (4,263 | ) | | | 2,447 | | | | 9,675 | | Changes in assets and liabilities, net of business combinations and dispositions: | | | | | | | | | | | | | | | | | | Accounts receivable | | | (45,808 | ) | | | | (29,507 | ) | | | (84,598 | ) | | | (37,207 | ) | Inventories | | | 21,666 | | | | | 4,805 | | | | (4,560 | ) | | | 1,853 | | Other assets | | | 27,682 | | | | | (23,872 | ) | | | (7,434 | ) | | | (18,748 | ) | Content rights, net of payables | | | 110,811 | | | | | (2,689 | ) | | | (84,377 | ) | | | (108,155 | ) | Accounts payable and accrued liabilities | | | 119,769 | | | | | (93,260 | ) | | | 73,646 | | | | 47,913 | | Representation rights | | | — | | | | | — | | | | 93,233 | | | | (6,000 | ) | Deferred launch incentives | | | (25,623 | ) | | | | (197,624 | ) | | | (49,386 | ) | | | (35,731 | ) | Long-term incentive plan liabilities | | | (76,315 | ) | | | | (7,773 | ) | | | (841 | ) | | | (325,756 | ) | | | | | | | | | | | | | | | | | | | Cash provided by (used in) operations | | | 374,162 | | | | | (132,090 | ) | | | 479,911 | | | | 68,893 | | | | | | | | | | | | | | | | | | | | INVESTING ACTIVITIES | | | | | | | | | | | | | | | | | | Acquisition of property and equipment | | | (55,965 | ) | | | | (24,588 | ) | | | (90,138 | ) | | | (99,684 | ) | Business combinations, net of cash acquired | | | (306,094 | ) | | | | — | | | | (194,905 | ) | | | (400 | ) | Purchase of intangibles | | | — | | | | | — | | | | — | | | | (583 | ) | Investments in and advances to unconsolidated affiliates | | | — | | | | | — | | | | — | | | | (363 | ) | Redemption of interests in subsidiaries | | | — | | | | | (44,000 | ) | | | (180,000 | ) | | | (92,874 | ) | Proceeds from sale of investments | | | — | | | | | — | | | | 1,467 | | | | 14,664 | | | | | | | | | | | | | | | | | | | | Cash used in investing activities | | | (362,059 | ) | | | | (68,588 | ) | | | (463,576 | ) | | | (179,240 | ) | | | | | | | | | | | | | | | | | | | FINANCING ACTIVITIES | | | | | | | | | | | | | | | | | | Proceeds from issuance of long-term debt | | | 1,286,362 | | | | | 211,277 | | | | 316,813 | | | | 1,785,955 | | Principal payments of long-term debt | | | (11,742 | ) | | | | (2,356 | ) | | | (307,030 | ) | | | (1,697,068 | ) | Deferred financing fees | | | (4,690 | ) | | | | (16 | ) | | | (1,144 | ) | | | (4,810 | ) | Repurchase of member’s interest | | | (1,284,544 | ) | | | | — | | | | — | | | | — | | Contributions from minority shareholders | | | — | | | | | — | | | | — | | | | 603 | | Other financing | | | (17,590 | ) | | | | (2,473 | ) | | | (9,963 | ) | | | 32,153 | | | | | | | | | | | | | | | | | | | | Cash (used in) provided by financing activities | | | (32,204 | ) | | | | 206,432 | | | | (1,324 | ) | | | 116,833 | | | | | | | | | | | | | | | | | | | | Effect of exchange rate changes on cash and cash equivalents | | | 2,658 | | | | | 4,377 | | | | 2,761 | | | | 3,723 | | CHANGE IN CASH AND CASH EQUIVALENTS | | | (17,443 | ) | | | | 10,131 | | | | 17,772 | | | | 10,209 | | Cash and cash equivalents, beginning of period | | | 62,394 | | | | | 52,263 | | | | 34,491 | | | | 24,282 | | CASH AND CASH EQUIVALENTS, END OF PERIOD | | $ | 44,951 | | | | $ | 62,394 | | | $ | 52,263 | | | $ | 34,491 | | | | | | | | | | | | | | | | | | | |
The accompanying notes are an integral part of these consolidated financial statements. IV-7
DISCOVERY COMMUNICATIONS HOLDING, LLC
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Accumulated Other
| | | | | | | | | | | | | | | | | | | Comprehensive Income (Loss) | | | | | | | | | | | | | | | | | | | | | | | | | Unrealized
| | | | | | | | | | | | | Additional
| | | | | | | | | | | | Gain
| | | | | | | | | | | | | Paid-in
| | | | | | | | | Unrealized
| | | (Loss)
| | | | | | | Class A
| | | Capital/
| | | Retained
| | | Foreign
| | | Gain
| | | from
| | | | | | | Common Stock | | | Members’
| | | Earnings
| | | Currency
| | | (Loss) on
| | | Hedging
| | | | | | | At Par | | | Redeemable | | | Equity | | | (Deficit) | | | Translation | | | Investment | | | Activities | | | TOTAL | | | | in thousands | | | Predecessor Company: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Balance, December 31, 2004 | | $ | 1 | | | $ | — | | | $ | 21,093 | | | $ | (672,931 | ) | | $ | 22,732 | | | $ | 1,179 | | | $ | — | | | $ | (627,926 | ) | Comprehensive income | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Net income | | | | | | | | | | | | | | | 159,620 | | | | | | | | | | | | | | | | | | Foreign currency translation, net of tax of $9.6 million | | | | | | | | | | | | | | | | | | | (16,017 | ) | | | | | | | | | | | | | Unrealized loss on investments, net of tax of $0.1 million | | | | | | | | | | | | | | | | | | | | | | | (101 | ) | | | | | | | | | Unamortized gain on cash flow hedge, net of tax of $1.3 million | | | | | | | | | | | | | | | | | | | | | | | | | | | 2,066 | | | | | | Total comprehensive income | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 145,568 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Balance, December 31, 2005 | | $ | 1 | | | $ | — | | | $ | 21,093 | | | $ | (513,311 | ) | | $ | 6,715 | | | $ | 1,078 | | | $ | 2,066 | | | $ | (482,358 | ) | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Comprehensive income | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Net income | | | | | | | | | | | | | | $ | 207,176 | | | | | | | | | | | | | | | | | | Foreign currency translation, net of tax of $8.8 million | | | | | | | | | | | | | | | | | | $ | 14,458 | | | | | | | | | | | | | | Unrealized loss on investments, net of tax of $0.2 million | | | | | | | | | | | | | | | | | | | | | | $ | (355 | ) | | | | | | | | | Amortization of gain on cash flow hedge, net of tax of $0.1 million | | | | | | | | | | | | | | | | | | | | | | | | | | $ | (209 | ) | | | | | Total comprehensive income | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | $ | 221,070 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Balance, December 31, 2006 | | $ | 1 | | | $ | — | | | $ | 21,093 | | | $ | (306,135 | ) | | $ | 21,173 | | | $ | 723 | | | $ | 1,857 | | | $ | (261,288 | ) | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Comprehensive income | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Net income for the period January 1, 2007 through May 14, 2007 | | | | | | | | | | | | | | | 37,279 | | | | | | | | | | | | | | | | | | Foreign currency translation, net of tax of $4.7 million | | | | | | | | | | | | | | | | | | | 7,691 | | | | | | | | | | | | | | Unrealized gain on investments, net of tax of $0.9 million | | | | | | | | | | | | | | | | | | | | | | | 1,552 | | | | | | | | | | Amortization of gain on cash flow hedge | | | | | | | | | | | | | | | | | | | | | | | | | | | (77 | ) | | | | | Cumulative effect for the adoption of FIN 48 | | | | | | | | | | | | | | | (5,011 | ) | | | | | | | | | | | | | | | | | Total comprehensive income | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 41,434 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Balance, May 14, 2007 | | $ | 1 | | | $ | — | | | $ | 21,093 | | | $ | (273,867 | ) | | $ | 28,864 | | | $ | 2,275 | | | $ | 1,780 | | | $ | (219,854 | ) | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Successor Company: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Formation of Successor Company | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Pushdown of investor basis | | | | | | | | | | | 4,392,804 | | | | | | | | | | | | | | | | | | | | 4,392,804 | | Comprehensive income | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Net income for the period May 15, 2007 through December 31, 2007 | | | | | | | | | | | | | | | 184,712 | | | | | | | | | | | | | | | | | | Foreign currency translation, net of tax of $4.4 million | | | | | | | | | | | | | | | | | | | 7,354 | | | | | | | | | | | | | | Unrealized gain on investments, net of tax of $1.8 million | | | | | | | | | | | | | | | | | | | | | | | 3,011 | | | | | | | | | | Changes from hedging activities, net of tax of $12.2 million | | | | | | | | | | | | | | | | | | | | | | | | | | | (20,509 | ) | | | | | Total comprehensive income | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 174,568 | | Repurchase of members’ interest | | | | | | | | | | | (1,859,110 | ) | | | | | | | | | | | | | | | | | | | (1,859,110 | ) | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Balance, December 31, 2007 | | | | | | | | | | $ | 2,533,694 | | | $ | 184,712 | | | $ | 7,354 | | | $ | 3,011 | | | $ | (20,509 | ) | | $ | 2,708,262 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
The accompanying notes are an integral part of these consolidated financial statements. IV-8
DISCOVERY COMMUNICATIONS HOLDING, LLC 1. Basis of Presentation and Description of Business Basis of Presentation Discovery Communications Holding, LLC (“Discovery” or “the Company”) was formed through a conversion completed by Discovery Communications, Inc. (“DCI” or “the Predecessor Company”) on May 14, 2007. As part of the conversion, DCI became Discovery Communications, LLC (“DCL”), a wholly-owned subsidiary of Discovery, and the former shareholders of DCI, including Cox Communications Holdings, Inc. (“Cox”), Advance/Newhouse Programming Partnerships, and Discovery Holding Company (“DHC”) became members of Discovery. Subsequent to this conversion, each of the members of Discovery held the same ownership interests in Discovery as their previous capital stock ownership interest had been in DCI. The formation of Discovery required “pushdown” accounting and each shareholder’s basis has been pushed down to Discovery. The pushdown of the investors’ bases resulted in the recording of approximately $4.6 billion of additional goodwill, which had been previously recorded on the investors’ books. No other basis differentials existed on the investors’ books; therefore, no other assets or liabilities were adjusted. The application of push down accounting represents the termination of the predecessor reporting entity, DCI, and the creation of the successor reporting entity, Discovery. Accordingly, the results for the year ended December 31, 2007 are required to be presented as two distinct periods. The “Predecessor” period refers to the period from January 1 through May 14, 2007, while the “Successor” period refers to the period from May 15 through December 31, 2007. Accordingly, a vertical black line is shown to separate the Company financial statements from those of the Predecessor Company for periods ended prior to May 15, 2007. As the entire pushdown was associated withnon-amortizable goodwill, there was no adjustment to the income statement during the Successor period as a result of this transaction. Subsequent to the formation of Discovery, Cox exchanged its 25% ownership interest in Discovery for all of the capital stock of a subsidiary of Discovery that held the Travel Channel and travelchannel.com (collectively, the “Travel Business”) and approximately $1.3 billion in cash. Discovery retired the membership interest previously owned by Cox. The distribution of the Travel Business, which was valued at $575.0 million, resulted in a $134.7 million tax-free gain included in continuing operations. The gain was net of $280.8 million in reporting unit goodwill and $159.5 million in net assets. The net impact to goodwill as a result of the pushdown of investor basis and disposition of the Travel Business was $4.3 billion. Description of Business Discovery is a global media and entertainment company that provides original and purchased cable and satellite television programming across multiple platforms in the United States and over 170 other countries. Discovery also develops and sells proprietary merchandise, other products and educational product lines in the United States and internationally. Discovery operates through three divisions: (1) U.S. networks, (2) international networks, and (3) Discovery commerce and education. 2. Summary of Significant Accounting Policies Principles of Consolidation The consolidated financial statements include the accounts of all majority-owned and controlled subsidiaries. In addition, the Company evaluates its relationships with other entities to identify whether they are variable interest entities as defined by Financial Accounting Standards Board (“FASB”) Interpretation No. 46, “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51” as revised in December 2003 (“FIN 46R”) and to assess whether it is the primary beneficiary of such entities. Variable Interest Entities (“VIEs”)are generally entities that lack sufficient equity to finance their activities without additional financial support from other parties or whose equity holders possess rights not proportionate to their ownership. The equity method of accounting is used for affiliates over which the Company exercises significant influence but does not control. IV-9
DISCOVERY COMMUNICATIONS HOLDING, LLC
Notes to Consolidated Financial Statements — (Continued) All inter-company accounts and transactions have been eliminated in consolidation. Use of Estimates The preparation of financial statements in accordance with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting periods. Actual results may differ from those estimates and could have a material impact on the consolidated financial statements. Recent Accounting Pronouncements In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities — including an amendment of FASB Statement No. 115” (“FAS 159”). FAS 159 gives entities the irrevocable option to carry most financial assets and liabilities at fair value, with changes in fair value recognized in earnings. FAS 159 is effective for the Company as of the beginning of the Company’s 2008 fiscal year. The Company expects to adopt fair value accounting for its equity investment in HSWi (see Note 4). The impact could be material to the financial statements depending upon changes in fair value. The Company is currently assessing the potential effect of FAS 159 on its other assets and liabilities. In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (“FAS 157”). FAS 157 defines fair value and establishes a framework to make the measurement of fair value in generally accepted accounting principles more consistent and comparable. FAS 157 requires expanded disclosures about the extent to which fair value is used to measure assets and liabilities, the methods and assumptions used to measure fair value and the effect of fair value measures on earnings. FAS 157 will be effective for the Company’s 2008 fiscal year. The Company is currently assessing the potential effect of FAS 157 on its financial statements. In December 2007, the FASB issued Statement of Financial Accounting Standards No. 141 (revised 2007), “Business Combinations” (“FAS 141R”). FAS 141R replaces Statement of Financial Accounting Standards No. 141, “Business Combinations” (“FAS 141”), although it retains the fundamental requirement in FAS 141 that the acquisition method of accounting be used for all business combinations. FAS 141R establishes principles and requirements for how the acquirer in a business combination (a) recognizes and measures the assets acquired, liabilities assumed and any noncontrolling interest in the acquiree, (b) recognizes and measures the goodwill acquired in a business combination or a gain from a bargain purchase and (c) determines what information to disclose regarding the business combination. FAS 141R applies prospectively to business combinations for which the acquisition date is on or after the beginning of the Company’s 2009 fiscal year. In December 2007, the FASB issued Statement of Financial Accounting Standards No. 160, “Noncontrolling Interests in Consolidated Financial Statements” (“FAS 160”). FAS 160 establishes accounting and reporting standards for the noncontrolling interest in a subsidiary, commonly referred to as minority interest. Among other matters, FAS 160 requires (a) the noncontrolling interest be reported within equity in the balance sheet and (b) the amount of consolidated net income attributable to the parent and to the noncontrolling interest to be clearly presented in the statement of income. FAS 160 is effective for the Company’s 2009 fiscal year. FAS 160 is to be applied prospectively, except for the presentation and disclosure requirements, which shall be applied retrospectively for all periods presented. The Company is currently assessing the potential effect of FAS 160 on its financial statements. IV-10
DISCOVERY COMMUNICATIONS HOLDING, LLC
Notes to Consolidated Financial Statements — (Continued) Revenue Recognition The Company derives revenue from three primary sources: (1) advertising revenue for commercial spots aired on the Company’s networks and websites, (2) distribution revenue from cable system and satellite operators (distributors), and (3) Other, which is largelye-commerce and educational sales. Advertising revenue is recorded net of agency commissions and audience deficiency liabilities in the period advertising spots are broadcast. Distribution revenue is recognized over the service period, net of launch incentives and other vendor consideration.E-commerce and educational product revenues are recognized either at thepoint-of-sale or upon product shipment. Educational service sales are generally recognized ratably over the term of the agreement. Advertising Costs The Company expenses advertising costs as incurred. Advertising costs of $107.7 million, $71.6 million, $207.7 million and $208.6 million were incurred from May 15, 2007 through December 31, 2007, from January 1, 2007 through May 14, 2007, in 2006 and in 2005, respectively. Cash and Cash Equivalents Highly liquid investments with original maturities of ninety days or less are recorded as cash equivalents. Restricted cash of $7.6 million and $7.1 million is included in other current assets as of December 31, 2007 and 2006, respectively. Book overdrafts representing outstanding checks in excess of funds on deposit are a component of accounts payable and total $10.9 million and $30.9 million in 2007 and 2006, respectively. Derivative Financial Instruments Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“FAS 133”), requires every derivative instrument to be recorded on the balance sheet at fair value as either an asset or a liability. The statement also requires that changes in the fair value of derivatives be recognized currently in earnings unless specific hedge accounting criteria are met. The Company uses financial instruments designated as cash flow hedges. The effective changes in fair value of derivatives designated as cash flow hedges are recorded in accumulated other comprehensive income (loss). Amounts are reclassified from accumulated other comprehensive income (loss) as interest expense is recorded for debt. The Company uses the cumulative dollar offset method to assess effectiveness. To be highly effective, the ratio calculated by dividing the cumulative change in the value of the actual swap by the cumulative change in the hypothetical swap must be between 80% and 125%. The ineffective portion of a derivative’s change in fair value is immediately recognized in earnings. The Company uses derivatives instruments principally to manage the risk associated with the movements of foreign currency exchange rates and changes in interest rates that will affect the cash flows of its debt transactions. See Note 17 for additional information regarding derivative instruments held by the Company and risk management strategies. Inventories Inventories are carried at the lower of cost or market. Cost is determined using the weighted average cost method. 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. The Company evaluates the net realizable value of content by considering the fair value of the underlying produced and co-produced content and the net realizable values of the licensed content quarterly. IV-11
DISCOVERY COMMUNICATIONS HOLDING, LLC
Notes to Consolidated Financial Statements — (Continued) The costs of produced and co-produced content airing on the Company’s networks are capitalized and amortized based on the expected realization of revenues, resulting in an accelerated basis over four years for developed networks (Discovery Channel, TLC and Animal Planet) in the United States, and a straight-line basis over no longer than five years for developing networks (all other networks in the United States) and all networks in the International division. The cost of licensed content is capitalized and amortized over the term of the license period based on the expected realization of revenues, resulting in an accelerated basis for developed networks in the United States, and a straight-line basis for all International networks, developing networks in the United States and educational ventures. The costs of content for electronic, video and hardcopy educational supplements are amortized on a straight-line basis over a three to five year period. All produced and co-produced content is classified as long-term. The portion of the unamortized licensed content balance that will be amortized within one year is classified as a current asset. The Company’s co-production arrangements generally represent the sharing of production cost. The Company records its share of costs gross and records no amounts for the portion of costs borne by the other party as the Company does not share any associated economics of exploitation. Property and Equipment Property and equipment are stated at cost less accumulated depreciation. Depreciation is recognized on a straight-line basis over the estimated useful lives of three to seven years for equipment, furniture and fixtures, five to forty years for building structure and construction, and six to twelve years for satellite transponders. Leasehold improvements are amortized on a straight-line basis over the lesser of their estimated useful lives or the terms of the related leases, beginning on the date the asset is put into use. Equipment under capital lease represents the present value of the minimum lease payments at the inception of the lease, net of accumulated depreciation. Capitalized Software Costs All capitalized software costs are for internal use. Capitalization of costs occurs during the application development stage. Costs incurred during the pre and post implementation stages are expensed as incurred. Capitalized costs are amortized on a straight-line basis over their estimated useful lives of one to five years. Unamortized capitalized costs totaled $57.1 million and $61.4 million at December 31, 2007 and 2006 respectively. Software costs of $8.7 million, $7.2 million, $21.6 million and $23.2 million were capitalized from May 15, 2007 through December 31, 2007, from January 1, 2007 through May 14, 2007, in 2006 and in 2005, respectively. Amortization of capitalized software costs totaled $12.7 million, $7.3 million, $18.3 million, and $19.3 million from May 15, 2007 through December 31, 2007, from January 1, 2007 through May 14, 2007, in 2006 and in 2005, respectively. There were no write-offs for capitalized software costs during 2007, 2006 and 2005. Recoverability of Long-Lived Assets, Goodwill, and Intangible Assets The Company annually assesses the carrying value of its acquired intangible assets, including goodwill, and its other long-lived assets, including deferred launch incentives, to determine whether impairment may exist, unless indicators of impairment become evident requiring immediate assessment. Goodwill impairment is identified by comparing the fair value of the reporting unit to its carrying value. If the fair value of the reporting unit is less than its carrying value, an impairment loss is recorded to the extent that the implied fair value of the goodwill within the reporting unit is less than its carrying value. Intangible assets and other long-lived assets are grouped for purposes of evaluating recoverability at the lowest level for which independent cash flows are identifiable. If the carrying amount of an intangible asset, long-lived asset, or asset grouping exceeds its fair value, an impairment loss is recognized. Fair values for reporting units, goodwill and other asset groups are determined based on discounted cash flows, market multiples, or comparable assets as appropriate. During the Predecessor period, DCI recorded an asset impairment of $26.2 million for education assets related to its consumer business, which is included as a component of depreciation and amortization. During the Successor period, the Company recorded a $28.3 million IV-12
DISCOVERY COMMUNICATIONS HOLDING, LLC
Notes to Consolidated Financial Statements — (Continued) write-off of leasehold improvements related to store closures which is included in loss from discontinued operations. The determination of recoverability of goodwill and other intangibles and 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 reporting units, asset groupings, or different valuation methodologies had been used, the impairment test results could have differed. Deferred Launch Incentives Consideration issued to cable and satellite distributors in connection with the execution of long-term network distribution agreements is deferred and amortized on a straight-line basis as a reduction to revenue over the terms of the agreements. Obligations for fixed launch incentives are recorded at the inception of the agreement. Following the renewal of a distribution agreement, the remaining deferred consideration is amortized over the extended period. Amortization of deferred launch incentives and interest on unpaid deferred launch incentives was $61.4 million, $39.0 million, $79.1 million and $74.1 million from May 15, 2007 through December 31, 2007, from January 1, 2007 through May 14, 2007, in 2006 and in 2005, respectively. During 2007, in connection with the settlement of terms under a pre-existing distribution agreement, Discovery completed negotiations for the renewal of long-term distribution agreements for certain of its U.K. networks and paid a distributor $195.8 million, most of which is being amortized over a 5 year period. Foreign Currency Translation The Company’s foreign subsidiaries’ assets and liabilities are translated at exchange rates in effect at the balance sheet date, while results of operations are translated at average exchange rates for the respective periods. The resulting translation adjustments are included as a separate component of members’ equity/stockholders’ deficit in accumulated other comprehensive income (loss). Intercompany accounts of a trading nature are revalued at exchange rates in effect at each month end and are included as part of operating income in the consolidated Statements of Operations. Long-term Incentive Plans Prior to August 2005, DCI maintained two unit-based, cash settled, long-term incentive plans. Under these plans, unit awards, which vest over a period of years, were granted to eligible employees and increased or decreased in value based on a specified formula of DCI’s business metrics. DCI accounted for these units similar to stock appreciation rights and applied the guidance in FASB Interpretation Number 28, “Accounting for Stock Issued to Employees” (“FIN 28”). Accordingly, DCI adjusted compensation expense for changes in the accrued value of these awards over the period outstanding. In August 2005, DCI discontinued one of its long-term incentive plans and settled all amounts with cash payments. In October 2005, DCI established a new long-term incentive plan for certain eligible employees. Substantially all participants in the remaining plan redeemed their vested units for cash payment and received units in the new plan. Under the new plan, eligible employees receive cash settled unit awards indexed to the price of Class A DHC stock. As the units are indexed to the equity of another entity, the Company treats the units similar to a derivative, by determining their fair value each reporting period. The Company attributes compensation expense for the new awards on a straight-line basis; the Company attributes compensation expense for the initial grant of partially vested units by continuing to apply the FIN 28 model that was utilized over the awards’ original vesting periods. Once units are fully vested, the Company recognizes allmark-to-market adjustments to fair value in each period as compensation expense. In March 2005, the Securities and Exchange Commission (the “SEC”) issued Staff IV-13
DISCOVERY COMMUNICATIONS HOLDING, LLC
Notes to Consolidated Financial Statements — (Continued) Accounting Bulletin No. 107 (“SAB 107”) regarding the classification of compensation expense associated with share-based payment awards. By applying the provisions of SAB 107, all long term incentive compensation expense is recorded as a component of selling, general and administrative expenses. The Company classifies as a current liability the lesser of 100% of the intrinsic value of the units that are vested or will become vested within one year or the Black-Scholes value of units that have been attributed. Upon voluntary termination of employment, the Company distributes 100% of unit benefits if employees agree to certain provisions. Prior to a plan amendment in August 2007, the Company classified as a current liability 75% of the intrinsic value of vested units or units vesting within one year, as this amount corresponded to the value potentially payable should all participants separate from the Company. Upon voluntary termination of employment, the Company distributed 75% of unit benefits. The remainder was paid at the one-year anniversary of termination date. The August 2007 plan amendment eliminated the deferral of the final 25%. As such, employees are paid 100% of their vested amount upon separation from the Company. Mandatorily Redeemable Interest in Subsidiaries For those instruments with an estimated redemption value, mandatorily redeemable interest in subsidiaries is accreted or decreted to an estimated redemption value ratably over the period to the redemption date. Accretion and decretion are recorded as a component of minority interest expense. For instruments with a specified rate of return, DCI records interest expense as incurred. Cash receipts and payments for the sale or purchase of mandatorily redeemable interests in subsidiaries are included as a component of investing cash flows. Minority Interest In addition to the accretion and decretion on redeemable minority interests, the Company records minority interest expense for the portion of the earnings of consolidated entities which are applicable to the minority interest partners. Treasury Stock Treasury stock is accounted for using the cost method.method by DCI, the Predecessor. The repurchased shares are held in treasury and are presented as if retired. There was no treasury stock activity from January 1, 2007 through May 14, 2007 or for the three yearsyear ended December 31, 2006. Discovery, the Successor, purchased and retired the membership equity of Cox. (See Note 1 Basis of Presentation and Description of Business.) Discontinued Operations In determining whether a group of assets disposed of should be presented as a discontinued operation, the Company makes a determination as to whether the group of assets being disposed of comprises a component of the entity, which requires cash flows that can be clearly distinguished from the rest of the entity. The Company also determines whether the cash flows associated with the group of assets have been or will be significantly eliminated from the ongoing operations of the Company as a result of the disposal transaction and whether the Company has no significant continuing involvement in the operations of the group of assets after the disposal transaction. If these determinations can be made affirmatively, the results of operations of the group of assets being disposed of (as well as any gain or loss on the disposal transaction) are aggregated for separate presentation apart from continuing operating results of the Company in the consolidated financial statements. The Company has elected not to segregate the cash flows from discontinued operations in its presentation of the Statements of Cash Flows. 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 IV-14
DISCOVERY COMMUNICATIONS HOLDING, LLC
Notes to Consolidated Financial Statements — (Continued) 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. Effective January 1, 2007, DCI adopted FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements, and prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. In instances where the Company has taken or expects to take a tax position in its tax return and the Company believes it is more likely than not that such tax position will be upheld by the relevant taxing authority upon settlement, the Company may record the benefits of such tax position in its consolidated financial statements. The tax benefit to be recognized is measured as the largest amount of benefit that is greater than fifty percent likely of being realized upon ultimate settlement. Upon adoption of FIN 48, DCI recorded a $5.0 million net tax liability recorded directly to accumulated deficit. | | 3. | Supplemental Disclosures to Consolidated Statements of Cash Flows |
| | | | | | | | | | | | | | | | | | | | Successor | | | Predecessor | | | May 15
| | | January 1
| | | | | | | through
| | | through
| | | | | | | December 31,
| | | May 14,
| | | | | | | 2007 | | | 2007 | | 2006 | | 2005 | | | in thousands | Cash paid for acquisitions: | | | | | | | | | | | | | | | | | | Fair value of assets acquired | | $ | 419,154 | | | | $ | — | | | $ | 223,293 | | | $ | 400 | | Fair value of liabilities Assumed | | | (113,060 | ) | | | | — | | | | (28,388 | ) | | | — | | | | | | | | | | | | | | | | | | | | Cash paid for acquisitions, net of cash acquired | | $ | 306,094 | | | | $ | — | | | $ | 194,905 | | | $ | 400 | | | | | | | | | | | | | | | | | | | | Cash paid for interest | | $ | 179,669 | | | | $ | 77,849 | | | $ | 196,195 | | | $ | 171,151 | | Cash paid for income taxes | | $ | 58,323 | | | | $ | 16,554 | | | $ | 70,215 | | | $ | 27,678 | |
On December 17, 2007, Discovery completed its acquisition of HowStuffWorks.com (“HSW”), an on-line source of explanations of how the world actually works. This acquisition provides an additional platform for Discovery’s library of video content and positions its brands as a hub for satisfying curiosity on both television and on-line. The results of operations have been included in the consolidated financial statements since December 17, 2007. The aggregate purchase price was $264.9 million, including $14.9 million of transaction costs. The Company also assumed net working capital of $1.1 million, content of $9.0 million, and deferred tax liabilities of $44.6 million. As of December 31, 2007, $4.6 million of the purchase price has not yet been paid. Of the $269.6 million of acquired intangibles, $95.8 million was ascribed to intangibles subject to amortization with useful lives between two and five years and the balance of $173.8 million to non-tax deductible goodwill. Acquired intangibles include trademarks, customer lists, and other items with weighted average useful lives of 4 years. The Company funded the purchase through additional borrowings under its credit facilities. HSW’s content is highly ranked by the world’s leading search engines and provides a natural link to the Company’s video library. The purchase provides the Company with an expanded platform for content, additional ad sales outlet, and brand enhancement. As part of the transaction, Discovery acquired approximately 49.5% of HSW International, Inc. (“HSWi”) outstanding shares, resulting in an investment balance of $79.4 million. Discovery has gained voting rights which are capped at 45% of the outstanding votes, three non-controlling board seats and certain other governance rights. As a result of its noncontrolling interest, the Company has recorded its investment in HSWi under the equity method. Discovery will hold approximately 77% of these shares over a period of at least12-24 months. Per terms of
IV-11IV-15
DISCOVERY COMMUNICATIONS INC.HOLDING, LLC
Notes to Consolidated Financial Statements — (Continued) 3. Supplemental Disclosures
the agreement, the Company may distribute the HSWi stock or sell and distribute substantially all of the proceeds to Consolidated Statementsformer HSW shareholders. The Company initially recorded a liability of Cash Flows | | | | | | | | | | | | | | | Year Ended December 31, | | | | 2006 | | | 2005 | | | 2004 | | | | in thousands | | | Cash paid for acquisitions: | | | | | | | | | | | | | Fair value of assets acquired | | $ | 223,293 | | | | 400 | | | | 21,414 | | Fair value of liabilities assumed | | | (28,388 | ) | | | — | | | | (4,196 | ) | Cash paid for acquisitions, net of cash acquired | | | 194,905 | | | | 400 | | | | 17,218 | | Cash paid for interest | | $ | 196,195 | | | | 171,151 | | | | 166,584 | | Cash paid for income taxes | | $ | 70,215 | | | | 27,678 | | | | 28,999 | |
$53.7 million at closing, which represents its estimated obligation to the HSW shareholders. The Company has estimated the fair value of its investment and associated liability with information from an investment bank. The Company will adjust the liability each period to fair value through adjustments to earnings. The valuation considers forecasted operating results and market valuation factors. The estimated liability at December 31, 2007 is unchanged from December 17, 2007. HSWi has a perpetual royalty free license to exploit HSW content in certain foreign markets. 4. Business CombinationsOn July 31, 2007, the Company acquired Treehugger.com, an eco-lifestyle website for $10.0 million. As of December 31, 2007, $1.8 million of this purchase price has not yet been paid. The results of operations have been included in the consolidated financial statements since that date. The acquisition furthers the Company’s goal of developing original programming related to the environment, sustainable development, conservation and organic living. The Company also has certain contingent considerations in connection with this acquisition payable in the event specific business metrics are achieved totaling up to $6.0 million over 2 years, which could result in the recording of additional goodwill.
Subsequent to the formation of Discovery, the Company acquired an additional 5% interest in Animal Planet L.P. (“APLP”) from Cox for $37.0 million. This transaction increased the Company’s ownership interest in APLP from 80% to 85% and has been recorded as a step acquisition. The $37.0 million has been recorded as brand intangibles of $7.0 million, affiliate relationships of $10.0 million, and goodwill of $17.0 million. The brand intangibles and affiliate relationships will be amortized over 10 years. The following table summarizes the combined estimated fair values of the assets acquired and the liabilities assumed at the dates of acquisition in 2007 for HSW, Animal Planet additional 5% interest and Treehugger.com. The HSW fair value allocation of assets and liabilities is preliminary because the acquisition closed December 17, 2007 and the fair value determination of assets and liabilities are subject to finalization. | | | | | | | HSW, Animal Planet and
| | Asset (Liability) | | Treehugger, Combined | | | | in thousands | | | Current assets and content | | $ | 22,399 | | Investment in HSWi stock | | | 79,375 | | Other tangible assets | | | 1,313 | | Finite-lived intangibles (including brand names, customer lists and trademarks) | | | 119,421 | | Goodwill | | | 196,646 | | Liabilities assumed | | | (14,753 | ) | Deferred taxes | | | (44,585 | ) | Estimated redemption liability to HSW shareholders | | | (53,722 | ) | | | | | | Cash paid, net of cash acquired | | $ | 306,094 | | | | | | |
During February 2006, the CompanyDCI acquired 98 percent98% of DMAX (formerly known as XXP), afree-to-air network in Germany. The results of operations have been included in the consolidated financial statements since that date. The acquisition of afree-to-air network is intended to support the Company’s strategic priority of strengthening its global presence. The aggregate purchase price was $60.2 million primarily in cash. Of the $54.3 million of acquired intangible assets, $23.0 million was assigned to contract-based distribution channels subject to amortization with a useful life of approximately 5 years and the remaining balance of $31.3 million to goodwill. During 2007, Discovery acquired the remaining 2% in conjunction with the return of purchase escrow balances, for a net cash return amount of $8.1 million. In March 2006, the CompanyDCI acquired all of the outstanding common shares of Antenna Audio Limited (“Antenna”), a provider of audio tours and multimedia at museums and cultural attractions around the globe. The results of IV-16
DISCOVERY COMMUNICATIONS HOLDING, LLC
Notes to Consolidated Financial Statements — (Continued) Antenna’s operations have been included in the consolidated financial statements since that date. The CompanyDCI acquired Antenna to facilitate the expansion of its Travel brand and media content to other platforms. The aggregate purchase price was $64.4 million, primarily in cash. Of the $49.1 million of acquired intangibles, $6.4 million was assigned to assets subject to amortization with useful lives between two and seven years and the balance of $42.7 million to goodwill. Antenna and the Travel Channel had been integrated within a single reporting. In 2006, the CompanyDCI also acquired the following four entities for a total cost of $70.4 million, which was paid primarily in cash: | | | | • | Petfinder.com, a facilitator of pet adoptions and PetsIncredible, a producer and distributor of pet-training videos. The Company also hasDuring 2007, the former owners earned payment of certain contingent considerationsconsideration in connection with this acquisition, payableresulting in the event specific business metrics are achieved totaling up to $13.5addition of $11.0 million over 3 years, which could result in the recording of additional goodwill. | | | • | Clearvue and SVE, Inc., a provider of curriculum-oriented media educational products. | | | • | Academy123, Inc., a provider of onlineon-line supplemental, educational content focusing largely on mathematics and sciences. In May 2007, Discovery recorded an asset impairment of $20.6 million, including $11.5 million of goodwill, for goodwill and intangible assets established during 2006 related to Academy 123, Inc. The business had not been integrated into the education reporting unit, and management decided to scale back its education business to consumers. | | | • | Thinklink, Inc., a provider of formative assessment testing services to schools servicing students in grades K through 12. |
Goodwill recognized for these transactions amounted to $27.9 million.million in 2006. Purchased identifiable intangible assets for these acquisitions are being amortized on a straight-line basis over lives ranging from one to ten years (weighted-average life of 4.4 years).
IV-12
DISCOVERY COMMUNICATIONS, INC.
Notes to Consolidated Financial Statements — (Continued)
The following table summarizes the estimated fair values of the assets acquired and the liabilities assumed at the dates of acquisition.acquisition in 2006. | | | | | | | | | | | | | | | | | | | | | | | | | | | Aggregation of
| | | | | DMAX, Antenna and
| | | | | | | | Remaining
| | | | | Other Acquisitions,
| | Asset (Liability) | | DMAX | | Antenna | | Acquisitions | | Total | | | Combined | | | | in thousands | | | in thousands | | | Current assets and content | | $ | 10,119 | | | | 21,403 | | | | 8,843 | | | | 40,365 | | | $ | 40,365 | | Other tangible assets | | | — | | | | 6,244 | | | | 1,521 | | | | 7,765 | | | | 7,765 | | Finite-lived intangible assets | | | 23,006 | | | | 6,383 | | | | 43,989 | | | | 73,378 | | | | 73,378 | | Goodwill | | | 31,255 | | | | 42,667 | | | | 27,863 | | | | 101,785 | | | | 101,785 | | Liabilities assumed | | | (4,204 | ) | | | (12,340 | ) | | | (11,844 | ) | | | (28,388 | ) | | | (28,388 | ) | | | | | | | | | | | | | | Cash paid, net of cash acquired | | $ | 60,176 | | | | 64,357 | | | | 70,372 | | | | 194,905 | | | $ | 194,905 | | | | | | | | | | | | | | |
Pro forma information related to 2006 acquisitions, either individually or in the aggregate, is not considered to be material to the Company’s consolidated results of operations.
During 2004, the Company completed two acquisitions in its Education division, in which the Company acquired customer lists valued at $14.6 million and covenants not to compete valued at $0.6 million, which are being amortized over their useful lives of three years.
| | 5. | Discontinued Operations |
Following a comprehensive strategic review of its businesses, the Company decided to close its 103 mall based and stand alone Discovery Stores (Retail) in the third quarter of 2007. The Company will continue to leverage its products through retail arrangements and itse-commerce platform. As there is no continuing involvement in the retail stores or significant migration of retail customers toe-commerce, the results of the Retail business are accounted for as discontinued operations in the consolidated financial statements for the periods presented herein, in accordance with Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment and Disposal of Long-lived Assets” (“FAS 144”). IV-17
DISCOVERY COMMUNICATIONS HOLDING, LLC
Notes to Consolidated Financial Statements — (Continued) The following amounts related to Retail have been segregated from continuing operations and included in loss from discontinued operations in the consolidated statements of income: | | | | | | | | | | | | | | | | | | | | Successor | | | Predecessor | | | May 15 through
| | | January 1 through
| | | | | | | December 31, 2007 | | | May 14, 2007 | | 2006 | | 2005 | | | | | | in thousands | Revenue | | $ | 30,491 | | | | $ | 27,362 | | | $ | 129,317 | | | $ | 127,396 | | Loss from discontinued operations before income taxes | | $ | (81,115 | ) | | | $ | (18,312 | ) | | $ | (35,911 | ) | | $ | (31,652 | ) | Loss from discontinued operations, net of tax | | $ | (52,490 | ) | | | $ | (12,533 | ) | | $ | (22,318 | ) | | $ | (20,568 | ) |
No interest expense was allocated to discontinued operations for the periods presented herein since there was no debt specifically attributable to discontinued operations or required to be repaid following the closure of the retail stores. For the Successor period, the loss from discontinued operations includes $31.1 million in lease terminations and other exit costs, $8.8 million for severance and other employee-related costs and $28.3 million in asset impairment charges, along with normal business operations. Summarized balance sheet information for discontinued operations for Retail is as follows: | | | | | | | | | | | | December 31, | | | | Successor
| | | | Predecessor
| | | | 2007 | | | | 2006 | | | | in thousands | | Current assets | | $ | — | | | | $ | 38,106 | | Total assets | | $ | — | | | | $ | 67,707 | | Current liabilities | | $ | (6,349 | ) | | | $ | (29,961 | ) | Total liabilities | | $ | (6,349 | ) | | | $ | (39,339 | ) |
IV-18
DISCOVERY COMMUNICATIONS HOLDING, LLC
Notes to Consolidated Financial Statements — (Continued) | | | | | | | | | | | | | | | | | | | | December 31, | | | | December 31, | | | Successor
| | | | Predecessor
| | Content Rights | | 2006 | | 2005 | | | 2007 | | | | 2006 | | | | in thousands | | | | | in thousands | | Produced content rights | | | | | | | | | | | | | | | | | | Completed | | $ | 1,594,549 | | | | 1,272,331 | | | $ | 1,346,985 | | | | $ | 1,476,830 | | In process | | | 161,942 | | | | 122,366 | | | | 195,025 | | | | | 161,942 | | Co-produced content rights | | | | | | | | | | | | | | | | | | Completed | | | 688,023 | | | | 731,344 | | | | 499,127 | | | | | 681,105 | | In process | | | 86,359 | | | | 53,704 | | | | 53,984 | | | | | 86,359 | | Licensed content rights | | | | | | | | | | | | | | | | | | Acquired | | | 229,878 | | | | 214,100 | | | | 209,082 | | | | | 213,691 | | Prepaid | | | 10,386 | | | | 3,371 | | | | 21,690 | | | | | 10,386 | | | | | | | | | | | | | | | Content rights, at cost | | | 2,771,137 | | | | 2,397,216 | | | | 2,325,893 | | | | | 2,630,313 | | Accumulated amortization | | | (1,453,189 | ) | | | (1,166,103 | ) | | | (1,198,538 | ) | | | | (1,312,365 | ) | | | | | | | | | | | | | | Content rights, net | | | 1,317,948 | | | | 1,231,113 | | | | 1,127,355 | | | | | 1,317,948 | | Current portion, licensed content rights | | | (64,395 | ) | | | (55,125 | ) | | | (79,162 | ) | | | | (64,395 | ) | | | | | | | | | | | | | | Non-current portion | | $ | 1,253,553 | | | | 1,175,988 | | | $ | 1,048,193 | | | | $ | 1,253,553 | | | | | | | | | | | | | | |
Amortization of content rights was $696.0 million, $601.1 million and $494.2 million in 2006, 2005 and 2004, and is recorded as a component of cost of revenue.revenue and was $558.0 million, $257.0 million, $696.0 million and $601.1 million from May 15, 2007 through December 31, 2007, from January 1, 2007 through May 14, 2007, in 2006 and in 2005, respectively. Amortization of content rights includes incremental amortization for certain programs to net realizable value of $34.6$171.7 million, $8.0$1.9 million, $40.1 million and $18.7$16.6 million from May 15, 2007 through December 31, 2007, from January 1, 2007 through May 14, 2007, in 2006 and in 2005, respectively. The $171.7 million of incremental amortization includes an impairment charge of $129.1 million at U.S. networks, where new programming leadership evaluated the networks’ programming portfolio assets and 2004.identified certain programming which no longer fit the go forward strategy of the networks. The Company wrote off those assets no longer intended for use. The Company estimates that approximately 86%96% of unamortized costs of content rights at December 31, 20062007 will be amortized within the next three years. The Company expects to amortize $477.5$434.3 million of unamortized content rights, not including in-process, not released, and prepaid productions, during the next twelve months.
IV-13IV-19
DISCOVERY COMMUNICATIONS INC.HOLDING, LLC
Notes to Consolidated Financial Statements — (Continued) | | 6.7. | Property and Equipment |
| | | | | | | | | | | | | | | | | | | | December 31, | | | | December 31, | | | Successor
| | | | Predecessor
| | Property and Equipment | | 2006 | | 2005 | | | 2007 | | | | 2006 | | | | in thousands | | | | | in thousands | | Equipment and software | | $ | 411,583 | | | | 347,667 | | | $ | 478,616 | | | | $ | 411,583 | | Land | | | 28,781 | | | | 28,781 | | | | 28,781 | | | | | 28,781 | | Buildings | | | 153,737 | | | | 157,896 | | | | 154,227 | | | | | 153,737 | | Furniture, fixtures, leasehold improvements and other | | | 217,884 | | | | 187,589 | | | | 151,417 | | | | | 217,884 | | Assets in progress | | | 11,833 | | | | 16,824 | | | | 14,471 | | | | | 11,833 | | | | | | | | | | | | | | | Property and equipment, at cost | | | 823,818 | | | | 738,757 | | | | 827,512 | | | | | 823,818 | | Accumulated depreciation and amortization | | | (399,777 | ) | | | (341,179 | ) | | | (430,082 | ) | | | | (399,777 | ) | | | | | | | | | | | | | | Property and equipment, net | | $ | 424,041 | | | | 397,578 | | | $ | 397,430 | | | | $ | 424,041 | | | | | | | | | | | | | | |
The cost and accumulated depreciation of equipment under capital leases was $53.3 million and $19.8 million, respectively, at December 31, 2007, and $39.7 million and $13.2 million, respectively, at December 31, 2006 and $23.5 million and $7.0 million at December 31, 2005.respectively. Depreciation and amortization of property and equipment, including equipment under capital lease, was $89.9$57.3 million, $85.0$40.4 million, $78.4 million and $85.4$74.5 million from May 15, 2007 through December 31, 2007, from January 1, 2007 through May 14, 2007, in 2006 and in 2005, respectively. Depreciation and 2004.amortization of property and equipment for Retail discontinued operations was $0.1 million, $3.2 million, $10.2 million and $10.4 million from May 15, 2007 through December 31, 2007, from January 1, 2007 through May 14, 2007, in 2006 and in 2005, respectively, exclusive of impairment write-downs. | | 7.8. | Sale of Equity Investments and Long-lived Assets |
In April 2006 and January 2005, the CompanyDCI recorded gains of $1.5 million and $12.8 million, respectively, as a component of other non-operating expenses for the sale of certain equity investments previously accounted for under the cost method. The gains represent the difference between the proceeds received and the net book value of the investments. In 2004, the Company recorded a net gain of $22.0 million on the sale of certain television technology patents. The transaction closed in August 2004,9. Goodwill and the gain represents the sale price less costs to sell. The Company expensed all of the costs to develop this technology in prior years.Intangible Assets
| | 8. | Goodwill and Intangible Assets |
| | | | | | | | | | | | December 31, | | | | Successor
| | | | Predecessor
| | Goodwill and Intangible Assets | | 2007 | | | | 2006 | | | | in thousands | | Goodwill | | $ | 4,870,187 | | | | $ | 365,266 | | | | | | | | | | | | Trademarks, net of accumulated amortization of $2,272 and $1,905 | | $ | 62,193 | | | | $ | 12,322 | | Customer lists, net of accumulated amortization of $76,919 and $136,049 | | | 67,282 | | | | | 26,500 | | Other, net of accumulated amortization of $77,026 and $55,355 | | | 52,181 | | | | | 68,851 | | | | | | | | | | | | Intangibles, net | | $ | 181,656 | | | | $ | 107,673 | | | | | | | | | | | |
IV-20
| | | | | | | | | | | December 31, | | Goodwill and Intangible Assets | | 2006 | | | 2005 | | | | in thousands | | | Goodwill | | $ | 365,266 | | | | 254,989 | | Trademarks | | | 12,322 | | | | 12,327 | | Customer lists, net of accumulated amortization of $136,049 and $111,954 | | | 26,500 | | | | 38,561 | | Distribution, net of accumulated amortization of $4,072 | | | 21,331 | | | | — | | Other, net of accumulated amortization of $55,283 and $41,107 | | | 47,520 | | | | 24,207 | | Representation rights, net of amortization of zero and $69,886 | | | — | | | | 67,843 | | | | | | | | | | | Goodwill and intangible assets, net | | $ | 472,939 | | | | 397,927 | | | | | | | | | | |
DISCOVERY COMMUNICATIONS HOLDING, LLC
Notes to Consolidated Financial Statements — (Continued) During 2007, changes in the net carrying amount of goodwill were as follows: | | | | | Reconciliation of net carrying amount of goodwill | | in thousands | | | Balance at January 1, 2007 (Predecessor) | | $ | 365,266 | | Impairment (Predecessor) (Note 4) | | | (11,478 | ) | Translation (Predecessor) | | | 2,047 | | Push down of investor basis (Successor) (Note 1) | | | 4,591,581 | | Disposals (Successor) (Note 1) | | | (280,838 | ) | Acquisitions (Successor) (Note 4) | | | 198,109 | | Translation (Successor) | | | 5,500 | | | | | | | Balance at December 31, 2007 (Successor) | | $ | 4,870,187 | | | | | | |
Purchase price in excessIn April 2007, DCI completed a strategic analysis of the fair value ofEducation business and does not expect to generate revenue from the assets and liabilities acquired from the Academy 123, Inc. acquisition. Goodwill of $101.8$11.5 million and $1.1intangible assets of $9.1 million was recorded to goodwill in 2006 and 2004. Changeswere written-off as a component of $8.5 million, $(2.5) million, and $1.6 million in goodwill resulted from fluctuations in foreign currency in 2006, 2005 and 2004.amortization expense.
Goodwill and trademarksis not amortized. Trademarks are not amortized.amortized on a straight-line basis over 3 to 10 years. Customer lists are amortized on a straight-line basis over the estimated useful lives of three to seven years. Non-compete assets are amortized on a straight-line basis over the contractual term of one to seven years. Other intangibles are amortized on a straight-line basis over the estimated useful lives of three to ten years. The weighted-average amortization period for intangible assets is 5.1 years. During AprilAmortization of intangible assets, totaled $22.3 million, $36.7 million, $43.6 million and $38.2 million from May 15, 2007 through December 31, 2007, from January 1, 2007 through May 14, 2007, in 2006 and in 2005, respectively. The Company estimates that unamortized costs of intangible assets at December 31, 2007 will be amortized over the Company terminated its existing agreementnext five years as follows: $52.5 million in 2008, $40.9 million in 2009, $37.2 million in 2010, $20.4 million in 2011, and entered into new agreements regarding its exclusive right to represent BBC America (“BBCA”), a cable network,$12.2 million in sales, marketing, distribution and other operational activities. In exchange for early termination of the previous agreement, the Company received $93.2 million, resulting in a deferred gain of $27.7 million. This deferred gain is recorded as a component of other current and non-2012.
IV-14IV-21
DISCOVERY COMMUNICATIONS INC.HOLDING, LLC
Notes to Consolidated Financial Statements — (Continued) current liabilities, is being amortized on a straight-line basis over the six year term of the agreement, and is reported in other revenue. The cost of acquiring the representation rights was amortized on a straight-line basis over the fifteen-year term of the original agreement, and was reported as a reduction of other revenue.
Amortization of intangible assets including representation rights, totaled $46.0 million, $45.0 million and $41.8 million in 2006, 2005 and 2004. The Company estimates that unamortized costs of intangible assets at December 31, 2006 will be amortized over the next five years as follows: $37.0 million in 2007, $28.3 million in 2008, $13.2 million in 2009, $10.4 million in 2010, and $3.4 million in 2011.10. Investments
The following table outlines the Company’s less than wholly-owned ventures and the method of accounting during 2006:2007: | | | | | Accounting
| Affiliates: | | Method | | Joint Ventures with the BBC: | | | JV Programs LLC (“JVP”) | | Consolidated | Joint Venture Network LLC (“JVN”) | | Consolidated | Animal Planet United States (see Note 11) | | Consolidated | Animal Planet Europe | | Consolidated | Animal Planet Latin America | | Consolidated | People & Arts Latin America | | Consolidated | Animal Planet Asia | | Consolidated | Animal Planet Japan (“APJ”) | | Consolidated | Animal Planet Canada | | Equity | Other Ventures: | | | Animal Planet United States (see Note 12) | | Consolidated | Discovery Canada | | Equity | Discovery Japan | | Equity | Discovery Health Canada | | Equity | Discovery Kids Canada | | Equity | Discovery Civilization Canada | | Equity | Meteor StudiosHSWi (See Note 4) | | Equity |
Joint Ventures with the BBC The Company and the BBC have formed several cable and satellite television network joint ventures, JVP, a venture to produce and acquire factual-based content, and JVN, a venture to provide debt funding to these joint ventures. In addition to its own funding requirements, the Company has assumed the BBC funding requirements, giving the Company preferential cash distribution with these ventures. The Company controls substantially all of the BBC ventures and consolidates them accordingly. As the BBC does not have risk of loss, no BBC cumulative losses were allocated to minority interest for consolidated joint ventures with the BBC, and the Company recognizes both its and the BBC’s share of earnings andcumulative losses in the equity method venture with the BBC. In connection with After December 31, 2006, JVP obtained a level of cumulative profitability. Minority interest expense of $4.3 million and $1.1 million for the adoptionBBC’s share of FIN 46R, the Company concluded thatearnings in JVP was recognized from May 15, 2007 through December 31, 2007 and APJ are VIEs and the Company is the primary beneficiary. Therefore, onfrom January 1, 2005, the Company began consolidating these entities, which had aggregate fair value net asset balances of $58.0 million. There is no minority interest income or expense for JVP; minority interest for APJ is an expense of $0.3 million in 2006 and income of $1.4 million in 2005 and is reported as a component of minority interest expense. Previously, the Company accounted for JVP and APJ under the equity method of accounting.2007 through May 14, 2007, respectively.
Other Ventures The Company is a partner in other international joint venture cable and satellite television networks. The Company also acquired an equity interest in HSWi stock as a result of its acquisition of HSW. DCI provided no funding to thesethe equity ventures in 2006. Funding2007, 2006 or 2005. At December 31, 2007, the Company’s maximum exposure to theseloss as a result of its involvement with the equity joint ventures totaled $0.2is the $47.0 million investment book value and $3.3 million duringfuture operating losses, should they occur, of the equity joint ventures that the Company is obligated to fund.
IV-15IV-22
DISCOVERY COMMUNICATIONS INC.HOLDING, LLC
Notes to Consolidated Financial Statements — (Continued) 2005 and 2004. At December 31, 2006,
| | | | | | | | | | | | December 31, | | | | Successor
| | | | Predecessor
| | Debt | | 2007 | | | | 2006 | | | | in thousands | | $1,000,000.0 Term Loan A due quarterly December 2008 to October 2010 | | $ | 1,000,000 | | | | $ | 1,000,000 | | $1,555,000.0 Revolving Loan, due October 2010 | | | 337,500 | | | | | 249,500 | | €260,000.0 Revolving Loan, due April 2009 | | | 94,174 | | | | | 187,828 | | $1,500,000.0 Term Loan B due quarterly September 2007 to May 2014 | | | 1,492,500 | | | | | — | | 8.06% Senior Notes, semi-annual interest, due March 2008 | | | 180,000 | | | | | 180,000 | | 7.45% Senior Notes, semi-annual interest, due September 2009 | | | 55,000 | | | | | 55,000 | | 8.37% Senior Notes, semi-annual interest, due March 2011 | | | 220,000 | | | | | 220,000 | | 8.13% Senior Notes, semi-annual interest, due September 2012 | | | 235,000 | | | | | 235,000 | | Floating Rate Senior Notes, semi-annual interest, due December 2012 | | | 90,000 | | | | | 90,000 | | 6.01% Senior Notes, semi-annual interest, due December 2015 | | | 390,000 | | | | | 390,000 | | £10,000.0 Uncommitted Facility, due August 2008 | | | 8,785 | | | | | — | | Obligations under capital leases | | | 37,172 | | | | | 32,355 | | Other notes payable | | | 960 | | | | | 1,100 | | | | | | | | | | | | Subtotal | | | 4,141,091 | | | | | 2,640,783 | | Current portion | | | (32,006 | ) | | | | (7,546 | ) | | | | | | | | | | | Total long-term debt | | $ | 4,109,085 | | | | $ | 2,633,237 | | | | | | | | | | | |
In May 2007, Discovery entered into a $1,500.0 million, seven year term loan credit agreement. Borrowings under this agreement bear interest at London Interbank Offered Rate (“LIBOR”) plus an applicable margin of 2.0% or the Company’s maximum exposure to losshigher of (a) the Federal Funds Rate plus1/2 of 1% or (b) “prime rate” set by Bank of America plus an applicable margin of 1.0%. The company capitalized $4.7 million of deferred financing costs as a result of its involvement with these joint ventures isthis transaction. At the $15.6end of 2007 there was $1,492.5 million investment book value and future operating losses, should they occur, of these joint ventures that the Company is obligated to fund. These joint ventures have no third party debt. These other ventures do not require consolidation. These other ventures are accounted foroutstanding under the equity method asterm loan agreement (net of mandatory principal repayments) with a weighted average interest rate of 6.83%. The average interest rate under this credit agreement was 7.44% for the Company does not have a controlling financial interest. Unaudited financial information of the Company’s unconsolidated ventures (amounts do not reflect eliminations of activity with the Company):
| | | | | | | | | | | | | | | Year Ended December 31, | | Operating Results (Unaudited) | | 2006 | | | 2005 | | | 2004 | | | | in thousands
| | | Net Revenue | | $ | 123,486 | | | | 111,872 | | | | 163,630 | | Income from operations | | | 42,090 | | | | 41,934 | | | | 26,201 | | Net income | | | 24,463 | | | | 24,634 | | | | 8,688 | |
| | | | | | | | | | | December 31, | | Balance Sheets (Unaudited) | | 2006 | | | 2005 | | | | in thousands | | | Current assets | | $ | 77,767 | | | | 68,529 | | Total assets | | | 89,058 | | | | 80,365 | | Current liabilities | | | 25,515 | | | | 24,204 | | Total liabilities | | | 33,619 | | | | 33,578 | | Total shareholders’ equity or partners’ capital | | | 55,439 | | | | 46,787 | |
10. Long-Term Debt
| | | | | | | | | | | December 31, | | Long-Term Debt | | 2006 | | | 2005 | | | | in thousands | | | $1,000,000.0 Term Loan, due quarterly December 2008 to October 2010 | | $ | 1,000,000 | | | | 1,000,000 | | $1,555,000.0 Revolving Loan, due October 2010 | | | 249,500 | | | | 103,000 | | €260.0 Revolving Loan, due April 2009 | | | 187,828 | | | | — | | 7.81% Senior Notes, semi annual interest, due March 2006 | | | — | | | | 300,000 | | 8.06% Senior Notes, semi annual interest, due March 2008 | | | 180,000 | | | | 180,000 | | 7.45% Senior Notes, semi annual interest, due September 2009 | | | 55,000 | | | | 55,000 | | 8.37% Senior Notes, semi annual interest, due March 2011 | | | 220,000 | | | | 220,000 | | 8.13% Senior Notes, semi annual interest, due September 2012 | | | 235,000 | | | | 235,000 | | Senior Notes, semi annual interest, due December 2012 | | | 90,000 | | | | 90,000 | | 6.01% Senior Notes, semi annual interest, due December 2015 | | | 390,000 | | | | 390,000 | | Obligations under capital leases | | | 32,355 | | | | 23,910 | | Other notes payable | | | 1,100 | | | | — | | | | | | | | | | | Total long-term debt | | | 2,640,783 | | | | 2,596,910 | | Current portion | | | (7,546 | ) | | | (6,470 | ) | | | | | | | | | | Non-current portion | | $ | 2,633,237 | | | | 2,590,440 | | | | | | | | | | |
period May 15, 2007 through December 31, 2007. In March 2006,September 2007, the Company’s United Kingdom (“UK”) subsidiary, Discovery Communications Europe Limited (“DCEL”), executed a £10 million uncommitted facility to supplement working capital requirements. The facility is available through August 1, 2008 and is guaranteed by Discovery. At December 31, 2007 there was £4.4 million (approximately $8.8 million) outstanding under this facility. In March 2006, DCEL entered into a €70.0 million three year multicurrency revolving credit agreement.agreement (“UK credit agreement”) which enables the Company to draw Euros and British Pounds. In April 2006, the UK credit agreement was amended and restated to provide for syndication and to increase the revolving commitments to €260.0 million. The Company guarantees DCEL’s obligations under the UK credit agreement. Borrowings under this agreement bear interest at London Interbank Offered Rate (“LIBOR”)LIBOR plus an applicable margin based on the Company’s leverage ratios. The cost of the UK credit agreement also includes a fee on the revolving commitments (ranging from 0.1% to 0.3%) based on the Company’s leverage ratio. DCEL capitalized £0.7 million (approximately U.S. $1.4 million)
IV-16
DISCOVERY COMMUNICATIONS, INC.
Notes to Consolidated Financial Statements — (Continued)
of deferred financing costs as a result of this transaction. At the end of 2007 there was £47.5 million (approximately U.S. $94.2 million) outstanding under the multicurrency credit agreement with a weighted average interest rate of 6.75%. At the end of 2006 there was £95.9 million (approximately U.S. $187.8 million) outstanding under the multicurrency credit agreement with a weighted average interest rate of 5.91%. The interest rate during 2006 averaged 5.62%.7.05% and 6.42% from May 15, 2007 IV-23
DISCOVERY COMMUNICATIONS HOLDING, LLC
Notes to Consolidated Financial Statements — (Continued) through December 31, 2007 and from January 1, 2007 through May 14, 2007, respectively. The UK credit agreement matures April 2009. In March 2006 the CompanyDCI borrowed additional funds under its RevolvingUS Credit Facility (Revolving Loan and Term A) to redeem the maturing $300.0 million Senior Notes. At the end of 2007 there was $1,337.5 million outstanding ($1,000 million Term A and $337.5 million Revolving Loan) under the facility with a weighted average interest rate of 5.61%. The amount available under the facility was $1,214.9 million, net of amounts committed for standby letters of credit of $2.6 million issued. At the end of 2006 there was $1,249.5 million outstanding under the Revolving Loanfacility with a weighted average interest rate of 6.35%. The amount available under the Revolving Loanfacility was $1,302.8 million, net of amounts committed for standby letters of credit of $2.7 million issued under the credit facility. At the end of 2005 there was $1,103.0 million outstanding with a weighted interest rate of 5.32%.issued. The average interest rate under the U.S. Credit AgreementFacility was 6.11%, 6.22% and 6.01% and 4.41% in 2006 and 2005. In October 2005, the Company refinanced its syndicated bank credit agreement, replacing the existing Term Loan and the Revolving Facility, which had principal payments beginning infrom May 15, 2007 through December 31, 2007, from January 1, 2007 through May 14, 2007 and final maturity in 2009, with a new $1,000 million Term Loan and $1,555 million Revolving Facility, with principal payments beginning in 2008 and final maturity in 2010.2006, respectively. The Term and Revolving Loans are unsecured. Interest, which is payable quarterly at a minimum, is based on LIBOR plus a margin basedCompany’s debt agreements have certain restrictions on the Company’s leverage ratio or prime. The costpayment of the Revolving Facility includes a fee on the revolving commitment (rangingdividends from 0.1% to 0.3%) based on the Company’s leverage ratios.
In November 2005, the Company modified the outstanding unsecured Senior Notes. In December 2005, the Company issued two series of unsecured Senior Notes, $90.0 million of floating rate Senior Notes due December 2012 and $390.0 million of 6.01% Senior Notes due December 2015. The weighted average interest rate on the floating rate Senior Note was 6.10% at December 31, 2006 and 5.33% at December 31, 2005. The average interest rate under the floating rate Senior Note during 2006 was 5.85%.
The Company capitalized $4.8 million in deferred financing costs in 2005 as a result of these transactions. The Company expensed $4.2 million in capitalized costs as a component of interest expense associated with the refinancing of the previous credit arrangement.subsidiaries.
The Company uses derivative instruments to modify its exposure to interest rate fluctuations on its debt. The Term Loans, Revolving Facility, and Senior Notes contain covenants that require the Company to meet certain financial ratios and place restrictions on the payment of dividends, sale of assets, borrowing level, mergers, and purchases of capital stock, assets, and investments. Future principal payments under the current debt arrangements, excluding obligations under capital leases and other notes payable, are as follows: none in 2007, $242.5$266.3 million in 2008, $617.8$539.2 million in 2009, $812.0$915.0 million in 2010, $220.0$235.0 million in 2011, $340.0 million in 2012 and $715.0$1,807.5 million thereafter. Of the $266.3 million of principal payments due in 2008, $242.5 million is excluded from 2012the current portion of long-term debt as of December 31, 2007 because the Company has the intent and ability to 2015. refinance its obligations on a long-term basis. Future minimum payments under capital leases are as follows: $9.3 million in 2007, $7.3$9.0 million in 2008 $7.3 million inand 2009, $5.1$6.8 million in 2010, $4.5$6.2 million in 2011, $3.0 million in 2012 and $5.4$10.0 million thereafter. | | 11.12. | Mandatorily Redeemable Interests in Subsidiaries |
| | | | | | | | | | | | | | | | | | | | December 31, | | | | December 31, | | | Successor
| | | | Predecessor
| | Mandatorily Redeemable Interests in Subsidiaries | | 2006 | | 2005 | | | 2007 | | | | 2006 | | | | in thousands | | | in thousands | | | | Discovery Times | | $ | — | | | | 106,862 | | | Animal Planet LLC | | | — | | | | 80,000 | | | Animal Planet LP | | | 48,950 | | | | 48,840 | | | $ | — | | | | $ | 48,950 | | People & Arts Latin America and Animal Planet Channel Group | | | 45,875 | | | | 36,800 | | | | 48,721 | | | | | 45,875 | | | | | | | | | | | | | | | Mandatorily redeemable interests in subsidiaries | | $ | 94,825 | | | | 272,502 | | | $ | 48,721 | | | | $ | 94,825 | | | | | | | | | | | | | | |
Discovery Times
In April 2002, the Company sold a 50% interest in Discovery Times Channel to the New York Times (“NYT”) for $100.0 million. Due to the NYT’s redemption rights, this transaction resulted in no gain or loss to the Company. In September 2006, NYT exercised its right to put its interest back to the Company for $100.0 million. Prior to the exercised put, the Company accreted or decreted the mandatorily redeemable interest in a subsidiary through the redemption date to its estimated redemption value, never decreting below the NYT’s estimated minority interest. The Company updated its
IV-17
DISCOVERY COMMUNICATIONS, INC.
Notes to Consolidated Financial Statements — (Continued)
estimate of the redemption value and estimated minority interest each period. The Company recorded decretion of $6.9 million in 2006 as a result of the redemption, and decretion of $19.5 million in 2005 and accretion of $1.3 million in 2004 as a result of valuation adjustments to minority interest expense.
FitTV (formerly known as The Health Network)
Fox Entertainment Group (“FEG”) had the right, from December 2003 to February 2004, to put its FitTV interests back to the Company. In December 2003, FEG notified the Company of its intention to put its interest in FitTV back to the Company. The Company acquired this interest for approximately $92.9 million in 2005. The Company recorded decretion of $1.1 million in 2004 to minority interest expense.
Animal Planet LLC
In April 2004, the BBC notified the Company of its intention to put its interest in Animal Planet LLC back to the Company. The redemption value of $80.0 million was paid in April 2006. The Company recorded accretion of $30.0 million and $50.0 million in 2005 and 2004 to minority interest expense.
Animal Planet LP OneAs of December 31, 2006, one of the Company’sDCI’s stockholders held 44,000 senior preferred partnership units of Animal Planet LP (“APLP”) that havehad a redemption value of $44.0 million and carrycarried a rate of return ranging from 8.75% to 13%. Payments arewere made quarterly and totaled $4.6 million during 2006 and 2005 and $5.8 million during 2004.2006. APLP’s senior preferred partnership units may bewere called by APLP during the periodDCI in January 2007 through December 2011 for $44.0 million, and may be put to the Company by the holder beginning in January 2012 for $44.0 million. In January 2007, the Company exercised its call rights and paid $44.0 million, plus accrued interest of $0.5 million on January 31, 2007.million. At December 31, 2006, and 2005, the Company hasDCI recorded this security at the redemption value of $44.0 million plus accrued returns of $5.0 million and $4.8 million. Preferred returns have beenwere recorded as a component of interest expense based on a constant rate of return of 10.75% through the full term and aggregated $4.7 million in 2006 2005 and 2004.2005. DCI reversed $5.0 million of accrued interest upon exercise of the call.
People & Arts Latin America and Animal Planet Channel Group The BBC has the right, upon a failure of the People & Arts Latin America or the Animal Planet Channel Group (comprised of Animal Planet Europe, Animal Planet Asia, and Animal Planet Latin America), the Channel Groups, IV-24
DISCOVERY COMMUNICATIONS HOLDING, LLC
Notes to Consolidated Financial Statements — (Continued) to achieve certain financial performance benchmarks to put its interests back to the Company for a value determined by a specified formula every three years which commenced December 31, 2002. The Company accretes the mandatorily redeemable equity in a subsidiary to its estimated redemption value through the applicable redemption date. The redemption value estimate is based on a contractual formula considering the projected results of each network within the channel group. Based on the Company’s calculated performance benchmarks, the Company believes the BBC has the right to put their interests as of December 2005. The BBC has 90 days following the valuation of the Channel Groups by an independent appraiser to exercise their right. During 2006 the CompanyDCI was notified that the BBC is evaluating whether to execute their rights under the agreement. As of December 31, 2006,2007, the BBC has not advisedand the Company of their intention.are assigning a valuation firm to formally assess the performance benchmarks and the BBC’s right to put. The Company is now accretinghas accreted to the 2008 redemption date and hasan estimated a redemption value of $45.9$48.7 million as of December 31, 2006.2007, based on certain estimates and legal interpretations. Changes in these assumptions could materially impact current estimates. Accretion to the redemption value has been recorded as a component of minority interest expense of $1.7 million, $1.1 million, $9.1 million and $34.6 million and $2.2 millionfrom May 15, 2007 through December 31, 2007, from January 1, 2007 through May 14, 2007, in 2006 and 2005, and 2004.
IV-18
DISCOVERY COMMUNICATIONS, INC. respectively.
Notes to Consolidated Financial Statements — (Continued)
12. Commitments and Contingencies
| | 13. | Commitments and Contingencies |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Year Ending December 31, | | | Year ending December 31, | | Future Minimum Payments | | Leases | | Content | | Other | | Total | | | Leases | | Content | | Other | | Total | | | | in thousands | | | in thousands | | | 2007 | | $ | 83,533 | | | | 260,829 | | | | 86,965 | | | | 431,327 | | | 2008 | | | 78,999 | | | | 55,447 | | | | 61,467 | | | | 195,913 | | | $ | 80,691 | | | $ | 269,175 | | | $ | 106,187 | | | $ | 456,053 | | 2009 | | | 60,850 | | | | 50,556 | | | | 54,635 | | | | 166,041 | | | | 65,991 | | | | 66,616 | | | | 85,546 | | | | 218,153 | | 2010 | | | 52,683 | | | | 44,129 | | | | 17,388 | | | | 114,200 | | | | 56,518 | | | | 41,287 | | | | 71,246 | | | | 169,051 | | 2011 | | | 47,932 | | | | 43,295 | | | | 7,876 | | | | 99,103 | | | | 41,360 | | | | 40,176 | | | | 23,852 | | | | 105,388 | | 2012 | | | | 35,417 | | | | 40,667 | | | | 4,148 | | | | 80,232 | | Thereafter | | | 176,070 | | | | 43,837 | | | | 1,120 | | | | 221,027 | | | | 133,741 | | | | 41,469 | | | | 400 | | | | 175,610 | | | | | | | | | | | | | | | | | | | | | Total | | $ | 500,067 | | | | 498,093 | | | | 229,451 | | | | 1,227,611 | | | $ | 413,718 | | | $ | 499,390 | | | $ | 291,379 | | | $ | 1,204,487 | | | | | | | | | | | | | | | | | | | | |
Expenses recorded in connection with operating leases, including rent expense, for continuing and discontinued operations were $91.2 million, $53.1 million, $142.5 million and $142.1 million and $127.8 million for the years endedfrom May 15, 2007 through December 31, 2007, from January 1, 2007 through May 14, 2007, in 2006 and in 2005, respectively. Expenses recorded in connection with operating leases, including rent expense, for discontinued operations were $37.2 million, $8.8 million, $24.0 million and 2004.$25.4 million from May 15, 2007 through December 31, 2007, from January 1, 2007 through May 14, 2007, in 2006 and in 2005, respectively. The Company receives contributions from certain landlords to fund leasehold improvements. Such contributions are recorded as deferred rent and amortized as reductions to lease expense over the lease term. Certain of the Company’s leases provide for rental rates that increase or decrease over time. The Company recognizes operating lease minimum rentals on a straight-line basis over the lease term. The Company’s deferred rent balance was $37.4 million and $29.8$24.2 million at December 31, 20062007 and 2005. The lease term begins on$37.4 million at December 31, 2006. Approximately $7.0 million of Discovery’s deferred rent balance was written off and included in discontinued operations following the dateclosure of the Company has access to the leased property.retail stores. In August 2005, the Company subleased rented property and guaranteed third party performance under the lease. The guarantee for the $5.2 million value of the lease is full and unconditional, through March 2008. The Company has other guarantees totaling $4.1 million.
The CompanyDiscovery has certain contingent considerations in connection with the acquisition of Petfinder.comTreehugger.com payable in the event specific business metrics are achieved totaling up to $13.5$6.0 million over 32 years (see Note 4).
In connection with the long-term distribution agreements for certain of its European cable networks, the Company committed to pay a satellite system operator 25% to 49% of the fair value of these networks, if any, as of December 31, 2006. The Company completed negotiations for the renewed distribution agreements including additional European cable networks in January 2007, including an inducement payment of £100.0 million (approximately U.S. $185.4 million), which also settled any liabilities from the prior agreement. The value of the networks, and the Company’s liability thereon, are materially impacted by the terms of future renewed distribution agreements with the satellite system operator. The commitment was designed as an inducement for renewed distribution agreements. As of December 31, 2006, the Company has recorded a liability of $10.4 million associated with this arrangement based on the range of estimated values of the networks at the termination of the agreement without renewed distribution agreements. The balance of the inducement payment will be deferred and amortized as a reduction of revenue over a five year period.
The Company is solely responsible for providing financial, operational and administrative support to the JVP, JVN, Animal Planet Latin America, People & Arts Latin America, Animal Planet Asia, and Animal Planet Europe ventures and has committed to do so through at least fiscal 2007.
The Company is involved in litigation incidental to the conduct of its business. In addition, the Company is involved in negotiations with organizations holding the rights to music used in the Company’s content. As global music rights societies evolve, the Company uses all information available to estimate appropriate obligations. During 2005, DCI analyzed its music rights reserves and recorded a net reduction to cost of revenue of approximately $11.0 million. The Company believes the reserves related to these music rights are adequate IV-25
DISCOVERY COMMUNICATIONS HOLDING, LLC
Notes to Consolidated Financial Statements — (Continued) and does not expect the outcome of such litigation and negotiations to have a material adverse effect on the Company’s results of operations, cash flows, or financial position. 13. Employee Savings Plans
| | 14. | Employee Savings Plans |
The Company maintains employee savings plans, defined contribution savings plans and a supplemental deferred compensation plan for certain management employees, together the “Savings Plans.” The Company contributions to the Savings Plans were $6.2 million, $5.5 million, $9.9 million and $8.2 million from May 15, 2007 through December 31, 2007, from January 1, 2007 through May 14, 2007 in 2006 and $6.8 million during 2006,in 2005, and 2004.
IV-19
DISCOVERY COMMUNICATIONS, INC. respectively.
Notes to Consolidated Financial Statements — (Continued)
14. Long-term Incentive Plans
| | 15. | Long-term Incentive Plans |
In October 2005, the CompanyDCI established a new long-term incentive plan. At inception of the plan, eligible participants in one of the Company’sDCI’s previously established long-term incentive plans chose to either continue in that plan or to redeem their vested units at the December 31, 2004 valuation and receive partially vested units in the new plan. Substantially all participants in the previously established plan redeemed their vested units and received partially vested units in the new plan. Certain eligible employees were granted new units in the new plan. Units partially vested in the new plan have vesting similar to units in the previously established plan. New units awarded vest 25% per year. The units in the new plan are indexed to the market price of Class A DHC stock. Every two years, one quarterOn August 17, 2007, the Company amended the plan so that each year 25% of the units awarded will expire and the employeeemployees will receive a cash payment for the increase in value throughoutvalue. Prior to the amendment, units were paid out every two years over an eight-year period after the grant date.eight year period. The Company has authorized the issuance of up to 31.9 million units under this plan. Prior to October 2005, the CompanyDCI maintained two unit-based, long-term incentive plans with substantially similar terms. Units were awarded to eligible employees following their one-year anniversary of hire and vested 25% per year thereafter. Upon exercise, participants received the increase in value from the date of issuance. The value of the units was based on changes in the Company’sDCI’s value as estimated by an external investment-banking firm utilizing a specified formula of CompanyDCI business metrics. The average assumptions used in the valuation model included adjusted projected operating cash flows segregated by business group. The valuation also included a business group specific discount rate and terminal value based on business risk. The intrinsic value for unit appreciation had been recorded as compensation expense over the period the units were outstanding. In August 2005, the CompanyDCI discontinued one of these plans, which resulted in the full vesting and cash redemption of units at the December 31, 2004 valuation, including a 25% premium on appreciated value. Upon voluntary termination of employment, the Company distributes 75% of the intrinsic value of the participant’s vested units, asif participants are requiredagree to comply with post-employment obligations for one year in order to receive remaining benefits. The Company’s cash disbursements under the new plan aggregated $75.6 million, $7.8 million and $0.3 million from May 15, 2007 through December 31, 2007, from January 1, 2007 through May 14, 2007 and in 2006.2006, respectively. There were no payments during 2005 related to the new plan. The Company’sDCI’s cash disbursements under the prior plans aggregated $325.8 million and $45.9 million during 2005 and 2004. Compensation expense under the prior plans was $20.4 million and $68.8 million in 2005 and 2004. 2005. The fair value of the units issued under the new plan has been determined using the Black-Scholes option-pricing model. The expected volatility represents the calculated volatility of the DHC stock price over each of the various contractual terms. As a result of the limited trading history of the DHC stock, this amount wasfor units paid out IV-26
DISCOVERY COMMUNICATIONS HOLDING, LLC
Notes to Consolidated Financial Statements — (Continued) after two years is determined based on an analysis of DHC’s industry peer group over the corresponding periods. In 2006 and 2005, the The weighted average assumptions used in this option-pricing model were as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | Successor | | | Predecessor | | | Year Ended December 31, | | | May 15 -
| | | January 1 -
| | | | | Weighted Average Assumptions | | 2006 | | 2005 | | | December 31, 2007 | | | May 14, 2007 | | 2006 | | 2005 | | | Risk-free interest rate | | | 4.79 | % | | | 4.36 | % | | | 3.20 | % | | | | 4.72 | % | | | 4.78 | % | | | 4.36 | % | Expected term (years) | | | 4.42 | | | | 4.75 | | | | 1.48 | | | | | 3.87 | | | | 3.86 | | | | 4.75 | | Expected volatility | | | 27.07 | % | | | 30.36 | % | | | 27.93 | % | | | | 23.78 | % | | | 27.06 | % | | | 30.36 | % | Dividend yield | | | 0 | % | | | 0 | % | | | 0 | % | | | | 0 | % | | | 0 | % | | | 0 | % |
The weighted average grant date fair values of units granted duringwas $29.65, $18.66, $16.51 and $15.81 from May 15, 2007 through December 31, 2007, from January 1, 2007 through May 14, 2007, in 2006 and in 2005, were $6.48 and $5.83.respectively. The weighted average fair valuesvalue of units outstanding arewas $11.68 and $6.71 and $6.63 atas of December 31, 2007 and 2006, and 2005.respectively. Compensation expense in connection with the new plan was $78.5 million, $62.9 million, $39.2 million and $29.1 million from May 15, 2007 through December 13, 2007, from January 1, 2007 through May 14, 2007, in 2006 and $29.1 million in 2005.2005, respectively. Included in the 2005 expense is $12.8 million related to the exchange of the partially vested units which represents the difference between the fair value of the award and the intrinsic value of the award attributable to prior vesting. The accrued fair values of units outstanding under the new plan were $84.2$141.6 million and $45.5$84.5 million at December 31, 20062007 and 2005.
IV-20
DISCOVERY COMMUNICATIONS, INC. 2006.
Notes to Consolidated Financial Statements — (Continued)
The following table summarizes information about unit transactions (units in millions) for the new plan: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 2006 | | 2005 | | | Successor | | | | Predecessor | | | | | | Weighted
| | | | Weighted
| | | May 15 -
| | | | January 1 -
| | | | | | | | | | Average
| | | | Average
| | | December 31, 2007 | | | | May 14, 2007 | | 2006 | | 2005 | | | | | | Exercise
| | | | Exercise
| | | | | Weighted
| | | | | | Weighted
| | | | Weighted
| | | | Weighted
| | | | Units | | Price | | Units | | Price | | | | | Average
| | | | | | Average
| | | | Average
| | | | Average
| | | | | | Exercise
| | | | | | Exercise
| | | | Exercise
| | | | Exercise
| | Outstanding at January 1 | | | 24.2 | | | $ | 14.82 | | | | — | | | $ | — | | | | | | Units | | Price | | | | Units | | Price | | Units | | Price | | Units | | Price | | Outstanding at Beginning of period | | | | 26.7 | | | $ | 16.01 | | | | | 26.3 | | | $ | 15.00 | | | | 24.2 | | | $ | 14.82 | | | | — | | | $ | — | | Units exchanged | | | — | | | | — | | | | 7.8 | | | | 12.77 | | | | — | | | | — | | | | | — | | | | — | | | | — | | | | — | | | | 7.8 | | | | 12.77 | | Units granted | | | 3.5 | | | | 16.36 | | | | 16.4 | | | | 15.81 | | | | 6.4 | | | | 29.65 | | | | | 7.8 | | | | 18.66 | | | | 3.5 | | | | 16.36 | | | | 16.4 | | | | 15.81 | | Units exercised | | | (0.1 | ) | | | 13.12 | | | | — | | | | — | | | | (1.1 | ) | | | 15.69 | | | | | (2.3 | ) | | | 14.01 | | | | (0.1 | ) | | | 13.12 | | | | — | | | | — | | Units redeemed/cancelled | | | (1.3 | ) | | | 15.43 | | | | — | | | | — | | | | (5.2 | ) | | | 15.29 | | | | | (5.1 | ) | | | 15.82 | | | | (1.3 | ) | | | 15.43 | | | | — | | | | — | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Outstanding at December 31 | | | 26.3 | | | | 15.00 | | | | 24.2 | | | | 14.82 | | | Outstanding at end of period | | | | 26.8 | | | | 19.42 | | | | | 26.7 | | | | 16.01 | | | | 26.3 | | | | 15.00 | | | | 24.2 | | | | 14.82 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Vested at December 31 | | | 8.5 | | | $ | 13.78 | | | | 1.6 | | | $ | 11.22 | | | Vested at Period-end | | | | 6.6 | | | $ | 13.97 | | | | | 6.5 | | | $ | 13.84 | | | | 8.5 | | | $ | 13.78 | | | | 1.6 | | | $ | 11.22 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
The Company has classified as a current liability $43.3 million for the intrinsic valueentire long term incentive plan liability of units that are or will become fully vested and potentially payable in the next twelve months. The aggregate intrinsic value of units outstanding at December 31, 2006 and 2005 is $82.0 million and $50.1$141.6 million. At December 31, 2006,2007, there was $92.0$137.3 million of unrecognized compensation cost related to unvested units, which the Company expects to recognize over a weighted average period of 2.22.4 years. The following table summarizes information aboutweighted average remaining years of contractual life for outstanding and vested unit awards was 1.48 and 0.75, respectively, for unit awards outstanding as of December 31, 2007. The aggregate intrinsic value of units outstanding at December 31, 2007 and 2006 (units in millions): | | | | | | | | | | | | | | | | | | | Outstanding | | | Vested | | | | | | | Weighted Average
| | | | | | Weighted Average
| | | | | | | Remaining Years of
| | | | | | Remaining Years of
| | Unit Price | | Number of Units | | | Contractual Life | | | Number of Units | | | Contractual Life | | | $3.48 | | | 0.1 | | | | 3.75 | | | | 0.1 | | | | 3.75 | | $7.06 | | | 0.6 | | | | 3.75 | | | | 0.6 | | | | 3.75 | | $12.52 | | | 5.1 | | | | 3.75 | | | | 3.3 | | | | 3.70 | | $15.81 | | | 17.1 | | | | 3.74 | | | | 4.5 | | | | 0.83 | | $16.22 | | | 1.1 | | | | 4.25 | | | | — | | | | — | | $15.84 | | | 1.3 | | | | 4.75 | | | | — | | | | — | | $17.22 | | | 1.0 | | | | 4.93 | | | | — | | | | — | | | | | | | | | | | | | | | | | | | Total | | | 26.3 | | | | 3.86 | | | | 8.5 | | | | 2.20 | | | | | | | | | | | | | | | | | | |
is $228.0 million and $82.0 million respectively. The following table summarizes information about unit transactions (units in millions) for previously established plans:vested intrinsic value of outstanding units was $94.2 million and $36.7 million at December 31, 2007 and 2006, respectively. | | | | | | | | | | | | | | | | | | | 2005 | | | 2004 | | | | | | | Weighted
| | | | | | Weighted
| | | | | | | Average
| | | | | | Average
| | | | | | | Exercise
| | | | | | Exercise
| | | | Units | | | Price | | | Units | | | Price | | | Outstanding at January 1 | | | 25.6 | | | $ | 24.10 | | | | 19.1 | | | $ | 18.18 | | Units exchanged | | | (7.8 | ) | | | 34.31 | | | | — | | | | — | | Units granted | | | 0.5 | | | | 37.35 | | | | 8.7 | | | | 34.22 | | Units redeemed/cancelled | | | (18.3 | ) | | | 20.53 | | | | (2.2 | ) | | | 13.49 | | | | | | | | | | | | | | | | | | | Outstanding at December 31 | | | — | | | | — | | | | 25.6 | | | | 24.10 | | | | | | | | | | | | | | | | | | | Vested at December 31 | | | — | | | $ | — | | | | 17.5 | | | $ | 19.76 | | | | | | | | | | | | | | | | | | |
IV-21IV-27
DISCOVERY COMMUNICATIONS INC.HOLDING, LLC
Notes to Consolidated Financial Statements — (Continued) Domestic and foreign income (loss) before income taxes and discontinued operations is as follows: | | | | | | | | | | | | | | | Year Ended December 31, | | Income Tax Expense | | 2006 | | | 2005 | | | 2004 | | | | in thousands | | | Current | | | | | | | | | | | | | Federal | | $ | 3,906 | | | | (1,479 | ) | | | (231 | ) | State | | | 4,101 | | | | (3,205 | ) | | | 3,952 | | Foreign | | | 59,879 | | | | 57,644 | | | | 32,556 | | | | | | | | | | | | | | | Total current income tax provision | | | 67,886 | | | | 52,960 | | | | 36,277 | | | | | | | | | | | | | | | Deferred | | | | | | | | | | | | | Federal | | | 103,672 | | | | 95,098 | | | | 95,761 | | State | | | 3,707 | | | | 16,298 | | | | 7,723 | | Foreign | | | (3,637 | ) | | | (3,851 | ) | | | — | | | | | | | | | | | | | | | Total deferred income tax expense | | | 103,742 | | | | 107,545 | | | | 103,484 | | | | | | | | | | | | | | | Change in valuation allowance | | | 5,160 | | | | 1,838 | | | | 2,038 | | | | | | | | | | | | | | | Total income tax expense | | $ | 176,788 | | | | 162,343 | | | | 141,799 | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | Successor | | | | Predecessor | | | | May 15 -
| | | | January 1 -
| | | | | | | | Income From Continuing Operations
| | December 31,
| | | | May 14,
| | | | | | | | Before Taxes | | 2007 | | | | 2007 | | | 2006 | | | 2005 | | Domestic | | $ | 254,772 | | | | $ | 86,601 | | | $ | 444,504 | | | $ | 358,065 | | Foreign | | | 7,733 | | | | | 15,374 | | | | (24,629 | ) | | | (4,450 | ) | | | | | | | | | | | | | | | | | | | Income from continuing operations before taxes | | $ | 262,505 | | | | $ | 101,975 | | | $ | 419,875 | | | $ | 353,615 | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | December 31, | | | | 2006 | | | 2005 | | Deferred Income Tax Assets and Liabilities | | Current | | | Non-current | | | Current | | | Non-current | | | | in thousands | | | Assets | | | | | | | | | | | | | | | | | Loss carryforwards | | $ | 19,855 | | | | 27,712 | | | | 43,470 | | | | 61,974 | | Compensation | | | 30,981 | | | | 15,563 | | | | 15,185 | | | | 12,432 | | Accrued expenses | | | 12,088 | | | | 14,981 | | | | 17,769 | | | | — | | Reserves and allowances | | | 10,938 | | | | — | | | | 10,392 | | | | 463 | | Tax credits | | | — | | | | 8,574 | | | | — | | | | 3,823 | | Derivative financial instruments | | | — | | | | 3,141 | | | | — | | | | 7,052 | | Investments | | | — | | | | 10,445 | | | | — | | | | 86,039 | | Intangibles | | | — | | | | 104,078 | | | | — | | | | 41,401 | | Other | | | 4,301 | | | | 20,897 | | | | 3,689 | | | | 11,732 | | | | | | | | | | | | | | | | | | | | | | 78,163 | | | | 205,391 | | | | 90,505 | | | | 224,916 | | Valuation allowance | | | — | | | | (26,552 | ) | | | — | | | | (21,392 | ) | | | | | | | | | | | | | | | | | | Total deferred income tax assets | | | 78,163 | | | | 178,839 | | | | 90,505 | | | | 203,524 | | | | | | | | | | | | | | | | | | | Liabilities | | | | | | | | | | | | | | | | | Accelerated depreciation | | | — | | | | (6,164 | ) | | | — | | | | (11,948 | ) | Content rights and deferred launch incentives | | | — | | | | (200,732 | ) | | | — | | | | (109,009 | ) | Foreign currency translation | | | — | | | | (12,936 | ) | | | — | | | | (4,103 | ) | Unrealized gains on investments | | | — | | | | (861 | ) | | | — | | | | (1,920 | ) | Other | | | (2,007 | ) | | | (4,435 | ) | | | (1,740 | ) | | | (7,228 | ) | | | | | | | | | | | | | | | | | | Total deferred income tax liabilities | | | (2,007 | ) | | | (225,128 | ) | | | (1,740 | ) | | | (134,208 | ) | | | | | | | | | | | | | | | | | | Deferred income tax assets (liabilities), net | | $ | 76,156 | | | | (46,289 | ) | | | 88,765 | | | | 69,316 | | | | | | | | | | | | | | | | | | |
Income tax expense from continuing operations for the years ended December 31, 2007, 2006 and 2005 is as follows: | | | | | | | | | | | | | | | | | | | | Successor | | | | Predecessor | | | | May 15 -
| | | | January 1 -
| | | | | | | | | | December 31,
| | | | May 14,
| | | | | | | | Income Tax Expense | | 2007 | | | | 2007 | | | 2006 | | | 2005 | | | | in thousands | | Current | | | | | | | | | | | | | | | | | | Federal | | $ | 52,346 | | | | $ | 20,526 | | | $ | 4,591 | | | $ | (1,479 | ) | State | | | 7,079 | | | | | 5,064 | | | | 5,695 | | | | (3,205 | ) | Foreign | | | 28,185 | | | | | 16,634 | | | | 59,879 | | | | 57,644 | | | | | | | | | | | | | | | | | | | | Total current income tax provision | | | 87,610 | | | | | 42,224 | | | | 70,165 | | | | 52,960 | | | | | | | | | | | | | | | | | | | | Deferred | | | | | | | | | | | | | | | | | | Federal | | | (65,091 | ) | | | | 4,618 | | | | 114,986 | | | | 106,182 | | State | | | 9,879 | | | | | 9,023 | | | | 3,707 | | | | 16,298 | | Foreign | | | 1,989 | | | | | 3,395 | | | | (3,637 | ) | | | (3,851 | ) | | | | | | | | | | | | | | | | | | | Total deferred income tax (benefit) expense | | | (53,223 | ) | | | | 17,036 | | | | 115,056 | | | | 118,629 | | | | | | | | | | | | | | | | | | | | Change in valuation allowance | | | (9,084 | ) | | | | (7,097 | ) | | | 5,160 | | | | 1,838 | | | | | | | | | | | | | | | | | | | | Total income tax expense | | $ | 25,303 | | | | $ | 52,163 | | | $ | 190,381 | | | $ | 173,427 | | | | | | | | | | | | | | | | | | | |
IV-22IV-28
DISCOVERY COMMUNICATIONS INC.HOLDING, LLC
Notes to Consolidated Financial Statements — (Continued) Components of deferred tax assets and liabilities as of December 31, 2007 and 2006 are as follows: | | | | | | | | | | | | | | | | | | | | December 31 | | | | Successor
| | | | Predecessor
| | | | 2007 | | | | 2006 | | Deferred Income Tax Assets and Liabilities | | Current | | | Non-current | | | | Current | | | Non-current | | | | in thousands | | Assets | | | | | | | | | | | | | | | | | | Loss carryforwards | | $ | 21,851 | | | $ | 21,145 | | | | $ | 19,855 | | | $ | 27,712 | | Compensation | | | 58,762 | | | | 9,489 | | | | | 30,981 | | | | 15,563 | | Accrued expenses | | | 11,161 | | | | 13,232 | | | | | 12,088 | | | | 14,981 | | Reserves and allowances | | | 8,613 | | | | — | | | | | 10,938 | | | | — | | Tax credits | | | — | | | | — | | | | | — | | | | 8,574 | | Derivative financial instruments | | | — | | | | 6,992 | | | | | — | | | | 3,141 | | Investments | | | — | | | | 13,337 | | | | | — | | | | 10,445 | | Depreciation | | | — | | | | 16,169 | | | | | — | | | | — | | Intangibles | | | — | | | | 68,293 | | | | | — | | | | 104,078 | | Uncertain tax positions | | | — | | | | 28,089 | | | | | — | | | | — | | Other | | | 4,769 | | | | 17,024 | | | | | 4,301 | | | | 20,897 | | | | | | | | | | | | | | | | | | | | | | | 105,156 | | | | 193,770 | | | | | 78,163 | | | | 205,391 | | Valuation allowance | | | — | | | | (10,250 | ) | | | | — | | | | (26,552 | ) | | | | | | | | | | | | | | | | | | | Total deferred income tax assets | | | 105,156 | | | | 183,520 | | | | | 78,163 | | | | 178,839 | | | | | | | | | | | | | | | | | | | | Liabilities | | | | | | | | | | | | | | | | | | Depreciation | | | — | | | | — | | | | | — | | | | (6,164 | ) | Content rights and deferred launch incentives | | | — | | | | (156,654 | ) | | | | — | | | | (200,732 | ) | Foreign currency translation | | | — | | | | (5,744 | ) | | | | — | | | | (12,936 | ) | Unrealized gains on investments | | | — | | | | (24,970 | ) | | | | — | | | | (861 | ) | Other | | | (1,433 | ) | | | (6,771 | ) | | | | (2,007 | ) | | | (4,435 | ) | | | | | | | | | | | | | | | | | | | Total deferred income tax liabilities | | | (1,433 | ) | | | (194,139 | ) | | | | (2,007 | ) | | | (225,128 | ) | | | | | | | | | | | | | | | | | | | Deferred income tax assets (liabilities), net | | $ | 103,723 | | | $ | (10,619 | ) | | | $ | 76,156 | | | $ | (46,289 | ) | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | Year Ended December 31, | | Reconciliation of Effective Tax Rate | | 2006 | | | 2005 | | | 2004 | | | Federal statutory rate | | | 35.0 | % | | | 35.0 | % | | | 35.0 | % | Increase (decrease) in tax rate arising from: | | | | | | | | | | | | | State income taxes, net of Federal benefit | | | 1.4 | | | | 3.0 | | | | 2.4 | | Foreign income taxes, net of Federal benefit | | | 8.5 | | | | 9.3 | | | | 6.4 | | Other | | | 1.1 | | | | 3.1 | | | | 2.0 | | | | | | | | | | | | | | | Effective income tax rate | | | 46.0 | % | | | 50.4 | % | | | 45.8 | % | | | | | | | | | | | | | |
IV-29
DISCOVERY COMMUNICATIONS HOLDING, LLC
Notes to Consolidated Financial Statements — (Continued) Income tax benefit (expense) from continuing operations differs from the amounts computed by applying the U.S. Federal income tax rate of 35.0% as a result of the following: | | | | | | | | | | | | | | | | | | | | Successor | | | Predecessor | | | May 15 -
| | | January 1 -
| | Year Ended December 31, | Reconciliation of Effective Tax Rate from Continuing Operations | | December 31, 2007 | | | May 14, 2007 | | 2006 | | 2005 | Federal statutory rate | | | 35.0 | % | | | | 35.0 | % | | | 35.0 | % | | | 35.0 | % | Increase (decrease) in tax rate arising from: | | | | | | | | | | | | | | | | | | State income taxes, net of Federal benefit | | | 2.4 | | | | | 1.9 | | | | 1.5 | | | | 3.2 | | Foreign income taxes, net of Federal benefit | | | 7.5 | | | | | 12.8 | | | | 7.7 | | | | 9.7 | | Non-taxable gain | | | (17.9 | ) | | | | — | | | | — | | | | — | | Travel deferred tax liabilities | | | (20.4 | ) | | | | — | | | | — | | | | — | | Change in US reserve | | | 3.3 | | | | | — | | | | — | | | | — | | Non-deductible goodwill write-off | | | — | | | | | 3.9 | | | | — | | | | — | | Domestic production deduction | | | (1.1 | ) | | | | (1.8 | ) | | | — | | | | — | | Other | | | 0.8 | | | | | (0.6 | ) | | | 1.1 | | | | 1.1 | | Effective income tax rate | | | 9.6 | % | | | | 51.2 | % | | | 45.3 | % | | | 49.0 | % |
The disposal of the Travel Business resulted in a gain of $134.7 million for book purposes, but the transaction was not recognized for tax purposes under Internal Revenue Code Sections 355 and 368. The transaction also resulted in a reduction of the Company’s deferred tax liabilities related to the Travel Channel of $54.0 million. As of December 31, 2007, the Company has Federalfederal operating loss carryforwards of $56.7$93.3 million that begin to expire in 2021 and state operating loss carryforwards of $728.1$296.9 million in various state jurisdictions available to offset future taxable income that expire in various amounts through 2025. In 2007, the Company acquired federal operating loss carryforwards of $89.6 million. The Company also has $8.6 millionstate operating loss carryforwards are subject to a valuation allowance of alternative minimum tax credits that do not have an expiration date.$5.4 million. The change in the valuation allowance from prior year reflects the elimination of fully reserved state operating loss carryforwards upon disposal of the Retail business. Deferred tax assets are reduced by a valuation allowance relating to the state tax benefits attributable to net operating losses in certain jurisdictions where realizability is not more likely than not. The Company’s ability to utilize foreign tax credits is currently limited by its overall foreign loss under Section 904(f) of the Internal Revenue Code. The Company has no alternative minimum tax credits. The Company files U.S. federal, state, and foreign income tax returns. With few exceptions, the Company is no longer subject to audit by the Internal Revenue Service (“IRS”), state tax authorities, ornon-U.S. tax authorities for years prior to 2003. It is reasonably possible that the total amount of unrecognized tax benefits related to tax positions taken (or expected to be taken) on 2005, 2006, and 2007non-U.S. tax returns could decrease by as much as $32.8 million within the next twelve months as a result of settlement of audit issuesand/or payment of uncertain tax liabilities, which could impact the effective tax rate. The IRS is not currently examining the Company’s consolidated federal income tax return. However, some of the Company’s joint ventures are under examination for the 2004 tax year. The Company does not expect any significant adjustments. As a result of the implementation of FIN 48, the Company recognized an increase of $36.3 million in its liability for unrecognized tax benefits, which was offset in part by a corresponding increase of $31.3 million in deferred tax assets. The remaining $5.0 million was accounted for as a reduction to the January 1, 2007 balance of IV-30
16. Financial InstrumentsDISCOVERY COMMUNICATIONS HOLDING, LLC
DerivativeNotes to Consolidated Financial InstrumentsStatements — (Continued)
retained earnings. A reconciliation of the beginning and ending amount of unrecognized tax benefits (without related interest amounts) is as follows: | | | | | Reconciliation of Unrecognized Tax Benefits | | | | | Balance at January 1, 2007 (Predecessor) | | $ | 91,375 | | Reductions for tax positions of prior years (Predecessor) | | | (412 | ) | Additions based on tax positions related to the current year (Successor) | | | 11,650 | | Additions for tax positions of prior years (Successor) | | | 16,830 | | Reductions for tax positions of prior years (Successor) | | | (28,674 | ) | Settlements (Successor) | | | (2,035 | ) | | | | | | Balance at December 31, 2007 (Successor) | | $ | 88,734 | | | | | | |
Included in the balance at December 31, 2007, are $9.5 million of tax positions for which the ultimate deductibility is highly certain but for which there is uncertainty about the timing of such deductibility. Because of the impact of deferred tax accounting, other than interest and penalties, the disallowance of the shorter deductibility period would not affect the annual effective tax rate but would accelerate the payment of cash to the taxing authority to an earlier period. FIN 48 requires uncertain tax positions to be recognized and presented on a gross basis (i.e., without regard to likely offsets for deferred tax assets, deductions,and/or credits that would result from payment of uncertain tax amounts). On a net basis, the balance at December 31, 2007 is $45.2 million (including related interest amounts) after offsetting deferred tax assets, deductions,and/or credits on the Company’s tax returns. The Company’s policy is to classify tax interest and penalties related to unrecognized tax benefits as tax expense. Interest expense related to unrecognized tax benefits recognized was approximately $2.1 million, $1.3 million, $0.8 million, and $0.9 million from May 15, 2007 through December 31, 2007, from January 1, 2007 through May 14, 2007, in 2006 and in 2005, respectively. The Company had accrued approximately $6.4 million and $2.3 million of total interest payable in the tax accounts as of December 31, 2007, and 2006, respectively. Additional interest of $0.7 million was accrued upon adoption of FIN 48 in the first quarter of its fiscal year 2007, with a corresponding reduction to retained earnings. | | 17. | Financial Instruments |
The Company uses derivative financial instruments to modify its exposure to market risks from changes in interest rates and foreign exchange rates. The Company does not hold or enter into financial instruments for speculative trading purposes. The Company’s interest expense is exposed to movements in short-term interest rates. Derivative instruments, including both fixed to variable and variable to fixed interest rate instruments, are used to modify this exposure. These instruments include a combination of swaps caps, collars, and other structured instrumentsswaptions to modify interest rate exposure. At December 31, 2006 and 2005, theThe variable to fixed interest rate instruments have a notional principal amount of $1,025.0$2,270.0 million and $1,200.0$1,025.0 million and have a weighted average interest rate of 4.68% and 5.09% and 5.82%. Atat December 31, 2007 and 2006, and 2005, therespectively. The fixed to variable interest rate agreements have a notional principal amount of $225.0 million and have a weighted average interest rate of 9.65% and 9.86% at December 31, 2007 and 8.39%.2006, respectively. At December 31, 2006,2007, the Company held an unexercised interest rate swap put with a notional amount of $25.0 million at a fixed rate of 5.44%. As a result of unrealized mark to marketmark-to-market adjustments, the Company recorded($10.0) million, $1.4 million, $10.4 million $29.1 million and $44.1$29.1 million in gains (losses) on these instruments duringwere recorded from May 15, 2007 through December 31, 2007, from January 1, 2007 through May 14, 2007, in 2006 and in 2005, and 2004. respectively. The fair value of these derivative instruments, which aggregate ($49.6) million and $8.5 million at December 31, 2007 and 2006, respectively, is recorded as a component of long-term liabilities and other current liabilities IV-31
DISCOVERY COMMUNICATIONS HOLDING, LLC
Notes to Consolidated Financial Statements — (Continued) in the consolidated balance sheets. Changes in the fair value of these derivative instruments are recorded as a component of operating cash flows. These Of the total of $2,270.0 million, a notional amount of $1,460.0 million of these derivative instruments didare 100% effective cash flow hedges. The value of these hedges at December 31, 2007 was ($32.5) million with changes in the mark-to-market value recorded as a component of other comprehensive income (loss), net of taxes. Should any portion of these instruments become ineffective due to a restructuring in the Company’s debt, the monthly changes in fair value would be reported as a component of other income on the Statement of Operations. The Company does not receiveexpect any hedge accounting treatment.ineffectiveness in the next twelve months. The foreign exchange instruments used are spot, forward, and option contracts. Additionally, the Company enters into non-designated forward contracts to hedge non-dollar denominated cash flows and foreign currency balances. At December 31, 20062007 and 2005,2006, the notional amount of foreign exchange derivative contracts was $174.2 million and $364.1 million, and $91.4 million.respectively. As a result of unrealized mark to marketmark-to-market adjustments, the Company recognized a($3.3) million, ($0.9) million, $2.0 million gain and $2.3 million and $0.4($2.3) million in lossesgains (losses) were recognized on these instruments duringfrom May 15, 2007 through December 31, 2007, from January 1, 2007 through May 14, 2007, in 2006 and in 2005, and 2004.respectively. The fair value of these derivative instruments is recorded as a component of long-term liabilities and other current liabilities in the consolidated balance sheets. These derivative instruments did not receive hedge accounting treatment. During 2005, the Company entered into several treasury locks to hedge a forecasted debt financing transaction. The value of the hedges at closing was $3.3 million. These derivatives received hedge accounting treatment and the deferred gain has been recorded as a component of Other Comprehensive Income (Loss), net of taxes and is being amortized as an adjustment to interest expense.
Fair Value of Financial Instruments The fair values of cash and cash equivalents, receivables, and accounts payable approximate their carrying values. Marketable equity securities are carried at fair value and fluctuations in fair value are recorded through other IV-23
DISCOVERY COMMUNICATIONS, INC.
Notes to Consolidated Financial Statements — (Continued)
comprehensive income.income (loss). Losses on investments that are other than temporary declines in value are recorded in the statement of operations. The carrying amount of the Company’s borrowings was $2,641$4,141.1 million and the fair value was $4,186.7 million at December 31, 2007. The carrying amount of the Company’s borrowings was $2,641.0 million and the fair value was $2,702.0 million at December 31, 2006. The carrying amount of the Company’s borrowings was $2,597.0 million and the fair value was $2,674.0 million at December 31, 2005. The carrying amount of all derivative instruments represents their fair value. The net fair value of the Company’s short and long-term derivative instruments is $(6.5)($51.2) million at December 31, 2006; 18.0%2007; 4%, 37.0%11%, 0.0%61%, 2.0%23%, and 43.0%1% of these derivative instrument contracts will expire in 2007, 2008, 2009, 2010, 2011 and thereafter. The net fair value of the Company’s short and long-term derivative instruments was $(19.8) million at December 31, 2005.thereafter, respectively. The fair value of derivative contracts was estimated by obtaining interest rate and volatility market data from brokers. As of December 31, 2006,2007, an estimated 100 basis point parallel shift in the interest rate yield curve would change the fair value of the Company’s portfolio by approximately $9.5$45.2 million. Credit Concentrations The Company continually monitors its positions with, and the credit quality of, the financial institutions that are counterparties to its financial instruments and does not anticipate nonperformance by the counterparties. In addition, the Company limits the amount of investment credit exposure with any one institution. The Company’s trade receivables and investments do not represent a significant concentration of credit risk at December 31, 20062007 due to the wide variety of customers and markets in which the Company operates and their dispersion across many geographic areas. | | 17.18. | Related Party Transactions |
The Company identifies related parties as investors andin their consolidated businesses,subsidiaries, the Company’s joint venture partners and equity investments, and the Company’s executive management. The most significant transactionsTransactions with related IV-32
DISCOVERY COMMUNICATIONS HOLDING, LLC
Notes to Consolidated Financial Statements — (Continued) parties typically result from companies that distributedistribution of networks, produceproduction of content, or provide media uplink services. Gross revenue earned from related parties was $21.3 million, $46.9 million, $90.0 million and $73.7 million and $71.8 millionfrom May 15, 2007 through December 31, 2007, from January 1, 2007 through May 14, 2007, in 2006 and in 2005, and 2004.respectively. Accounts receivable from these entities were $15.0$6.5 million and $17.0$15.0 million at December 31, 2007 and 2006, and 2005.respectively. Purchases from related parties totaled $54.8 million, $31.8 million, $83.3 million and $71.4 million and $133.2 millionfrom May 15, 2007 through December 31, 2007, from January 1, 2007 through May 14, 2007, in 2006 and in 2005, and 2004;respectively; of these purchases, $5.1 million, $3.0 million, $8.4 million and $23.1 million and $91.0 million relaterelated to capitalized assets.assets from January 1, 2007 through May 14, 2007, May 15, 2007 through December 31, 2007, in 2006 and in 2005 respectively. Amounts payable to these parties totaled $2.4$0.6 million and $2.3$2.4 million at December 31, 2007 and 2006, and 2005.respectively.
IV-24IV-33
SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. DISCOVERY HOLDING COMPANY | | | | | | By | DISCOVERY HOLDING COMPANY | | | | | | Dated: February 28, 2007 | | By | | /s/ John C. Malone
John C. Malone
Chief Executive Officer
|
John C. Malone Chief Executive Officer Dated: February 15, 2008 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the date indicated. | | | | | | | February 28, 2007 | | /s/ John C. MaloneSignature
| | Title John C. Malone
Chairman of the Board, Director
and Chief Executive Officer | | Date | | | | | | | February 28, 2007/s/ John C. Malone John C. Malone | | /s/ Robert R. Bennett
Robert R. Bennett Chairman of the Board, Director and PresidentChief Executive Officer | | February 15, 2008 | | | | | | February 28, 2007/s/ Robert R. Bennett Robert R. Bennett | | /s/ Paul A. Gould
Paul A. Gould Director and President | | February 15, 2008 | | | | | | February 28, 2007/s/ Paul A. Gould Paul A. Gould | | /s/ M. LaVoy Robison
M. LaVoy Robison Director | | February 15, 2008 | | | | | | February 28, 2007/s/ M. LaVoy Robison M. LaVoy Robison | | /s/ J. David Wargo
J. David Wargo Director | | February 15, 2008 | | | | | | February 28, 2007/s/ J. David Wargo J. David Wargo | | /s/ David J.A. Flowers
David J.A. Flowers
Senior Vice President and Treasurer
(Principal Financial Officer)Director | | February 15, 2008 | | | | February 28, 2007 | | /s/ David J.A. Flowers David J.A. Flowers | | Senior Vice President and Treasurer (Principal Financial Officer) | | February 15, 2008 | | | | | | /s/ Christopher W. Shean Christopher W. Shean
| | Senior Vice President and Controller
(Principal (Principal Accounting Officer) | | February 15, 2008 |
IV-25IV-34
EXHIBIT INDEX Listed below are the exhibits which are filed as a part of this Report (according to the number assigned to them in Item 601 ofRegulation S-K): | | | | | 2 — Plan of Acquisition, Reorganization, Arrangement, Liquidation or Succession: | | 2.1 | | | Reorganization Agreement among Liberty Media Corporation, Discovery Holding Company (“DHC”) and Ascent Media Group, Inc. (incorporated by reference to Exhibit 2.1 to DHC’s Registration Statement on Form 10, dated July 15, 2005 (FileNo. 000-51205) (the “Form 10”)). | 3 — Articles of Incorporation and Bylaws: | | 3.1 | | | Restated Certificate of Incorporation of DHC (incorporated by reference to Exhibit 3.1 to the Form 10). | | 3.2 | | | Bylaws of DHC (incorporated by reference to Exhibit 3.2 to the Form 10). | 4 — Instruments Defining the Rights of Securities Holders, including Indentures: | | 4.1 | | | Specimen Certificate for shares of the Series A common stock, par value $.01 per share, of DHC (incorporated by reference to Exhibit 4.1 to the Form 10). | | 4.2 | | | Specimen Certificate for shares of the Series B common stock, par value $.01 per share, of DHC (incorporated by reference to Exhibit 4.2 to the Form 10). | | 4.3 | | | Rights Agreement between DHC and EquiServe Trust Company, N.A., as Rights Agent (incorporated by reference to Exhibit 4.3 to the Form 10). | 10 — Material Contracts: | | 10.1 | | | The ShareholdersAmended and Restated Limited Liability Company Agreement of Discovery Communications Holding, LLC, dated as of November 30, 1991 (the “Stockholders’ Agreement”),May 14, 2007, by and among Discovery Communications, Inc. (“Discovery”), CoxAdvance/Newhouse Programming Partnership, LMC Discovery, Inc. (“Cox”), NewsChannels TDC Investments, Inc. (“NewChannels”), TCI Cable Education, Inc. (“TCID”) and John S. Hendricks, (“Hendricks”) (incorporated by reference to Exhibit 10.1 to the Form 10).filed herewith. | | 10.2 | | | First Amendment to the Stockholders’ Agreement, dated as of December 20, 1996, by and among Discovery, Cox Communications Holdings, Inc. (the successor to Cox), Newhouse Broadcasting Corporation ( the successor to NewChannels), TCID, Hendricks and for the purposes stated therein only, LMC Animal Planet, Inc. (“LMC”) and Liberty Media Corporation, a Colorado corporation (“Liberty”) (incorporated by reference to Exhibit 10.2 to the Form 10). | | 10.3 | | | Second Amendment to the Stockholders’ Agreement, dated as of September 7, 2000, by and among Discovery, Cox Communications Holdings, Inc. (the successor to Cox), Advance/Newhouse Programming Partnership (the successor to NewChannels), LMC Discovery, Inc. (formerly known as TCID) and Hendricks (incorporated by reference to Exhibit 10.3 to the Form 10). | | 10.4 | | | Third Amendment to the Stockholders’ Agreement, dated as of September, 2001, by and among Discovery, Cox, NewChannels, TCID, Hendricks and Advance Programming Holdings Corp. (incorporated by reference to Exhibit 10.4 to the Form 10). | | 10.5 | | | Fourth Amendment to the Stockholders’ Agreement, dated as of June 23, 2003, by and among Discovery, Cox NewChannels, TCID, Liberty Animal, Inc. (the successor in interest to LMC) for the purposes stated in the First Amendment to the Stockholders’ Agreement, and Hendricks (incorporated by reference to Exhibit 10.5 to the Form 10). | | 10.6 | | | Form of Tax Sharing Agreement between Liberty Media Corporation and DHC (incorporated by reference to Exhibit 10.6 to the Form 10). | | 10.710.3 | | | Discovery Holding Company 2005 Incentive Plan (As Amended and Restated Effective August 15, 2007) (incorporated by reference to Exhibit 10.710.1 to the Quarterly Report onForm 10)10-Q of Discovery Holding Company for the quarter ended September 30, 2007 (FileNo. 000-51205) as filed on November 7, 2007). | | 10.810.4 | | | Discovery Holding Company 2005 Non-Employee Director Incentive Plan (As Amended and Restated Effective August 15, 2007) (incorporated by reference to Exhibit 10.810.2 to the Quarterly Report onForm 10)10-Q of Discovery Holding Company for the quarter ended September 30, 2007 (FileNo. 000-51205) as filed on November 7, 2007). | | 10.910.5 | | | Discovery Holding Company Transitional Stock Adjustment Plan (As Amended and Restated Effective August 15, 2007) (incorporated by reference to Exhibit 10.910.3 to the Quarterly Report onForm 10)10-Q of Discovery Holding Company for the quarter ended September 30, 2007 (FileNo. 000-51205) as filed on November 7, 2007). | | 10.1010.6 | | | Agreement between DHC and John C. Malone (incorporated by reference to Exhibit 10.10 to the Form 10). | | 10.1110.7 | | | Agreement, dated June 24, 2005, between Discovery and DHC (incorporated by reference to Exhibit 10.11 to the Form 10). | | 10.1210.8 | | | Indemnification Agreement, dated as of June 24, 2005, between Cox and DHC (incorporated by reference to Exhibit 10.12 to the Form 10). | | 10.1310.9 | | | Indemnification Agreement, dated as of June 24, 2005, between NewChannels and DHC (incorporated by reference to Exhibit 10.13 to the Form 10). | | 10.1410.10 | | | Form of Indemnification Agreement with Directors and Executive Officers (incorporated by reference to Exhibit 10.14 to the Form 10). |
| | | | | 21 — Subsidiaries of Discovery Holding Company, filed herewith. | | 23.1 | | | Consent of KPMG LLP, filed herewith. | | 23.2 | | | Consent of PricewaterhouseCoopers LLP, filed herewith. | | 31.1 | | | Rule 13a-14(a)/15d — 14(a) Certification, filed herewith. | | 31.2 | | | Rule 13a-14(a)/15d — 14(a) Certification, filed herewith. | | 31.231.3 | | | Rule 13a-14(a)/15d — 14(a) Certification, filed herewith. | | 31.3 | | | Rule 13a-14(a)/15d — 14(a) Certification, filed herewith. | 32 — Section 1350 Certification, filed herewith. |
|
|
|
|
|