UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.D. C. 20549
 
FORMForm 10-K
 
   
þ
 ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
  For the fiscal year ended December 31, 20062007
OR
o
 TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
  For the transition period from          to          
 
Commission File Number000-51205
 
DISCOVERY HOLDING COMPANY
(Exact name of Registrant as specified in its charter)
 
   
State of Delaware 20-2471174
(State or other jurisdiction of
incorporation or organization)		 (I.R.S. Employer
Identification No.)
   
12300 Liberty Boulevard  
Englewood, Colorado 80112
(Address of principal executive offices) (Zip Code)
 
Registrant’s telephone number, including area code:
(720) 875-4000
Securities registered pursuant to Section 12(b) of the Act:
 
   
Title of each classEach Class
 
Name of exchangeExchange on which registeredWhich Registered
Series A Common Stock, par value $.01 per share
Nasdaq Global Select Market
Series B Common Stock, par value $.01 per share Nasdaq
Nasdaq Global Select Market
 
Securities registered pursuant to Section 12(g) of the Act:
None
 
Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act of 1933.  Yes oþ     No þo
 
Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Securities Exchange Act of 1934.  Yes o     No þ
 
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 ofRegulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of thisForm 10-K or any amendment to thisForm 10-K.  þ
 
Indicate by check mark whether the Registrantregistrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer, (as definedor a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” inRule 12b-2 of the Act).Exchange Act. (Check One):
Large accelerated filer þ     Accelerated filer o     Non-accelerated filer o
Large accelerated filer þ
Accelerated filer oNon-accelerated filer oSmaller reporting company o
(Do not check if a smaller reporting company)
 
Indicate by check mark whether the Registrant is a shell company (as defined inRule 12b-2 of the Act)  Yes o     No þ
 
The aggregate market value of the voting stock held by nonaffiliates of Discovery Holding Company computed by reference to the last sales price of such stock, as of the closing of trading on June 30, 2006,2007, was approximately $3.9$6.1 billion.
 
The number of shares outstanding of Discovery Holding Company’s common stock as of January 31, 20072008 was:
 
Series A Common Stock – 268,197,601;— 269,179,015; and
Series B Common Stock – 12,025,078— 11,869,696 shares.
 
Documents Incorporated by ReferenceDOCUMENTS INCORPORATED BY REFERENCE
The Registrant’s definitive proxy statement for its 20072008 Annual Meeting of Stockholders is hereby incorporated by reference into Part III of this Annual Report onForm 10-K
 

 

 
DISCOVERY HOLDING COMPANY
2006
2007 ANNUAL REPORT ONFORM 10-K

Table of Contents
 
         
    Page
 
PartPART I
Item 1.
 Business I-1
Item 1A.
 Risk Factors I-12I-27
Item 1B.
 Unresolved Staff Comments I-18I-37
Item 2.
 Properties I-18I-37
Item 3.
 Legal Proceedings I-18I-37
Item 4.
 Submission of Matters to a Vote of Security Holders I-18I-37
 
PartPART II
Item 5.
 Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities II-1
Item 6.
 Selected Financial Data II-1II-2
Item 7.
 Management’s Discussion and Analysis of Financial Condition and Results of Operations II-2II-3
Item 7A.
 Quantitative and Qualitative Disclosures About Market Risk II-13II-25
Item 8.
 Financial Statements and Supplementary Data II-13II-25
Item 9.
 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure II-13II-25
Item 9A.
 Controls and Procedures II-13II-25
Item 9B.
 Other Information II-14II-25
 
PartPART III
Item 10.
 Directors, Executive Officers and Corporate Governance III-1
Item 11.
 Executive Compensation III-1
Item 12.
 Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters III-1
Item 13.
 Certain Relationships and Related Transactions, and Director Independence III-1
Item 14.
 Principal Accounting Fees and Services III-1
 
PartPART IV
Item 15.
 Exhibits and Financial Statement Schedules IV-1
Amended and Restated Limited Liability Company Agreement
 Subsidiaries of Discovery Holding Company
 Consent of KPMG LLP
 Consent of PricewaterhouseCoopers LLP
 Rule 13a-14(a)/15d-14(a) Certification
 Rule 13a-14(a)/15d-14(a) Certification
 Rule 13a-14(a)/15d-14(a) Certification
 Section 1350 Certification

 
PART I.
 
Item 1.BusinessBusiness..
 
(a)  General Development of Business
(a)  General Development of Business
 
Discovery Holding Company was incorporated in the state of Delaware on March 9, 2005 as a wholly-owned subsidiary of Liberty Media Corporation, which we refer to as Liberty. On July 21, 2005, Liberty completed the spin off of Discovery Holding Company to Liberty’s shareholders. In the spin off, each holder of Liberty common stock received 0.10 of a share of our Series A common stock for each share of Liberty Series A common stock held and 0.10 of a share of our Series B common stock for each share of Liberty Series B common stock held. Approximately 268.1 million shares of our Series A common stock and 12.1 million shares of our Series B common stock were issued in the spin off, which iswas intended to qualify as a tax-free transaction.
 
We are a holding company. Through our wholly owned subsidiary,two wholly-owned operating subsidiaries, Ascent Media Group, LLC (“Ascent Media”) and Ascent Media CANS, LLC (dba AccentHealth) (“AccentHealth”), and through our 50%662/3% owned equity affiliate Discovery Communications Inc.Holding, LLC (“Discovery” or “DCI”), we are engaged primarily in (1) the production, acquisition and distribution of entertainment, educational and information programming and software, (2) the retail sale and licensing of branded and other specialty products and (3) the provision of creative and network services to the media and entertainment industries.industries and (2) the production, acquisition and distribution of entertainment, educational and informational programming and software. Our subsidiaries and affiliates operate in the United States, Europe, Latin America, Asia, Africa and Australia.
 
The assets and operations of Ascent Media are composed primarily of the assets and operations of 13 companies acquired by Liberty from 2000 through 2004, including The Todd-AO Corporation, Four Media Company, certain assets of SounDelux Entertainment Group, Video Services Corporation, Group W Network Services, London Playout Centre and the systems integration business of Sony Electronics. The combination and integration of these and other acquired entities allowallows Ascent Media to offer integrated outsourcing solutions for the technical and creative requirements of its clients, from content creation and other post-production services to media management and transmission of the final product to broadcast television stations, cable system head-ends and other destinations and distribution points.
 
Discovery is a leading global media and entertainment company. Discovery has grown from the 1985 launch in the United States of its core property, Discovery Channel, to current global operations in over 170 countries across six continents, with over 1.5 billion total cumulative subscription units. Discovery operates its businesses in three groups: Discovery networks U.S., Discovery networks international, and Discovery commerce, education and other.
On January 27, 2006,AccentHealth, which we acquired AccentHealth, LLC (“AccentHealth”) for cash consideration of $45 million, plus working capital adjustments of $1.8 million. AccentHealthin January 2006, operates an advertising-supported captive audience television network in doctor office waiting rooms nationwide. For financial
Discovery is a leading global media and entertainment company that provides original and purchased programming across multiple distribution platforms in the United States and more than 170 other countries, including television networks offering customized programming in 35 languages. Discovery also develops and sells consumer and educational products and services in the United States and internationally, and owns and operates a diversified portfolio of website properties and other digital services. Discovery operates through three divisions: (1) Discovery networks U.S., (2) Discovery networks international, and (3) Discovery commerce and education.
Discovery was formed in the second quarter of 2007 as part of a restructuring (the “DCI Restructuring”) completed by Discovery Communications, Inc. (“DCI”). In the DCI Restructuring, DCI was converted into a limited liability company and became a wholly-owned subsidiary of Discovery, and the former shareholders of DCI, including us, became members of Discovery. Subsequent to the DCI Restructuring, each of the members of Discovery held the same membership interests in Discovery as they previously held in DCI. Discovery is the successor reporting purposes,entity to DCI.
On May 14, 2007, Discovery and Cox Communications Holdings, Inc. (“Cox”) completed an exchange of Cox’s 25% membership interest in Discovery for all of the capital stock of a subsidiary of Discovery that held Travel Channel, travelchannel.com and approximately $1.3 billion in cash (the “Cox Transaction”). Discovery raised the cash component through additional debt financing, and retired the membership interest previously owned by Cox. Upon completion of this transaction, we own a 662/3% interest in Discovery and Advance/Newhouse Programming Partnership (“Advance/Newhouse”) owns a 331/3% interest. We continue to account for our investment in Discovery using the equity method of accounting due to governance rights possessed by Advance/Newhouse which restrict our ability to control Discovery.


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In December 2007, we announced that we had signed a non-binding letter of intent with Advance/Newhouse to combine our respective stakes in Discovery. As currently contemplated by the non-binding letter of intent, the transaction, if completed, would involve the following steps:
• We will spin-off to our shareholders a wholly-owned subsidiary holding cash and Ascent Media, except for those businesses of Ascent Media that provide sound, music, mixing, sound effects and other related services;
• Immediately following the spin-off, we will combine with a new holding company (“New DHC”), and our existing stockholders will receive shares of common stock of New DHC;
• As part of this transaction, Advance/Newhouse will contribute its interests in Discovery and Animal Planet to New DHC in exchange for preferred stock of New DHC that, immediately after the closing of the transactions, will be convertible at any time into shares initially representing one-third of the outstanding shares of common stock of New DHC. The preferred stock held by Advance/Newhouse will entitle it to elect two members to New DHC’s board of directors and to exercise approval rights with respect to the taking of specified actions by New DHC and Discovery.
Although no assurance can be given, consummation of this transaction (the “Newhouse Transaction and Ascent Spin Off”) is expected to close in the second quarter of 2008 and would result in the consolidation of the results of operations of AccentHealth have been included in our consolidated results as part of Ascent Media’s network services group.Discovery within New DHC.
 
* * * * *
 
Certain statements in this Annual Report onForm 10-K constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including statements regarding our business, marketing and operating strategies, integration of acquired businesses, new service offerings, financial prospects and anticipated sources and uses of capital. In particular, statements under Item 1. “Business,” Item 1A. “Risk Factors”, Item 2. “Properties,” Item 3. “Legal Proceedings,” Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Item 7A. “Quantitative and Qualitative Disclosures About Market Risk” contain forward-looking statements. Where, in any forward-looking statement, we express an expectation or belief as to future results or events, such expectation or belief is expressed in good faith and believed to have a reasonable basis, but there can be no assurance that the expectation or belief will result or be achieved or accomplished. The following include some but not all of the factors that could cause actual results or events to differ materially from those anticipated:
 
 • general economic and business conditions and industry trends including the timing of, and spending on, feature film, television and television commercial production;
 
 • spending on domestic and foreign television advertising and spending on domestic and foreign first-run and existing content libraries;
 
 • the regulatory and competitive environment of the industries in which we, and the entities in which we have interests, operate;
 
 • continued consolidation of the broadband distribution and movie studio industries;


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 • uncertainties inherent in the development and integration of new business lines acquired operations and business strategies;
 
 • changes in the distribution and viewingintegration of television programming, including the expanded deployment of personal video recorders and other technology, and their impact on television advertising revenue;
• rapid technological changes;acquired operations;
 
 • uncertainties associated with product and service development and market acceptance, including the development and provision of programming for new television and telecommunications technologies;
 
 • changes in the distribution and viewing of television programming, including the expanded deployment of personal video recorders, video on demand and IP television and their impact on television advertising revenue;
• rapid technological changes;
• future financial performance, including availability, terms and deployment of capital;


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 • fluctuations in foreign currency exchange rates and political unrest in international markets;
 
 • the ability of suppliers and vendors to deliver products, equipment, software and services;
 
 • the outcome of any pending or threatened litigation;
 
 • availability of qualified personnel;
 
 • the possibility of an industry-wide strike or other job action affecting a major entertainment industry union;union, or the duration of any existing strike or job action;
 
 • changes in, or failure or inability to comply with, government regulations, including, without limitation, regulations of the Federal Communications Commission, and adverse outcomes from regulatory proceedings;
 
 • changes in the nature of key strategic relationships with partners and joint venturers;
 
 • competitor responses to our products and services, and the products and services of the entities in which we have interests; and
 
 • threatened terrorists attacks and ongoing military action in the Middle East and other parts of the world.
 
These forward-looking statements and such risks, uncertainties and other factors speak only as of the date of this Annual Report, and we expressly disclaim any obligation or undertaking to disseminate any updates or revisions to any forward-looking statement contained herein, to reflect any change in our expectations with regard thereto, or any other change in events, conditions or circumstances on which any such statement is based. When considering such forward-looking statements, you should keep in mind the factors described in Item 1A, “Risk Factors” and other cautionary statements contained in this Annual Report. Such risk factors and statements describe circumstances which could cause actual results to differ materially from those contained in any forward-looking statement.
 
(b)  Financial Information About Operating Segments
(b)  Financial Information About Operating Segments
 
We identify our reportable segments based on financial information reviewed by our chief operating decision maker, or his designee. We report financial information for our consolidated business segments that represent more than 10% of our consolidated revenue or earnings before taxes and equity affiliates whose share of earnings represent more than 10% of our earnings before taxes.
 
Based on the foregoing criteria, our three reportable segments are our Creative Services group and Network Services group, which are operating segments of Ascent Media, and Discovery, which is an equity affiliate. A fourth reportable segment, media management services group, existed for a portion of 2006, but was realigned within the Creative Services group and Network Services group during the third and fourth quarters of 2006. Financial information related to our operating segments can be found in note 1718 to our consolidated financial statements found in Part II of this report.
 
(c)  Narrative Description of Business
(c)  Narrative Description of Business
 
ASCENT MEDIA
 
Ascent Media provides a wide variety of creative and network services to the media and entertainment industries.industries in the United States, the United Kingdom (“UK”) and Singapore. Ascent Media’s clients includeMedia provides effective solutions for the creation, management and distribution of content to major motion picture studios, independent producers, broadcast networks, programming networks, advertising agencies and other companies that produce, ownand/or distribute entertainment, news, sports, corporate, educational, industrial and advertising content. Services are marketed to target industry segments through Ascent Media’s internal sales force and may be sold on a bundled or individual basis.
 
Following an operational realignment in 2006, Ascent Media’s operations are organized into two main categories: Creativecreative services and Networknetwork services.


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Creative Services
Creative Services
 
Ascent Media’s creative services group provides various technical and creative services necessary to complete principal photography into final products, such as feature films, movie trailers and TV spots, documentaries, and independent films, episodicscripted and reality television, TV movies and mini-series, television commercials, internet and new media advertising, 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 reformat and repurpose completed media assets for global distribution via freight, satellite, fiber and the Internet.
 
Ascent Media markets its creative services under various brand names that are generally well known in the entertainment industry, includingBlink Digital, Cinetech, Company 3, Design Music Group (DMG), Digital Media Data Center (DMDC), Digital Symphony, Encore Hollywood, FilmCore, Level 3 Post, Method, Modern Music, One Post, POP Sound, R!OT,RIOT, Rushes, Soho Images, Soundelux, Soundelux Design Music Group (DMG), Sound One, St. Anne’s Post, Todd-AOandVisionText.VisionText.
 
The creative services client base comprises major motion picture studios and their international divisions, independent television production companies, broadcast networks, cable programming networks, advertising agencies, creative editorial companies, corporate media producers, independent owners of television and film libraries and emerging new media distribution channels. The principal facilities of the creative services group are in Los Angeles, the New York Northvale (New Jersey),metropolitan area and London, with additional facilities in Atlanta and San Francisco, Mexico City and London.Francisco.
 
Key services provided by Ascent Media’s creative services group include the following:
 
Dailies.  Clients that are in production require daily screening of their previous day’s recorded workfootage captured on film, video or data in order to evaluate technical and aesthetic qualities of the production and to beginfacilitate the creative editorial process. Ascent Media provides the film development, digital transfer from film to video and video processingservices necessary for clients to view principal photography on a daily basis, also known as “dailies.” For clients that record their productions on“dailies”, including film Ascent Media processesprocessing and printsdigital transfer, which is the transfer of film negatives for film projection. The company also delivers dailies that are transferred from film to video or digital media using telecine equipment. The transfer process is technically challenging and is useddata. Dailies may be delivered to integrate various forms of audio and encode the footage with feet and frame numbers from the original film. Dailies delivered as a digital file can be processedcustomers in high definition or standard definition video and can be screened in a nonlinear manner on a variety of playback equipment.
Telecine.  Telecine is the process of transferring film into video (in either analogvideotape or digital medium). During this process, a variety of parameters can be manipulated, such as color and contrast. Because the color spectrum of film and digital media are different, Ascent Media has creative talent who utilize creative colorizing techniques, equipment and processes to enable its clients to achieve a desired visual look and feel for television commercials and music videos, as well as feature films and television shows. Ascent Mediafile based formats. The Company also provides live telecine services via satellite, using a secure closed network able to accurately transmit subtle color changes to connect its telecine artists withdailies viewing environments at client offices or other affiliated post-production facilities.locations and in editorial cutting rooms for their clients’ productions.
 
Digital intermediates.  Ascent Media’s digital intermediatesintermediate service provides customers with the ability to convert film to a high resolution digital master file for color correction, creative editorial and electronic assembly of masters in other formats. If needed,The digital intermediate process provides filmmakers and commercial producers with greater creative control through enhanced visual manipulation options and the digital fileability to see their creative decisions applied in real time.
Color Correction.  The color correction process allows for the development of a creative look and feel for media content, which can then be converted backapplied to film.different source elements that are assembled in sequence to allow for consistency of visual presentation, notwithstanding variations in the original source material and the differing color spectrums of film and other media. Ascent Media employs highly-skilled creative talent who utilize creative colorizing techniques, equipment and processes to enable its clients to achieve desired results for creative content including television commercials, music videos, feature films and television shows.
 
Creative editorial.  After principal photography of advertising content has been completed, Ascent Media’s editors assemble the various elements into a cohesive story consistent with the messaging, branding and creative direction byof Ascent Media’s advertising agency clients. Ascent Media provides the tools and talent required to support its clients through all stages of the editing“finishing” process beginning with the low-resolution digital imagesnecessary for creation, and off-line editing workstations used to create an edit decision list, through the high-resolution editorial process used to complete a final product suitable for broadcast. In addition,primary and secondary distributions, of completed advertising content. Ascent Media is able to offer expanded communications infrastructure to provide digital images directly fromalso provides thefilm-to-tape transfer process to a workstation through dedicated data lines. rental of editorial equipment for use in the creation of feature film and episodic television content.
 
Visual effects.  Visual effects are used to enhance the viewing audience’s experience by supplementing images obtained in principal photography with computer-generated imagery and graphical elements. Visual effects are typicallycan be used to create images that cannot be created physically through a more cost-effective means, to digitally remove elements captured in principal photography, and to enhance or supplement original visual images by any other cost-effective means.integrating computer generated images with images captured during


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principal photography. Ascent Media also provides its visual effects services onwith teams of artists utilizing an array of graphics and animation workstations and using a variety of software to accomplish unique effects, including three-dimensional animation.effects.
 
Assembly, formatting and master creation and duplication.  Ascent Media implements clients’ creative decisions, including decisions regarding the integration of sound and visual effects, to assemble source material into its final form. In addition, Ascent Media uses sophisticated computer graphics equipment to generate titles and character imagery and to format a given programcertain entertainment media content to meet specific networkproduction and distribution requirements, including time compression and commercial breaks. Finally, Ascent


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Media creates and delivers multiple master videotapescopies of the applicable final product for delivery to the network fordistribution, broadcast, archival and other purposes designated by the customer.
 
Distribution.Digital media management services.  Ascent Media’s Digital Media Data Center provides services that enable content owners to digitize content once, then store, manage, re-purpose and distribute such content globally in multiple formats and languages to numerous providers. These file-based services can help Ascent Media’s clients exploit existing and emerging global revenue streams, including broadband, mobile and other digital outlets and devices, reducing time-to-market while providing increased security, flexibility and database functionality. Such services can be implemented as a fully outsourced platform or individual managed services. As used in the media services industry, the term “element” refers to a unit of created content of any length, such as a feature film, television episode, commercial spot, movie trailer, promotional clip or other unique product, such as a foreign language version or alternate format of any of the foregoing.
Advertising distribution.  Once a television commercial has been completed, Ascent Media provides broadcast and support services required to manufacture and deliver commercials to specific television broadcasters or radio stations, including completeformat conversion, video and audio duplication, distribution, and storage and asset management, for advertising agencies, corporate advertisers and entertainment companies.other content owners. Ascent Media uses domestic and international satellite, fiberfiber-optic and Integrated Services Digital Network, or ISDN, Internet access, terrestrial broadband, and conventional air freight for the delivery of television and radio spots. Ascent Media currently houses over 85,000 commercial production elements in its vaults for future use by its clients.spots to broadcasters and radio stations. Ascent Media’s commercial television distribution facilities in Los Angeles and San Francisco, California enable Ascent Media to service any regional or national client.
 
Restoration, preservation and asset protection of existing and damaged content.  Ascent Media provides film restoration, preservation and asset protection services. Ascent Media’s technicians use photochemical and digital processes to clean, repair and rebuild a film’s elements in order to return the content to its original and sometimes to an improved image quality. Ascent Media also protects film element content from future degradation by transferring the film’s image to newer archival film stocks or digital files. Ascent Media also provides asset protection services for its clients’ color library titles, which is a preservation process whereby B/W, silver image, polyester, positive and color separation masters are created, sufficiently protecting the images of new and older films.
Transferring film to video or digital media masters.  A considerable amount of film content is ultimately distributed to the home video, broadcast, cable orpay-per-view television markets. This requires film images to be transferred to a video or digital file format. Each frame must be color corrected and adapted to the desired aspect ratio to meet the required distribution specifications and ensure the highest level of conformity to the original film version. Because certain film formats require transfers with special characteristics, it is not unusual for a motion picture to be mastered in many different versions. Technological developments, such as the domestic introduction of television sets with a 16 X 9 aspect ratio and the implementation of advanced and high definition digital television systems for terrestrial and satellite broadcasting, have contributed to the growth of Ascent Media’s film transfer business. Ascent Media also digitally removes dirt and scratches from a damaged film master that is transferred to a digital file format.
Professional duplication and standards conversion.  Ascent Media provides professional duplication, which is the process of creating broadcast quality and resolution independent sub-masters for distribution to professional end users. Ascent Media uses master elements to make sub-masters in numerous domestic and international broadcast standards as well as up to 22 different tape formats. Ascent Media also provides standards conversion, which is the process of changing the frame rate of a video signal from one video standard, such as the United States standard (NTSC), to another, such as a European standard (PAL or


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SECAM). Content is regularly copied, converted and checked by quality control for use in intermediate processes, such as editing, on-air backup and screening and for final delivery to cable andpay-per-view programmers, broadcast networks, television stations, airlines, home video duplicators and foreign distributors. Ascent Media’s duplication and standards conversion facilities are technically advanced with unique characteristics that significantly increase equipment capacity while reducing error rates and labor cost.
DVD compression and authoring and menu design.  Ascent Media provides all stages of DVD production, including creative menu design, special feature production, interactive features, compression, authoring, multi channel audio mixing, and quality control. Ascent Media supports DVD production in traditional DVD formats as well as Blu Ray and HD DVD formats. Ascent Media also prepares and optimizes content for evolving formats of digital distribution, such asvideo-on-demand and interactive television.
Storage of elements and working masters.  Ascent Media’s physical archives are designed to store working master videotapes and film elements in a highly controlled environment protected from temperature and humidity variation, seismic disturbance, fire, theft and other external events. In addition to the physical security of the archive, content owners require frequent and regular access to their libraries. Physical elements stored in Ascent Media’s archive are uniquely bar-coded and maintained in a library management database offering rapid access to elements, concise reporting of element status and element tracking throughout its travel through Ascent Media’s operations. Ascent Media also provides file-based digital archive services, as discussed under the headingDigital media management servicesabove.
Syndicated television distribution.  Ascent Media’s syndication services provide AMOL-encoding and closed-captioned sub-mastering, commercial integration, library distribution, station list management and v-chip encoding. Ascent Media distributes syndicated television content by freight, satellite, fiber or the Internet, in formats ranging from low-resolution proxy streams to full-bandwidth high-definition television and streaming media.
Sound supervision, sound design and sound editorial.  Ascent Media provides creative talent, facilities and support services to enhance, modify or create sound for feature films, television content, commercials and trailers, interactive multimedia games and special live venues. Sound supervisors ensure that all aspects of sound, dialogue, sound effects and music are properly coordinated. Ascent Media’s sound services include, but are not limited to, sound editing, sound design, sound effect libraries, ADR (automated dialogue replacement, a process for recording dialogue in synchronization with previously recorded picture) and Foley (non-digital sound effects).
 
Music services.  Music services are an essential component of post-production sound. Ascent Media has the technology and talent to handle all types of music-related services, including original music composition, music supervision, music editing, scoring/recording, temporary sound tracks, composer support and preparing music for soundtrack album release.
 
Re-recording / Mixing.  Once sound editors, sound designers, composers, music editors, ADR and Foley crews and many others, have prepared the elements that will make up the finished product, the final component ofprocess in the creative sound post production process is the mix (or re-recording). Mixing a film involves the process of combining multiple elements, such as tracks of sound effects, dialogue and music, to complete the final product. Ascent Media maintains a significant number of mixing stages, purpose-built and provisioned with advanced recording equipment, capable of handling any type of project, from major motion pictures to smaller independent films.
 
Sound effects and music libraries.  Through its Soundelux brand, Ascent Media maintains an extensive sound effects library with over 300,000 unique sounds, which editors and clients access through the company’s intranet and remotely via the Internet. The company also owns several production music libraries through its Hollywood Edge brand. Ascent Media’s clients use the sound effects and music libraries in feature films, television shows, commercials, interactive and multimedia games. Ascent Media actively continues to add new, original recordings to its library.
Negative developing and cutting.  Ascent Media’s film laboratories provide negative developing for television shows such asone-hour dramas and movie-length programming, including negative developing of “dailies” (the original negative shot during each production day), as well as the often complex and technically demanding commercial work and motion picture trailers. Ascent Media also provides negative cutting services for the distribution of commercials on film.
Restoration, preservation and asset protection of existing and damaged content.  Ascent Media provides film restoration, preservation and asset protection services. Ascent Media’s technicians use photochemical and digital processes to clean, repair and rebuild a film’s elements in order to return the content to its original and sometimes to an improved image quality. Ascent Media also protects film element content from future degradation by transferring the film’s image to newer archival film stocks. Ascent Media also provides asset protection services for its clients’ color library titles, which is a preservation process whereby B/W, silver image, polyester, positive and color separation masters are created, sufficiently protecting the images of new and older films.
Transferring film to analog video or digital media.  A considerable amount of film content is ultimately distributed to the home video, broadcast, cable orpay-per-view television markets. This requires film images to be transferred to an analog video or digital file format. Each frame must be color corrected and adapted to the size and aspect ratio of a television screen in order to ensure the highest level of conformity to the original film version. Because certain film formats require transfers with special characteristics, it is not unusual for a motion picture to be mastered in many different versions. Technological developments, such as the domestic introduction of television sets with a 16 X 9 aspect ratio and the implementation of advanced and high definition digital television systems for terrestrial and satellite broadcasting, are expected to contribute to the growth of Ascent Media’s film transfer business. Ascent Media also digitally removes dirt and scratches from a damaged film master that is transferred to a digital file format.
Professional duplication and standards conversion.  Ascent Media provides professional duplication, which is the process of creating broadcast quality and resolution independentsub-masters for distribution to professional end users. Ascent Media uses master elements to makesub-masters in numerous domestic and international broadcast standards as


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well as up to 22 different tape formats. Ascent Media also provides standards conversion, which is the process of changing the frame rate of a video signal from one video standard, such as the United States standard (NTSC), to another, such as a European standard (PAL or SECAM). Content is regularly copied, converted and checked by quality control for use in intermediate processes, such as editing, on-air backup and screening and for final delivery to cable andpay-per-view programmers, broadcast networks, television stations, airlines, home video duplicators and foreign distributors. Ascent Media’s duplication and standards conversion facilities are technically advanced with unique characteristics that significantly increase equipment capacity while reducing error rates and labor cost.
DVD compression and authoring and menu design.  Ascent Media provides all stages of DVD production, including creative menu design, special feature production, project management, encoding, 5.1 surround editing and quality control. Ascent Media also prepares and optimizes content for evolving formats of digital distribution, such asvideo-on-demand and interactive television.
Storage of original elements and working masters.  Ascent Media’s archives are designed to store working master videotapes and film elements in a highly controlled environment protected from temperature and humidity variation, seismic disturbance, fire, theft and other external events. In addition to the physical security of the archive, content owners require frequent and regular access to their libraries. Physical elements stored in Ascent Media’s archive are uniquely bar-coded and maintained in a library management database offering rapid access to elements, concise reporting of element status and element tracking throughout its travel through Ascent Media’s operations.
Syndicated television distribution.  Ascent Media’s syndication services provide AMOL-encoding and closed-captionedsub-mastering, commercial integration, library distribution, station list management and v-chip encoding. Ascent Media distributes syndicated television content by freight, satellite, fiber or the Internet, in formats ranging from low-resolution proxy streams to full-bandwidth high-definition television and streaming media.
Network Services
Ascent Media’s network services group provides origination, transmission/distribution and technical services to broadcast, cable and satellite programming networks, local television channels, broadcast syndicators, satellite broadcasters, government, other broadband telecommunications companies and corporations that operate private networks. Ascent Media’s network services group operates from facilities located in California, Connecticut, Florida, Minnesota, New York, New Jersey, Virginia and the United Kingdom and Singapore.
Key services provided by Ascent Media’s network services group include the following:
Network origination and master control.  The network services group provides videotape and file-based playback and origination to cable, satellite andpay-per-view programming networks. Ascent Media accepts daily program schedules, programs, promotional materials and advertising and transmits 24 hours of seamless daily programming to cable operators, direct broadcast satellite systems and other destinations, over fiber and satellite, using automated systems for broadcast playback. Associated services includecut-to-clock and compliance editing, tape library management, ingest & quality control, format conversion, and tape duplication. For programming designed for export to other markets, Ascent Media provides subtitling and voice dubbing.
Ascent Media’s network services group provides origination, transmission/distribution and technical services to broadcast, cable and satellite programming networks, local television channels, broadcast syndicators, satellite broadcasters, government, other broadband telecommunications companies and corporations that operate private networks. Ascent Media’s network services group operates from facilities located in California, Connecticut, Florida, Minnesota, New York, New Jersey, Virginia and the United Kingdom and Singapore.
Key services provided by Ascent Media’s network services group include the following:
Network origination and master control.  The network services group provides outsourced network origination services to cable, satellite andpay-per-view programming networks. Ascent Media accepts daily program schedules, programs, promotional materials and advertising and transmits 24 hours of seamless daily programming to cable operators, direct broadcast satellite systems and other destinations via fiber and satellite. Currently, over two hundred programming feeds — running 24 hours a day, seven days a week — are supported by Ascent Media’s facilities in the United States, London and Singapore. Network origination services are provided from large-scale technical platforms with integrated asset management, hierarchical storage management (a data storage technique which automatically moves data between high-cost and low-cost storage media), and broadcast automation capabilities. These platforms, which are designed, built, owned and operated by Ascent Media, require Ascent Media to incorporate and integrate hardware and software from multiple third-party suppliers into a coordinated service solution. Associated services include cut-to-clock and compliance editing, tape library management, ingest & quality control, format conversion, and tape duplication. Formulti-language television services, Ascent Media facilitates the collection, aggregation, and playout of languaging materials, including subtitles and foreign language dubs. On-air graphics and other secondary events are also integrated with the content by Ascent Media. In conjunction with network origination services, Ascent Media operates television production studios and provides complete post-production services for on-air promotions for some clients.
Transport and connectivity.  Ascent Media operates satellite earth station facilities in Singapore, California, New York, New Jersey, Minnesota and Connecticut. Ascent Media’s facilities are staffed 24 hours a day and may be used for uplink, downlink and turnaround services. Ascent Media accesses various “satellite neighborhoods,” including basic and premium cable, broadcast syndication, direct-to-home and DBS markets. Ascent Media resells transponder capacity for occasional and full-time use and bundles its transponder capacity with other broadcast and syndication services to provide a complete broadcast package at a fixed price. Ascent Media’s “teleports” are high-bandwidth communications gateways with video switches and facilities for satellite, optical fiber and microwave transmission. Ascent Media’s facilities offer satellite antennae capable of transmitting and receiving feeds in both C-Band and Ku-Band frequencies. Ascent Media operates a global fiber network to carry real-time video and data services between its various locations in the US, London, and Singapore. This network is used to provide full-time program feeds and ad hoc services to clients and to transport files and real-time signals between Ascent Media locations. Ascent Media also operates industry-standard encryptionand/or compression systems as needed for customer satellite transmission. Currently, over two hundred programming feeds — running 24 hours a day, seven days a week — are supported by Ascent Media’s facilities in the United States, London and Singapore. Ascent Media operates television production studios withlive-to-satellite interview services, cameras, production and audio control rooms, videotape playback and record,multi-language prompters, computerized lighting, dressing and makeup rooms and field and teleconferencing services. Ascent Media offers complete post-production services for on-air promotions, including graphics, editing, voice-over record, sound effects editing, sound mixing and music composition.
Transport and connectivity.  Ascent Media operates satellite earth station facilities in Singapore, California, New York, New Jersey, Minnesota, Connecticut and Florida. Ascent Media’s facilities are staffed 24 hours a day and may be used for uplink, downlink and turnaround services. Ascent Media accesses various “satellite neighborhoods,” including basic and premium cable, broadcast syndication,direct-to-home and DBS markets. Ascent Media resells transponder capacity for occasional and full-time use and bundles its transponder capacity with other broadcast and syndication services to provide a complete broadcast package at a fixed price. Ascent Media’s “teleports” are high-bandwidth communications gateways with video switches and facilities for satellite, optical fiber and microwave transmission. Ascent Media’s facilities offer satellite antennae capable of transmitting and receiving feeds in both C-Band and Ku-Band frequencies. Ascent Media also provides transportable services, includingpoint-to-point microwave transmission, transportable up-link and downlink transmission and broadcast quality teleconference services. Ascent Media operates


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a global fiber network (branded Global Interconnect) to carry real-time video between its various locations in the US, London, and Singapore. This network is used to provide full-time program feeds and ad hoc services to clients.
Consulting Services.  Ascent Media provides strategic, technology and business consulting services to the media and entertainment industry, leveraging the core strengths and knowledge-base of the company. Key practice areas include: digital migration; content delivery strategies; workflow analysis and design; emerging delivery platforms (such as Internet-protocol television, mobile and broadband); technology assessment; and technology-enabled business strategies.
 
Engineering and systems integration.  Ascent Media designs, builds, installs and services advanced technical systems for production, management and delivery of rich media content to the worldwide broadcast, cable television, broadband, government and telecommunications industries. Ascent Media’s engineering and systems integration business operates out of facilities in New Jersey, California, Florida, and London, and services global clients including major broadcasters, cable and satellite networks, telecommunications providers, and corporate television networks, a major telecommunications company as well as numerous production and post-production facilities. Services offered include program management, engineering design, equipment procurement, software integration, construction, installation, service and support. Ascent Media also designs and constructs satellite earth stations and related facilities.
 
Consulting Services.  Ascent Media provides strategic, technology and business consulting services to the media and entertainment industry. Key practice areas include: digital migration; content delivery strategies; workflow analysis and design; emerging delivery platforms (such as Internet-protocol television, mobile and broadband); technology assessment; and technology-enabled business strategies.


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Network Operations, Field Service and Call Center.  The network services group provides field service operations — 24 hours a day, seven days a week — through an on-staff network of approximately 50 field engineers located throughout the United States. Services include preventative and reactive maintenance of satellite earth stations, satellite networks, fiber-based digital transmission facilities, cable and telecommunications stations (also called head ends), and other technical facilities for the distribution of video content. The group operates a call center — 24 hours a day, seven days a week — out of its Palm Bay, Florida facility, providing outsourced services for technology manufacturing companies, networks and telecoms. In addition, the group operates a network operations center, providing outsourced services relating to monitoring and management of satellite and terrestrial distribution networks and remote monitoring and control of technical facilities. End users for field service, call center and network operation center services include major US broadcast and cable networks, telecommunications providers, digital equipment manufacturers, and government and corporate operations.
 
AccentHealth
AccentHealth provides advertising-supported health education programming for distribution in doctor office waiting rooms via three AccentHealth Waiting Room TV Networks: the General Health Network, the Young Family Network and the Silver Network. The General Health Network targets general practice and family practice patients, and provides news and health information applicable to the general needs of that demographic. The Young Family Network targets pediatric and Ob-Gyn patients, and provides baby, child and parenting related programming. The Silver Network targets internal medicine, general practice and cardiology patients, and provides programming tailored to appeal to the specific interests of patients over the age of 50. Programming on the AccentHealth Waiting Room TV Networks is produced monthly by CNN and features customized content relating to a variety of topics, including medical breakthroughs, parenting issues, nutrition, fitness, safety and wellness.
AccentHealth’s programming content airs on television monitors installed in doctor office waiting rooms, and is provided at no cost to the practice. AccentHealth offers its advertising clients a number of products and services, including:
• selected commercial time slots on the AccentHealth Waiting Room TV Networks;
• print-display advertising space (traditionally used for product brochures, information pamphlets or coupons) alongside the Health Panels, AccentHealth’s wall-mounted educational print displays;
• turn-key literature distribution services; and
• certain services related to the production of commercial advertising spots or the customization of certain advertising services.
We believe that AccentHealth is the largest point-of-care media supplier in the U.S., with the AccentHealth Waiting Room TV networks reaching 11.7 million viewers per month in 11,200 waiting rooms nationwide.
Strategy
The entertainment services industry has been historically fragmented with numerous providers offering discrete, geographically-limited, non-integrated services. Ascent Media’s services, however, span the entirety of the value chain from the creation and management of media content to the distribution of media content via multiple transmission paths including satellite, fiber and Internet Protocol-based networks. Ascent Media believes the breadth and range of its services uniquely provide it the scale and flexibility necessary to realize significant operating and marketing efficiencies: a global, scaleable media services platform integrating preparation, management and transmission services; and common “best practices” operations management across the Ascent Media enterprise. Ascent Media’s goal is to be the premier
Ascent Media’s goal is to be the premier end-to-end digital media supply chain services provider to the media and entertainment industry — creating, managing and distributing rich media content across all distribution channels on a global basis. Ascent Media believes it can optimize its position in the market by pursuing the following strategies:
Grow digital media management business.  Ascent Media intends to increase business with major media and entertainment clients by storing, managing and distributing their digital media, which are necessary for repurposing for file-based network origination and other forms of digital distribution. In this regard, it intends to deploy its digital media management system, which is currently deployed in Los Angeles, in the United Kingdom and the East Coast of the U.S.
Increase scale of operations.  Ascent Media intends to increase the scale of its operations through a combination of internal investment in facilities plus external investment in companies and joint ventures. Its goal is to attract additional customers in its existing lines of business and expand its business operations geographically.
Expand scope of services.  Ascent Media intends to expand the scope of its services by applying its core capabilities to new business activities, providing content management and distribution services based on electronic data files rather than physical tapes, participating in emerging high revenue-generating services such as re-formatting content for distribution to new platforms, and attracting new customers with unique service needs that are less susceptible to competitive threats.
Deploy an interconnected global media network.  Ascent Media plans to provide clients access to an Internet-based network that manages and provides solutions for integrated workflows. The network will provide global connectivity and file transport capabilities, which will make client workflows more efficient and enhance Ascent’s internal business systems.


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Optimize the organization.  In order to reach the strategic goals described above, Ascent Media streamlined its internal organization in 2006. Specifically, Ascent Media re-aligned its divisional structure to become more compatible with its diversified customer base and the integrated file-based solutions that they seek.
 
Provide a broad range of media services.  The entertainment services industry has historically been fragmented, with numerous providers offering discrete, geographically-limited, non-integrated services. Ascent Media spans the value chain with a broad range of services from the creation and management of media content to the distribution of content via multiple transmission paths, including satellite, fiber and Internet Protocol-based networks on a global basis. Ascent Media believes its range of service offerings and in-depth knowledge of media workflows provide it with a strategic advantage over less-diversified service providers in developing deep, long-term relationships with creators, owners and distributors of creative content. In addition, Ascent Media believes that the reputations of its highly-respected creative boutiques, which operate under their own well-known brand names, help distinguish Ascent Media from commodity suppliers.


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Grow digital media management business.  Ascent Media seeks to increase business with major media and entertainment clients by creating, storing, managing, repurposing and distributing their digital media content through traditional channels as well as emerging new media outlets on a global basis. Ascent Media believes that the technical complexity and scale issues associated with providing these services will make outsourcing of activities more attractive to Ascent Media’s client base, creating opportunities for increased market share. In 2007, Ascent Media extended the geographical reach of its proprietary digital media management system, adding capabilities in the New York metropolitan area and the United Kingdom to the original center in Los Angeles. Ascent Media currently plans to deploy its proprietary digital media management system in Singapore during 2008.
Deploy an interconnected global media network.  Ascent Media plans to provide clients access to a fiber-based network integrated with its creative and management services. The network will provide global connectivity and file transport capabilities, which will make client workflows more efficient and enhance Ascent’s end-to-end portfolio of services.
Invest in core business operations.  Ascent Media intends to increase its capabilities through internal investments to improve the capacity, utilization and throughput of its existing facilities. Ascent Media will also consider opportunities that may arise to add scale or service offerings, or to increase market share, through strategic acquisitions or joint ventures. Consistent with this strategy, Ascent Media will also seek opportunities to divest non-core assets, when appropriate.
Seek opportunities to offer new services within core competencies.  Ascent Media intends to expand its market share by applying its core capabilities to develop new value-added service offerings, participating in emerging high revenue-generating services such as re-versioning content for distribution to new platforms. In that regard, Ascent Media will endeavor to develop service offerings that meet unique needs of its customers.
For a description of the risks associated with the foregoing strategies, and with Ascent Media’s business in general, see “Risk Factors” beginning onpage I-27.
Seasonality
 
The demand for Ascent Media’s core motion picture services, primarily in its creative services group, has historically been seasonal, with higher demand in the spring (second fiscal quarter) and fall (fourth fiscal quarter), and lower demand in the winter and summer. Similarly, demand for Ascent Media’s television program services, primarily in its creative services group, is higher in the first and fourth quarters and lowest in the summer, or third quarter. Demand for Ascent Media’s commercial services, primarily in its creative services group, are fairly consistent with slightly higher activity in the third quarter. However, changes in the timing of the demand for television program services may result in increased business for Ascent Media in the summer. In addition, the timing of long-term projects in Ascent Media’s creative services group and network services group are beginning to offset the quarters in which there has been historically lower demand for Ascent Media’s motion picture and television services. Accordingly, Ascent Media expects to experience less dramatic quarterly fluctuations in its operating performance in the future.
 
DISCOVERY
 
Discovery Communications, Inc. is a leading global media and entertainment company. Discovery has grown from the 1985 launchcompany that provides original and purchased programming across multiple distribution platforms in the United States and more than 170 other countries, with over 100 television networks offering customized programming in 35 languages. As one of the world’s largest providers of non-fiction television programming, Discovery’s strategy is to optimize the distribution, ratings and profit potential of each of its core property,branded channels. Discovery also develops and sells consumer and educational products and services in the United States and internationally, and owns and operates a diversified portfolio of website properties and other digital services. Discovery operates through three divisions: (1) Discovery networks U.S., (2) Discovery networks international, and (3) Discovery commerce and education.
Discovery’s media content spans non-fiction genres including science, exploration, survival, natural history, sustainability of the environment, technology, anthropology, health and wellness, engineering, adventure, lifestyles and current events. This type of programming tends to be culturally neutral and maintains its relevance for an extended period of time, referred to as “long-tail.” As a result, Discovery’s content translates well across


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international borders and is made even more accessible through extensive use of dubbing and subtitles in local languages as well as the creation of local programming tailored to individual market preferences.
Discovery’s content is designed to target key audience demographics, and the popularity of its programming offers a compelling reason for advertisers to purchase time on its channels. Discovery’s audience ratings are a key driver in generating advertising revenue and create demand on the part of cable television operators, direct-to-home or “DTH” satellite operators, telephone and communications companies and other content distributors to deliver its programming to their customers.
Discovery has an extensive library of over 100,000 hours of programming and footage that provides a high-quality source of content for creating new services and launching into new markets and onto new platforms. Discovery generally owns most or all rights to the majority of this programming and footage which enables Discovery to exploit its library to launch new brands and services into new markets quickly without significant incremental spending. Programming can be re-edited and updated to provide topical versions of subject matter in a cost-effective manner and utilized around the world.
In addition to growing distribution and advertising revenue for its branded channels, Discovery is focused on growing revenue across new distribution platforms, including brand-aligned web properties, mobile devices,video-on-demand and broadband channels, which serve as additional outlets for advertising and affiliate sales, and provide promotional platforms for its programming. Discovery currently operates Internet sites providing news, information and entertainment content that are aligned with its television programming. In December 2007, Discovery completed the acquisition of HowStuffWorks.com, an award-winning online source of high-quality, unbiased and easy-to-understand explanations of how the world actually works. This acquisition provides an additional platform for Discovery’s extensive library of video content and positions its brand as a hub for satisfying curiosity on a variety of topics on both television and online.
Discovery is also exploiting its programming assets to take advantage of the growing demand for high definition (HD) programming in the U.S. and throughout the world. In 2007, Discovery launched HD simulcasts of four of its networks (Discovery Channel, TLC, Animal Planet and Science Channel) in addition to current global operationsits existing HD Theater service, which was launched in over 1702002. Discovery also operates HD channels in 15 countries across six continents, with over 1.5 billion total cumulative subscription units. The term “subscription units” means, for each separate network or otheroutside of the U.S., making it the number-one programming service that Discovery offers,provider of HD channels outside of the U.S. based on the number of HD channels that it operates. Discovery believes it is well positioned to take advantage of the accelerating growth in sales of HD televisions and Blu-Ray and HD DVD players, and the expanding distribution of HD channels around the world. Where Discovery operates HD simulcasts of its networks, Discovery also benefits from the ability to aggregate audiences for advertising sales purposes.
Strategy
Discovery’s strategy is to develop high quality media brands that build consumer viewership, optimize distribution growth and capture advertising sales. In addition, Discovery is focused on maximizing the overall efficiency and effectiveness of its global operations through collaboration and innovation across operating units and regions around the world and across all television householdsand digital platforms.
In line with this strategy, Discovery’s specific priorities include:
• Maintaining Discovery’s focus on creative excellence in non-fiction programming and expanding the portfolio’s brand entitlement by developing compelling content that increases audience growth, builds advertising relationships and supports continued distribution revenue on all platforms.
• Exploiting Discovery’s distribution strength in the U.S. — with three channels reaching more than 90 million U.S. subscribers and six channels reaching approximately 50 million to 70 million U.S. subscribers — to build additional branded channels and businesses that can sustain long-term growth and profitability. For example, Discovery recently announced the repositioning of several emerging television networks to build stronger consumer brands through specific category ownership that supports more passionate audience loyalty and increased advertiser and affiliate interest and integration.


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• Maintaining a leadership position in non-fiction entertainment in international markets, and continuing to grow and improve the performance of the international operations. This will be achieved through expanding local advertising sales capabilities, creating licensing and digital growth opportunities, and improving operating efficiencies by strengthening development and promotional collaboration between U.S. and international network groups.
• Developing and growing compelling and profitable content experiences on new platforms that are aligned with its core branded channels. Specifically, extending ownership of non-fiction entertainment to all digital media devices around the world to enhance the consumer entertainment experience, further monetize Discovery’s extensive programming library, and create additional vehicles on which to offer new products and services that deliver new revenue streams.
Recent Developments
In support of its strategy and priorities, in January 2007, Discovery re-evaluated its operations to identify and implement strategic initiatives designed to improve operational and financial performance and allocate capital in a more disciplined and efficient manner. The following actions are representative of these initiatives:
• Business Restructuring:  Improved margins through revenue growth and cost efficiencies across Discovery’s divisions. Management implemented a growth strategy to address underperforming assets, closed all of its 103 retail stores and shifted the focus of its commerce business toe-commerce and licensing in order to broaden the reach of Discovery-branded products. Discovery also streamlined its education business to focus on direct-to-school products includingDiscovery Education streamingand significantly reduced the investment in direct-to-consumer services. These actions, coupled with an overall focus on improved efficiency, resulted in an approximate 25% reduction in global personnel in 2007. As a result of these restructurings, Discovery improved the operating cash flow margins from the properties that it continues to use and operate.
• Global Content Sharing:  Strengthened development and promotional collaboration between U.S. and international networks to improve operating margins, promote content sharing and build global brand strength.
• Television Network Rebrands:  In January 2008, Discovery Times Channel was rebranded as Investigation Discovery as a means to exploit Discovery’s extensive library of fact-based investigation and current affairs programming. In June 2008, Discovery expects to rebrand Discovery Home as Planet Green, the only24-hour eco-lifestyle television network committed to documenting, preserving and celebrating the planet. In January 2008, Discovery announced a proposed50-50 joint venture with Oprah Winfrey and Harpo, Inc. to rebrand Discovery Health as OWN: The Oprah Winfrey Network, a new multi-platform venture designed to entertain, inform and inspire people to live their best lives through the OWN Channel and the Oprah.com website. It is expected that Discovery Health Channel will be rebranded as OWN in the second half of 2009.
• Digital Media Acquisitions and Website Relaunch:  Expanded internal web operations while acquiring HowStuffWorks.com and TreeHugger.com, to create a portfolio of brand-aligned digital properties that expand Discovery’s cross-platform sales and promotional opportunities and realize economies through programs that can be produced once and used often in both long- and short-form across multiple platforms. In December 2007, Discovery completed the acquisition of HowStuffWorks.com, an award-winning online source of high-quality, unbiased and easy-to-understand explanations of how the world actually works, and in August 2007, Discovery acquired Treehugger.com, an eco-lifestyle website. Discovery relaunched its flagship website, Discovery.com, and is in the process of expanding and deepening the content of all of its channel websites (e.g., TLC.com, AnimalPlanet.com) to move beyond being television promotion vehicles and to focus on audience growth, engagement and improved monetization. Together with these recent acquisitions, Discovery now has approximately 25 million unique visitors per month to all of its wholly owned websites (source: Omniture, Inc.).


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• Dispositions- In May 2007, Discovery and Cox completed an exchange of Cox’s 25% interest in Discovery for all of the capital stock of a subsidiary of Discovery that held Discovery’s entire interest in Travel Channel, travelchannel.com and approximately $1.3 billion in cash.
Business Operations
Discovery operates through the three divisions discussed below. A discussion of the financial performance of each of these divisions can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
Discovery Networks U.S.
Reaching approximately 675 million cumulative subscribers (as defined below) in the United States as of December 31, 2007 and having one of the industry’s most widely distributed portfolio of brands, Discovery networks U.S. delivers 11 cable and satellite television channels in the U.S. The portfolio includes three channels that each reach over 90 million U.S. subscribers (as defined below) and four channels that each reach over 50 million U.S. subscribers. Discovery networks U.S. also provides distribution and advertising sales services for Travel Channel and BBC America and distribution services for BBC World Service.
Domestic subscriber numbers set forth in this document are ableaccording to receiveThe Nielsen Company. As used herein, a “U.S. subscriber” is a single household that network or programming servicereceives the applicable Discovery channel from theirits cable, satellite or other television provider, and the term “cumulative subscription units” refers to the sum of such figures for multiple networksand/or programming services, including: (1) multiple networks received in the same household, (2) subscription units for joint venture networks, (3) subscription units for branded programming blocks, which are generally provided without charge, and (4) households thatincluding those who receive Discovery programming networks from pay-television providers without charge pursuant to various pricing plans that include free periodsand/or free carriage. The term “cumulative subscribers” in the U.S. refers to the collective sum of the total number of U.S. subscribers to each of Discovery’s U.S. channels. By way of example, two U.S. households that each receive five Discovery operates its businessesnetworks from their cable provider represent 10 cumulative subscribers in three groups:the U.S. The term cumulative subscribers in the U.S. also includes seven million cumulative subscribers in Canada who receive direct feeds of TLC and Military Channel from Discovery Networksnetworks U.S., Discovery Networks International, and Discovery Commerce, Education and Other.
Discovery Channel

•  Launched in June 1985, Discovery Channel reached approximately 97 million U.S. subscribers as of December 31, 2007.

•  Discovery Channel brings viewers engaging stories and extraordinary experiences that share knowledge, satisfy curiosity and inspire the very joy of discovery.

•  Discovery’s flagship, Discovery Channel, was the second most widely distributed cable channel in the United States, according to The Nielsen Company as of December 31, 2007.

•  Some of the networks most popular returning and new series includeDeadliest Catch, Mythbusters, Dirty Jobs, Man Vs Wild, Smash Lab, Some Assembly Required, Fight Quest,andBone Detectives. Discovery Channel is also home to high-profile specials and mini-series, including the critically acclaimedPlanet Earthand the forthcomingWhen We Left Earth: The NASA Missions.

•  Target viewers are adults25-54, particularly men.

•  Discovery Channel is simulcast in HD.


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TLC

•  Acquired by Discovery in 1991, TLC reached approximately 96 million U.S. subscribers as of December 31, 2007.

•  TLC features educational programming that explores life’s key transitions and turning points, and presents high-quality, relatable and authentic personal stories.

•  Series highlights on TLC includeL.A. Ink, Little People, Big World, Jon And Kate Plus 8, What Not To Wear, Miami Ink, Flip That House, and the recently relaunchedTrading Spaces.

•  Target viewers are adults18-49, particularly women.

•  TLC is simulcast in HD.
Animal Planet

•  Launched in October 1996, Animal Planet reached approximately 94 million U.S. subscribers as of December 31, 2007.

•  With a new logo and on-air look, Animal Planet leads viewers to relate to animals as characters that inspire and engage, not merely creatures to observe. Animal Planet’s engaging, insightful and high-quality entertainment taps into the instincts that drive us all with compelling stories.

•  Programming highlights on Animal Planet includeMeerkat Manor, Orangutan Island, Animal Precinctand Jeff Corwin specials.

•  Target viewers are adults25-54, particularly women.

•  Animal Planet is simulcast in HD.
Discovery Health

•  Launched in August 1999, Discovery Health reached approximately 68 million U.S. subscribers as of December 31, 2007.

•  Discovery Health takes viewers inside the fascinating and informative world of health and medicine to experience first-hand compelling, real-life stories of medical breakthroughs and human triumphs.
•  In January 2008, Discovery announced a planned joint venture with Oprah Winfrey and Harpo, Inc. to create OWN: The Oprah Winfrey Network, a new multi-platform venture designed to entertain, inform and inspire people to live their best lives. Oprah Winfrey will serve as Chairman of OWN, LLC and the venture will be50-50 owned by Discovery and Harpo. Discovery will handle distribution, origination and other operational requirements and both organizations will contribute advertising sales services to the venture. Discovery and Harpo are currently negotiating a definitive agreement to govern these arrangements.

•  Discovery Health is expected to be rebranded as OWN in the second half of 2009.

•  OWN will build on Discovery Health’s target audience of women25-54.

•  OWN will be simulcast in HD.

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Discovery Kids

•  Launched in October 1996, Discovery Kids reached approximately 58 million U.S. subscribers as of December 31, 2007.

•  Discovery Kids lets kids of all ages (from preschoolers to ’tweens and teens) explore the world from their point of view. This network provides entertaining, engaging and high-quality programming that kids enjoy and parents trust. Kids can learn about science, adventure, exploration and natural history through documentaries, reality shows, scripted dramas and animated stories.

•  Series highlights on Discovery Kids include the animated Real Toon series TutensteinandSaving A Species: The Great Penguin Rescue.

•  Target viewers are children and families.
Science Channel

•  Launched in October 1996, Science Channel reached approximately 52 million U.S. subscribers as of December 31, 2007.

•  Science Channel is devoted to science by celebrating the “why” in everything and providing context and understanding of the full spectrum of the wonders of science.

•  With a refreshed brand, Science Channel includes series such asSurvivorman, How It’s Made, Patent BendingandWeird Connections.

•  Target viewers are men25-54.

•  Science Channel is simulcast in HD.
Planet Green

•  Planet Green is expected to be rebranded from Discovery Home in June 2008 with an expected reach of approximately 50 million U.S. subscribers.

•  Committed to documenting, preserving and celebrating the planet, Planet Green will be the only24-hour eco-lifestyle television network.

•  Planet Green will speak to people who want to understand green living and to those who are excited to make a difference by providing tools and information to meet the critical challenge of protecting our environment.

•  Target viewers will be adults18-54 with a focus on late teens/college-aged viewers, new parents and young baby boomers.

•  Planet Green will be simulcast in HD.

•  In August 2007, in support of the Planet Green initiative, Discovery purchased TreeHugger.com, an eco-lifestyle website with news, opinions and information spanning the green spectrum. Discovery has also launched companion website PlanetGreen.com with a focus on community and action oriented content.
Investigation Discovery

•  Launched in March 2003, Investigation Discovery (formerly Discovery Times Channel) reached approximately 50 million U.S. subscribers as of December 31, 2007.

•  In January 2008, Discovery Times Channel was rebranded as Investigation Discovery, exploiting Discovery’s extensive library of fact-based investigation and current affairs programming that sheds new light on our culture, history and the human condition.

•  Programming highlights includeDateline On ID, Fugitive Task Force, andDiamond Road.

•  Target viewers are adults25-54.

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Military Channel

•  Originally launched in 1996 as Discovery Wings and rebranded as Military Channel in January 2005, the network reached approximately 50 million U.S. subscribers as of December 31, 2007.

•  Military Channel salutes the sacrifices made by our men and women in uniform with real stories and access to a world of human drama, strategic innovation and long-held traditions.

•  Original programming includesWeaponologyandShowdown: Air Combat.

•  Target viewers are men35-64.
FitTV

•  Acquired by Discovery in June 2001, FitTV reached approximately 43 million U.S. subscribers as of December 31, 2007.

•  FitTV is designed to inspire viewers to improve their fitness and well-being on their terms.

•  Programming features experts and entertaining shows that help people learn how to incorporate fitness into their daily lives.

•  Target viewers are adults25-54.
HD Theater

•  Launched in June 2002, HD Theater reached approximately 11 million U.S. subscribers as of December 31, 2007.

•  HD Theater was one of the first nationwide24-hour-a-day,7-day-a-week high definition networks in the U.S. offering compelling, real-world content including adventure, nature, world culture, technology and engineering programming.

•  Programming highlights on HD Theater includeRisk Takers, Equatorand the critically acclaimedSunrise Earth. In addition, HD Theater offers “motorized” HD content including upcoming live muscle car auctions withMecum Auto Auctions.

•  Target viewers are adults25-54, particularly men.
 
Discovery’s relationshipsU.S. networks are wholly owned by Discovery except for (1) Animal Planet, which is co-owned with DHC (10%) and agreements with the distributors of its channels are critical to its business as they provideAdvance/Newhouse (5%) and (2) OWN Network, which would be a50-50 joint venture between Discovery and Harpo, Inc.
Discovery networks U.S. also includes Discovery’s subscription revenue stream and access to an audience for advertising sales purposes. There has been a great deal of consolidation among cable and satellite television operatorsdigital media businesses in the United States, in recent years, with over 90%which feature three main components: (1) organic channel websites such as Discovery.com, TLC.com and AnimalPlanet.com and acquired assets including HowStuffWorks.com, TreeHugger.com and Petfinder.com; (2) Discovery Mobile, Discovery’s mobile video service; and (3) Discovery on-demand, a free on demand service featuring content from across Discovery’s stable of the pay television households in the country now controlled by the top eight distributors. Discovery also operates in certain overseas markets which have experienced similar industry consolidation. Industry consolidation has generally provided more leverage to the distributors in their relationships with programmers. Accordingly, as its affiliation agreements expire, Discovery may not be able to obtain terms in new affiliation agreements that are comparable to terms in its existing agreements.
Discovery earns revenue from global delivery of its programming pursuant to affiliation agreements with cable television anddirect-to-home satellite operators (which is described as distribution revenue throughout this report), from the sale of advertising on its networks and from product and subscription sales in its commerce and education businesses. Distribution revenue includes all components of revenue earned through affiliation agreements. Discovery’s affiliation agreements typically have terms of 3 to 10 years and provide for payments based on the number of subscribers that receive Discovery’s services. Discovery has grown its global network business by securing as broad a subscriber base as possible for each of its channels by entering into affiliation agreements. After obtaining scalable distribution of its networks, Discovery invests in programming and marketing in order to build a viewing audience to support advertising sales. In certain cases, Discovery has made cash payments to distributors in exchange for carriage or has entered into contractual arrangements that allow the distributors to show certain of Discovery’s channels for extended free periods. In the United States, Discovery has the necessary audience and ratings for its programming such that advertising sales provide more revenue than channel subscriptions. Distribution revenue still accounts for the majority of the international networks’ revenue base, and this is anticipated to be the case for the foreseeable future. As a result, growing the distribution base for existing and newly launched international networks will continue to be the primary focus of the international division. No single customer represented more than 10% of Discovery’s consolidated revenue for the year ended December 31, 2006.U.S. networks.
 
Discovery’s principal operating costs consistdigital media business is an increasingly important part of programming expense,Discovery’s business, given the broad cross-platform sales and marketing expense, personnel expensepromotional opportunities with Discovery’s television networks and generalthe reach of the websites themselves, coupled with the economies realized through programs that can be produced once and administrative expenses. Programming is Discovery’s largest expense. Costs incurredused often in both long- and capitalized for the direct production of programming content are amortized over varying periods based on the expected realization of revenue from the underlying programs. Licensed programming is amortized over the contract period basedshort-term formats across multiple platforms.


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on the expected realization of revenue. Discovery incurs sales and marketing expenseThe U.S. Internet traffic data set forth herein is according to promote brand recognition and to secure quality distribution channels worldwide.Omniture, Inc. Discovery’s digital assets include:
 
Discovery.com

•  This flagship website is the official website for Discovery Channel and was relaunched in 2007 to feature more robust content, including a new media player, increased video clips and new search tools.

•  Discovery.com attracted an average of more than three million unique visitors per month in 2007.

•  Discovery is enhancing its other vertical sites (e.g. TLC.com, AnimalPlanet.com) to feature more robust content, a new media player, increased video clips and new search tools in order to move beyond being promotional vehicles for Discovery’s television networks and focus on visitor growth, engagement and improved monetization.

•  Discovery’s vertical sites attracted an average of more than 12 million unique visitors per month in 2007.
Discovery produces original programming and acquires content from numerous producers worldwide that is tailored to the specific preferences of viewers around the globe. Discovery believes it is generally well positioned for continued access to a broad range of high-quality programming for both its U.S. and international networks. It has assembled one of the largest libraries of non-fiction programming and footage in the world, due both to the aggregate purchasing power of its many networks and a policy to own as many rights as possible in the programs aired on its networks. Discovery also has long-term relationships with some of the world’s most significant non-fiction program producers, including the British Broadcasting Corporation, which we refer to as the BBC. Discovery believes the broad international appeal of its content combined with its ability to utilize its programming library on a global basis is one of its competitive advantages. Discovery is also developing programming applications designed to position the company to take advantage of emerging distribution technologies includingvideo-on-demand,IP-delivered programming and mobile.
 
HowStuffWorks.com

•  Acquired in December 2007, HowStuffWorks.com is an award-winning online source of high-quality, unbiased and easy-to-understand explanations of how the world actually works.

•  HowStuffWorks.com provides a high-profile platform for promoting and distributing Discovery’s extensive library of programming content and for developing advertising opportunities from the additional Discovery video content on this platform. Discovery believes that the mission alignment between Discovery and HowStuffWorks.com will allow for cross promotion and cross selling opportunities across multiple platforms.

•  HowStuffWorks.com attracted an average of more than 10 million unique visitors per month in 2007.
Discovery’s other properties consist of Discovery.com and over 100 retail outlets that offer technology, kids, lifestyle, health, science and education oriented products, as well as products related to other programming offered by Discovery. Additionally, Discovery’s newest division, Discovery Education, distributes digital-based educational products to schools and consumers primarily in the United States.
 
TreeHugger.com

•  Acquired by Discovery in August 2007, TreeHugger.com is an eco-lifestyle web site that complements the pending debut of the Planet Green television network. Together, TreeHugger.com and PlanetGreen.com will provide consumers with a multi-platform offering across topics and issues around the environment and sustainable development.

•  TreeHugger.com attracted an average of more than one million unique visitors per month in 2007.

•  Discovery has also launched companion website PlanetGreen.com with a focus on community action oriented content.
Petfinder.com

•  Acquired in November 2006, Petfinder.com provides an additional promotional platform for the Animal Planet brand.

•  Over 260,000 homeless pets in over 11,000 animal placement organizations across North America have their own homepages on Petfinder.com, the oldest and largest searchable directory of adoptable pets on the web.

•  Petfinder.com attracted an average of more than 3.5 million unique visitors per month in 2007.
Discovery is a leader in offering solutions to advertisers that allow them to reach a broad range of audience demographics in the face of increasing fragmentation of audience share. The overall industry is facing several issues with regard to its advertising revenue, including (1) audience fragmentation caused by the proliferation of other television networks,video-on-demand offerings from cable and satellite companies and broadband content offerings; (2) the deployment of digital video recording devices (DVRs), allowing consumers to time shift programming and skip or fast-forward through advertisements; and (3) consolidation within the advertising industry, shifting more leverage to the bigger agencies and buying groups.
Discovery Networks U.S.
 
Discovery networks U.S. currentlyalso has distribution arrangements with the majority of mobile carriers in the U.S. to provide unique made-for-mobile short-form content and long-form episodes of popular titles on mobile devices. Discovery’svideo-on-demand service is distributed across most major U.S. affiliates, offering a selection of full-length programming such as Discovery Channel’sMythbustersandDeadliest Catch.


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Discovery Networks International
Reaching approximately 810 million cumulative subscribers (as defined below) in over 170 countries outside the U.S as of December 31, 2007, Discovery networks international operates 12one of the most extensive international television businesses in the media industry and executes a localization strategy by offering customized programming and in-market schedules via more than 100 unique distribution feeds and 35 languages. Discovery networks international encompasses five regional operations covering all major foreign cable and satellite markets, including Asia-Pacific, India, Latin America, the UK and EMEA (Europe, the Middle East and Africa), and has more than 25 international offices with regional headquarters located in Singapore, New Delhi, Miami and London.
International subscriber statistics are derived from internal data review coupled with external sources when available. As used herein, an “international subscriber” is a single household that receives the applicable Discovery network or programming service from its cable, satellite or other television provider, including those who receive Discovery networks from pay-television providers without charge pursuant to various pricing plans that include free periodsand/or free carriage. The term “cumulative subscribers” outside the U.S. refers to the collective sum of the total number of international subscribers to each of Discovery’s networks or programming services outside of the U.S. By way of example, two international households that each receive five Discovery networks from their cable provider represent 10 cumulative subscribers outside the U.S. Cumulative subscribers outside the U.S. include subscriptions for branded programming blocks in China, which are generally provided without charge to third-party channels and provides distribution and advertising sales services for BBC America and distribution services for BBC World News. The division’s channels includerepresented approximately 280 million cumulative subscribers outside the Discovery Channel, TLC, Animal Planet, Travel Channel, Discovery Health Channel, Fit TV and the following emerging digital tier networks: The Science Channel, Discovery Kids, The Military Channel, Discovery Home, Discovery Times and Discovery HD Theater, which we refer to collectivelyU.S. as the emerging networks. All of these channelsDecember 31, 2007.
Discovery’s international networks are wholly owned by Discovery other than Animal Planet, in which Discovery has an 80% ownership interest. Cox Communications, Advance/Newhouse and a subsidiary of Discovery Holding Company, combined, own the remaining 20% interest in Animal Planet. Discovery networks U.S. also operates web sites related to its channel businesses and various other new media businesses, including avideo-on-demand offering distributed by various cable operators.
Discovery Networks International
Discovery networks international, or the international networks, manages a portfolio of channels, led by Discovery Channel and Animal Planet, that are distributed in virtually every pay-television market in the world via an infrastructure that includes major operational centers in London, Singapore, New Delhi and Miami. Discovery networks international currently operates over 100 separate feeds in 35 languages with channel feeds customized according to language needs and advertising sales opportunities. Most of the division’s channels are wholly owned by Discovery with the exception ofexcept (1) the international Animal Planet channels which are generally50-50 joint ventures with the BBC, (2) People + People+Arts which operates in Latin America and Iberia as a50-50 joint venture with the BBC and (3) several channels in Japan, Canada and Canada,Poland which operate as joint ventures with strategically importantstrategic local partners. Aspartners and which are not consolidated in Discovery’s financial statements but whose subscribers are included in Discovery’s international cumulative subscribers. Pursuant to the terms of the Animal Planet international joint ventures, BBC has the right, subject to certain conditions, to cause Discovery to acquire BBC’s interest in these joint ventures. Pursuant to the terms of the People + Arts joint venture, BBC has the right, subject to certain conditions, to cause Discovery to either acquire BBC’s interest in, or sell to the BBC Discovery’s interest in, this joint venture. Certain preliminary steps have been taken with respect to the exercise by BBC of its rights; however, we cannot assure you whether the conditions to the exercise of either or both of these rights will be satisfied or if they are satisfied whether BBC will exercise either or both of these rights.
Led by flagship brand Discovery Channel, Discovery networks international distributes 16 network entertainment brands, including:
Discovery Channel

•  Launched internationally in 1989, Discovery Channel reached approximately 240 million international subscribers in more than 170 countries as of December 31, 2007.

•  Discovery Channel’s international programming includes documentaries, docudramas and reality formats covering a wide range of topics and themes, including human adventure and exploration, engineering, science, history and world culture.


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Animal Planet

•  Launched internationally in 1997, Animal Planet reached approximately 210 million international subscribers in over 160 countries as of December 31, 2007.

•  Animal Planet is dedicated to mankind’s fascination with the creatures that share our world, featuring programs such asMeerkat Manor, UnearthedandLemur Street.

•  The international Animal Planet channels are generally a50-50 joint venture with the BBC.
Discovery Lifestyle Networks

•  Launched beginning in 1998, Discovery Lifestyle Networks reached approximately 213 million international subscribers in over 90 countries as of December 31, 2007.
•  Discovery Lifestyle Networks is a global portfolio of three lifestyle brands offering inspirational content that encourages viewers to pursue unique interests and experiences: Discovery Travel & Living, Discovery Home & Health and Discovery Real Time.
•  Discovery Travel & Living provides a mix of lifestyle programming on travel, food, design and décor. Discovery Home & Health provides relevant and practical programming on relationships, babies, beauty and wellbeing. Discovery Real Time features practical and motivating programming on how to make the most of free time.
Discovery Science

•  Launched internationally in 1998, Discovery Science reached approximately 29 million international subscribers in over 60 countries as of December 31, 2007.

•  Discovery Science uncovers fascinating clues to the questions that have eluded us for centuries and reveals life’s greatest mysteries and smallest wonders.
Discovery Kids.

•  Launched internationally in 1997, Discovery Kids reached approximately 21 million international subscribers in over 25 countries across Latin America, the Carribean and Canada as of December 31, 2007.

•  Discovery Kids provides a unique environment that nurtures children’s curiosity using characters and stories, enabling them to relate to real-life experiences.
Discovery HD.

•  Launched internationally in 2005, Discovery HD reached subscribers in 15 countries as of December 31, 2007.

•  Discovery HD showcases dynamic content from Discovery’s library of thousands of hours of visually compelling HD footage includingDiscovery Atlas.

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People+Arts.

•  Launched in 1997, People+Arts reached approximately 20 million international subscribers in Latin America, Spain and Portugal as of December 31, 2007.

•  People+Arts is the entertainment network from the BBC and Discovery that explores the complete range of human emotions, with engaging storytelling that is moving, unexpected and authentic.

•  People + Arts is a50-50 joint venture with the BBC.
DMAX Germany.

•  Launched in Germany in 2006, DMAX reached approximately 27 million homes in Germany as of December 31, 2007.

•  DMAX is a free-to-air service which has broad distribution. DMAX generates only advertising revenue, offering a broad range of original content from Germany and around the world including documentaries, talk shows and reality-based series.
Discovery networks international also includes the following television channels: Discovery Civilization, Discovery Geschichte, Discovery Historia, Discovery Knowledge, Discovery Turbo, and DMAX UK.
The followingSpanish-language networks are distributed to U.S. subscribers, but are operated by and included as part of Discovery networks division, the international for financial reporting and management purposes:
Discovery en Español.

•  Launched in the U.S. in June 1998, Discovery en Español reached approximately eight million U.S. subscribers as of December 31, 2007.

•  Discovery en Español is a non-fiction network delivering content that stimulates, informs and empowers, giving viewers a fascinating look at the incredible and often surprising world from an Hispanic perspective.

•  Discovery en Español is designed to give viewers more of the programming they enjoy including original programming developed specifically for Spanish-speaking audiences.

•  Target viewers are adults18-49, particularly men.
Discovery Familia.

•  Launched in the U.S. in August 2007, Discovery Familia reached approximately one million U.S. subscribers as of December 31, 2007.

•  Discovery Familia is Discovery’sSpanish-language network dedicated to bringing the best educational and entertaining, family-oriented programming to kids and families.

•  Target viewers are Hispanic children, women and families.
Discovery networks divisioninternational also operates webAntenna Audio which was acquired by Discovery in 2006, and is a leading provider of audio and multimedia tours to museums, exhibitions, historic sites and other new media businesses.visitor attractions around the world. Each year, more than 20 million visitors purchase Antenna Audio’s tours in 12 languages across 20 countries at approximately 450 of the world’s most famous, fascinating and frequented locations, including museums such as the Metropolitan Museum of Art, the Musée du Louvre and Tate; historic and cultural sites including Graceland, Château de Versailles and Alcatraz; and popular destinations such as the Statue of Liberty and Yosemite National Park.
 
Discovery Commerce, Education & Other
This group includesnetworks international’s digital business is in its early stages of development. Discovery’s international websites currently function as marketing vehicles for the network brands. Discovery commerce, which operates a chain of retail stores in the United States that offer technology, kids, lifestyle, health, science and education-oriented products, as well as products specifically related to programming on Discovery’s networks. This divisionnetworks international also operates a catalogprogram sales business pursuant to which it sells programming internationally and electronic commercea licensing business sellingpursuant to which it licenses its brands for consumer products similar to that sold in the Discovery Channel Stores, as well as a business that licenses Discovery trademarks and intellectual property to third parties for the purpose of creating and selling retail merchandise.
This group also includes Discovery education. In 2004, the company expanded beyond its traditional education businesses of airing educational programming on its networks and selling hard copies of such programs to schools andinternationally.


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began streaming educational video material into schools viaDiscovery Commerce and Education
Discovery Commerce
Discovery commerce represents an additional revenue stream for Discovery. It also plays an important role in support of Discovery’s overall strategic objectives by driving consumers to Discovery’s television and online properties and instilling viewer loyalty. In 2007, as part of a company-wide strategic review, Discovery made the Internet. decision to discontinue itsbrick-and-mortar retail stores and instead focus on exploiting its on-air brands and increasing the reach of its products through itse-commerce platform and licensing arrangements. In the third quarter of 2007, Discovery completed the closing of its 103 mall-based and stand-alone Discovery Channel stores.
The division’s platforms now include ane-commerce business, seasonal catalogs and domestic licensing business:
• Discoverystore.comis ane-commerce site where customers can shop for a large assortment of proprietary Discovery merchandise and other products. Discoverystore.com logged more than 12 million unique visitors in 2007. Discoverystore.com also reaches consumers through relationships with leadinge-commerce sites such as Amazon.com.
• The Discovery Channel Store Catalogis distributed to over nine million consumers annually and highlights a selection of proprietary and other products for the whole family. The catalog is a highly targeted marketing and branding tool driving online and phone sales. It also adds value as a cross promotional vehicle for network and corporate initiatives.
• Domestic Licensinghas agreements with key manufacturers and retailers, including JAKKS, Activision, and others to develop long-term, strategic programs that translate Discovery’s network brands and signature properties into an array of merchandising opportunities. From Animal Planet toy and pet products,Mythbustersbooks, DVDs and calendars toMiami Inkapparel and accessories, domestic licensing develops products that capture the look and feel of Discovery’s core brands and programs.
Discovery Education
Discovery education now operatesprovides video-based broadband educational content through subscription services to public and private K-12 schools serving over one million teachers nationwide. Discovery’s flagship educational service,UnitedstreamingDiscovery Education streaming, iPower-Media-Plussan onlinevideo-on-demand teaching service that features 4,000 digital videos andCosmeo, 40,000 content specific video clips correlated to state K-12 curriculum standards.
Discovery education also publishes and distributes content on DVD, VHS, and CD-ROM through catalogs, an online teacher store, and a network of distributors. Discovery education also participates in licensing and sponsorship programs with corporate partners and supports Discovery’s digital initiatives by providing educational content in multiple formats that meet the needs of teachers and students.
Content Development
Discovery’s content development strategy is designed to increase viewership, maintain innovation and quality leadership, and provide value for its distributors and advertising customers. Discovery’s production agreements fall into three categories: commissions, co-productions and acquisitions. Commissions refer to programming for which Discovery generally owns most or all rights for at least 10 years and, in exchange for paying for all production costs, retains all editorial control. Co-productions refer to programs where Discovery retains significant (but more limited) rights to exploit the programs. The rights package retained by Discovery is generally in proportion to the portion of the total project costs covered by Discovery, which generally ranges from25-70% of the total project cost. Co-productions are typically high-cost projects for which neither Discovery nor its co-producers wish to bear the entire cost or productions in which the producer has already taken on an international broadcast partner. Acquisitions are license agreements for films or series that have already been produced.
As revenue and network distribution grows, Discovery’s program mix matures from acquired content to sharing in co-productions to full commissions. To minimize programming expense in the early stages, as an audience base begins to form, acquired programming is used to a greater extent and repeated frequently. The


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transition from acquired content provides for more customized use of programming for individual networks and broader rights for re-use on television networks and new platforms.
Discovery sources content from a wide range of producers, building long-standing relationships with some of the world’s leading non-fiction production companies as well as consistently developing and encouraging young independent producers. Discovery also has long-term relationships with some of the world’s most significant non-fiction program producers, including the British Broadcasting Corporation.
The programming schedule on Discovery’s most widely distributed networks is mostly a mix of high-cost “special event” programming combined with miniseries and regular series. Large-scale programming events such asPlanet Earth, Nefertiti Resurrected, Walking With CavemenandBlue Planetbring brand prestige, favorable media coverage and substantial cross-promotional opportunities for other content platforms. Given the success of these global programming “tent-poles,” Discovery will continue to invest in a mix of programs that have the potential to draw larger audiences while also increasing the investment in regularly scheduled series. Brand-defining series such asMythbusters, Dirty Jobs, Deadliest Catch, What Not To Wear, Man Vs Wild, John And Kate Plus 8andLittle People, Big Worldbring predictability to the schedule, increase repeat viewership and channel loyalty, and create new sub-brands that can be exploited and monetized across other platforms and around the world.
Discovery has an extensive library of over 100,000 hours of programming and footage that provides a high-quality source of programming for debuting new services quickly without significant incremental spending. For example, Discovery was able to exploit the “long-tail” popularity of its extensive non-fiction library of forensics and investigation programming to debut the re-branded Investigation Discovery channel in January 2008. Programming can be re-edited and updated to provide topical versions of subject matter in a cost-effective manner. Library development also provides a mechanism to share program ideas around the world and repurpose for display on new digital and mobile platforms.
Sources of Revenue
Discovery earns revenue principally from (1) the receipt of affiliate fees from the global delivery of non-fiction programming pursuant to affiliation agreements with cable television operators, direct-to-home satellite operators and other distributors, (2) advertising sales on its television networks and websites and (3) product and subscription sales in the commerce and education businesses. No single customer represented more than 10% of Discovery’s consolidated revenue for the year ended December 31, 2007.
Distribution Revenue
Distribution revenue represented 47% of Discovery’s consolidated total revenue in 2007. Distribution revenue in the U.S. represented 44% of U.S. networks revenue, and international distribution fees represented 60% of international networks revenue in 2007. Distribution revenue is generated through affiliation agreements with cable, satellite and other television distributors, which have a typical term of 3-7 years. These affiliation agreements generally provide for the level of carriage Discovery’s networks will receive, such as channel placement and package inclusion (whether on more widely distributed, broader packages or lesser-distributed, specialized packages), and for payment of a fee to Discovery based on the numbers of subscribers that receive its networks. Upon the launch of a new channel, Discovery may initially pay distributors to carry such channel (such payments are referred to as “launch incentives”), or may provide the channel to the distributor for free for a predetermined length of time. Discovery has long-term contracts with distributors representing most cable and satellite operators around the world, including the largest operators in the U.S. and major international distributors. In the U.S., 90% of distribution revenue comes from the top eight distributors, with whom Discovery has agreements that expire at various times beginning in 2008 through 2014. In 2008, Discovery will enter negotiations to renew distribution agreements for carriage of its networks involving a substantial portion of its domestic subscribers. A failure to secure a renewal or a renewal on less favorable terms may have a material adverse effect on Discovery’s results of operations and financial position. Outside of the U.S., Discovery has agreements with numerous distributors with no individual agreement representing more than 10% of Discovery’s international distribution revenue.


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Advertising Revenue
Advertising revenue comprised 43% of Discovery’s consolidated total revenue in 2007. Advertising revenue in the U.S. represented 51% of U.S. networks revenue, and international advertising revenue represented 32% of international networks revenue in 2007. Discovery typically builds network brands by securing as broad a subscriber base as possible. After obtaining sufficient distribution to provide an attractive platform for advertising, Discovery increases its investment in programming and marketing to build audience share and drive strong ratings performance in order to increase advertising sales opportunities. Advertising revenue generated by each program service depends on the number of subscribers receiving the service, viewership demographics, the brand appeal of the network and ratings as determined by third-party research companies such as The Nielsen Company. Revenue from advertising is subject to seasonality and market-based variations. Advertising revenue is typically highest in the second and fourth quarters. Revenue can also fluctuate due to the popularity of particular programs and viewership ratings. In some cases, advertising sales are subject to ratings guarantees requiring Discovery to provide additional advertising time or refunds if the guarantees are not met.
Discovery sells advertising time in both the upfront and scatter markets. In the upfront market, advertisers buy advertising time for the upcoming season, and by buying in advance, often receive discounted rates. In the scatter market, advertisers buy advertising time close to the time when the ads will be run, and often pay a premium. The mix between the upfront and scatter markets is based upon a number of factors such as pricing, demand for advertising time and economic conditions.
The company’s two flagship networks, Discovery Channel and TLC, target key demographics that have historically been considered attractive to advertisers, notably viewers in the18-54 age range who are viewed as having significant spending power. The Discovery Channel’s target audience skews toward male viewers, while TLC targets female viewers, providing a healthy gender balance in Discovery’s portfolio for distribution and advertising clients.
Discovery benefits by having a portfolio of networks appealing to a broad range of demographics. This allows Discovery to create advertising packages that exploit the strength of its large networks to benefit smaller niche or targeted networks and networks on digital tiers. Utilizing the strength of its diverse networks, coupled with its online and digital platforms, Discovery seeks to create innovative programming initiatives and multifaceted campaigns for the benefit of a wide variety of companies and organizations who desire to reach key audience demographics unique to each network. Discovery delivers customized, integrated marketing campaigns to clients worldwide by catering to the special needs of multi-regional advertisers who are looking for integrated campaigns that move beyond traditional spot advertising to include sponsorships, product placements and other opportunities.
Discovery also generates advertising revenue from its websites. Discovery sells advertising on its websites both on a stand-alone basis and as part of advertising packages with its television networks.
Commerce and Education Revenue
Discovery commerce and education derives revenue principally from the sale of products online and through its catalogs, licensing royalties and subscriptions to its educational broadbandstreaming services. As part of its commerce business, Discovery has a domestic consumer products licensing business which licenses Discovery’s brands in connection with merchandise, videogames and publishing. Discovery is generally paid a royalty based upon a percentage of its licensees’ wholesale revenues, with an advance against future expected royalties. As part of its strategic reorganization described above, Discovery closed its 103 retail stores in 2007.
E-commerce and catalog sales are highly seasonal with a majority of the sales occurring in the fourth quarter due to the holiday season. Licensing revenue may vary from period to period depending upon the popularity of the properties available for license and the popularity of licensed products in a particular period. Subscription sales to Discovery’s educational streaming services are primarily sold at the beginning of each school year as school budgets are appropriated and approved. The revenue derived from the subscription agreements are generally recognized over the school year. Discovery education also provides products that are sold throughout the school year. In 2007, revenue frome-commerce and catalog sales (excluding sales from Discovery’s retail stores which


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were closed in the United States. These services earn2007), licensing and education subscriptions was 54%, 5% and 27%, respectively, of total revenue through subscription fees paid by schools, school districtsfor Discovery commerce and consumers which use the services.education.
 
Operating Expenditures
Discovery’s principal operating costs consist of programming expense, sales and marketing expense, personnel expense and general and administrative expenses. Content amortization expense is Discovery’s largest category, representing 35% of Discovery’s 2007 consolidated operating expenses, as investment in maintaining high-quality editorial and production values is a key differentiator for Discovery Stockholders’ Agreementcontent. In connection with creating original content, Discovery incurs production costs associated with acquiring new show concepts and retaining creative talent, including actors, writers and producers. Discovery also incurs higher production costs when filming in HD versus standard definition. Discovery incurs sales and marketing expense to promote brand recognition and to secure quality distribution channels worldwide.
Discovery Limited Liability Company Agreement
 
A subsidiary of ours, together with a subsidiary of Cox Communications, which we refer to as Cox Communications, and Advance/Newhouse Programming Partnership, which we refer to as Advance/Newhouse and John Hendricks, the founder and Chairman of Discovery, are parties to a Stockholders’Limited Liability Company Agreement. We own 50%, and Cox Communications662/3% and Advance/Newhouse each own 25%,owns 331/3% of Discovery. Mr. Hendricks is the record holder of one share of capital stockmembership interest of Discovery; however, Mr. Hendricks cannot transfer this share,interest, the shareinterest is subject to an irrevocable proxy in favor of Advance/Newhouse and the shareinterest is subject to a call arrangement pursuant to which Advance/Newhouse can purchase the share.interest. Accordingly, we treat such shareinterest as being owned by Advance/Newhouse for purposes of Advance/Newhouse’s percentage ownership of Discovery as described in this Annual Report. As a “close corporation” under Delaware law, the stockholders manage the business of Discovery, rather than a board of directors. The Stockholders’Limited Liability Company Agreement provides that a number of decisions affecting Discovery, such as, among other things, a decision to effect a fundamental change in its business, a merger or other business combination, issuance of Discovery’s equity securities, approval of transactions between Discovery, on the one hand, and any of its stockholders, on the other hand, and adoption of Discovery’s annual business plan or payment of any distributions on the membership interests must be approved by the holders of 80% of its outstanding capital stock. In addition, other matters, such as the declaration and payment of dividends on its capital stock, require the approval of the holders of a majority of Discovery’s outstanding capital stock.
membership interests. Because we own 50%, Cox Communications owns 25%662/3% and Advance/Newhouse owns 25% of the stock331/3% of Discovery, anyeither one of us may block Discovery from taking any action that requires 80% approval. In addition, because Cox Communications and Advance/Newhouse, on the one hand, and our company, on the other, each owns 50% of the outstanding stock of Discovery, there is the possibility that the stockholders could deadlock over various other matters, which require the approval of the holders of a majority of its capital stock. To reduce the possibility that this could occur, the stockholders have given John Hendricks, the founder and Chairman of Discovery, the right (but not the obligation), subject to certain limitations, to cast a vote to break a deadlock on certain matters requiring a majority vote for approval.
 
The Stockholders’Limited Liability Company Agreement also restricts, subject to certain exceptions, the ability of a stockholdermember to transfer its sharesmembership interests in Discovery to a third party. Any such proposed transfer is subject to a pro rata right of first refusal in favor of the other stockholders.member. If all of the offered sharesmembership interests are not purchased by the other stockholders,member, then the selling stockholdermember may sell all of the offered sharesmembership interests to the third party that originally offered to purchase such sharesinterests at the same price and on the same terms, provided that such third party agrees to be bound by the restrictions contained in the Stockholders’Limited Liability Company Agreement. In addition, in the event that either Cox Communications or Advance/Newhouse proposes to transfer shares, Cox Communications or Advance/Newhouse, whichever is not proposing to transfer, would have a preemptive right to buy the other’s shares, and if it does not elect to purchase all such shares, then the remaining shares would be subject to the pro rata right of first refusal described above.
 
The Stockholders’Limited Liability Company Agreement also prohibits Cox Communications, Advance/Newhouse and our company from starting, or acquiring a majority of the voting power of, a basic programming service carried in the United States that consists primarily of documentary, science and nature programming, subject to certain exceptions.
 
In connection with theour spin off from Liberty, Liberty contributed to us 100% of an entity that owns a 10% interest in the Animal Planet limited partnership. Our partners in this entity include Discovery Cox Communications and Advance/Newhouse. The Stockholders’Limited Liability Company Agreement prohibits us from selling, transferring or otherwise disposing of either of the subsidiaries that hold the Discovery interest or Animal Planet interest, respectively, unless, after such transaction, such subsidiaries are controlled by the same person or entity.
 
The foregoing summary of the Discovery Stockholders’Limited Liability Agreement is qualified by reference to the full text of the agreement and amendments.
 
Regulatory MattersREGULATORY MATTERS
 
Ascent Media
Some of Ascent Media’s subsidiary companies hold licenses and authorizations from the Federal Communications Commission, or FCC, required for the conduct of their businesses, including earth station and various classes of wireless licenses and an authorization to provide certain services pursuant to Section 214 of the Communications Act. Most of the FCC licenses held by such subsidiaries are for transmit/receive earth stations, which cannot be operated without


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Some of Ascent Media’s subsidiary companies hold licenses and authorizations from the Federal Communications Commission, or FCC, required for the conduct of their businesses, including earth station and various


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classes of wireless licenses and an authorization to provide certain services pursuant to Section 214 of the Communications Act. Most of the FCC licenses held by such subsidiaries are for transmit/receive earth stations, which cannot be operated without individual licenses. The licenses for these stations are granted for a period of fifteen years and, while the FCC generally renews licenses for satellite earth stations, there can be no assurance that these licenses will be renewed at their expiration dates. Registration with the FCC, rather than licensing, is required for receiving transmissions from domestic satellites from points within the United States. Ascent Media relies on third party licenses or authorizations when it and its subsidiaries transmit domestic satellite traffic through earth stations operated by third parties. The FCC establishes technical standards for satellite transmission equipment that change from time to time and requires coordination of earth stations with land-based microwave systems at certain frequencies to assure non-interference. Transmission equipment must also be installed and operated in a manner that avoids exposing humans to harmful levels of radio-frequency radiation. The placement of earth stations or other antennae also is typically subject to regulation under local zoning ordinances.
 
Discovery
Discovery’s businesses are subject to and affected by regulations of U.S. federal, state and local government authorities, and Discovery’s international operations are subject to laws and regulations of local countries and international bodies such as the European Union. The rules, regulations, policies and procedures affecting Discovery’s businesses are constantly subject to change. These descriptions are summary in nature and do not purport to describe all present and proposed laws and regulations affecting Discovery’s businesses.
 
In the United States, the FCC regulates the providers of satellite communications services and facilities for the transmission of programming services, the cable television systems that carry such services and, to some extent, the availability of the programming services themselves through its regulation of program licensing. Cable television systems in the United States are also regulated by municipalities or other state and local government authorities and are currently subject to federal rate regulation on the provision of basic service. Continued rate regulation or other franchise conditions could place downward pressure on the fees cable television companies are willing or able to pay for the Discovery networks. Regulatory carriage requirements also could adversely affect the number of channels available to carry the Discovery networks.
MVPD Programming
The FCC’s Program Access Rules prevent a cable programming vendor in which a cable operator has an “attributable” ownership interest under FCC rules from entering into exclusive contracts for programming with a cable operator and from discriminating among competing Multi-Channel Video Programming Distributors (“MVPDs”) in the price, terms and conditions for the sale or delivery of programming. These rules also permit MVPDs to initiate complaints to the FCC against program suppliers if an MVPD is unable to obtain rights to programming on nondiscriminatory terms. The FCC recently voted to extend the Program Access Rules exclusivity ban for an additional five years, and has proposed other changes that would increase the rights of MVPDs. Discovery is currently subject to the Program Access Rules because: (a) Advance/Newhouse, which operates cable systems, holds an attributable interest in Discovery under the FCC’s rules on ownership interests; and (b) Mr. John Malone, who holds an attributable interest in Discovery through Discovery Holding Company, also holds an attributable interest in a company whose subsidiary operates a cable television system. Another company in which Mr. Malone holds an attributable interest and serves as Chairman of the Board, Liberty Media Corporation, has applied to acquire de facto control of DirecTV, a direct broadcast satellite provider. When de facto control of DirecTV was acquired by a subsidiary of News Corporation, the FCC imposed program access conditions on certain of the programming networks affiliated with News Corporation that are similar to the Program Access Rules, but also gave MVPDs the right to enter into commercial arbitration to resolve impasses over certain programming agreements relating to regional sports networks and the signals of local broadcast television stations owned and operated by News Corporation. In its application to acquire de facto control of DirecTV, Liberty Media stated that it would agree to be bound by the program access conditions previously imposed upon News Corporation. Whether the FCC will impose those conditions, other conditions, or additional conditions, and how Discovery will be affected, is not yet known.
 
The Cable Television Consumer Protection
À la Carte Programming and Competition Act of 1992 (the 1992 Cable Act) directed the FCC to promulgate regulations regarding the sale and acquisition of cable programming between multi-channel video programming distributors (including cable operators) and satellite-delivered programming services in which a cable operator has an attributable interest. Because cable operators have an attributable interest in Discovery, the Discovery networks are subject to these rules. The legislation and the implementing regulations adopted by the FCC preclude virtually all exclusive programming contracts between cable operators and satellite programmers affiliated with any cable operator and the 1992 Cable Act requires that such affiliated programmers make their programming services available to cable operators and competing multi-channel video programming distributors on terms and conditions that do not unfairly discriminate among distributors. As a result, Discovery has not been, and will not be, able to enter into exclusive distribution agreements, which could provide more favorable terms than non-exclusive agreements. The contract exclusivity restrictions will sunset in 2007, unless extended by the FCC. The FCC is expected to initiate a proceeding to consider the extension of the contract exclusivity rules early in 2007.
The 1992 Cable Act required the FCC, among other things, to prescribe rules and regulations establishing reasonable limits on the number of channels on a cable system that will be allowed to carry programming in which the owner of such cable system has an attributable interest. In 1993, the FCC adopted such channel carriage limits. However, in 2001, the United States Court of Appeals for the District of Columbia Circuit found that the FCC had failed to adequately justify the channel carriage limit, vacated the FCC’s decision and remanded the rule to the FCC for further consideration. In response to the Court’s decision, the FCC issued a further notice of proposed rulemaking in 2001 to consider channel carriage limitations. The FCC issued a Second Further Notice of Proposed Rulemaking on May 17, 2005, requesting comment on these issues. If such channel carriage limitations are implemented, the ability of Cox Communications and Advance/Newhouse to carry the full range of Discovery’s networks could be limited.
The 1992 Cable Act granted broadcasters a choice of must carry rights or retransmission consent rights. The rules adopted by the FCC generally provided for mandatory carriage by cable systems of all local full-power commercial television broadcast signals selecting must carry rights and, depending on a cable system’s channel capacity, non-commercial television broadcast signals. Such statutorily mandated carriage of broadcast stations coupled with the provisions of the Cable Communications Policy Act of 1984, which require cable television systems with 36 or more “activated” channels to reserve a percentage of such channels for commercial use by unaffiliated third parties and permit franchise authorities to require the cable operator to provide channel capacity, equipment and facilities for public, educational and government access channels, could adversely affect the Discovery networks by limiting their carriage of such services in cable systems with limited channel capacity. In 2001, the FCC adopted rules relating to the cable carriage of digital television signals. Among other things, the rules clarify that a digital-only television station can assert a right to analog or digital carriage on a cable system. The FCC initiated a further proceeding to determine whether television stations may assert rights to carriage of both analog and digital signals during the transition to digital television and to carriage of all digital signals (“multicast must carry”). On February 10, 2005, the FCC denied mandatory dual carriage of a television station’s analog and digital signals during the digital television transition and mandatory carriage of all digital


I-10Unbundling Proposals

The FCC has initiated proceedings inquiring about its authority to require MVPD programming to be provided to subscribers on an à la carte basis, which would require them to be sold as individual channels rather than as part of program tiers. It also has proposed that program vendors be required to sell programming to MVPDs on an unbundled basis, so that programming vendors like Discovery would be precluded from requiring MVPDs to take a basket of program channels. Members of Congress also have indicated an interest in enabling legislation to achieve these same goals.


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signals, other than its “primary” signal. Television station owners have petitioned the FCC to reconsider its decision
Must Carry and are seeking legislative change. Those petitions are still pending. In addition, Congress may address this issue.Leased Access
The Cable Act of 1992 imposed “must carry” regulations on cable systems, requiring them to carry the signals of local broadcast television stations. The scope of the must carry rules has since been extended to direct broadcast satellite systems. The FCC recently adopted an order requiring most cable systems, following the anticipated end of analog television broadcasting in February 2009, to carry the digital signals of local television stationsandto carry the same signal in an analog format. The FCC also has under consideration a proposal to require carriage by cable systems of additional program streams (“multicast programming”) transmitted by broadcast television stations. The FCC in November 2007 announced that it will require cable operators to provide independent programmers with leased capacity at rates below those now prevailing. In June 2007, the FCC released a notice of proposed rulemaking considering changes to its program carriage rules, which govern carriage disputes between programmers and distributors. Changes to these rules could affect the terms under which Discovery’s services are distributed
 
In 2004, the FCC’s Media Bureau conducted a notice of inquiry proceeding regarding the feasibility of selling video programming services “a la carte”, i.e. on an individual or small tier basis. The Media Bureau released a report in November 2004, which concluded that a la carte sales of video programming services would not result in lower video programming costs for most consumers and that they would adversely affect video programming networks. On February 9, 2006, the Media Bureau released a new report which stated that the 2004 report was flawed and which concluded that a la carte sales could be in the best interests of consumers. Although the FCC likely cannot mandate a la carte sales, its endorsement
Children’s Programming
FCC rules limit the amount and content of commercial matter that may be shown on cable channels during programs designed for children 12 years of age or younger. Additionally, new rules, which became effective in 2007, restrict the ability of programmers to display website addresses during children’s programming unless those websites meet certain criteria designed to limit exposure to commercial matter. The FCC and other policymakers are examining other issues that could affect advertising during programming designed for children.
Regulation of the concept could encourage Congress to consider proposals to mandate a la carte sales or otherwise seek to impose greater regulatory controls on how a la carte programming is sold. The programming companies that distribute these services in tiers or packages of programming services could experience decreased distribution if a la carte carriage were mandated.
In general, authorization from the FCC must be obtained for the construction and operation of a communications satellite. Satellite orbital slots are finite in number, thus limiting the number of carriers that can provide satellite transponders and the number of transponders available for transmission of programming services. At present, however, there are numerous competing satellite service providers that make transponders available for video services to the cable industry. The FCC also regulates the earth stations uplinking toand/or downlinking from such satellites.
The regulation of programming services is subject to the political process and has been in constant flux over the past decade. Further material changes in the law and regulatory requirements must be anticipated and there can be no assurance that our business will not be adversely affected by future legislation, new regulation or deregulation.
International Regulatory MattersInternet
Video distribution and content businesses are regulated in each of the countries in which we operate. The scope of regulation varies from country to country, although in some significant respects regulation in Western European markets is harmonized under the regulatory structure of the European Union, which we refer to as the EU. Adverse regulatory developments could subject our businesses to a number of risks. Regulations could limit growth, revenue and the number and types of services offered. In addition, regulation may restrict our operations and subject them to further competitive pressure, including restrictions imposed on foreign programming distributors that could limit the content they may carry in ways that affect us adversely. Failure to comply with current or future regulation of our businesses could expose our businesses to various penalties.
Competition
The creative media services industry is highly competitive, with much of the competition centered in Los Angeles, California, the largest and most competitive market, particularly for domestic television and feature film production as well as for the management of content libraries. We expect that competition will increase as a result of industry consolidation and alliances, as well as from the emergence of new competitors. In particular, major motion picture studios such as Paramount Pictures, Sony Pictures Corporation, Twentieth Century Fox, Universal Pictures, The Walt Disney Company,Metro-Goldwyn-Mayer and Warner Brothers, while Ascent Media’s customers, can perform similar services in-house with substantially greater financial resources than Ascent Media’s, and in some cases significant marketing advantages. These studios may also outsource their requirements to other independent providers like us or to other studios. Thomson, a French corporation, is also a major competitor of Ascent Media, particularly under its Technicolor brand, as is Kodak through its Laser Pacific division. Ascent Media also actively competes with certain industry participants that have a unique operating niche or specialty business. There is no assurance that Ascent Media will be able to compete effectively against these competitors. Ascent Media’s management believes that important competitive factors include the range of services offered, reputation for quality and innovation, pricing and long-term relationships with customers.
The business of distributing programming for cable and satellite television is highly competitive, both in the United States and in foreign countries. Discovery competes with other programmers for distribution on a limited number of channels. Increasing concentration in the multichannel video distribution industry could adversely affect Discovery by reducing the number of distributors available to carry Discovery’s networks, subjecting more of Discovery’s subscriber fees to volume discounts and increasing the distributors’ bargaining power in negotiating new affiliation agreements. Once distribution is obtained, Discovery’s programming services compete, in varying degrees, for viewers and advertisers with other cable and off-air broadcast television programming services as well as with other entertainment media, including home video,pay-per-view services, online activities, movies and other forms of news, information and entertainment. Discovery also competes, to varying degrees, for creative talent and programming content. Discovery’s


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management believes that important competitive factors include the prices charged for programming, the quantity, quality and variety of the programming offered and the effectiveness of marketing efforts.
Employees
We currently have no corporate employees. Liberty provides us with certain management and administrative services pursuant to a services agreement, which includes the services of our executive officers some of whom remain executive officers of Liberty.
As of December 31, 2006, Ascent Media had approximately 4,000 employees, most of which worked on a full-time basis. Approximately 2,900 of Ascent Media’s employees were employed in the United States, with the remaining 1,100 employed outside the United States, principally in the United Kingdom and the Republic of Singapore. Approximately 400 of Ascent Media’s employees belong to either the International Alliance of Theatrical Stage Employees in the United States or the Broadcasting Entertainment Cinematograph and Theatre Union in the United Kingdom.
As of December 31, 2006, Discovery had approximately 4,500 employees.
Discovery operates several internet websites which Discovery uses to distribute information about and supplement Discovery’s programs and to offer consumers the opportunity to purchase consumer products and services. Internet services are now subject to regulation in the United States relating to the privacy and security of personally identifiable user information and acquisition of personal information from children under 13, including the federal Child Online Protection Act (COPA) and the federal Controlling the Assault of Non-Solicited Pornography and Marketing Act (CAN-SPAM). In addition, a majority of states have enacted laws that impose data security and security breach obligations. Additional federal and state laws and regulations may be adopted with respect to the Internet or other online services, covering such issues as user privacy, child safety, data security, advertising, pricing, content, copyrights and trademarks, access by persons with disabilities, distribution, taxation and characteristics and quality of products and services. In addition, to the extent Discovery offers products and services to online consumers outside the United States, the laws and regulations of foreign jurisdictions, including, without limitation, consumer protection, privacy, advertising, data retention, intellectual property, and content limitations, may impose additional compliance obligations on Discovery.
 
COMPETITION
The entertainment and media services industry is highly competitive, with much of the competition centered in Los Angeles, California, the largest and most competitive market, particularly for domestic television and feature film production as well as for the management of content libraries. We expect that competition will increase as a result of industry consolidation and alliances, as well as from the emergence of new competitors. In particular, major motion picture studios such as Paramount Pictures, Sony Pictures Entertainment, Twentieth Century Fox, Universal Pictures, The Walt Disney Company and Warner Bros. Entertainment, while Ascent Media’s customers, can perform similar services in-house with substantially greater financial resources than Ascent Media’s, and in some cases significant marketing advantages. These studios may also outsource their requirements to other independent providers like us or to other studios. Other major competitors of Ascent Media include: Thomson, a French corporation, particularly under its Technicolor brand; Kodak, through its Laser Pacific division; Deluxe Entertainment Services; and DG FastChannel, Inc. Ascent Media also actively competes with certain industry participants that have a unique operating niche or specialty business. There is no assurance that Ascent Media will be able to compete effectively against these competitors. Ascent Media’s management believes that important competitive factors include the range of services offered, reputation for quality and innovation, pricing and long-term relationships with customers.


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Cable and satellite network programming is a highly competitive business in the United States and worldwide. Discovery’s cable and satellite networks and websites generally compete for advertising revenue with other cable and broadcast television networks, online and mobile outlets, radio programming and print media. Discovery’s networks and websites also compete for their target audiences with all forms of programming and other media provided to viewers, including broadcast networks, local over-the-air television stations, competitors’ pay and basic cable television networks,pay-per-view andvideo-on-demand services, online activities and other forms of news, information and entertainment. Discovery’s networks also compete with other television networks for distribution and affiliate fees derived from distribution agreements with cable television operators, satellite operators and other distributors. The Discovery commerce and education division also operates in highly competitive industries with Discovery’se-commerce and catalogue business competing with brick and mortar and online retailers and Discovery’s education business competing with other providers of educational products to schools, including providers with long-standing relationships, such as Scholastic.
EMPLOYEES
We currently have no corporate employees. Liberty provides us with certain management and administrative services pursuant to a services agreement, which includes the services of our executive officers some of whom remain executive officers of Liberty.
As of December 31, 2007, Ascent Media had approximately 3,900 employees, most of which worked on a full-time basis. Approximately 2,900 of Ascent Media’s employees were employed in the United States, with the remaining 1,000 employed outside the United States, principally in the United Kingdom and the Republic of Singapore. Approximately 450 of Ascent Media’s employees belong to either the International Alliance of Theatrical Stage Employees in the United States or the Broadcasting Entertainment Cinematograph and Theatre Union in the United Kingdom.
As of December 31, 2007, Discovery had approximately 3,600 employees. None of Discovery’s employees is subject to a collective bargaining agreement.
INTELLECTUAL PROPERTY
Discovery’s intellectual property assets principally include copyrights in television programming, websites and other content, trademarks in brands, names and logos, domain names and licenses of intellectual property rights of various kinds.
Discovery is fundamentally a content company and the protection of its brands and content are of primary importance. To protect Discovery’s intellectual property assets, Discovery relies upon a combination of copyright, trademark, unfair competition, trade secret and Internet/domain name statutes and laws and contract provisions. However, there can be no assurance of the degree to which these measures will be successful in any given case. Moreover, effective intellectual property protection may be either unavailable or limited in certain foreign territories. Policing unauthorized use of Discovery’s products and services and related intellectual property is often difficult and the steps taken may not always prevent the infringement by unauthorized third parties of Discovery’s intellectual property. Discovery seeks to limit that threat through a combination of approaches.
Third parties may challenge the validity or scope of Discovery’s intellectual property from time to time, and such challenges could result in the limitation or loss of intellectual property rights. Irrespective of their validity, such claims may result in substantial costs and diversion of resources which could have an adverse effect on Discovery’s operations. In addition, piracy, including in the digital environment, continues to present a threat to revenues from products and services based on intellectual property.
(d)  Financial Information About Geographic Areas
For financial information related to the geographic areas in which we do business, see note 17 to our consolidated financial statements found in Part II of this report.
 
For financial information related to the geographic areas in which we do business, see note 18 to our consolidated financial statements found in Part II of this report.


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(e)  Available Information
All of our filings with the Securities and Exchange Commission (the “SEC”), including ourForm 10-Ks,Form 10-Qs andForm 8-Ks, as well as amendments to such filings are available on our Internet website free of charge generally within 24 hours after we file such material with the SEC. Our website address is www.discoveryholdingcompany.com.
Our corporate governance guidelines, code of business conduct and ethics, compensation committee charter, and audit committee charter are available on our website. In addition, we will provide a copy of any of these documents, free of charge, to any shareholder who calls or submits a request in writing to Investor Relations, Discovery Holding Company, 12300 Liberty Boulevard, Englewood, Colorado 80112, Tel. No.(866) 876-0461.
The information contained on our website is not part of this Annual Report and is not incorporated by reference herein.
 
All of our filings with the Securities and Exchange Commission (the “SEC”), including our
Form 10-Ks,Form 10-QsItem 1A. andForm 8-Ks, as well as amendments to such filings are available on our Internet website free of charge generally within 24 hours after we file such material with the SEC. Our website address is www.discoveryholdingcompany.com.
Our corporate governance guidelines, code of ethics, compensation committee charter, and audit committee charter are available on our website. In addition, we will provide a copy of any of these documents, free of charge, to any shareholder who calls or submits a request in writing to Investor Relations, Discovery Holding Company, 12300 Liberty Boulevard, Englewood, Colorado 80112, Tel. No.(866) 876-0461.
The information contained on our website is not incorporated by reference herein.
Item 1ARisk Factors..Risk Factors.
 
An investment in our common stock involves risk. You should carefully consider the risks described below, together with all of the other information included in this annual report in evaluating our company and our common stock. Any of the following risks, if realized, could have a material adverse effect on the value of our common stock.
 
We are a holding company, and we could be unable in
Risk Factors Relating to the future to obtain cash in amounts sufficient to service our financial obligations or meet our other commitments.  Our ability to meet our financial obligations and other contractual commitments depends upon our ability to access cash. We are a holding company, and our sources of cash include our available cash balances, net cash from the operating activitiesOwnership of our subsidiaries, any dividends and interest we may receive from our investments, availability under any credit facilities that we may obtain in the future and proceeds from any asset sales we may undertake in the future. The ability of our operating subsidiaries to pay dividends or to make other payments or advances to us depends on their individual operating results and any statutory, regulatory or contractual restrictions to which they may be or may become subject.
We do not have access to the cash that Discovery generates from its operating activities.  Discovery generated approximately $480 million, $69 million and $125 million of cash from its operations during the years ended December 31, 2006, 2005 and 2004, respectively. Discovery uses the cash it generates from its operations to fund its investing activities and to service its debt and other financing obligations. We do not have access to the cash that Discovery generates unless Discovery declares a dividend on its capital stock payable in cash, redeems any or all of its outstanding shares of capital stock for cash or otherwise distributes or makes payments to its stockholders, including us. Historically, Discovery has not paid any dividends on its capital stock or, with limited exceptions, otherwise distributed cash to its stockholders and instead has used all of its available cash in the expansion of its business and to service its debt obligations. Covenants in Discovery’s existing debt instruments also restrict the payment of dividends and cash distributions to stockholders. We expect that Discovery will continue to apply its available cash to the expansion of its business. We do not have sufficient voting control to cause Discovery to pay dividends or make other payments or advances to its stockholders, or otherwise provide us access to Discovery’s cash.


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We have limited operating history as a separate company upon which you can evaluate our performance.  Although our subsidiary Ascent Media was a separate public company prior to June 2003 (when Liberty acquired the outstanding shares of Ascent Media that it did not already own), we have limited operating history as a separate public company. Additionally, the historical financial information included in this annual report for periods prior to our existence may not necessarily be representative of our results as a separate company. There can be no assurance that our business strategy will be successful on a long-term basis. We may not be able to grow our businesses as planned and may not be profitable.
We do not have the right to manage Discovery, which means we cannot cause Discovery to operate in a manner that is favorable to us.  Discovery is managed by its stockholders rather than a board of directors. Generally, all significant actions to be taken by Discovery require the approval of the holders of a majority of Discovery’s shares; however, pursuant to a Stockholders’ Agreement, the taking of certain actions (including, among other things, a merger of Discovery, or the issuance of additional shares of Discovery capital stock or approval of annual business plans) require the approval of the holders of at least 80% of Discovery’s shares. Because we do not own a majority of the outstanding equity interests of Discovery, we do not have the right to manage the businesses or affairs of Discovery. Although our status as a 50% stockholder of Discovery enables us to exercise influence over the management and policies of Discovery, such status does not enable us to cause any actions to be taken. Cox Communications and Advance/Newhouse each hold a 25% interest in Discovery, which ownership interest enables each such company to prevent Discovery from taking actions requiring 80% approval.
Actions to be taken by Discovery that require the approval of a majority of Discovery’s shares may, under certain circumstances, result in a deadlock. Because we own a 50% interest in Discovery and each of Cox Communications and Advance/Newhouse own a 25% interest in Discovery, a deadlock may occur when the stockholders vote to approve an action that requires majority approval. Accordingly, unless either Cox Communications or Advance/Newhouse elects to vote with us on items that require majority action, such actions may not be taken. Pursuant to the terms of the Stockholders’ Agreement, if an action that requires approval by a majority of Discovery’s shares is approved by 50%, but not more than 50%, of the outstanding shares then the proposed action will be submitted to an arbitrator designated by the stockholders. Currently, the arbitrator is John Hendricks, the founder and Chairman of Discovery. Mr. Hendricks, as arbitrator, is entitled to cast the deciding vote on matters where the stockholders have deadlocked because neither side has a majority. Mr. Hendricks, however, is not obligated to take action to break such a deadlock. In addition, Mr. Hendricks may elect to approve actions we have opposed, if such a deadlock exists. In the event of a dispute among the stockholders of Discovery, the possibility of such a deadlock could have a material adverse effect on Discovery’s business.
The liquidity and value of our interest in Discovery may be adversely affected by a Stockholders’ Agreement to which we are a party.  Our 50% interest in Discovery is subject to the terms of a Stockholders’ Agreement among the holders of Discovery capital stock. Among other things, the Stockholders’ Agreement restricts our ability to directly sell or transfer our interest in Discovery or to borrow against its value. These restrictions impair the liquidity of our interest in Discovery and may make it difficult for us to obtain full value for our interest in Discovery should such a need arise. In the event we chose to sell all or a portion of our direct interest in Discovery, we would first have to obtain an offer from an unaffiliated third party and then offer to sell such interest to Cox Communications and Advance/Newhouse on substantially the same terms as the third party had agreed to pay.
If either Cox Communications or Advance/Newhouse decided to sell their respective interests in Discovery, then the other of such two stockholders would have a right to acquire such interests on the terms set by a third party offer obtained by the selling stockholder. If the non-selling stockholder elects not to exercise this acquisition right, then, subject to the terms of the Stockholders’ Agreement, we would have the opportunity to acquire such interests on substantially the terms set by a third party offer obtained by the selling stockholder. We anticipate that the purchase price to acquire the interests held by Cox Communications or Advance/Newhouse would be significant and could require us to obtain significant funding in order to raise sufficient funds to purchase one or both of their interests. This opportunity to purchase the Discovery interests held by Cox Communicationsand/orCommon Stock Advance/Newhouse may arise (if at all) at a time when it would be difficult for us to raise the funds necessary to purchase such interests.
We do not have the ability to require Cox Communications or Advance/Newhouse to sell their interests in Discovery to us, nor do they have the ability to require us to sell our interest to them. Accordingly, the current governance relationships affecting Discovery may continue indefinitely.
Because we do not control the business management practices of Discovery, we rely on Discovery for the financial information
We are a holding company, and we could be unable in the future to obtain cash in amounts sufficient to service our financial obligations or meet our other commitments.  Our ability to meet our financial obligations and other contractual commitments depends upon our ability to access cash. We are a holding company, and our sources of cash include our available cash balances, net cash from the operating activities of our subsidiaries, any dividends and interest we may receive from our investments, availability under any credit facilities that we may obtain in the future and proceeds from any asset sales we may undertake in the future. The ability of our operating subsidiaries to pay dividends or to make other payments or advances to us depends on their individual operating results and any statutory, regulatory or contractual restrictions to which they may be or may become subject.
We do not have access to the cash that we use in accounting for our ownership interest in Discovery.  We account for our 50% ownership interest in Discovery using the equity method of accounting and, accordingly, in our financial statements we record our share of Discovery’s net income or loss. Because we do not control Discovery’s decision-making process or business management practices, within the meaning of U.S. accounting rules, we rely on Discovery to provide us with financial information prepared in accordance with generally accepted accounting principles, which we use in the application of the


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equity method. We have entered into an agreement with Discovery regarding the use by us of certain information regarding Discovery in connection with our financial reporting and disclosure requirements as a public company. However, such agreement limits the public disclosure by us of certain non-public information regarding Discovery (other than specified historical financial information), and also restricts our ability to enforce the agreement against Discovery with a lawsuit seeking monetary damages, in the absence of gross negligence, reckless conduct or willful misconduct on the part of Discovery. In addition, we cannot change the way in which Discovery reports its financial results or require Discovery to change its internal controls over financial reporting.
We cannot be certain that we will be successful in integrating acquired businesses, if any.  Our businesses and those of our subsidiaries may grow through acquisitions in selected markets. Integration of new businesses may present significant challenges, including: realizing economies of scale in programming and network operations; eliminating duplicative overheads; and integrating networks, financial systems and operational systems. We or the applicable subsidiary cannot assure you that, with respect to any acquisition, we will realize anticipated benefits or successfully integrate any acquired business with our existing operations. In addition, while we intend to implement appropriate controls and procedures as we integrate acquired companies, we may not be able to certify as to the effectiveness of these companies’ disclosure controls and procedures or internal control over financial reporting (as required by U.S. federal securities laws and regulations) until we have fully integrated them.
A loss of any of Ascent Media’s large customers would reduce our revenue. Although Ascent Media serviced over 3,800 customers during the year ended December 31, 2006, its ten largest customers accounted for approximately 48% of its consolidated revenue and Ascent Media’s single largest customer accounted for approximately 8% of its consolidated revenue during that period. The loss of, and the failure to replace, any significant portion of the services provided to any significant customer could have a material adverse effect on the business of Ascent Media.
Ascent Media’s business depends on certain client industries.  Ascent Media derives much of its revenue from services provided to the motion picture and television production industries and from the data transmission industry. Fundamental changes in the business practices of any of these client industries could cause a material reduction in demand by Ascent Media’s clients for the services offered by Ascent Media. Ascent Media’s business benefits from the volume of motion picture and television content being created and distributed as well as the success or popularity of an individual television show. Accordingly, a decrease in either the supply of, or demand for, original entertainment content would have a material adverse effect on Ascent Media’s results of operations. Because spending for television advertising drives the production of new television programming, as well as the production of television commercials and the sale of existing content libraries for syndication, a reduction in television advertising spending would adversely affect Ascent Media’s business. Factors that could impact television advertising and the general demand for original entertainment content include the growing use of personal video recorders andvideo-on-demand services, continued fragmentation of and competition for the attention of television audiences, and general economic conditions.
Changes in technology may limit the competitiveness of and demand for our services.  The post-production industry is characterized by technological change, evolving customer needs and emerging technical standards, and the data transmission industry is currently saturated with companies providing services similar to Ascent Media’s. Historically, Ascent Media has expended significant amounts of capital to obtain equipment using the latest technology. Obtaining access to any new technologies that may be developed in Ascent Media’s industries will require additional capital expenditures, which may be significant and may have to be incurred in advance of any revenue that may be generated by such new technologies. In addition, the use of some technologies may require third party licenses, which may not be available on commercially reasonable terms. Although we believe that Ascent Media will be able to continue to offer services based on the newest technologies, we cannot assure you that Ascent Media will be able to obtain any of these technologies, that Ascent Media will be able to effectively implement these technologies on a cost-effective or timely basis or that such technologies will not render obsolete Ascent Media’s role as a provider of motion picture and television production services. If Ascent Media’s competitors in the data transmission industry have technology that enables them to provide services that are more reliable, faster, less expensive, reach more customers or have other advantages over the data transmission services Ascent Media provides, then the demand for Ascent Media’s data transmission services may decrease.
Technology in the video, telecommunications and data services industry is changing rapidly. Advances in technologies such as personal video recorders andvideo-on-demand and changes in television viewing habits facilitated by these or other technologies could have an adverse effect on Discovery’s advertising revenue and viewership levels. The ability to anticipate changes in, and adapt to, changes in technology and consumer tastes on a timely basis and exploit new sources of revenue from these changes will affect the ability of Discovery to continue to grow, increase its revenue and number of subscribers and remain competitive.


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A labor dispute in our client industries may disrupt our business.  The cost of producing and distributing entertainment programming has increased substantially in recent years due to, among other things, the increasing demands of creative talent and industry-wide collective bargaining agreements.
A significant labor dispute in Ascent Media’s client industries could have a material adverse effect on its business. An industry-wide strike or other job action by or affecting the Writers Guild, Screen Actors Guild or other major entertainment industry union could reduce the supply of original entertainment content, which would in turn, reduce the demand for Ascent Media’s services.
Discovery airs certain entertainment programs that are dependent on specific on-air talent, and Discovery’s ability to continue to produce these series is dependent on keeping that on-air talent under contract.
Risk of loss from earthquakes or other catastrophic events could disrupt Ascent Media’s business.  Some of Ascent Media’s specially equipped and acoustically designed facilities are located in Southern California, a region known for seismic activity. Due to the extensive amount of specialized equipment incorporated into the specially designed recording and scoring stages, editorial suites, mixing rooms and other post-production facilities, Ascent Media’s operations in this region may not be able to be temporarily relocated to mitigate the impacts of a catastrophic event. Ascent Media carries insurance for property loss and business interruption resulting from such events, including earthquake insurance, subject to deductibles, and has facilities in other geographic locations. Although we believe Ascent Media has adequate insurance coverage relating to damage to its property and the temporary disruption of its business from casualties, and that it could provide services at other geographic locations, there can be no assurance that such insurance and other facilities would be sufficient to cover all of Ascent Media’s costs or damages or Ascent Media’s loss of income resulting from its inability to provide services in Southern California for an extended period of time.
Discovery is dependent upon advertising revenue.  Discovery earns a significant portion of its revenue from the sale of advertising time on its networks and web sites. Discovery’s advertising revenue is affected by viewer demographics, viewer ratings and market conditions for advertising. The overall cable and broadcast television industry is facing several issues with regard to its advertising revenue, including (1) audience fragmentation caused by the proliferation of other television networks,video-on-demand offerings from cable and satellite companies and broadband content offering, (2) the deployment of digital video recording devices, allowing consumers to time shift programming and skip or fast-forward through advertisements and (3) consolidation within the advertising industry, shifting more leverage to the bigger agencies and buying groups. Expenditures by advertisers tend to be cyclical, reflecting overall economic conditions as well as budgeting and buying patterns. A decline in the economic prospects of advertisers or the economy in general could alter current or prospective advertisers’ spending priorities. In addition, the public’s reception toward programs or programming genres can decline. An adverse change in any of these factors could have a negative effect on Discovery’s revenue in any given period. Ascent Media’s business is also dependent in part on the advertising industry, as a significant portion of Ascent Media’s revenue is derived from the sale of services to agenciesand/or the producers of television advertising.
Discovery’s revenue is dependent upon the maintenance of affiliation agreements with cable and satellite distributors on acceptable terms.  Discovery earns a significant portion of its revenue from per-subscriber license fees paid by cable operators,direct-to-home (DTH) satellite television operators and other channel distributors. Discovery’s networks maintain affiliation arrangements that enable them to reach a large percentage of cable and direct broadcast satellite households across the United States, Asia, Europe and Latin America. These arrangements are generally long-term arrangements ranging from 3 to 10 years. These affiliation arrangements usually provide for payment to Discovery based on the numbers of subscribers that receive the Discovery generates from its operating activities.  Discovery generated approximately $242 million, $480 million and $69 million of cash from its operations during the years ended December 31, 2007, 2006 and 2005, respectively. Discovery uses the cash it generates from its operations to fund its investing activities and to service its debt and other financing obligations. We do not have access to the cash that Discovery generates unless Discovery makes a distribution with respect to its membership interests payable in cash, redeems any or all of its outstanding membership interests for cash or makes other payments or advances to its members. Prior to May 14, 2007, DCI did not pay any dividends on its capital stock, and since that date, Discovery has not made any distributions to its members, and instead has used all of its available cash in the expansion of its business and to service its debt obligations. Covenants in Discovery’s existing debt instruments also restrict the payment of dividends and cash distributions to members. We expect that Discovery will continue to apply its available cash to the expansion of its business. We do not currently have sufficient voting control to cause Discovery to make distributions, payments or advances to its members, or otherwise provide us access to Discovery’s cash.
We have limited operating history as a separate company upon which you can evaluate our performance.  We became a separate public company on July 21, 2005, the effective date of our spin off to Liberty’s shareholders. The historical financial information included in this annual report for periods prior to our existence may not necessarily be representative of our results as a separate company. There can be no assurance that our business strategy will be successful on a long-term basis. We may not be able to grow our businesses as planned and may not be profitable.
We do not have the right to manage Discovery, which means we cannot cause Discovery to operate in a manner that is favorable to us.  Discovery is managed by its members rather than a board of directors. Generally, all significant actions to be taken by Discovery require the approval of the holders of a majority of Discovery’s membership interests. However, pursuant to a Limited Liability Company Agreement, the taking of certain actions (including, among other things, a merger of Discovery, or the issuance of additional membership interests in Discovery or approval of annual business plans) requires the approval of the holders of at least 80% of Discovery’s


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membership interests. Although our status as a 662/3% member of Discovery enables us to exercise influence over the management and policies of Discovery, such status does not enable us to cause any actions to be taken. Advance/Newhouse holds a 331/3% interest in Discovery, which ownership interest enables them to prevent Discovery from taking actions requiring 80% approval. Even if the proposed transaction with Advance/Newhouse is completed, the terms of the preferred stock they would receive is expected to provide them with similar blocking rights.
The liquidity and value of our interest in Discovery may be adversely affected by a Limited Liability Company Agreement to which we are a party.  Our 662/3% interest in Discovery is subject to the terms of a Limited Liability Company Agreement among the holders of Discovery membership interests. Among other things, the Limited Liability Company Agreement restricts our ability to directly sell or transfer our interest in Discovery or to borrow against its value. These restrictions impair the liquidity of our interest in Discovery.
We do not have the ability to require Advance/Newhouse to sell its interest in Discovery to us, nor does it have the ability to require us to sell our interest to Advance/Newhouse. We and Advance/Newhouse have announced our intention to effect a restructuring of our respective interests pursuant to which Discovery would be 100% owned by a new holding company. No assurance can be made that this transaction will be completed on the terms contemplated or at all. If the transaction is not completed, the current governance relationships affecting Discovery and our liquidity in Discovery may continue indefinitely.
Because we do not control the business management practices of Discovery, we rely on Discovery for the financial information that we use in accounting for our ownership interest in Discovery.  We account for our 662/3% membership interest in Discovery using the equity method of accounting and, accordingly, in our financial statements we record our share of Discovery’s net income or loss. Because we do not control Discovery’s decision-making process or business management practices, within the meaning of U.S. accounting rules, we rely on Discovery to provide us with financial information prepared in accordance with generally accepted accounting principles, which we use in the application of the equity method. We have entered into an agreement with Discovery regarding the use by us of certain information regarding Discovery in connection with our financial reporting and disclosure requirements as a public company. However, such agreement limits the public disclosure by us of certain non-public information regarding Discovery (other than specified historical financial information), and also restricts our ability to enforce the agreement against Discovery with a lawsuit seeking monetary damages, in the absence of gross negligence, reckless conduct or willful misconduct on the part of Discovery. In addition, we cannot change the way in which Discovery reports its financial results or require Discovery to change its internal controls over financial reporting.
We cannot be certain that we will be successful in integrating acquired businesses, if any.  Our businesses and those of our subsidiaries may grow through acquisitions in selected markets. Integration of new businesses may present significant challenges, including: realizing economies of scale in programming and network operations; eliminating duplicative overheads; and integrating networks, financial systems and operational systems. We or the applicable subsidiary cannot assure you that, with respect to any acquisition, we will realize anticipated benefits or successfully integrate any acquired business with our existing operations. In addition, while we intend to implement appropriate controls and procedures as we integrate acquired companies, we may not be able to certify as to the effectiveness of these companies’ disclosure controls and procedures or internal control over financial reporting (as required by U.S. federal securities laws and regulations) until we have fully integrated them.
Our businesses are subject to risks of adverse government regulation.  Programming services, satellite carriers, television stations and Internet and data transmission companies are subject to varying degrees of regulation in the United States by the Federal Communications Commission and other entities and in foreign countries by similar entities. Such regulation and legislation are subject to the political process and have been in constant flux over the past decade. Moreover, substantially every foreign country in which our subsidiaries or business affiliates have, or may in the future make, an investment regulates, in varying degrees, the distribution, content and ownership of programming services and foreign investment in programming companies. Further material changes in the law and regulatory requirements must be anticipated, and there can be no assurance that our business and the business of our affiliates will not be adversely affected by future legislation, new regulation or deregulation.


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We have overlapping directors and management with Liberty and Liberty Global, Inc., which may lead to conflicting interests.  Five of our six executive officers also serve as executive officers of Liberty and one of our executive officers serves as an executive officer of Liberty Global, Inc., or LGI. LGI is an independent, publicly traded company, which was formed in connection with the business combination between UnitedGlobalCom, Inc. and Liberty Media International, Inc., or LMI. All of the shares of LMI were distributed by Liberty to its shareholders in June 2004. LGI is the largest international cable operator based on number of subscribers as of September 30, 2007. Our board of directors includes persons who are members of the board of directors of Libertyand/or LGI. We do not own any interest in Liberty or LGI, and to our knowledge Liberty and LGI do not own any interest in us. The executive officers and the members of our board of directors have fiduciary duties to our stockholders. Likewise, any such persons who serve in similar capacities at Libertyand/or LGI have fiduciary duties to such company’s stockholders. Therefore, such persons may have conflicts of interest or the appearance of conflicts of interest with respect to matters involving or affecting each company. For example, there may be the potential for a conflict of interest when we, Liberty or LGI look at acquisitions and other corporate opportunities that may be suitable for each of us. Moreover, most of our directors and officers continue to own Libertyand/or LGI stock and options to purchase Libertyand/or LGI stock. These ownership interests could create, or appear to create, potential conflicts of interest when these individuals are faced with decisions that could have different implications for our company and Liberty or LGI. From time to time, Liberty or LGI or their respective affiliates may enter into transactions with us or our subsidiaries or other affiliates, such as affiliation agreements relating to the distribution of Discovery’s international networks. Discovery’s core networks depend on achieving and maintaining carriage within the most widely distributed cable programming tiers to maximize their subscriber base and revenue. The loss of a significant number of affiliation arrangements on basic programming tiers could reduce the distribution of Discovery’s networks, thereby adversely affecting such networks’ revenue from per-subscriber fees and their ability to sell advertising or the rates they are able to charge for such advertising. Those Discovery networks that are carried on digital tiers are dependent upon the continued upgrade of cable systems to digital capability and the public’s continuing acceptance of, and willingness to pay for upgrades to, digital cable, as well as Discovery’s ability to negotiate favorable carriage agreements on widely accepted digital tiers.
Our businesses are subject to risks of adverse government regulation.  Programming services, satellite carriers, television stations and Internet and data transmission companies are subject to varying degrees of regulation in the United States by the Federal Communications Commission and other entities and in foreign countries by similar entities. Such regulation and legislation are subject to the political process and have been in constant flux over the past decade. Moreover, substantially every foreign country in which our subsidiaries or business affiliates have, or may in the future make, an investment regulates, in varying degrees, the distribution, content and ownership of programming services and foreign investment in programming companies. Further material changes in the law and regulatory requirements must be


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anticipated, and there can be no assurance that our business and the business of our affiliates will not be adversely affected by future legislation, new regulation or deregulation.
Failure to obtain renewal of FCC licenses could disrupt our business.  Ascent Media holds licenses, authorizations and registrations from the FCC required for the conduct of its network services business, including earth station and various classes of wireless licenses and an authorization to provide certain services. Most of the FCC licenses held by Ascent Media are for transmit/receive earth stations, which cannot be operated without individual licenses. The licenses for these stations are granted for a period of fifteen years and, while the FCC generally renews licenses for satellite earth stations routinely, there can be no assurance that Ascent Media’s licenses will be renewed at their expiration dates. Registration with the FCC, rather than licensing, is required for receiving transmissions from satellites from points within the United States. Ascent Media relies on third party licenses or authorizations when it transmits domestic satellite traffic through earth stations operated by third parties. Our failure, and the failure of third parties, to obtain renewals of such FCC licenses could disrupt the network services segment of Ascent Media and have a material adverse effect on Ascent Media. Further material changes in the law and regulatory requirements must be anticipated, and there can be no assurance that our businesses will not be adversely affected by future legislation, new regulation, deregulation or court decisions.
Our businesses operate in an increasingly competitive market, and there is a risk that our businesses may not be able to effectively compete with other providers in the future.  The entertainment and media services and programming businesses in which we compete are highly competitive and service-oriented. Ascent Media has few long-term or exclusive service agreements with its creative services customers. Business generation in these groups is based primarily on customer satisfaction with reliability, timeliness, quality and price. The major motion picture studios, which are Ascent Media’s customers, such as Paramount Pictures, Sony Pictures Entertainment, Twentieth Century Fox, Universal Pictures, The Walt Disney Company,Metro-Goldwyn-Mayer and Warner Brothers, have the capability to perform similar services in-house. These studios also have substantially greater financial resources than Ascent Media’s, and in some cases significant marketing advantages. Thus, depending on the in-house capacity available to some of these studios, a studio may be not only a customer but also a competitor. There are also numerous independent providers of services similar to Ascent Media’s. Thomson, a French corporation, is also a major competitor of Ascent Media, particularly under its Technicolor brand, as is Kodak through its Laser Pacific division. We also actively compete with certain industry participants that have a unique operating niche or specialty business. If there were a significant decline in the number of motion pictures or the amount of original television programming produced, or if the studios or Ascent Media’s other clients either established in-house post-production facilities or significantly expanded their in-house capabilities, Ascent Media’s operations could be materially and adversely affected.
Discovery is primarily an entertainment and programming company that competes with other programming networks for viewers in general, as well as for viewers in special interest groups and specific demographic categories. In order to compete for these viewers, Discovery must obtain a regular supply of high quality category-specific programming. To the extent Discovery seeks third party suppliers of such programming, it competes with other cable and broadcast television networks for programming. The expanded availability of digital cable television and the introduction ofdirect-to-home satellite distribution has greatly increased the amount of channel capacity available for new programming networks, resulting in the launch of a number of new programming networks by Discovery and its competitors. This increase in channel capacity has also made competitive niche programming networks viable, because such networks do not need to reach the broadest possible group of viewers in order to be moderately successful.
Discovery’s program offerings must also compete for viewers and advertisers with other entertainment media, such as home video, online activities and movies. Increasing audience fragmentation could have an adverse effect on Discovery’s advertising and subscription revenue. In addition, the cable television anddirect-to-home satellite industries have been undergoing a period of consolidation. As a result, the number of potential buyers of the programming services offered by Discovery is decreasing. In this more concentrated market, there can be no assurance that Discovery will be able to obtain or maintain carriage of its programming services by distributors when its current long-term contracts are up for renewal.
We have overlapping directors and management with Liberty and Liberty Global, Inc., which may lead to conflicting interests.  Five of our six executive officers also serve as executive officers of Liberty and one of our executive officers serves as an executive officer of Liberty Global, Inc., or LGI. LGI is an independent, publicly traded company, which was formed in connection with the business combination between UnitedGlobalCom, Inc. and Liberty Media International, Inc., or LMI. All of the shares of LMI were distributed by Liberty to its shareholders in June 2004. Our board of directors includes persons who are members of the board of directors of Libertyand/or LGI. We do not own any interest in Liberty or LGI, and to our knowledge Liberty and LGI do not own any interest in us. The executive officers and the members of our board of directors have fiduciary duties to our stockholders. Likewise, any such persons who serve in similar capacities at Libertyand/or LGI have fiduciary duties to such company’s stockholders. Therefore, such persons may have


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conflicts of interest or the appearance of conflicts of interest with respect to matters involving or affecting each company. For example, there may be the potential for a conflict of interest when we, Liberty or LGI look at acquisitions and other corporate opportunities that may be suitable for each of us. Moreover, most of our directors and officers continue to own Libertyand/or LGI stock and options to purchase Libertyand/or LGI stock. These ownership interests could create, or appear to create, potential conflicts of interest when these individuals are faced with decisions that could have different implications for our company and Liberty or LGI. On June 1, 2005, the board of directors of Liberty adopted a policy statement that, subject to certain qualifications, including the fiduciary duties of Liberty’s board of directors, Liberty will use its commercially reasonable efforts to make available to us any corporate opportunity relating to the acquisition of all or substantially all of the assets of, or equity securities representing “control” (as defined in the policy statement) of, any entity whose primary business is the acquisition, creationand/or distribution of television programming consisting primarily of science and nature programming for distribution primarily in the “basic” service provided by cable and satellite television distributors. This policy statement of Liberty’s board of directors can be amended, modified or rescinded by Liberty’s board of directors in its sole discretion at any time, and the policy automatically terminates without any further action of the board of directors of Liberty on the second anniversary of the distribution date. From time to time, Liberty or LGI or their respective affiliates may enter into transactions with us or our subsidiaries or other affiliates. Although the terms of any such transactions or agreements will be established based upon negotiations between employees of the companies involved, there can be no assurance that the terms of any such transactions will be as favorable to us or our subsidiaries or affiliates as would be the case where the parties are completely at arms’ length.
 
We and Liberty or LGI may compete for business opportunities.  Liberty and LGI each own interests in various U.S. and international programming companies that have subsidiaries or controlled affiliates that own or operate domestic or foreign programming services that may compete with the programming services offered by our businesses. LGI is also the largest cable operator outside the U.S. We have no rights in respect of U.S. or international programming opportunities developed by or presented to the subsidiaries or controlled affiliates of Liberty or LGI, and the pursuit of these opportunities by such subsidiaries or affiliates may adversely affect the interests of our company and its shareholders. In addition, a subsidiary of LGI operates a playout facility that competes with Ascent Media’s London playout facility, and it is likely that other competitive situations will arise in the future. Because we, Liberty and LGI have some overlapping directors and officers, the pursuit of these opportunities by such subsidiaries or affiliates may adversely affect the interests of our company and its shareholders. We also have no special rights in respect to programming distribution on LGI’s cable systems outside the scope of an arms-length affiliation agreement. In addition, a subsidiary of LGI operates a playout facility that competes with Ascent Media’s London playout facility, and it is likely that other competitive situations will arise in the future. Because we, Liberty and LGI have some overlapping directors and officers, the pursuit of business opportunities may serve to intensify the conflicts of interest or appearance of conflicts of interest faced by our respective management teams. Our restated certificate of incorporation provides that no director or officer of ours will be liable to us or our stockholders for breach of any fiduciary duty by reason of the fact that any such individual directs a corporate opportunity to another person or entity (including LMI and LGI) instead of us, or does not refer or communicate information regarding such corporate opportunity to us, unless (x) such opportunity was expressly offered to such person solely in his or her capacity as a director or officer of our company or as a director or officer of any of our subsidiaries, and (y) such opportunity relates to a line of business in which our company or any of our subsidiaries is then directly engaged.
 
It may be difficult for a third party to acquire us, even if doing so may be beneficial to our shareholders.  Certain provisions of our restated certificate of incorporation and bylaws may discourage, delay or prevent a change in control of our company that a shareholder may consider favorable. These provisions include the following:
 
 • authorizing a capital structure with multiple series of common stock: a Series B that entitles the holders to ten votes per share, a Series A that entitles the holders to one vote per share and a Series C that, except as otherwise required by applicable law, entitles the holders to no voting rights;
 
 • authorizing the issuance of “blank check” preferred stock, which could be issued by our board of directors to increase the number of outstanding shares and thwart a takeover attempt;
 
 • classifying our board of directors with staggered three-year terms, which may lengthen the time required to gain control of our board of directors;
• limiting who may call special meetings of shareholders;
• prohibiting shareholder action by written consent (subject to certain exceptions), thereby requiring shareholder action to be taken at a meeting of the shareholders;
• establishing advance notice requirements for nominations of candidates for election to our board of directors or for proposing matters that can be acted upon by shareholders at shareholder meetings;
• requiring shareholder approval by holders of at least 80% of our voting power or the approval by at least 75% of our board of directors with respect to certain extraordinary matters, such as a merger or consolidation of our company, a sale of all or substantially all of our assets or an amendment to our restated certificate of incorporation;
• requiring the consent of the holders of at least 75% of the outstanding Series B common stock (voting as a separate class) to certain share distributions and other corporate actions in which the voting power of the Series B common


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• limiting who may call special meetings of shareholders;
• prohibiting shareholder action by written consent (subject to certain exceptions), thereby requiring shareholder action to be taken at a meeting of the shareholders;
• establishing advance notice requirements for nominations of candidates for election to our board of directors or for proposing matters that can be acted upon by shareholders at shareholder meetings;
• requiring shareholder approval by holders of at least 80% of our voting power or the approval by at least 75% of our board of directors with respect to certain extraordinary matters, such as a merger or consolidation of our company, a sale of all or substantially all of our assets or an amendment to our restated certificate of incorporation;
• requiring the consent of the holders of at least 75% of the outstanding Series B common stock (voting as a separate class) to certain share distributions and other corporate actions in which the voting power of the Series B common stock would be diluted by, for example, issuing shares having multiple votes per share as a dividend to holders of Series A common stock; and
 • the existence of authorized and unissued stock which would allow our board of directors to issue shares to persons friendly to current management, thereby protecting the continuity of its management, or which could be used to dilute the stock ownership of persons seeking to obtain control of us.
Our company has adopted a shareholder rights plan in order to encourage anyone seeking to acquire us to negotiate with our board of directors prior to attempting a takeover. Whileissue shares to persons friendly to current management, thereby protecting the plan is designedcontinuity of its management, or which could be used to guard against coercive or unfair tactics to gain controldilute the stock ownership of us, the plan may have the effect of making more difficult or delaying any attempts by otherspersons seeking to obtain control of us.
Our company has adopted a shareholder rights plan in order to encourage anyone seeking to acquire us to negotiate with our board of directors prior to attempting a takeover. While the plan is designed to guard against coercive or unfair tactics to gain control of us, the plan may have the effect of making more difficult or delaying any attempts by others to obtain control of us.
 
Holders of any single series of our common stock may not have any remedies if any action by our directors or officers has an adverse effect on only that series of our common stock.Principles of Delaware law and the provisions of our restated certificate of incorporation may protect decisions of our board of directors that have a disparate impact upon holders of any single series of our common stock. Under Delaware law, the board of directors has a duty to act with due care and in the best interests of all of our shareholders, including the holders of all series of our common stock. Principles of Delaware law established in cases involving differing treatment of multiple classes or series of stock provide that a board of directors owes an equal duty to all common shareholders regardless of class or series and does not have separate or additional duties to any group of shareholders. As a result, in some circumstances, our directors may be required to make a decision that is adverse to the holders of one series of our common stock. Under the principles of Delaware law referred to above, you may not be able to challenge these decisions if our board of directors is disinterested and adequately informed with respect to these decisions and acts in good faith and in the honest belief that it is acting in the best interests of all of our shareholders.
Risk Factors Relating to Ascent Media
A loss of any of Ascent Media’s large customers would reduce its revenue.  Although Ascent Media serviced over 3,800 customers during the year ended December 31, 2007, its ten largest customers accounted for approximately 47% of its consolidated revenue. The ten largest customers of the Creative Services group accounted for approximately 47% of the revenue of the Creative Services operating segment during the 2007 fiscal year. The ten largest customers of the Network Services group accounted for approximately 62% of the revenue of the Network Services operating segment during the 2007 fiscal year. The loss of, and failure to replace, any significant portion of the revenue generated from sales to any of Ascent Media’s largest customers could have a material adverse effect on the business of Ascent Media or on the affected operating segment. Creative Services group revenue generated by Ascent Media’s largest customers represent various types of services provided by various facilities within the Creative Services group for multiple points of contact at the corporate customer. Network origination services are generally provided pursuant to contracts, with terms of one to three years, or longer. Ascent Media’s ten largest customers include, among others, the parent companies of six major motion picture studios.
Discovery and its subsidiaries accounted for approximately 6% of Ascent Media’s consolidated revenue, including 15% of Network Services group revenue during 2007. Sales by Ascent Media to Discovery in 2007


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consisted primarily of $7.3 million in systems integration projects and $34.5 million in content distribution. Ascent Media provides content distribution services to Discovery primarily in Asia and Europe pursuant to contracts that currently extend to 2010 and 2011, respectively.
Ascent Media’s business depends on certain client industries.  Ascent Media derives much of its revenue from services provided to the motion picture and television production industries and from the data transmission industry. Fundamental changes in the business practices of any of these client industries could cause a material reduction in demand by Ascent Media’s clients for the services offered by Ascent Media. Ascent Media’s business benefits from the volume of motion picture and television content being created and distributed as well as the success or popularity of an individual television show. Accordingly, a decrease in either the supply of, or demand for, original entertainment content would have a material adverse effect on Ascent Media’s results of operations. Because spending for television advertising drives the production of new television programming, as well as the production of television commercials and the sale of existing content libraries for syndication, a reduction in television advertising spending would adversely affect Ascent Media’s business. Factors that could impact television advertising and the general demand for original entertainment content include the growing use of personal video recorders andvideo-on-demand services, continued fragmentation of and competition for the attention of television audiences, and general economic conditions.
Because Ascent Media uses third-party satellite and terrestrial connectivity services to provide certain of its creative, media management and network services, a material disruption to such connectivity services could have a negative impact on Ascent Media’s operations.  Ascent Media obtains satellite transponder capacity, fiber-optic capacity and Internet connectivity pursuant to long-term contracts and other arrangements with third-party vendors. Such connectivity services are used in connection with many aspects of Ascent Media’s business, including network origination, teleport services, digital media management, dailies, live remote telecine services, distribution of advertising, syndicated television programming and other content, and various Web-based services and interfaces. Although Ascent Media believes that its arrangements with connectivity suppliers are adequate, disruptions in such services may occur from time to time as a result of technical malfunction, disputes with suppliers, force majeure or other causes. In the event of any such disruption in satellite or terrestrial connectivity service, Ascent Media may incur additional costs to supplement or replace the affected service, and may be required to compensate its own customers for any resulting declines in service levels.
A labor dispute in our client industries may disrupt Ascent Media’s business.  The cost of producing and distributing entertainment programming has increased substantially in recent years due to, among other things, the increasing demands of creative talent and industry-wide collective bargaining agreements.
A significant labor dispute in Ascent Media’s client industries could have a material adverse effect on its business. An industry-wide strike or other job action by or affecting the Writers Guild, Screen Actors Guild or other major entertainment industry union could reduce the supply of original entertainment content, which would in turn, reduce the demand for Ascent Media’s services. An extensive work stoppage would affect feature film production as well as episodic television and commercial production and could have a material adverse effect on the creative services group, including the potential loss of key personnel and the possibility that broadcast and cable networks will seek to reduce the proportion of their schedules devoted to scripted programming.
On November 5, 2007, Writers Guild of America, East and West (“Writers Guild”) declared a strike affecting the script writing for television shows and films. The strike has had a significant adverse effect on the revenue generated by Ascent Media’s creative services business for services provided on new entertainment projects utilizing scripted content and the production of new television commercials.
On February 10, 2008, the Writers Guild announced that its governing boards had voted to recommend the terms of a proposed new contract with the Alliance of Motion Picture and Television Producers (“AMPTP”) and suspended picketing by the Writers Guild against producers. Members of the Writers Guild voted to end the strike on February 12, 2008. Voting on ratification of the proposed contracts was expected to take place over the following several weeks. There can be no assurances that the proposed contract will be approved by the members of the Writers Guild and AMPTP, respectively. Failure to ratify the proposed contract could result in further strikes or job actions. Even if the contract is approved, the2007-2008 television season has been significantly affected by the strike. Networks and producers are expected to resume production of some scripted television programming soon.


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However, it is expected that some programming will not resume production this season, if at all. Accordingly, the full impact of the strike cannot currently be determined.
The existing contract between the Screen Actors Guild and AMPTP is currently scheduled to expire June 30, 2008.
Changes in technology may limit the competitiveness of and demand for Ascent Media’s services.  The post-production industry is characterized by technological change, evolving customer needs and emerging technical standards, and the data transmission industry is currently saturated with companies providing services similar to Ascent Media’s. Historically, Ascent Media has expended significant amounts of capital to obtain equipment using the latest technology. Obtaining access to any new technologies that may be developed in Ascent Media’s industries will require additional capital expenditures, which may be significant and may have to be incurred in advance of any revenue that may be generated by such new technologies. In addition, the use of some technologies may require third party licenses, which may not be available on commercially reasonable terms. Although we believe that Ascent Media will be able to continue to offer services based on the newest technologies, we cannot assure you that Ascent Media will be able to obtain any of these technologies, that Ascent Media will be able to effectively implement these technologies on a cost-effective or timely basis or that such technologies will not render obsolete Ascent Media’s role as a provider of motion picture and television production services. If Ascent Media’s competitors in the data transmission industry have technology that enables them to provide services that are more reliable, faster, less expensive, reach more customers or have other advantages over the data transmission services Ascent Media provides, then the demand for Ascent Media’s data transmission services may decrease.
While Ascent Media believes that its business methods and technical processes do not infringe upon the proprietary rights of any third parties, there can be no assurances that third parties will not assert infringement claims against Ascent Media.  Ascent Media’s business of providing Creative and Network services is highly dependent upon the technical abilities and knowledge of its personnel and business methods and processes developed by Ascent Media and its subsidiaries and their respective predecessors over time. There can be no assurance that third parties will not bring copyright, trademark infringement or other proprietary rights claims against Ascent Media, or claim that Ascent Media’s use of certain technologies violates a patent. There can be no assurances as to the outcome of any such claims. However, even if these claims are not meritorious, they could be costly and could divert management’s attention from other more productive activities. If it is determined that Ascent Media has infringed upon or misappropriated a third party’s proprietary rights, there can be no assurance that any necessary license or rights could be obtained on terms satisfactory to Ascent Media, if at all. The inability to obtain any such license or rights could result in the incurrence of expenses and changes in the way Ascent Media operates its business.
Loss of key personnel could negatively impact our business.  Our future success depends in large part on the retention, continued service and specific abilities of our key creative, technical and management personnel. A significant percentage of our revenues can be attributed to services that can only be performed by certain highly compensated, specialized employees, and in certain instances, our customers have identified by name those personnel requested to work on such customers’ projects. Competition for highly qualified employees in the entertainment and media services industry is intense and the process of locating and recruiting key creative, technical and management personnel with the combination of skills and abilities required to execute our strategy is time-consuming. We have employment agreements with many of our key creative, technical and management personnel. However, there can be no assurance that we will continue to attract, motivate and retain key personnel, and any inability to do so could negatively impact our business and our ability to grow.
Risk of loss from earthquakes or other catastrophic events could disrupt Ascent Media’s business.  Some of Ascent Media’s purpose-built facilities are located in Southern California, a region known for seismic activity. Due to the extensive amount of specialized equipment incorporated into the specially designed recording and scoring stages, editorial suites, mixing rooms and other post-production facilities, Ascent Media’s operations in this region may not be able to be temporarily relocated to mitigate the impacts of a catastrophic event. Ascent Media carries insurance for property loss and business interruption resulting from such events, including earthquake insurance, subject to deductibles, and has facilities in other geographic locations. Although we believe Ascent Media has adequate insurance coverage relating to damage to its property and the temporary disruption of its business from


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casualties, and that it could provide services at other geographic locations, there can be no assurance that such insurance and other facilities would be sufficient to cover all of Ascent Media’s costs or damages or Ascent Media’s loss of income resulting from its inability to provide services in Southern California for an extended period of time.
Failure to obtain renewal of FCC licenses could disrupt Ascent Media’s business.  Ascent Media holds licenses, authorizations and registrations from the FCC required for the conduct of its network services business, including earth station and various classes of wireless licenses and an authorization to provide certain services. Most of the FCC licenses held by Ascent Media are for transmit/receive earth stations, which cannot be operated without individual licenses. The licenses for these stations are granted for a period of fifteen years and, while the FCC generally renews licenses for satellite earth stations routinely, there can be no assurance that Ascent Media’s licenses will be renewed at their expiration dates. Registration with the FCC, rather than licensing, is required for receiving transmissions from satellites from points within the United States. Ascent Media relies on third party licenses or authorizations when it transmits domestic satellite traffic through earth stations operated by third parties. Our failure, and the failure of third parties, to obtain renewals of such FCC licenses could disrupt the network services segment of Ascent Media and have a material adverse effect on Ascent Media. Further material changes in the law and regulatory requirements must be anticipated, and there can be no assurance that our businesses will not be adversely affected by future legislation, new regulation, deregulation or court decisions.
Ascent Media operates in an increasingly competitive market, and there is a risk that it may not be able to effectively compete with other providers in the future.  The entertainment and media services and programming businesses in which Ascent Media competes are highly competitive and service-oriented. Ascent Media has few long-term or exclusive service agreements with its creative services customers. Business generation in these markets is based primarily on the reputation of the provider’s creative talent and customer satisfaction with reliability, timeliness, quality and price. The major motion picture studios, which are Ascent Media’s customers, such as Paramount Pictures, Sony Pictures Entertainment, Twentieth Century Fox, Universal Pictures, The Walt Disney Company and Warner Bros. Entertainment, have the capability to perform similar services in-house. These studios also have substantially greater financial resources than Ascent Media’s, and in some cases significant marketing advantages. Thus, depending on the in-house capacity available to some of these studios, a studio may be not only a customer but also a competitor. There are also numerous independent providers of services similar to Ascent Media’s and we actively compete with certain industry participants that have a unique operating niche or specialty business. If there were a significant decline in the number of motion pictures or the amount of original television programming produced, or if the studios or Ascent Media’s other clients either established in-house post-production facilities or significantly expanded their in-house capabilities, Ascent Media’s operations could be materially and adversely affected.
Risk Factors Relating to Discovery
Discovery’s success is dependent upon U.S. and foreign audience acceptance of its programming and other entertainment content which is difficult to predict.  The production and distribution of pay television programs and other entertainment content are inherently risky businesses because the revenue Discovery derives and its ability to distribute its content depend primarily on consumer tastes and preferences that change in often unpredictable ways. The success of Discovery’s businesses depends on its ability to consistently create and acquire content and programming that meets the changing preferences of viewers in general, viewers in special interest groups, viewers in specific demographic categories and viewers in various overseas marketplaces. The commercial success of its programming and other content also depends upon the quality and acceptance of competing programs and other content available in the applicable marketplace at the same time. Other factors, including the availability of alternative forms of entertainment and leisure time activities, general economic conditions, piracy, digital and on-demand distribution and growing competition for consumer discretionary spending may also affect the audience for its content. Audience sizes for its media networks are critical factors affecting both (i) the volume and pricing of advertising that Discovery receives, and (ii) the extent of distribution and the license fees Discovery receives under agreements with its distributors. Consequently, reduced public acceptance of its entertainment content may decrease its audience share and adversely affect all of its revenue streams.
The loss of Discovery’s affiliation agreements, or renewals with less advantageous terms, could cause its revenue to decline.  Because Discovery’s media networks are licensed on a wholesale basis to distributors such as cable and satellite operators which in turn distribute them to consumers, Discovery is dependent upon the maintenance of


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affiliation agreements with these operators. These affiliation agreements generally provide for the level of carriage Discovery’s networks will receive, such as channel placement and programming package inclusion (widely distributed, broader programming packages compared to lesser distributed, specialized programming packages), and for payment of a license fee to Discovery based on the numbers of subscribers that receive its networks. These per-subscriber payments represent a significant portion of Discovery’s revenue. These affiliation agreements generally have a limited term which varies from market to market and from distributor to distributor, and there can be no assurance that these affiliation agreements will be renewed in the future, or renewed on terms that are as favorable to Discovery as those in effect today. A reduction in the license fees that Discovery receives per subscriber or in the number of subscribers for which Discovery is paid, including as a result of a loss or reduction in carriage for Discovery’s media networks, could adversely affect its distribution revenue. Such a loss or reduction in carriage could also decrease the potential audience for Discovery’s programs thereby adversely affecting its advertising revenue.
Consolidation among cable and satellite operators has given the largest operators considerable leverage in their relationship with programmers, including Discovery. The two largest U.S. cable television system operators provide service to approximately 35% of U.S. households receiving cable or satellite television service and the two largest satellite television operators provide service to an additional 26% of such households. Discovery currently has agreements in place with the major U.S. cable and satellite operators which expire at various times beginning in 2008 through 2014. In 2008, Discovery will enter negotiations to renew distribution agreements for carriage of its networks involving a substantial portion of its domestic subscribers. A failure to secure a renewal or a renewal on less favorable terms may have a material adverse effect on Discovery’s results of operations and financial position. In addition, many of the overseas markets in which Discovery distributes its networks also have a small number of dominant distributors. Continued consolidation within the industry could further reduce the number of distributors available to carry Discovery’s programming and increase the negotiating leverage of its distributors which could adversely affect Discovery’s revenue.
Discovery operates in increasingly competitive industries.  The entertainment and media programming industries in which Discovery operates are highly competitive. Discovery competes with other programming networks for advertising, distribution and viewers. Discovery also competes for viewers with other forms of media entertainment, such as home video, movies, periodicals and online and mobile activities. In particular, online websites and search engines have seen significant advertising growth, a portion of which is derived from traditional cable network and satellite advertisers. In addition, there has been consolidation in the media industry and Discovery’s competitors include market participants with interests in multiple media businesses which are often vertically integrated. Discovery’s online businesses compete for users and advertising in the enormously broad and diverse market of free internet-delivered services. Discovery’s commerce business competes against a wide range of competitive retailers selling similar products. Its educational video business competes with other providers of educational products to schools. Discovery’s ability to compete successfully depends on a number of factors, including its ability to consistently supply high quality and popular content, access its niche viewerships with appealing category-specific programming, adapt to new technologies and distribution platforms and achieve widespread distribution. There can be no assurance that Discovery will be able to compete successfully in the future against existing or new competitors, or that increasing competition will not have a material adverse effect on its business, financial condition or results of operations.
Discovery’s business is subject to risks of adverse laws and regulations, both domestic and foreign.  Programming services like Discovery’s, and the distributors of its services, including cable operators, satellite operators and Internet companies, are highly regulated by U.S. federal laws and regulations issued and administered by various federal agencies, including the FCC, as well as by state and local governments. The U.S. Congress and the FCC currently have under consideration, and may in the future adopt, new laws, regulations and policies regarding a wide variety of matters that could, directly or indirectly, affect the operations of Discovery’s U.S. media properties. For example, legislators and regulators continue to consider rules that would effectively require cable television operators to offer all programming on an à la carte basis (which would allow viewers to subscribe for individual networks rather a package of channels)and/or require programmers to sell channels to distributors on an à la carte basis. Certain cable television operators and other distributors have already introduced tiers, or more targeted channel packages, to their customers that may or may not include some or all of Discovery’s networks. The unbundling of program services at the retailand/or wholesale level could reduce distribution of certain of


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Discovery’s program services, thereby leading to reduced viewership and increased marketing expenses, and could affect its ability to compete for or attract the same level of advertising dollars or distribution fees. If the number of channels occupied by leased access programmers expands, it could have an adverse effect on Discovery’s ability to obtain carriage for its programming. In addition, a recent decision by the FCC will effectively require cable operators, beginning February 2009 and lasting for at least three years, to carry the signals of “must carry” broadcast stations in both digital and analog format unless all subscribers of the cable operator’s system can view the digital signal on every television set connected to the system. Carrying these additional signals may result in less capacity for other programming services, such as Discovery’s networks, which could adversely affect Discovery’s revenue.
Similarly, the foreign jurisdictions in which Discovery’s networks are offered have, in varying degrees, laws and regulations governing Discovery’s businesses. Programming businesses are subject to regulation on a country by country basis. Such regulations include à la carte pricing, license requirements, local programming quotas, limits on the amounts and kinds of advertising that can be carried, and requirements to make programming available on non-discriminatory terms, and can increase the cost of doing business internationally. Changes in regulations imposed by foreign governments could also adversely affect Discovery’s business, results of operations and ability to expand its operations beyond their current scope.
Macroeconomic risks associated with Discovery’s business could adversely affect its financial condition.  The current economic downturn in the United States and in other regions of the world in which Discovery operates could adversely affect demand for any of its businesses, thus reducing its revenue and earnings. For example, expenditures by advertisers are sensitive to economic conditions and tend to decline in recessionary periods and other periods of uncertainty. Because Discovery derives a substantial portion of its revenue from the sale of advertising, a decline or delay in advertising expenditures could reduce advertising prices and volume and result in a decrease in its revenue. The decline in economic conditions could also impact consumer discretionary spending. Such a reduction in consumer spending may impact pay television subscriptions, particularly to the more expensive digital service tiers, which could lead to a decrease in Discovery’s distribution fees.
Increased programming production and content costs may adversely affect Discovery’s results of operations and financial condition.  One of the most significant areas of expense for Discovery is for the licensing and production of content. In connection with creating original content, Discovery incurs production costs associated with, among other things, acquiring new show concepts and retaining creative talent, including actors, writers and producers. Discovery also incurs higher production costs when filming in HD than standard definition. The costs of producing programming have generally increased in recent years. These costs may continue to increase in the future, which may adversely affect Discovery’s results of operations and financial condition.
Disruption or failure of satellites and facilities on which Discovery depends to distribute its programming could adversely affect its business.  Discovery depends on satellite systems to transmit its media networks to cable television operators and other distributors worldwide. The distribution facilities include uplinks, communications satellites and downlinks. Even withback-up and redundant systems, transmissions may be disrupted as a result of local disasters that impair on-ground uplinks or downlinks, or as a result of an impairment of a satellite. Currently, there are a limited number of communications satellites available for the transmission of programming. If a disruption or failure occurs, Discovery may not be able to secure alternate distribution facilities in a timely manner, which could have a material adverse effect on its business and results of operations.
Discovery cannot be certain that it will realize anticipated benefits from any business acquisition that it effects.  Discovery may seek to grow through acquisitions in select markets, both within and outside its traditional lines of business. Acquisitions involve risks and significant challenges, including: realizing economies of scale; eliminating duplicative overhead; integrating networks, financial systems and operating systems; diverting the resources of management; incurring debt (which may be substantial) in financing such acquisitions; and addressing unanticipated problems and liabilities. In addition, while Discovery intends to implement appropriate controls and procedures as it integrates acquired companies, Discovery may not be able to certify as to the effectiveness of these companies’ disclosure controls and procedures or internal control over financial reporting (as required by U.S. federal securities laws and regulations) until it has fully integrated those acquired businesses.
Discovery must respond to and capitalize on rapid changes in new technologies and distribution platforms, including their effect on consumer behavior, in order to remain competitive and exploit new opportunities.  Technology in the video, telecommunications and data services industry is changing rapidly. Discovery must adapt


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to advances in technologies, distribution outlets and content transfer and storage (whether legal or illegal) to ensure that its content remains desirable and widely available to its audiences while protecting its intellectual property interests. Discovery may not have the right, and may not be able to secure the right, to distribute some of its licensed content across these, or any other, new platforms and must adapt accordingly. The ability to anticipate and take advantage of new and future sources of revenue from these technological developments will affect Discovery’s ability to expand its business and increase revenue.
Similarly, Discovery also must adapt to changing consumer behavior driven by technological advances such asvideo-on-demand and a desire for more user-generated and interactive content. Devices that allow consumers to view Discovery’s entertainment content from remote locations or on a time-delayed basis and technologies which enable users to fast-forward or skip advertisements may cause changes in audience behavior that could affect the attractiveness of Discovery’s offerings to advertisers and could therefore adversely affect its revenues. If Discovery cannot ensure that its content is responsive to the lifestyles of its target audiences and capitalize on technological advances, there could be a negative effect on its business.
Discovery’s revenue and operating results are subject to seasonal and cyclical variations.  Discovery’s business has experienced and is expected to continue to experience some seasonality due to, among other things, seasonal advertising patterns, seasonal influences on people’s viewing habits, and a heavy concentration of sales in its commerce business during the fourth quarter. For example, due to increased demand in the spring and holiday seasons, the second and fourth quarters normally have higher advertising revenue than the first and third quarters. In addition, advertising revenue in even-numbered years benefit from political advertising. If a short-term negative impact on our business were to occur during a time of high seasonal demand, there could be a disproportionate effect on the operating results of Discovery’s business for the year.
Discovery continues to develop new products and services for evolving markets. There can be no assurance of the success of these efforts due to a number of factors, some of which are beyond Discovery’s control.  There are substantial uncertainties associated with Discovery’s efforts to develop new products and services for evolving markets, and substantial investments may be required. Initial timetables for the introduction and development of new products and services may not be achieved, and price and profitability targets may not prove feasible. External factors, such as the development of competitive alternatives, rapid technological change, regulatory changes and shifting market preferences, may cause new markets to move in unanticipated directions.
Risks associated with Discovery’s international operations could harm its financial condition.  Discovery’s networks are offered worldwide. Inherent economic risks of doing business in international markets include, among other things, longer payment cycles, foreign taxation and currency exchange risk. As Discovery expands the provision of its products and services to overseas markets, we cannot assure you whether these risks and uncertainties will harm Discovery’s results of operations.
Discovery’s international operations may also be adversely affected by export and import restrictions, other trade barriers and acts of disruptions of services or loss of property or equipment that are critical to overseas businesses due to expropriation, nationalization, war, insurrection, terrorism or general social or political unrest or other hostilities.
The loss of key talent could disrupt Discovery’s business and adversely affect its revenue.  Discovery’s business depends upon the continued efforts, abilities and expertise of its corporate and divisional executive teams and entertainment personalities. Discovery employs or contracts with entertainment personalities who may have loyal audiences. These individuals are important to audience endorsement of its programs and other content. There can be no assurance that these individuals will remain with Discovery or retain their current audiences. If Discovery fails to retain these individuals or if Discovery’s entertainment personalities lose their current audience base, Discovery’s revenue could be adversely affected.
Piracy of Discovery’s entertainment content, including digital piracy, may decrease revenue received from its programming and adversely affect its business and profitability.  The success of Discovery’s business depends in part on its ability to maintain the intellectual property rights to its entertainment content. Discovery is fundamentally a content company and piracy of its brands, DVDs, cable television and other programming, digital content and other intellectual property has the potential to significantly affect the company. Piracy is particularly prevalent in many parts of the world that lack copyright and other protections similar to existing law in the U.S. It is also made easier by technological advances allowing the conversion of programming into digital formats, which facilitates the creation, transmission and


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sharing of high quality unauthorized copies. Unauthorized distribution of copyrighted material over the Internet is a threat to copyright owners’ ability to protect and exploit their property. The proliferation of unauthorized use of Discovery’s entertainment content may have an adverse effect on its business and profitability because it reduces the revenue that Discovery potentially could receive from the legitimate sale and distribution of its content.
Financial market conditions may impede access to or increase the cost of financing Discovery’s operations and investments.  The recent changes in U.S. and global financial and equity markets, including market disruptions and tightening of the credit markets, may make it more difficult for Discovery to obtain financing for its operations or investments or increase the cost of obtaining financing. In addition, Discovery’s borrowing costs can be affected by short and long-term debt ratings assigned by independent rating agencies which are based, in significant part, on its performance as measured by credit metrics such as interest coverage and leverage ratios. A decrease in these ratings could increase Discovery’s cost of borrowing or make it more difficult for Discovery to obtain financing.
Item 1B.Unresolved Staff Comments.
None
Item 2.Properties.
We share our executive offices in Englewood, Colorado under a services agreement with Liberty. All of our other real or personal property is owned or leased by our subsidiaries or affiliates.
Ascent Media’s operations are conducted at approximately 60 properties. Certain of these facilities are used by multiple operations within Ascent Media. In the United States, Ascent Media utilizes owned and leased properties in California, Connecticut, Florida, Georgia, New Jersey, New York and Virginia; the network services group also operates a satellite earth station and related facilities in Minnesota. Internationally, Ascent Media utilizes owned and leased properties in London, England. In addition, the creative services group operates a leased facility in Mexico City, Mexico, and the network services group operates two leased facilities in Singapore. Worldwide, Ascent Media leases approximately 1.4 million square feet and owns another 325,000 square feet. In the United States, Ascent Media’s leased properties total approximately 1.1 million square feet and have terms expiring between March 2008 and January 2018. Several of these agreements have extension options. The leased properties are used for our technical operations, office space and media storage. Ascent Media’s international leases have terms that expire between June 2008 and September 2020, and are also used for technical operations, office space and media storage. Over half of the international leases have extension clauses. Approximately 250,000 square feet of Ascent Media’s owned properties are located in Southern California, with another 45,000 square feet located in Northvale, New Jersey, Tappan, New York, Minneapolis, Minnesota and Stamford, Connecticut. In addition, Ascent Media owns approximately 30,000 square feet in London, England. Nearly all of Ascent Media’s owned properties are purpose-built for its technical and creative service operations. Ascent Media’s facilities are adequate to support its current near term growth needs.
Discovery owns its world headquarters located at One Discovery Place, Silver Spring, Maryland, where Discovery uses approximately 543,000 square feet for its executive offices. Discovery manages the distribution of its domestic network television programming through an approximately 53,000 square foot origination facility that it owns in Sterling, Virginia. Discovery also leases the following facilities for certain of its operating divisions: (i) approximately 151,000 square feet of office space at 850 Third Avenue, New York, New York and (ii) approximately 148,000 square feet of office space at 8045 Kennett Street, Silver Spring, Maryland.
Discovery also leases other office, studio and transmission facilities in the United States and several other countries for its businesses. Discovery considers its properties adequate for its present needs.
Item 3.Legal Proceedings.
The registrant and its subsidiaries are not a party to any material legal proceedings.
Item 4.Submission of Matters to a Vote of Security Holders.
None.


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Item 1B.Unresolved Staff Comments.
None
Item 2.Properties.
We share our executive offices in Englewood, Colorado under a services agreement with Liberty. All of our other real or personal property is owned or leased by our subsidiaries or affiliates.
Ascent Media’s operations are conducted at over 80 properties. In the United States, Ascent Media occupies owned and leased properties in California, Connecticut, Florida, Georgia, New Jersey, New York and Virginia; the network services group also operates a satellite earth station and related facilities in Minnesota. Internationally, Ascent Media has owned and leased properties in London, England. In addition, the creative services group operates a leased facility in Mexico City, Mexico, and has a 50% owned equity affiliate with facilities in Barcelona and Madrid, Spain, and the network services group operates two leased facilities in the Republic of Singapore. Worldwide, Ascent Media leases approximately 1.4 million square feet and owns another 325,000 square feet. In the United States, Ascent Media’s leased properties total approximately 1.1 million square feet and have terms expiring between March 2007 and April 2015. Several of these agreements have extension options. The leased properties are used for our technical operations, office space and media storage. Ascent Media’s international leases have terms that expire between March 2007 and September 2020, and are also used for technical operations, office space and media storage. Over half of the international leases have extension clauses. Approximately 250,000 square feet of Ascent Media’s owned properties are located in Southern California, with another 45,000 square feet located in Northvale, New Jersey, Tappan, New York, Minneapolis, Minnesota and Stamford, Connecticut. In addition, Ascent Media owns approximately 30,000 square feet in London, England. Nearly all of Ascent Media’s owned properties are purpose-built for its technical and creative service operations. Ascent Media’s facilities are adequate to support its current near term growth needs.
Item 3.Legal Proceedings.
The registrant and its subsidiaries are not a party to any material legal proceedings.
Item 4.Submission of Matters to a Vote of Security Holders.
None.


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PART II.
Item 5.Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Market Information
 
We have two series
Item 5.Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of common stock, Series A and Series B, which trade on the Nasdaq National Market under the symbols DISCA and DISCB, respectively. The following table sets forth the range of high and low sales prices of shares of our Series A and Series B common stock since our spin off on July 21, 2005.Equity Securities.
Market Information
We have two series of common stock, Series A and Series B, which trade on the Nasdaq Global Select Market under the symbols DISCA and DISCB, respectively. The following table sets forth the range of high and low sales prices of shares of our Series A and Series B common stock for the years ended December 31, 2007 and 2006.
                 
  Series A  Series B 
  High  Low  High  Low 
 
2007                
First quarter $19.48   15.52   19.46   15.70 
Second quarter $24.70   19.12   24.70   19.25 
Third quarter $29.33   21.92   29.25   21.98 
Fourth quarter $29.81   22.55   30.25   25.40 
2006                
First quarter $15.65   13.88   15.96   13.58 
Second quarter $15.18   13.61   15.21   13.73 
Third quarter $14.82   12.81   14.54   12.97 
Fourth quarter $16.96   14.18   16.85   13.97 
Holders
As of January 31, 2008, there were approximately 3,000 and 100 record holders of our Series A common stock and Series B common stock, respectively (which amounts do not include the number of shareholders whose shares are held of record by banks, brokerage houses or other institutions, but include each institution as one shareholder).
Dividends
We have not paid any cash dividends on our Series A common stock and Series B common stock, and we have no present intention of so doing. Payment of cash dividends, if any, in the future will be determined by our Board of Directors in light of our earnings, financial condition and other relevant considerations.


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Stock Performance Graph
The following graph sets forth the performance of our Series A common stock and our Series B common stock for the period beginning July 21, 2005 and ended December 31, 2007 as compared to the S&P Media Index and the Nasdaq Stock Market Index. The graph assumes $100 originally invested on July 21, 2005 and that all subsequent dividends were reinvested in additional shares.
 
                 
  Series A  Series B 
  High  Low  High  Low 
 
2006                
First quarter $15.65   13.88   15.96   13.58 
Second quarter $15.18   13.61   15.21   13.73 
Third quarter $14.82   12.81   14.54   12.97 
Fourth quarter $16.96   14.18   16.85   13.97 
2005                
July 21, 2005 through September 30, 2005 $16.30   13.51   16.77   14.40 
Fourth quarter $16.23   13.69   16.80   13.59 
Item 6.Selected Financial Data.
Effective July 21, 2005, Liberty Media Corporation (“Liberty”) completed a spin off transaction pursuant to which our capital stock was distributed as a dividend to holders of Liberty’s Series A and Series B common stock. Subsequent to the spin off, we are a separate publicly traded company and we and Liberty operate independently. The spin off has been accounted for at historical cost due to the pro rata nature of the distribution. Accordingly, our historical financial statements are presented in a manner similar to a pooling of interest. The spin off did not involve the payment of any consideration by the holders of Liberty common stock and was intended to qualify as a tax-free spin off.
The following tables present selected historical information relating to our financial condition and results of operations for the past five years. The following data should be read in conjunction with our consolidated financial statements.
                     
  December 31, 
  2007  2006  2005  2004  2003 
  amounts in thousands 
 
Summary Balance Sheet Data:                    
Current assets $371,707   317,362   400,386   198,969   131,437 
Investment in Discovery Communications Holding, LLC $3,271,553   3,129,157   3,018,622   2,945,782   2,863,003 
Goodwill $1,909,823   2,074,789   2,133,518   2,135,446   2,130,897 
Total assets $5,865,752   5,870,982   5,819,236   5,564,828   5,396,627 
Current liabilities $120,137   121,887   93,773   108,527   60,595 
Stockholders’ equity $4,494,321   4,549,264   4,575,425   4,347,279   4,260,269 


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  Years Ended December 31, 
  2007  2006  2005  2004  2003 
  amounts in thousands,
 
  except per share amounts 
 
Summary Statement of Operations Data:                    
Net revenue $707,214   688,087   694,509   631,215   506,103 
Operating income (loss)(1) $(167,643)  (115,137)  (1,402)  16,935   (2,404)
Share of earnings of Discovery $141,781   103,588   79,810   84,011   37,271 
Net earnings (loss)(1) $(68,392)  (46,010)  33,276   66,108   (52,394)
Basic and diluted earnings (loss) per common share — Series A and Series B(2) $(0.24)  (0.16)  0.12   0.24   (0.19)
 
Holders
As
(1)Includes impairment of February 6, 2007, there were approximately 84,000goodwill of $165,347,000 and 700 record and beneficial holders of our Series A common stock and Series B common stock, respectively.
Dividends
We have not paid any cash dividends on our Series A common stock and Series B common stock, and we have no present intention of so doing. Payment of cash dividends, if any, in the future will be determined by our Board of Directors in light of our earnings, financial condition and other relevant considerations.
Securities Authorized for Issuance Under Equity Compensation Plans
Information required by this item is incorporated by reference to our definitive proxy statement for our 2007 Annual Meeting of shareholders.
Item 6.Selected Financial Data.
Effective July 21, 2005, Liberty Media Corporation (“Liberty”) completed a spin off transaction pursuant to which our capital stock was distributed as a dividend to holders of Liberty’s Series A and Series B common stock. Subsequent to the spin off, we are a separate publicly traded company and we and Liberty operate independently. The spin off has been accounted for at historical cost due to the pro rata nature of the distribution. Accordingly, our historical financial statements are presented in a manner similar to a pooling of interest.
The following tables present selected historical information relating to our financial condition and results of operations for the past five years. The following data should be read in conjunction with our consolidated financial statements.
                     
  December 31, 
  2006  2005  2004  2003  2002 
  amounts in thousands 
 
Summary Balance Sheet Data:                    
                     
Investment in Discovery Communications, Inc.  $3,129,157   3,018,622   2,945,782   2,863,003   2,816,513 
Goodwill $2,074,789   2,133,518   2,135,446   2,130,897   2,104,705 
Total assets $5,870,982   5,819,236   5,564,828   5,396,627   5,373,150 
Stockholders’ equity $4,549,264   4,575,425   4,347,279   4,260,269   3,617,417 


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  Years ended December 31, 
  2006  2005  2004  2003  2002 
  amounts in thousands,
 
  except per share amounts 
 
Summary Statement of Operations Data:                    
                     
Net revenue $688,087   694,509   631,215   506,103   539,333 
Operating income (loss)(1) $(115,137)  (1,402)  16,935   (2,404)  (61,452)
Share of earnings (losses) of Discovery $103,588   79,810   84,011   37,271   (32,046)
Net earnings (loss)(1) $(46,010)  33,276   66,108   (52,394)  (129,275)
Basic and diluted earnings (loss) per common share(2) $(0.16)  0.12   0.24   (0.19)  (0.46)
(1)Includes impairment of goodwill and other long-lived assets of $93,402,000 and $83,718,000 for the years ended December 31, 2006 and 2002, respectively.
(2)Basic and diluted net earnings (loss) per common share is based on (1) 280,199,000 shares, which is the number of shares issued in the spin off, for all periods prior to the spin off and (2) the actual number of weighted average outstanding shares for all periods subsequent to the spin off.
Item 7.Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion and analysis provides information concerning our results of operations and financial condition. This discussion should be read in conjunction with our accompanying consolidated financial statements and the notes thereto.
Overview
Effective July 21, 2005, Liberty completed a spin off transaction pursuant to which our capital stock was distributed as a dividend to holders of Liberty’s Series A and Series B common stock. Subsequent to the spin off, we are a separate publicly traded company and we and Liberty operate independently. The spin off did not involve the payment of any consideration by the holders of Liberty common stock and was intended to qualify as a tax-free spin off. The spin off has been accounted for at historical cost due to the pro rata nature of the distribution. We are a holding company and our businesses and assets include Ascent Media Group, LLC (“Ascent Media”), which we consolidate, and a 50% ownership interest in Discovery Communications, Inc. (“Discovery” or “DCI”), which we account for using the equity method of accounting. Accordingly, as described below, Discovery’s revenue is not reflected in the revenue we report in our financial statements. In addition to the foregoing assets, immediately prior to the spin off, Liberty transferred to a subsidiary of our company $200 million in cash.
Ascent Media provides creative and network services to the media and entertainment industries. Ascent Media’s clients include major motion picture studios, independent producers, broadcast networks, cable programming networks, advertising agencies and other companies that produce, ownand/or distribute entertainment, news, sports, corporate, educational, industrial and advertising content. Subsequent to an operational realignment in 2006, Ascent Media’s operations are organized into the following three groups: Creative services, Network services and Corporate and other. Ascent Media has few long-term or exclusive agreements with its creative services customers.
In 2007, Ascent Media will continue to focus on leveraging its broad array of media services to market itself as a full service provider to new and existing customers within the feature film and television production industry. Ascent Media also believes it can optimize its position in the market by growing its digital media management business. With facilities in the U.S., the United Kingdom, Asia and Mexico, Ascent Media hopes to increase its services to multinational companies. The challenges that Ascent Media faces include differentiating its products and services to help maintain or increase operating margins and financing capital expenditures for equipment and other items to satisfy customers’ desire for services using the latest technology.
Our most significant asset is Discovery, in which we do not have a controlling financial interest. Discovery is a global media and entertainment company that provides original and purchased video programming in the United States and over 170 other countries. We account for our 50% ownership interest in Discovery using the equity method of accounting. Accordingly, our share of the results of operations of Discovery is reflected in our consolidated results as earnings or losses of Discovery. To assist the reader in better understanding and analyzing our business, we have included a separate discussion and analysis of Discovery’s results of operations and financial condition below.

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Acquisitions
AccentHealth.  Effective January 27, 2006, one of our subsidiaries acquired substantially all of the assets of AccentHealth, LLC’s (“AccentHealth”) healthcare media business for cash consideration of $46,793,000. AccentHealth operates an advertising-supported captive audience television network in doctor office waiting rooms nationwide. For financial reporting purposes, the acquisition is deemed to have occurred on February 1, 2006, and the results of operations of AccentHealth have been included in our consolidated results as part of the network services group since the date of acquisition.
Cinetech.  On October 20, 2004, Ascent Media acquired substantially all of the assets of Cinetech, Inc., a film laboratory and still image preservation and restoration company, for $10,000,000 in cash plus contingent compensation of up to $1,500,000 to be paid based on the satisfaction of certain contingencies as set forth in the purchase agreement. Cinetech is included in Ascent Media’s creative services group.
London Playout Centre.  On March 12, 2004, Ascent Media acquired the entire issued share capital of London Playout Centre Limited, for a cash purchase price of $36,573,000. London Playout Centre, which we refer to as LPC, is a UK-based television channel origination facility. LPC is included in Ascent Media’s network services group.
Operating Cash Flow
We evaluate the performance of our operating segments based on financial measures such as revenue and operating cash flow. We define operating cash flow as revenue less cost of services and selling, general and administrative expense (excluding stock and other equity-based compensation and accretion expense on asset retirement obligations). We believe this is an important indicator of the operational strength and performance of our businesses, including the ability to invest in ongoing capital expenditures and service any debt. 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, restructuring and impairment charges that are included in the measurement of operating income pursuant to U.S. generally accepted accounting principles, or 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. See note 17 to the accompanying consolidated financial statements for a reconciliation of operating cash flow to earnings (loss) before income taxes.
Results of Operations
Our consolidated results of operations include general and administrative expenses incurred at the DHC corporate level, 100% of Ascent Media’s and AccentHealth’s results and our 50% share of earnings of Discovery.
Ascent Media’s creative services group revenue is primarily generated from fees for video and audio post production, special effects and editorial services for the television, feature film and advertising industries. Generally, these services pertain to the completion of feature films, television programs and advertisements. These projects normally span from a few days to three months or more in length, and fees for these projects typically range from $10,000 to $1,000,000 per project. Additionally, the creative services group provides owners of film libraries a broad range of restoration, preservation, archiving, professional mastering and duplication services. The scope of these creative services vary in duration from one day to several months depending on the nature of the service, and fees typically range from less than $1,000 to $100,000 per project. The creative services group includes Ascent Media’s digital media center which is developing new products and businesses in areas such as digital imaging, digital media and interactive media.
The network services group’s revenue consists of fees relating to facilities and services necessary to assemble and transport programming for cable and broadcast networks across the world via fiber, satellite and the Internet. The group’s revenues are also driven by systems integration and field support services, technology consulting services, design and implementation of advanced video systems, engineering project management, technical help desk and field service. Approximately 60% of the network services group’s revenue relates to broadcast services, satellite operations and fiber services that are earned monthly under long-term contracts ranging generally from one to seven years. Additionally, approximately 40% of revenue relates to systems integration and engineering services that are provided on a project basis over terms generally ranging from three to twelve months.
Corporate related items and expenses are reflected in Corporate and other, below. Cost of services and operating expenses consists primarily of production wages, facility costs and other direct costs and selling, general and administrative expenses.


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Our consolidated results of operations for the year ended December 31, 2006 include approximately eleven months of results for AccentHealth. The consolidated results of operations for the year ended December 31, 2004 include approximately nine months of results for LPC and approximately two months of results for Cinetech.
             
  Years ended December 31, 
  2006  2005  2004 
  amounts in thousands 
 
Segment Revenue
            
Creative Services group $417,876   421,797   405,026 
Network Services group  270,211   272,712   226,189 
Corporate and other  —   —   — 
             
  $688,087   694,509   631,215 
             
Segment Operating Cash Flow
            
Creative Services group $52,554   70,708   72,903 
Network Services group  49,522   55,877   62,537 
Corporate and other  (43,347)  (47,960)  (37,645)
             
  $58,729   78,625   97,795 
             
Revenue.  Our total revenue decreased 0.9% and increased 10.0% for the years ended December 31, 2007 and 2006, respectively.
(2)Basic and 2005, respectively, as compareddiluted net earnings (loss) per common share is based on (1) 280,199,000 shares, which is the number of shares issued in the spin off, for all periods prior to the corresponding prior year. In 2006, creative services group revenue decreased $3,921,000 as a result of (i) an $8,400,000 decline in media services due to lower traditional mediaspin off and DVD services from major studios partially offset by continued growth in new digital services and (ii) lower television revenue of $2,165,000 driven by declines in(2) the U.K. broadcast work, partially offset by higher television audio and post services in the U.S. These creative services revenue decreases were partially offset by a $6,535,000 increase in commercial services, driven primarily by strong U.S. demand, and higher feature revenue of $1,770,000, driven by an increasedactual number of titlesweighted average outstanding shares for post production services, partially offset by smaller size feature sound projects and lower home theatre. Network services group’s 2006 revenue decreased $2,501,000 as a result of (i) a decline in systems integration and services revenue of $11,080,000, reflecting significant one-time projects in 2005 and (ii) lower revenue in the U.K. of $15,060,000, primarily as a result of termination of content distribution contracts. These network services revenue decreases were partially offset by the acquisition of AccentHealth in 2006, which generated $20,873,000 of revenue, and by increased content distribution activity in the U.S. and Singapore.
In 2005, creative services group revenue increased $16,771,000 as a result of a $7,330,000 increase in commercial revenue, primarily in the U.S., a $4,660,000 increase due to strong sales of U.S. television services from an increased number of shows, and $9,906,000 of higher lab revenue driven by the acquisition of Cinetech. These increases were offset by declining sound services revenue of $2,960,000 resulting from lower sales of services for features and games and lower media services volumes of $2,470,000 from traditional services, subtitling and DVD, partially offset by higher digital services. Network services group’s 2005 revenue increased $46,523,000 due to $9,423,000 of revenue related to the LPC acquisition, $33,634,000 from a higher number of large engineering and systems integration projects and $13,083,000 of higher origination business revenue and other new initiatives, partially offset by the $9,550,000 effect of lower renewal rates on certain ongoing broadcast services contracts.
Cost of Services.  Our cost of services increased 1.9% and 17.2% for the years ended December 31, 2006 and 2005, respectively, as compared to the corresponding prior year. In 2006, the increase in cost of services is driven by the AccentHealth acquisition which contributed costs of $6,439,000 and by changes in foreign currency exchange rates of $1,367,000. The 2005 increase is partially attributable to the 2004 acquisitions discussed above, which contributed $12,109,000 in cost of services. In addition, cost of services increased in 2005 due to a change in revenue mix driven by higher systems engineering and integration projects in the network services group which have higher production and engineering labor and production material and equipment costs.
As a percent of revenue, cost of services was 66.1%, 64.2% and 60.2% for the years ended December 31, 2006, 2005 and 2004, respectively. The increase in each year is driven by increases in labor costs partially offset by decreases in materials cost. Labor costs have increased as the revenue mix moves toward more labor intensive feature services and as projects have become increasingly more integrated, with complex work flows requiring higher levels of production labor and project management.
Selling, General and Administrative.  Our selling, general and administrative expenses (“SG&A”), (excluding stock-based compensation and accretion expense on asset retirement obligations), increased 2.8% and 11.0% for the years


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ended December 31, 2006 and 2005, respectively, as compared to the corresponding prior year. For 2006, the acquisition of AccentHealth added $6,565,000 of SG&A expense, slightly offset by lower personnel costs and professional fees. The 2005 increase in SG&A expense is primarily attributable to the impact of the 2004 acquisitions of $5,270,000 and the growth in 2005 revenue driving higher labor, facility and selling expenses. As a percent of revenue, SG&A increased from 24.5% to 25.4% for the years ended December 31, 2005 and 2006, respectively, due to the acquisition of AccentHealth in 2006, combined with a slight overall decline in revenue.
Corporate and other operating cash flow improved $4,613,000 in 2006 primarily due to lower Ascent Media corporate expenses, partially offset by an increase in DHC corporate, general and administrative expenses which were $9,360,000 and $6,467,000 for the years ended December 31, 2006 and 2005, respectively. The 2005 decrease in operating cash flow of $10,315,000 is due to DHC corporate expenses, which primarily relate to the Spin Off ($5,072,000) and charges pursuant to the services agreement with Libertyall periods subsequent to the Spin Off ($876,000), and to higher Ascent Media corporate expenses ($3,848,000) as a result of higher labor, facility, and professional services costs related to reengineering of corporate departments and processes and to a legal settlement.
spin off.
 
Item 7.Depreciation and Amortization.  The decrease in depreciation and amortization expense from 2005 to 2006 is due to assets becoming fully depreciated partially offset by capital expenditures and the AccentHealth acquisition. Depreciation and amortization were comparable in 2005 and 2004.
Stock Compensation.  Stock-based compensation was $1,817,000, $4,383,000 and $2,775,000 for the years ended December 31, 2006, 2005 and 2004, respectively, and is included in SG&A in the Consolidated Statements of Operations and Comprehensive Earnings (Loss). Effective January 1, 2006, we adopted Statement No. 123R. Statement No. 123R requires that we amortize the grant date fair value of our stock option and SAR Awards that qualify as equity awards as stock compensation expense over the vesting period of such Awards. Statement No. 123R also requires that we record our liability awards at fair value each reporting period and that the change in fair value be reflected as stock compensation expense in our consolidated statement of operations. Prior to adoption of Statement No. 123R, the amount of expense associated with stock-based compensation was generally based on the vesting of the related stock options and stock appreciation rights and the market price of the underlying common stock. The expense reflected in our consolidated financial statements was based on the market price of the underlying common stock as of the date of the financial statements.
In 2001, Ascent Media granted to certain of its officers and employees stock options (the “Ascent Media Options”) with exercise prices that were less than the market price of Ascent Media common stock on the date of grant. The Ascent Media Options became exercisable for Liberty shares in connection with Liberty’s acquisition in 2003 of the Ascent Media shares that it did not already own. Prior to January 1, 2006, we amortized the“in-the-money” value of these options over the5-year vesting period. Certain Ascent Media employees also hold options and stock appreciation rights granted by companies acquired by Ascent Media in the past several years and exchanged for Liberty options and SARs. Prior to January 1, 2006 we recorded compensation expense for the SARs based on the underlying stock price and vesting of such awards.
On May 24, 2005, Liberty commenced an offer to purchase certain stock options and SARs held by eligible employees of Ascent Media. The offer to purchase related to 1,173,028 options and SARs, and the aggregate offering price for such options and SARs was approximately $2.15 million. The offer to purchase expired at 9:00 p.m., Pacific time, on June 21, 2005. Eligible employees tendered options with respect to 1,121,673 shares of Liberty Series A common stock, and Liberty purchased such options for aggregate cash payments of approximately $2.14 million. In connection with these purchases, Ascent Media recorded 2005 compensation expense of $3,830,000, which included (1) the amount of the cash payments less any previously accrued compensation for the SARs, (2) the previously unamortizedin-the-money value related to the Ascent Media Options and (3) ongoing amortization of the unexercised Ascent Media options.
As of December 31, 2006, the total compensation cost related to unvested equity awards was $1.1 million. Such amount will be recognized in our consolidated statements of operations through 2009.
Restructuring Charges.  On August 18, 2006, Ascent Media announced that it intended to streamline its structure into two global operating divisions — creative services group and network services group — to better align Ascent Media’s organization with the company’s strategic goals and to respond to changes within the industry driven by technology and customer requirements (the “2006 Restructuring”). The operations of the media management services group were realigned with the other two groups, which was completed in the fourth quarter of 2006. As a result of the realignment, Ascent Media recorded a restructuring charge of $12,092,000 during the year ended December 31, 2006, primarily related to severance. These restructuring activities were primarily in the Corporate and other group in the United States and United Kingdom.


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During the year ended December 31, 2005, Ascent Media recorded a restructuring charge of $4,112,000 related to the consolidation of certain operating facilities resulting in excess leased space, consolidation expenses and severance from reductions in headcount. These restructuring activities were implemented to improve ongoing operating efficiencies and effectiveness primarily in the creative services group in the U.K. There was no restructuring charge in 2004.
Impairment of Goodwill.  As a result of the 2006 Restructuring and the declining financial performance of the media management services group, including ongoing operating losses driven by technology and customer requirement changes in the industry, the media management services group was tested for goodwill impairment in the third quarter of 2006, prior to DHC’s annual goodwill valuation assessment of the entire company. DHC estimated the fair value of that reporting unit principally by using trading multiples of revenue and operating cash flows of similar companies in the industry. This test resulted in a goodwill impairment loss for the media management services group of $93,402,000, which represents the excess of the carrying value over the implied fair value of such goodwill.
Share of Earnings of Discovery.  Our share of earnings of Discovery increased $23,778,000 or 29.8% in 2006 and decreased $4,201,000 or 5.0% in 2005. The 2006 increase is due to Discovery’s higher operating income partially offset by higher interest expense and the change in minority interests in consolidated subsidiaries. Discovery’s net income decreased in 2005 as increases in revenue and operating income were more than offset by increases in interest expense and income tax expense.
For a more detailed discussion of Discovery’s results of operations, see “— Management’s Discussion and Analysis of Financial Condition and Results of Operations of Discovery.”Operations.
The following discussion and analysis provides information concerning our results of operations and financial condition. This discussion should be read in conjunction with our accompanying consolidated financial statements and the notes thereto.
Overview
We are a holding company and our businesses and assets include consolidated subsidiaries Ascent Media Group, LLC (“Ascent Media”) and Ascent Media CANS, LLC (dba AccentHealth) (“AccentHealth”), and a 662/3% ownership interest in Discovery Communications Holding, LLC. (“Discovery”), which we account for using the equity method of accounting. Accordingly, as described below, Discovery’s revenue is not reflected in the revenue we report in our financial statements.
Ascent Media provides creative and network services to the media and entertainment industries in the United States, the United Kingdom (“UK”) and Singapore. Ascent Media’s clients include major motion picture studios, independent producers, broadcast networks, programming networks, advertising agencies and other companies that produce, ownand/or distribute entertainment, news, sports, corporate, educational, industrial and advertising content. Ascent Media’s operations are organized into the following three groups: creative services, network services and corporate and other.
In 2008, Ascent Media will continue to focus on leveraging its broad array of traditional media and file-based services to market itself as a full service provider to new and existing customers within the feature film, television production and advertising industries. Ascent Media’s strategy will focus on providing a unified portfolio of business-to-business services to enable media companies to realize the increasing benefits of digital distribution. With facilities in the U.S., the U.K. and Singapore, Ascent Media hopes to increase its services to multinational companies on a worldwide basis. The challenges that Ascent Media faces include continued development of end to end file-based solutions, increased competition in both its creative and network services, differentiation of its products and services to help maintain or increase operating margins and financing capital expenditures for equipment and other items to meet customers’ requirements for integrated and file-based workflows.
Our most significant asset is our interest in Discovery, which we do not control. During the second quarter of 2007, each of the shareholders of Discovery Communications, Inc. (“DCI”) contributed its DCI common stock to a newly formed company, Discovery, in exchange for Discovery membership interests. Subsequent to this contribution, each of the members of Discovery held the same ownership interests in Discovery as they previously held in DCI. DCI became a wholly-owned subsidiary of Discovery, and Discovery is the successor reporting entity of DCI.

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Discovery is a leading global media and entertainment company that provides original and purchased programming across multiple distribution platforms in the United States and more than 170 other countries. Discovery also develops and sells consumer and educational products and services in the United States and internationally, and owns and operates a diversified portfolio of website properties and other digital services. Our share of the results of operations of Discovery is reflected in our consolidated results as earnings or losses of Discovery. To assist the reader in better understanding and analyzing our business, we have included a separate discussion and analysis of Discovery’s results of operations and financial condition below.
On May 14, 2007, Discovery and Cox Communications Holdings, Inc. (“Cox”) completed an exchange of Cox’s 25% ownership interest in Discovery for all of the capital stock of a subsidiary of Discovery that held Travel Channel, travelchannel.com and approximately $1.3 billion in cash (the “Cox Transaction”). Discovery raised the cash component through additional debt financing, and retired the membership interest previously owned by Cox. Upon completion of this transaction, we own a 662/3% interest in Discovery and Advance/Newhouse Programming Partnership (“Advance/Newhouse”) owns a 331/3% interest. We continue to account for our investment in Discovery using the equity method of accounting due to governance rights possessed by Advance/Newhouse which restrict our ability to control Discovery.
In December 2007, we announced that we had signed a non-binding letter of intent with Advance/Newhouse to combine our respective stakes in Discovery. As currently contemplated by the non-binding letter of intent, the transaction, if completed, would involve the following steps:
 
Income Taxes.  For the year ended December 31, 2006, we recorded income tax expense of $43,942,000, but had a loss before taxes of $2,068,000. The pre-tax loss resulted primarily from a $93,402,000 goodwill impairment charge recorded in the third quarter of 2006, for which we receive no tax benefit. Our effective tax rate was 59.5% and 34.6% for the years ended December 31, 2005 and 2004, respectively. While we were a subsidiary of Liberty, we calculated our deferred tax liabilities using Liberty’s blended weighted average state tax rate. Subsequent
• We will spin-off to our spin off, we assessed such rate in light of the fact that we are located primarily in California, which hasshareholders a higher state income tax rate than many of the other states in which Liberty does business,wholly-owned subsidiary holding cash and we determined that our effective tax rate should be increased from 39% to 39.55%. This increase resulted in additional deferred tax expense in 2005 of $15,263,000. Our income tax rate in 2005 was higher than the federal income tax rate of 35% due to state and foreign tax expense.
Net Earnings (Loss).  We recorded net earnings (loss) of ($46,010,000), $33,276,000 and $66,108,000Ascent Media, except for the years ended December 31, 2006, 2005 and 2004, respectively. The change between each of these years is discussed in the aforementioned fluctuations in revenue and expenses.
Liquidity and Capital Resources
For the year ended December 31, 2006, our primary uses of cash were capital expenditures ($77,541,000) and acquisitions ($46,793,000). We funded these investing activities with cash from operating activities of $73,633,000 and with our available cash. Of the foregoing 2006 capital expenditures, $20,316,000 relates to the buildoutthose businesses of Ascent Media’s existing facilities for customer specific contracts. The remainder of our capital expenditures relates to purchases of new equipmentMedia that provide sound, music, mixing, sound effects and other related services;
• Immediately following the upgrade of existing facilities and equipment. For the foreseeable future, we expect to have sufficient available cash balances and net cash from operating activities to meet our working capital needs and capital expenditure requirements. We intend to seek external equity or debt financing in the event any new investment opportunities, additional capital expenditures or our operations require additional funds, but there can be no assurance thatspin-off, we will be able to obtain equity or debt financing on terms that are acceptable to us.
In 2007, Ascent Media and AccentHealth expect to spend approximately $60,000,000 for capital expenditures, which we expect will be fundedcombine with their cash from operations and cash on hand.
Our ability to seek additional sources of funding depends on our future financial position and results of operations, which, to a certain extent, are subject to general conditions in or affecting our industrynew holding company (“New DHC”), and our customers and to general economic, political, financial, competitive, legislative and regulatory factors beyond our control.
We do not have access to the cash Discovery generates fromexisting stockholders will receive shares of common stock of New DHC;
• As part of this transaction, Advance/Newhouse will contribute its operations, unless Discovery pays a dividend on its capital stock or otherwise distributes cash to its stockholders. Historically, Discovery has not paid any dividends on its capital stock and we do not have sufficient voting control to cause Discovery to pay dividends or make other payments or advances to us.


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Off-Balance Sheet Arrangements and Contractual Obligations
Information concerning the amount and timing of required payments under our contractual obligations at December 31, 2006 is summarized below:
                     
  Payments due by period 
  Less than
        After 5
    
  1 year  1-3 years  4-5 years  years  Total 
  amounts in thousands 
 
Operating leases $32,058   56,801   44,026   59,144   192,029 
Other  —   6,100   —   —   6,100 
                     
Total contractual obligations $32,058   62,901   44,026   59,144   198,129 
                     
We have contingent liabilities related to legal proceedings and other matters arising in the ordinary course of business. Although it is reasonably possible we may incur losses upon conclusion of such matters, an estimate of any loss or range of loss cannot be made. In the opinion of management, it is expected that amounts, if any, which may be required to satisfy such contingencies will not be material in relation to the accompanying consolidated financial statements.
Recent Accounting Pronouncements
The Financial Accounting Standards Board (“FASB”) has issued interpretation No. 48, “Accounting for Uncertainty in Income Taxes — An Interpretation of FASB Statement No. 109” (“FIN 48”), regarding accounting for, and disclosure of, uncertain tax positions. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, “Accounting for Income Taxes.” FIN 48 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. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting for interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. We are in the process of evaluating the potential impact of the adoption of FIN 48 on our consolidated balance sheet and statements of operations and comprehensive earnings (loss), and do not believe this adoption will have a material impact.
Critical Accounting Estimates
Valuation of Long-lived Assets and Amortizable Other Intangible Assets.  We perform impairment tests for our long-lived assets if an event or circumstance indicates that the carrying amount of our long-lived assets may not be recoverable. In response to changes in industry and market conditions, we may also strategically realign our resources and consider restructuring, disposing of, or otherwise exiting businesses. Such activities could result in impairment of our long-lived assets or other intangible assets. We are subject to the possibility of impairment of long-lived assets arising in the ordinary course of business. We regularly consider the likelihood of impairment and recognize impairment if the carrying amount of a long-lived asset or intangible asset is not recoverable from its undiscounted cash flows in accordance with SFAS No. 144, “Accounting for Impairment or Disposal of Long-Lived Assets”. Impairment is measured as the difference between the carrying amount and the fair value of the asset. We use both the income approach and market approach to estimate fair value. Our estimates of fair value are subject to a high degree of judgment. Accordingly, any value ultimately derived from our long-lived assets may differ from our estimate of fair value.
Valuation of Goodwill andNon-amortizable Other Intangible Assets.  We assess the impairment of goodwill annually and whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors we consider important which could trigger an impairment review include significant underperformance to historical or projected future operating results, substantial changes in our strategy or the manner of use of our assets, and significant negative industry or economic trends. Fair value of each reporting unit is determined through the use of an outside independent valuation consultant. Both the income approach and market approach are used in determining fair value.
Valuation of Trade Receivables.  We must make estimates of the collectibility of our trade receivables. Our management analyzes the collectibility based on historical bad debts, customer concentrations, customer credit-worthiness, current economic trends and changes in our customer payment terms. We record an allowance for doubtful accounts based upon specifically identified receivables that we believe are uncollectible. In addition, we also record an amount based upon a percentage of each aged category of our trade receivables. These percentages are estimated based upon our historical experience of bad debts. Our trade receivables balance was $156,481,000, net of allowance for doubtful accounts of $9,045,000, as of December 31, 2006.


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Valuation of Deferred Tax Assets.  In accordance with SFAS No. 109, “Accounting for Income Taxes”, we review the nature of each component of our deferred income taxes for reasonableness. We have determined that it is more likely than not that we will not realize the tax benefits associated with certain cumulative net operating loss carry forwards and impairment reserves, and as such, we have established a valuation allowance of $96,223,000 and $91,235,000 as of December 31, 2006 and 2005, respectively.
Discovery
We hold a 50% ownership interestinterests in Discovery and accountAnimal Planet to New DHC in exchange for this investment usingpreferred stock of New DHC that, immediately after the equity method of accounting. Accordingly, in our financial statements we record our share of Discovery’s net income or loss available to common shareholders and reflect this activity in one line item in the statement of operations as “Share of earnings of Discovery.” The following financial information of Discovery for the years ended December 31, 2006, 2005 and 2004 and related discussion is presented to provide the reader with additional analysisclosing of the operating results and financial position of Discovery. Because we do not control the decision-making process or business management practices of Discovery, we rely on Discovery to provide us with financial information prepared in accordance with GAAP that we use in the applicationtransactions, will be convertible at any time into shares initially representing one-third of the equity method.outstanding shares of common stock of New DHC. The information included in this section should be read in conjunction with the audited financial statementspreferred stock held by Advance/Newhouse will entitle it to elect two members to New DHC’s board of Discovery for the year ended December 31, 2006 included elsewhere herein. The following discussiondirectors and analysis of Discovery’s operations and financial position has been prepared based on information that we receive from Discovery and represents our views and understanding of their operating performance and financial position based on such information. Discovery is not a separately traded public company, and we do not have the ability to cause Discovery’s management to prepare their own management’s discussion and analysis for our purposes. Accordingly, we note that the material presented in this section might be different if Discovery’s management had prepared it.
The following discussion of Discovery’s results of operations is presented on a consolidated basis. In order to provide a better understanding of Discovery’s operations, we have also included a summarized presentation of revenue and operating cash flow of Discovery’s three operating groups: Discovery networks U.S., or U.S. networks, Discovery networks international, or international networks, and Discovery commerce, education & other.
The U.S. networks is Discovery’s largest division. It owns and operates 12 cable and satellite channels and provides distribution and advertising sales services for BBC America and distribution services for BBC World News. International networks manages a portfolio of channels, led by the Discovery Channel and Animal Planet brands, that is distributed in virtually every pay-television market in the world via an infrastructure that includes major operational centers in London, Singapore, New Delhi and Miami. Discovery commerce, education & other includes Discovery’s retail chain store operations and other direct consumer marketing activities, as well as Discovery education, which manages Discovery’s distribution of education content to schools and consumers.


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Consolidated Results of Discovery
             
  Years ended December 31, 
  2006  2005  2004 
  amounts in thousands 
 
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 revenue  3,012,988   2,671,754   2,365,346 
             
Expenses
            
Cost of revenue  (1,120,377)  (979,765)  (846,316)
SG&A expense  (1,170,187)  (1,005,351)  (856,340)
             
Operating cash flow  722,424   686,638   662,690 
             
Expenses arising from long-term incentive plans  (39,233)  (49,465)  (71,515)
Depreciation & amortization  (133,634)  (123,209)  (129,011)
Gain on sale of patents  —   —   22,007 
             
Operating income  549,557   513,964   484,171 
             
Other Income (Expense)
            
Interest expense, 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)
Other  8,527   13,771   2,470 
             
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 
             
Business Segment Results of Discovery
             
  Years ended December 31, 
  2006  2005  2004 
  amounts in thousands 
 
Revenue
            
U.S. networks $1,926,180   1,743,358   1,599,678 
International networks  879,074   738,094   596,450 
Discovery commerce, education & other  207,734   190,302   169,218 
             
Total revenue $3,012,988   2,671,754   2,365,346 
             
Operating Cash Flow
            
U.S. networks $727,469   643,366   597,922 
International networks  116,446   107,096   101,875 
Discovery commerce, education & other  (121,491)  (63,824)  (37,107)
             
Total operating cash flow $722,424   686,638   662,690 
             
Note:Discovery commerce, education & other includes intercompany eliminations. Certain prior period amounts have been reclassified to conform to the current period presentation.
Revenue.  Discovery’s consolidated revenue increased 13% for each of the years ended December 31, 2006 and 2005 as compared to the corresponding prior year. Increased revenue was primarily due to increases of 20% and 23% in distribution revenue for 2006 and 2005, respectively, as well as an increase of 5% in advertising revenue for each of the same periods. Other revenue increased 17% and 12% for 2006 and 2005.


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Distribution revenue increased $128,901,000 or 18% and $130,609,000 or 22% at the U.S. networks during the years ended December 31, 2006 and 2005, respectively. These increases are due to an 11% and 10% increase in paying subscription units for the years ended December 31, 2006 and 2005, respectively, combined with contractual rate increases. Launch amortization at the U.S. networks, a contra-revenue item, was $72,585,000, $67,750,000 and $93,763,000 for the years ended December 31, 2006, 2005 and 2004, respectively. Many of Discovery’s domestic networks are currently distributed to substantially all of the cable television and direct broadcast satellite homes in the U.S. Accordingly, the rate of growth in U.S. distribution revenue in future periods is expected to be less than historical rates.
At the international networks, distribution revenue increased 23% and 25% during 2006 and 2005, respectively. Such increases were principally comprised of combined revenue growth in Europe and Latin America of $96,897,000 during 2006 and growth in Europe and Asia of $79,767,000 during 2005, resulting from a 2006 increase in paying subscription units of 13% combined with contractual rate increases in certain markets. Discovery also experienced a 2006 full year impact of new channel launches in Italy, France and Germany. Subsequent to December 31, 2006, Discovery completed negotiations for the renewal of long-term distribution agreements for certain of its European cable networks and paid a distributor $185.4 million. Such payment will be amortized over a five year term, resulting in an approximate $35 million annual reduction in international distribution revenue.
Advertising revenue, which includes revenue from paid programming, experienced a 5% increase for each of the years ended December 31, 2006 and 2005, with a $34,710,000 or 14% increase at the international networks and a $20,879,000 or 2% increase at the U.S. networks from 2005 to 2006. The increase in international networks advertising revenue was due primarily to higher viewership in Europe and Latin America combined with an increased subscriber base in most markets worldwide. The increase in advertising revenue at the U.S. networks was primarily due to higher advertising sell-out rates and higher audience delivery on certain channels. Paid programming, where Discovery sells blocks of time primarily for infomercials that are aired during the overnight hours on certain networks, represented 6% of total advertising revenue for each of the years ended December 31, 2006, 2005 and 2004.
The increase in advertising revenue during 2005 was primarily due to a 28% increase at the international networks. Over two-thirds of the international networks’ advertising revenue is generated by its operations in the United Kingdom and Europe. The increase in international networks advertising revenue was comprised of a $36,926,000 increase resulting from higher viewership in the U.K. combined with an increased subscriber base in the U.K. and Europe. Advertising revenue at the U.S. networks was essentially flat in 2005, increasing $1,316,000, as higher rates at certain of the larger networks, combined with growth at other newer networks, was offset by decreases resulting from lower audience delivery at certain of the larger networks.
With 12 domestic channels, Discovery offers solutions to advertisers that allow them to reach a broad range of U.S. audience demographics in the face of increasing fragmentation of audience share. The television industry is facing several issues with regard to its advertising revenue, including (1) audience fragmentation caused by the proliferation of other television networks,video-on-demand offerings from cable and satellite companies and broadband content offerings; (2) the deployment of digital video recording devices, allowing consumers to time shift programming and skip or fast-forward through advertisements; and (3) consolidation within the advertising industry, shifting more leverage to the bigger agencies and buying groups.
Commerce, education and other revenue increased $10,577,000 and $10,959,000 related to the education business and increased $10,051,000 and $9,163,000 related to the commerce business for the years ended December 31, 2006 and 2005, respectively. During the fourth quarter of 2006, Discovery made a number of organizational and strategic adjustments to its education business to focus the resources dedicated to the company’sdirect-to-school distribution platform,unitedstreaming,as well as the division’s other premiumdirect-to-school subscription services. Subsequent to December 31, 2006, Discovery initiated a strategic review of its commerce business to evaluate potential new operating alternativesexercise approval rights with respect to such business unit.
Costthe taking of Revenue.  Cost of revenue increased 14%specified actions by New DHC and 16% for the years ended December 31, 2006 and 2005, respectively. As a percent of revenue, cost of revenue was 37%, 37% and 36% for the years ended December 31, 2006, 2005 and 2004, respectively. The $140,612,000 increase in 2006 primarily resulted from a $94,981,000 increase in content amortization expense due to continued investment in original productions across the U.S. networks combined with increases in Europe associated with the launch of several networks to create a package of lifestyle-focused programming, along with a newfree-to-air channel in Germany branded as DMAX.
The increase in 2005 primarily resulted from a $106,901,000 increase in content amortization expense due to continued investment across all U.S. networks in original productions and high profile specials and continued investment


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in the lifestyles category internationally, particularly in Europe. These increases were offset partially by a net aggregate benefit of approximately $11 million related to reductions in estimates for music rights accruals.
SG&A Expenses.  SG&A expenses increased 16% and 17% during the years ended December 31, 2006 and 2005, respectively. As a percent of revenue, SG&A expense was 39%, 38% and 36% for the years ended December 31, 2006, 2005 and 2004, respectively. During 2006, SG&A expenses increased $32,535,000, $67,275,000 and $50,817,000 in the U.S. networks, international networks and education groups, respectively. SG&A expense within the commerce group was relatively consistent with the prior year period. In U.S. networks, the increase is primarily due to a $33,312,000 or 20% increase in personnel expense resulting from compensation increases combined with increased headcount from acquisitions. In international networks, the increase is primarily due to a $38,202,000 or 32% increase in personnel expense, resulting from infrastructure expansions in Europe and Asia which increased headcount and office locations, a $5,888,000 or 7% increase in marketing expense resulting from marketing campaigns in Europe and Asia for the launch of new channels and a $16,920,000 or 16% increase in general and administrative expenses to support the growth of the business, coupled with the effects of foreign currency exchange rates. As a percent of revenue, international SG&A expense was consistent at 43% for both of the years ended December 31, 2006 and 2005. In the education group, the increase is primarily due to (i) a $23,539,000 or 98% increase in personnel expense, resulting primarily from a full year of salary expense for headcount hired in 2005 and (ii) a $19,142,000 or 174% increase in marketing expense resulting mainly from Discovery’s investment in Cosmeo, a new consumer homework help service. In 2007, Discovery implemented cost cutting measures in its education group which should reduce personnel expense for that group in comparison to 2006.
Within the different business segments during 2005, SG&A expense decreased 2% at the U.S. networks and increased 34% and 65% at the international networks and Discovery commerce, education and other, respectively. The increase at the international networks was caused by a $27,872,000 increase in personnel expense resulting from adding headcount as the business expands, particularly in the U.K. and Europe combined with a $27,124,000 increase in marketing expense associated with branding and awareness efforts related to the lifestyles category initiative. The increase at Discovery commerce, education and other is comprised of a $34,329,000 increase primarily resulting from acquisitions and organic growth in Discovery’s education business.
Expenses Arising from Long-term Incentive Plans.  Expenses arising from long-term incentive plans are related to Discovery’s unit-based, long-term incentive plans, or LTIP, for its employees who meet certain eligibility criteria. Units are awarded to eligible employees and vest at a rate of 25% per year. In August 2005, Discovery discontinued one of its LTIPs and settled all amounts with cash. Discovery established a new LTIP in October 2005 (the “2005 LTIP Plan”) for certain eligible employees pursuant to which participants in Discovery’s remaining plan could elect to (1) continue in such plan or (2) redeem vested units and convert partially vested units to the 2005 LTIP Plan. Substantially all participants in the remaining plan redeemed their vested units and received partially vested units in the 2005 LTIP Plan. Certain eligible employees were also granted new units in the 2005 LTIP Plan. The value of units in the 2005 LTIP Plan is indexed to the value of DHC Series A common stock, and upon redemption, participants receive a cash payment based on the change in market price of DHC Series A common stock. Under the old plans, upon exercise, participants received a cash payment for the increase in value of the units from the unit value on the date of issuance determined by the year over year change in Discovery’s aggregate equity value, using a consistent methodology. The change in unit value of LTIP awards outstanding is recorded as compensation expense over the period outstanding. Compensation expense aggregated $39,233,000 and $49,465,000 for the years ended December 31, 2006 and 2005, respectively. The decrease is primarily the result of the change in unit value determination for the 2005 LTIP Plan units. If the remaining vested LTIP awards at December 31, 2006 were redeemed, the aggregate cash payments by Discovery would be approximately $36,650,000.
Depreciation and Amortization.  The increase in depreciation and amortization for the year ended December 31, 2006 is due to an increase in new assets placed in service combined with acquisition activity occurring during 2006. The decrease in depreciation and amortization for the year ended December 31, 2005 is due to intangibles becoming fully amortized and a decrease in the depreciable asset base resulting from a reduction in the number of retail stores, offset by new assets placed in service during 2005.
Gain on Sale of Patents.  In 2004, Discovery recorded a gain on the sale of certain of its television technology patents. The $22 million gain represents the sale price less the costs incurred to sell the patents. The cost of developing the technology had been expensed in prior years to SG&A expense. Discovery does not expect a significant amount of income from patent salesDiscovery.
Although no assurance can be given, consummation of this transaction (the “Newhouse Transaction and Ascent Spin Off”) is expected to close in the second quarter of 2008 and would result in the consolidation of the results of Discovery within New DHC.
Acquisitions
Effective January 27, 2006, we acquired substantially all of the assets of AccentHealth’s healthcare media business for cash consideration of $46,793,000. AccentHealth operates an advertising-supported captive audience television network in doctor office waiting rooms nationwide. For financial reporting purposes, the acquisition is deemed to have occurred on February 1, 2006, and the results of operations of AccentHealth have been included in our consolidated results as part of the network services group since the date of acquisition.
Operating Cash Flow
We evaluate the performance of our operating segments based on financial measures such as revenue and operating cash flow. We define operating cash flow as revenue less cost of services and selling, general and administrative expense (excluding stock and other equity-based compensation and accretion expense on asset retirement obligations). We believe this is an important indicator of the operational strength and performance of our businesses, including the ability to invest in ongoing capital expenditures and service any debt. 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, restructuring and impairment


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charges that are included in the measurement of operating income pursuant to U.S. generally accepted accounting principles, or 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. See note 18 to the accompanying consolidated financial statements for a reconciliation of operating cash flow to earnings (loss) before income taxes.
Results of Operations
Our consolidated results of operations include 100% of Ascent Media’s and AccentHealth’s results of operations, general and administrative expenses incurred at the DHC corporate level, and our share of earnings of Discovery.
Ascent Media’s creative services group generates revenue primarily from fees for video and audio post production, special effects and editorial services for the television, feature film and advertising industries. Generally, these services pertain to the completion of feature films, television programs and advertisements. These projects normally span from a few days to three months or more in length, and fees for these projects typically range from $10,000 to $1,000,000 per project. Additionally, the creative services group provides owners of film libraries a broad range of restoration, preservation, archiving, professional mastering and duplication services. The scope of these creative services vary in duration from one day to several months depending on the nature of the service, and fees typically range from less than $1,000 to $100,000 per project. The creative services group includes Ascent Media’s digital media distribution center, which provides file-based services in areas such as digital imaging, digital vault, distribution services and interactive media to new and existing distribution platforms.
The network services group’s revenue consists of fees relating to facilities and services necessary to assemble and transport programming for cable and broadcast networks across the world via fiber, satellite and the Internet. The group’s refvenue is also driven by systems integration and field support services, technology consulting services, design and implementation of advanced video systems, engineering project management, technical help desk and field service. This operating segment also includes the operations of AccentHealth. Approximately 55% of the network services group’s revenue relates to broadcast services, satellite operations and fiber services that are earned monthly under long-term contracts ranging generally from one to seven years. Additionally, approximately 45% of revenue relates to systems integration and engineering services that are provided on a project basis over terms generally ranging from three to twelve months.
Corporate related items and expenses are reflected in Corporate and other, below. Cost of services and operating expenses consists primarily of production wages, facility costs and other direct costs and selling, general and administrative expenses.
Our consolidated results of operations for the year ended December 31, 2006 include approximately eleven months of results for AccentHealth.
             
  Years Ended December 31, 
  2007  2006  2005 
  amounts in thousands 
 
Segment Revenue
            
Creative Services group $420,504   417,876   421,797 
Network Services group  286,710   270,211   272,712 
Corporate and other  —   —   — 
             
  $707,214   688,087   694,509 
             
Segment Operating Cash Flow
            
Creative Services group $48,493   48,035   65,098 
Network Services group  49,256   47,005   52,797 
Corporate and other  (30,831)  (36,311)  (39,270)
             
  $66,918   58,729   78,625 
             


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Revenue.  Our total revenue increased 2.8% and decreased 0.9% for the years ended December 31, 2007 and 2006, respectively, as compared to the corresponding prior year. In 2007, creative services group revenue increased $2,628,000 due to (i) an increase of $6,117,000 in commercial revenue driven primarily by strong worldwide demand in the first quarter, (ii) an increase of $3,042,000 in media services driven by growth in file-based digital vaulting and digital distribution services, offset by lower traditional lab and DVD services and (iii) favorable changes in foreign currency exchange rates of $6,284,000. These increases were partially offset by an $8,141,000 decrease in television post production services in the U.S. and U.K. and lower feature sound revenue of $4,163,000 driven by smaller feature sound projects and the shut down of certain audio facilities. In addition, creative services revenue was negatively impacted by the Writers Guild of America strike that primarily impacted television production in the fourth quarter of 2007. Network services group’s 2007 revenue increased $16,499,000 due to (i) an increase of $16,377,000 in system integration services revenue due to an increase in the number of projects, (ii) an increase of $5,175,000 in content distribution revenue in the U.S. and Singapore, (iii) an increase of $5,492,000 driven by AccentHealth due mainly to growth in advertising rates and (vi) favorable changes in foreign currency exchange rates of $4,519,000. These increases in revenue were partially offset by (i) a decrease of $10,500,000 primarily due to the expiration of certain distribution contracts in the U.K. which were not renewed and (ii) a decrease of $4,352,000 due to a one-time project in 2006.
In 2006, creative services group revenue decreased $3,921,000 as a result of (i) an $8,400,000 decline in media services due to lower traditional media and DVD services from major studios partially offset by continued growth in new digital services and (ii) lower television revenue of $2,165,000 driven by declines in the U.K. broadcast work, partially offset by higher television audio and post production services in the U.S. These creative services revenue decreases were partially offset by a $6,535,000 increase in commercial services, driven primarily by strong U.S. demand, and higher feature revenue of $1,770,000, driven by an increased number of titles for post production services, partially offset by smaller size feature sound projects and lower home theatre revenue. Network services group’s 2006 revenue decreased $2,501,000 as a result of (i) a decline in systems integration and services revenue of $11,080,000, reflecting significant one-time projects in 2005 and (ii) lower revenue in the U.K. of $15,060,000, primarily as a result of termination of content distribution contracts. These network services revenue decreases were partially offset by the acquisition of AccentHealth in 2006, which generated $20,873,000 of revenue, and by increased content distribution activity in the U.S. and Singapore.
Cost of Services.  Our cost of services increased $22,977,000 or 4.9% and $7,252,000 or 1.6% for the years ended December 31, 2007 and 2006, respectively, as compared to the corresponding prior year. A significant portion of the 2007 increase was across network services resulting from higher volumes of system integration services which have a higher percentage of equipment and labor costs. Creative services was slightly higher driven by revenue increases in commercial, features and new digital services. Additionally, changes in foreign currency exchange rates resulted in an increase of $7,220,000. In 2006, the increase in cost of services is driven by the AccentHealth acquisition which contributed costs of $6,439,000 and by changes in foreign currency exchange rates of $1,367,000.
As a percent of revenue, cost of services was 69.4%, 68.0% and 66.3% for the years ended December 31, 2007, 2006 and 2005, respectively. The increase in cost of services as a percent of revenue is driven by the higher system integration services revenue which has lower margins. Additionally, in each year, labor costs have increased as the revenue mix moves toward more labor intensive feature services and as projects have become increasingly more integrated, with complex work flows requiring higher levels of production labor and project management.
Selling, General and Administrative.  Our selling, general and administrative expenses (“SG&A”), including corporate expenses of both DHC and Ascent Media but excluding stock-based compensation and accretion expense on asset retirement obligations, decreased 7.5% and increased 4.0% for the years ended December 31, 2007 and 2006, respectively, as compared to the corresponding prior year. For 2007, the decline is driven by lower personnel costs, resulting from Ascent Media’s restructuring in the third and fourth quarters of 2006, and lower professional fees. For 2006, the acquisition of AccentHealth added $6,565,000 of SG&A expense, slightly offset by lower personnel costs and professional fees. As a percent of revenue, SG&A was 21.1%, 23.4% and 22.3% for the years ended December 31, 2007, 2006 and 2005, respectively.


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Restructuring Charges.  During 2007, Ascent Media recorded restructuring charges of $761,000 related to severance in conjunction with ongoing restructuring efforts primarily within the U.K. creative services business. During 2006, Ascent Media recorded restructuring charges of $12,092,000 primarily related to severance from the realignment of its operating divisions. These restructuring activities were primarily in the Corporate and other group in the United States and United Kingdom. During 2005, Ascent Media recorded a restructuring charge of $4,112,000 related to the consolidation of certain operating facilities resulting in excess leased space, consolidation expenses and severance from reductions in headcount.
Depreciation and Amortization.  The decrease in depreciation and amortization expense for both 2007 and 2006 is due to assets becoming fully depreciated partially offset by new assets placed in service and for 2006, the AccentHealth acquisition.
Stock Compensation.  Stock-based compensation was $1,129,000, $1,817,000 and $4,383,000 for the years ended December 31, 2007, 2006 and 2005, respectively, and is included in SG&A in our consolidated statements of operations. Effective January 1, 2006, we adopted Statement No. 123R. Statement No. 123R requires that we amortize the grant date fair value of our stock option and SAR Awards that qualify as equity awards as stock compensation expense over the vesting period of such Awards. Statement No. 123R also requires that we record our liability awards at fair value each reporting period and that the change in fair value be reflected as stock compensation expense in our consolidated statement of operations. Prior to adoption of Statement No. 123R, the amount of expense associated with stock-based compensation was generally based on the vesting of the related stock options and stock appreciation rights and the market price of the underlying common stock. The expense reflected in our consolidated financial statements was based on the market price of the underlying common stock as of the date of the financial statements.
In 2001, Ascent Media granted to certain of its officers and employees stock options (the “Ascent Media Options”) with exercise prices that were less than the market price of Ascent Media common stock on the date of grant. The Ascent Media Options became exercisable for Liberty shares in connection with Liberty’s acquisition in 2003 of the Ascent Media shares that it did not already own. Prior to January 1, 2006, we amortized the “in-the-money” value of these options over the5-year vesting period. Certain Ascent Media employees also hold options and stock appreciation rights granted by companies acquired by Ascent Media in the past several years and exchanged for Liberty options and SARs. Prior to January 1, 2006 we recorded compensation expense for the SARs based on the underlying stock price and vesting of such awards.
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 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. Ascent Media recorded 2006 Plan expense of $276,000 for the year ended December 31, 2007, with no 2006 Plan expense recorded in 2006.
On July 21, 2005, Liberty completed the spin off of our capital stock. As a result of the 2005 Spin Off and related adjustments to Liberty’s stock incentive awards, options to acquire an aggregate of approximately 2.0 million shares of our Series A common stock and 3.0 million shares of our Series B common stock were issued to employees of Liberty. In addition, employees of Ascent Media who held stock options or stock appreciation rights (“SARs”) to acquire shares of Liberty common stock prior to the 2005 Spin Off continue to hold such options. SAR expense was a credit of $14,000 and an expense of $21,000 for the years ended December 31, 2007 and 2006, respectively. Pursuant to a reorganization agreement we entered into with Liberty in connection with the 2005 Spin Off, we are responsible for all stock options related to DHC common stock, and Liberty is responsible for all incentive awards related to Liberty common stock. We record stock-based compensation for all stock incentive awards held by our employees and our subsidiaries’ employees. Stock-based compensation expense was $867,000 and $1,796,000 for the years ended December 31, 2007 and 2006, respectively.
On May 24, 2005, Liberty commenced an offer to purchase certain stock options and SARs held by eligible employees of Ascent Media. The offer to purchase related to 1,173,028 options and SARs, and the aggregate offering price for such options and SARs was approximately $2.15 million. The offer to purchase expired on


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June 21, 2005. Eligible employees tendered options with respect to 1,121,673 shares of Liberty Series A common stock, and Liberty purchased such options for aggregate cash payments of approximately $2.14 million. In connection with these purchases, Ascent Media recorded 2005 compensation expense of $3,830,000, which included (1) the amount of the cash payments less any previously accrued compensation for the SARs, (2) the previously unamortized in-the-money value related to the Ascent Media Options and (3) ongoing amortization of the unexercised Ascent Media options.
As of December 31, 2007, the total compensation cost related to unvested equity awards was approximately $540,000. Such amount will be recognized in our consolidated statements of operations over a weighted average period of approximately 1.2 years.
Impairment of Goodwill.  In connection with our 2007 annual evaluation of the recoverability of our goodwill, we estimated the value of our reporting units using a discounted cash flow analysis. The result of this valuation indicated that the fair value of the network services reporting unit was less than its carrying value. The network services reporting unit fair value was then used to calculate an implied value of the goodwill related to this reporting unit. The $165,347,000 excess of the carrying amount of the network services goodwill over its implied value was recorded as an impairment charge in the fourth quarter of 2007. The impairment charge is the result of lower future expectations for network services operating cash flow due to a continued decline in operating cash flow margins as a percent of revenue, resulting from competitive conditions in the entertainment and media services industries and increasingly complex customer requirements that are expected to continue for the foreseeable future.
 
As a result of the 2006 Restructuring and the declining financial performance of the former media management services group, including ongoing operating losses driven by technology and customer requirement changes in the industry, the former media management services group was tested for goodwill impairment in the third quarter of 2006, prior to our annual goodwill valuation assessment of the entire company. We estimated the fair value of that reporting unit principally by using trading multiples of revenue and operating cash flows of similar companies in the industry. This test resulted in a goodwill impairment loss for the former media management services group of $93,402,000, which represents the excess of the carrying value over the implied fair value of such goodwill.
Share of Earnings of Discovery.  From January 1, 2005 through May 14, 2007, we recorded our 50% share of the earnings of DCI. Subsequent to May 14, 2007, we recorded our 662/3% share of the earnings of Discovery. Our share of earnings of Discovery increased $38,193,000 and $23,778,000 for the years ended December 31, 2007 and 2006, respectively, as compared to the corresponding prior year periods. The 2007 increase resulted from our $89,781,000 share of Discovery’s gain on the Cox Transaction, along with an $8,340,000 increase as the result of our ownership interest in Discovery increasing from 50% to 662/3%. These increases were partially offset by Discovery incurring higher long-term incentive plan expenses and higher interest expense resulting from the debt incurred by Discovery in connection with the Cox Transaction. The 2006 increase is due to Discovery’s higher operating income partially offset by higher interest expense and the change in minority interests in consolidated subsidiaries.
For a more detailed discussion of Discovery’s results of operations, see “— Management’s Discussion and Analysis of Financial Condition and Results of Operations of Discovery.”
Income Taxes.  Our effective tax rate for the year ended December 31, 2007 was not meaningful because we recorded income tax expense of $59,157,000, but had a loss before taxes of $9,235,000. The pre-tax loss resulted primarily from a $165,347,000 goodwill impairment charge recorded in the fourth quarter of 2007, for which we receive no tax benefit. For the year ended December 31, 2006, the effective tax rate was not meaningful because we recorded income tax expense of $43,942,000, but had a loss before taxes of $2,068,000. The pre-tax loss resulted primarily from a $93,402,000 goodwill impairment charge recorded in the third quarter of 2006, for which we receive no tax benefit. Our effective tax rate was 59.5% for the year ended December 31, 2005. While we were a subsidiary of Liberty, we calculated our deferred tax liabilities using Liberty’s blended weighted average state tax rate. Subsequent to our spin off, we assessed such rate in light of the fact that our operations are located primarily in California, which has a higher state income tax rate than many of the other states in which Liberty does business, and we determined that our effective tax rate should be increased from 39% to 39.55%. This increase resulted in additional deferred tax expense in 2005 of $15,263,000. In addition, our income tax rate in 2005 was higher than the federal income tax rate of 35% due to state and foreign tax expense.


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Net Earnings (Loss).  We recorded net earnings (loss) of ($68,392,000), ($46,010,000) and $33,276,000 for the years ended December 31, 2007, 2006 and 2005, respectively. The change between each of these years is discussed in the aforementioned fluctuations in revenue and expenses.
Liquidity and Capital Resources
Our primary sources of funds are cash on hand and cash flows from operating activities. During the year ended December 31, 2007, our primary use of cash was capital expenditures of $47,115,000. Of the foregoing 2007 capital expenditures, $11,500,000 relates to the buildout of Ascent Media’s existing facilities for specific customer contracts. The remainder of our capital expenditures relate to purchases of new equipment and the upgrade of existing facilities and equipment. At December 31, 2007, we have approximately $209.4 million of cash and $23.5 million of marketable securities and for the foreseeable future, we expect to have sufficient available cash balances and net cash from operating activities to meet our working capital needs and capital expenditure requirements. We intend to seek external equity or debt financing in the event any new investment opportunities, additional capital expenditures or our operations require additional funds, but there can be no assurance that we will be able to obtain equity or debt financing on terms that are acceptable to us.
In 2008, Ascent Media and AccentHealth expect to spend approximately $52,000,000 for capital expenditures, which we expect will be funded with their cash from operations and cash on hand.
Our ability to seek additional sources of funding depends on our future financial position and results of operations, which, to a certain extent, are subject to general conditions in or affecting our industry and our customers and to general economic, political, financial, competitive, legislative and regulatory factors beyond our control.
We do not have access to the cash Discovery generates from its operations, unless Discovery makes a distribution with respect to its membership interests or makes other payments or advances to its members. Prior to May 14, 2007, DCI did not pay any dividends on its capital stock, and since that date, Discovery has not made any distributions to its members, and we do not have sufficient voting control to cause Discovery to make distributions or make other payments or advances to us.
Off-Balance Sheet Arrangements and Contractual Obligations
Information concerning the amount and timing of required payments under our contractual obligations at December 31, 2007 is summarized below:
                     
  Payments Due by period 
  Less than
        After 5
    
  1 year  1-3 years  3-5 years  years  Total 
  amounts in thousands 
 
Operating leases $31,374   58,673   39,316   62,080   191,443 
Capital lease  1,080   2,160   2,160   1,080   6,480 
Other  6,100   —   —   —   6,100 
                     
Total contractual obligations $38,554   60,833   41,476   63,160   204,023 
                     
We have contingent liabilities related to legal proceedings and other matters arising in the ordinary course of business. Although it is reasonably possible we may incur losses upon conclusion of such matters, an estimate of any loss or range of loss cannot be made. In the opinion of management, it is expected that amounts, if any, which may be required to satisfy such contingencies will not be material in relation to the accompanying consolidated financial statements.
Recent Accounting Pronouncements
In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 157,“Fair Value Measurements”(“SFAS No. 157”), which defines fair value, establishes a framework for measuring fair value under GAAP and expands disclosures about fair value


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measurements. SFAS No. 157 applies to other accounting pronouncements that require or permit fair value measurements. The new guidance is effective for financial statements issued for fiscal years beginning after November 15, 2007, and for interim periods within those fiscal years. We do not expect that our adoption of SFAS No. 157 will have a significant impact on the reported amounts of our assets and liabilities that we report at fair value in our consolidated balance sheet.
In December 2007, the FASB issued Statement of Financial Accounting Standards No. 141(R),“Business Combinations”(“SFAS No. 141(R)”). The statement will significantly change the accounting for business combinations, and under this statement, an acquiring entity will be required to recognize all the assets acquired and liabilities assumed in a transaction at the acquisition-date fair value with limited exceptions. SFAS No. 141 (R) will change the accounting treatment for certain specific items, including acquisition costs, noncontrolling interests, acquired contingent liabilities, in-process research and development, restructuring costs and changes in deferred tax asset valuation allowances and income tax uncertainties after the acquisition date. The adoption of the requirements of SFAS No. 141 (R) applies prospectively to business combinations for which the acquisition date is on or after fiscal years beginning after December 15, 2008. Early adoption is prohibited.
Critical Accounting Polices and Estimates
Valuation of Long-lived Assets and Amortizable Other Intangible Assets.  We perform impairment tests for our long-lived assets if an event or circumstance indicates that the carrying amount of our long-lived assets may not be recoverable. In response to changes in industry and market conditions, we may also strategically realign our resources and consider restructuring, disposing of, or otherwise exiting businesses. Such activities could result in impairment of our long-lived assets or other intangible assets. We are subject to the possibility of impairment of long-lived assets arising in the ordinary course of business. We regularly consider the likelihood of impairment and recognize impairment if the carrying amount of a long-lived asset or intangible asset is not recoverable from its undiscounted cash flows in accordance with SFAS No. 144, “Accounting for Impairment or Disposal of Long-Lived Assets”. Impairment is measured as the difference between the carrying amount and the fair value of the asset. We use both the income approach and market approach to estimate fair value. Our estimates of fair value are subject to a high degree of judgment. Accordingly, any value ultimately derived from our long-lived assets may differ from our estimate of fair value.
Valuation of Goodwill andNon-amortizable Other Intangible Assets.  We assess for impairment of goodwill annually and whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors we consider important which could trigger an impairment review include significant underperformance to historical or projected future operating results, substantial changes in our strategy or the manner of use of our assets, and significant negative industry or economic trends. Fair value of each reporting unit is determined through a combination of discounted cash flow models and comparisons to similar businesses in the industry.
Valuation of Trade Receivables.  We must make estimates of the collectibility of our trade receivables. Our management analyzes the collectibility based on historical bad debts, customer concentrations, customer credit-worthiness, current economic trends and changes in our customer payment terms. We record an allowance for doubtful accounts based upon specifically identified receivables that we believe are uncollectible. In addition, we also record an amount based upon a percentage of each aged category of our trade receivables. These percentages are estimated based upon our historical experience of bad debts. Our trade receivables balance was $153,336,000, net of allowance for doubtful accounts of $8,994,000, as of December 31, 2007.
Valuation of Deferred Tax Assets.  In accordance with SFAS No. 109, “Accounting for Income Taxes”, we review the nature of each component of our deferred income taxes for reasonableness. After consideration of all available evidence, we have determined that it is more likely than not that we will not realize the tax benefits associated with certain cumulative net operating loss carry forwards and impairment reserves, and as such, we have established a valuation allowance of $117,551,000 and $96,223,000 as of December 31, 2007 and 2006, respectively.


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Discovery
Overview
Effective May 15, 2007 and as a result of the Cox Transaction, our ownership interest in Discovery increased from 50% to 662/3%, and we continue to account for this investment using the equity method of accounting due to governance rights which restrict our ability to control Discovery. Accordingly, in our consolidated financial statements we record our share of Discovery’s net income or loss available to members and reflect this activity in one line item in our consolidated statement of operations as “Share of earnings of Discovery.” The following financial information of Discovery for the years ended December 31, 2007, 2006 and 2005 and related discussion is presented to provide the reader with additional analysis of the operating results and financial position of Discovery. Because we do not control the decision-making process or business management practices of Discovery, we rely on Discovery to provide us with financial information prepared in accordance with GAAP that we use in the application of the equity method. The information included in this section should be read in conjunction with the audited financial statements of Discovery for the year ended December 31, 2007 included elsewhere herein. The following discussion and analysis of Discovery’s operations and financial position has been prepared based on information that we receive from Discovery and represents our views and understanding of its operating performance and financial position based on such information. Discovery is not a separately traded public company, and we do not have the ability to cause Discovery’s management to prepare its own management’s discussion and analysis for our purposes. Accordingly, we note that the material presented in this section might be different if Discovery’s management had prepared it.
Discovery is a leading global media and entertainment company that provides original and purchased programming across multiple distribution platforms in the United States and more than 170 other countries, including television networks offering customized programming in 35 languages. Discovery’s strategy is to optimize the distribution, ratings and profit potential of each of its branded channels. Discovery also develops and sells consumer and educational products and services in the United States and internationally, and owns and operates a diversified portfolio of website properties and other digital services. Discovery operates through three divisions: (1) Discovery networks U.S., or U.S. networks, (2) Discovery networks international, or international networks, and (3) Discovery commerce and education.
Discovery’s media content is designed to target key audience demographics and the popularity of its programming creates a reason for advertisers to purchase commercial time on Discovery’s channels. Audience ratings are a key driver in generating advertising revenue and create demand on the part of cable television operators, direct-to-home or “DTH” satellite operators and other content distributors to deliver Discovery’s programming to their customers.
In addition to growing distribution and advertising revenue for its branded channels, Discovery is focused on growing revenue across new distribution platforms, including brand-aligned web properties, mobile devices,video-on-demand and broadband channels, which serve as additional outlets for advertising and affiliate sales, and provide promotional platforms for its programming. Discovery also operates internet sites providing supplemental news, information and entertainment content that are aligned with its television programming. Discovery’s recent acquisition of HowStuffWorks.com creates a stronger platform for distributing Discovery’s extensive video library.
U.S. Networks
U.S. networks is Discovery’s largest division, which owns and operates 11 cable and satellite channels, including Discovery Channel, TLC and Animal Planet, as well as a portfolio of website properties and other digital services. U.S. networks also provides distribution and advertising sales services for Travel Channel and BBC America and provides distribution services for BBC World News. U.S. networks derives revenue primarily from distribution fees and advertising sales, which comprised 44% and 51%, respectively, of revenue for this division for the year ended December 31, 2007. During each of the years ended December 31, 2007, 2006 and 2005, Discovery Channel and TLC collectively generated more than 65% of U.S. networks total revenue. U.S. networks earns distribution fees under multi-year affiliation agreements with cable operators, DTH satellite operators and other distributors of television programming. Distribution fees are based on the number of subscribers receiving Discovery’s programming. Upon the launch of a new channel, Discovery may initially pay distributors to carry


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such channel (such payments are referred to as “launch incentives”), or may provide the channel to the distributor for free for a predetermined length of time. Launch incentives are amortized on a straight-line basis as a reduction of revenue over the term of the affiliation agreement. U.S. networks sells commercial time on its networks and websites. The number of subscribers to Discovery’s channels, the popularity of its programming and its ability to sell commercial time over a group of channels are key drivers of advertising revenue.
Several of Discovery’s domestic networks, including Discovery Channel, TLC and Animal Planet, are currently distributed to substantially all of the cable television and direct broadcast satellite homes in the U.S. Accordingly, the rate of growth in U.S. distribution revenue in future periods is expected to be less than historical rates. Discovery’s other U.S. networks are distributed primarily on the digital tier of cable systems and equivalent tiers on DTH platforms and have been successful in maximizing their distribution within this more limited universe. There is, however, no guarantee that these digital networks will ever be able to gain the distribution levels or advertising rates of Discovery’s major networks. Discovery’s contractual arrangements with U.S. distributors are renewed or renegotiated from time to time in the ordinary course of business. Although U.S. networks believes carriage and marketing of its networks by the larger affiliates will continue, the loss of one or more affiliate agreements could have a material adverse impact on U.S. networks results of operations. In 2008, Discovery will enter negotiations to renew distribution agreements for carriage of its networks involving a substantial portion of its domestic subscribers. A failure to secure a renewal or a renewal on less favorable terms may have a material adverse effect on Discovery’s results of operations and financial position.
U.S. networks largest single cost is the cost of programming, including production costs for original programming. U.S. networks amortizes the cost of original or purchased programming based on the expected realization of revenue resulting in an accelerated amortization for Discovery Channel, TLC and Animal Planet and straight-line amortization over three to five years for the remaining networks.
U.S. networks’ top strategic priorities are (1) maintaining the company’s focus on creative excellence in nonfiction programming and expanding the portfolio’s brand entitlement by developing compelling content that increases audience growth, builds advertising relationships and supports continued distribution revenue on all platforms, (2) leveraging Discovery’s distribution strength in the U.S. to build additional branded channels and businesses that can sustain long-term growth and profitability, and (3) developing and growing compelling and profitable content experiences on new platforms that are aligned with its core branded channels.
International Networks
International networks manages a portfolio of channels, led by the Discovery Channel and Animal Planet brands, that are distributed in virtually every pay-television market in the world through an infrastructure that includes major operational centers in London, Singapore, New Delhi and Miami. International networks regional operations cover most major markets including the U.K., Europe, Middle East and Africa (“EMEA”), Asia, Latin America and India. International networks currently operates over 100 unique distribution feeds in 35 languages with channel feeds customized according to language needs and advertising sales opportunities. Most of the division’s channels are wholly owned by Discovery with the exception of (1) the international Animal Planet channels, which are generally joint ventures in which the BBC owns 50%, (2) People + Arts, which operates in Latin America and Iberia as a50-50 joint venture with the BBC and (3) several channels in Japan, Canada and Poland, which operate as joint ventures with strategically important local partners.
Similar to U.S. networks, the primary sources of revenue for international networks are distribution fees and advertising sales, and the primary cost is programming. International networks executes a localization strategy by offering customized content and localized schedules via its distribution feeds. Distribution revenue represents approximately 60% of the division’s operating revenue and continues to deliver growth in markets with the highest potential for pay television expansion. Advertising sales are increasingly important to the division’s financial success. International television markets vary in their stages of development. Some, notably the U.K., are among the more advanced digital multi-channel television markets in the world, while others remain in the analog environment with varying degrees of investment from operators in expanding channel capacity or converting to digital. Discovery believes there is future growth in many markets including Latin American and Central and Eastern Europe that are in the early stage of pay TV evolution. In developing pay TV markets, Discovery expects to see


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advertising revenue growth from its localization strategy and the shift of advertising spending from broadcast to pay TV. In relatively mature markets, such as the U.K., the growth dynamic is changing. Increased penetration and distribution are unlikely to drive rapid growth in those markets. Instead, growth is expected in advertising sales, which are driven by increased audience performance and viewing market share. To help further drive this focus, Discovery entered the global free-to-air television business with the acquisition of a free-to-air channel in Germany (“DMAX”) in early 2006.
Discovery’s international businesses are subject to a number of risks including fluctuations in currency exchange rates, regulatory issues, and political instability. The past few years have seen relative economic and political stability, but these trends may not be indicative of future events. Changes in any of these areas could adversely affect the performance of the international networks.
International networks’ priorities include maintaining a leadership position in nonfiction entertainment in international markets, and continuing to grow and improve the performance of the international operations. These priorities will be achieved through expanding local advertising sales capabilities, creating licensing and digital growth opportunities, and improving operating efficiencies by strengthening development and promotional collaboration between U.S. and international network groups.
Commerce and Education
During 2007, Discovery evaluated its commerce business and made the decision to transition from runningbrick-and-mortar retail locations to leveraging its products through retail arrangements and ane-commerce platform. In the third quarter, Discovery completed the closing of its 103 mall-based and stand-alone Discovery Channel stores. As a result of the store closures, Discovery’s results of operations have been prepared to reflect the retail store business as discontinued operations. Accordingly, the revenue, costs and expenses of the retail store business have been excluded from the respective captions in Discovery financial statements and have been reported as discontinued operations.
Discovery commerce is now focused on itse-commerce, catalog, and domestic licensing businesses. Discovery commerce leverages its partnerships with leadinge-commerce portals such as Amazon and QVC, to showcase key products, increase customer outreach, acquisition and conversion and maximize transaction opportunities. Discovery commerce adds value to Discovery’s television assets by reinforcing consumer loyalty and creating opportunities for Discovery’s advertising and distribution partners.
Discovery’s education business will continue to focus on its direct-to-school distribution platform and its other premium direct-to-school subscription services in addition to publishing and distributing content on DVD, VHS, online and through a network of distribution partners. Discovery education also participates in licensing and sponsorship programs with corporate partners.
Acquisitions
To complement its existing businesses, Discovery completed several acquisitions in 2006 and 2007. Among these acquisitions are (i) DMAX, a free-to-air network in Germany, which was acquired in February 2006, (ii) Antenna Audio, a provider of audio tours and multimedia at museums and cultural attractions around the globe, which was acquired in March 2006, (iii) PetFinder.com, a facilitator of pet adoptions and PetsIncredible, a producer of pet-training videos were acquired in November 2006, (iv) TreeHugger.com, an eco-lifestyle website to supplement the Planet Green initiative was acquired in August 2007 and (v) HowStuffWorks.com, an online source of easy-to-understand explanations of how the world works, which was acquired in December 2007. These entities have been included in Discovery’s results of operations since their respective dates of acquisition.
Dispositions
On May 14, 2007 Discovery and Cox Communications Holdings, Inc. (“Cox”) completed an exchange of Cox’s 25% ownership interest in Discovery for all of the capital stock of a subsidiary of Discovery that held Travel Channel, travelchannel.com and approximately $1.3 billion in cash (the “Cox Transaction”). Discovery raised the cash component through additional debt financing, and retired the membership interest previously owned by Cox.


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Results of Operations
The following discussion of Discovery’s results of operations is presented in two parts to assist the reader in better understanding Discovery’s operations. The first section is an overall discussion of Discovery’s consolidated operating results. The second section includes a more detailed discussion of revenue and operating cash flow activity of Discovery’s three operating divisions: U.S. networks, international networks, and commerce and education.
Consolidated Results
Discovery was formed in the second quarter of 2007 as part of a restructuring (the “DCI Restructuring”) completed by Discovery Communications, Inc. (“DCI”). In the DCI Restructuring, DCI became a wholly-owned subsidiary of Discovery, and the former shareholders of DCI, including DHC, became members of Discovery. Discovery is the successor reporting entity to DCI. In connection with the DCI Restructuring, Discovery applied “pushdown” accounting and each shareholder’s basis in DCI as of May 14, 2007 has been pushed down to Discovery resulting in $4.3 billion of goodwill being recorded by Discovery. Since goodwill is not amortizable, there is no current income statement impact for this change in basis.
During 2007, Discovery undertook broad restructuring activities to better position its portfolio of assets and to facilitate growth and enhanced profitability. These activities resulted in additional operating expenses that impact the comparability of results from 2006 to 2007. The more significant items include fourth quarter 2007 content impairment charges of $129,091,000 at U.S. networks and $9,976,000 at Education, which are included in cost of revenue, $20,424,000 in 2007 restructuring charges, and an asset impairment charge in the second quarter of 2007 of $26,174,000 related to write-offs of education intangible assets.


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The combining of predecessor and successor accounting periods is not permitted by GAAP. However, to provide a more meaningful basis for comparing 2007 to 2006 and 2005, Discovery’s operating results for the seven and one-half months ended December 31, 2007 have been combined with the four and one-half months ended May 14, 2007 in the following tables and discussion.
             
  Years Ended December 31, 
  2007  2006  2005 
  amounts in thousands 
 
Revenue
            
Advertising $1,345,033   1,243,500   1,187,823 
Distribution  1,477,479   1,434,901   1,198,686 
Other  304,821   205,270   157,849 
             
Total revenue  3,127,333   2,883,671   2,544,358 
             
Expenses
            
Cost of revenue  (1,172,907)  (1,032,789)  (907,664)
SG&A expenses  (1,148,246)  (1,104,116)  (928,950)
             
Operating cash flow  806,180   746,766   707,744 
             
Expenses arising from long-term incentive plans  (141,377)  (39,233)  (49,465)
Restructuring charges and asset impairments  (46,598)  —   — 
Depreciation and amortization  (130,576)  (122,037)  (112,653)
Gain from disposition of business  134,671   —   — 
             
Operating income  622,300   585,496   545,626 
             
Other Income (Expense)
            
Interest expense, net  (248,757)  (194,255)  (184,585)
Unrealized gains (losses) from derivative instruments, net  (8,636)  22,558   22,499 
Minority interests in consolidated subsidiaries  (8,266)  (2,451)  (43,696)
Other  7,839   8,527   13,771 
             
Income from continuing operations before income taxes  364,480   419,875   353,615 
Income tax expense  (77,466)  (190,381)  (173,427)
             
Income from continuing operations  287,014   229,494   180,188 
Loss from discontinued operations, net of taxes  (65,023)  (22,318)  (20,568)
             
Net income $221,991   207,176   159,620 
             
Revenue.  Discovery’s consolidated revenue increased 8% for the year ended December 31, 2007, as compared to 2006, due to increases of 8% in advertising revenue, 48% in other revenue and 3% in distribution revenue. Increases in advertising revenue were primarily due to increased ratings and advertising rates at the U.S. networks, particularly at Discovery Channel and TLC, combined with increased growth in local ad sales in Europe and the impact of favorable exchange rates, partially offset by the disposition of Travel Channel. Program ratings are an indication of consumer acceptance and directly affect Discovery’s ability to generate revenue during the airing of its programs. If programs do not achieve sufficient acceptance, the revenue from advertising sales may decline. International networks advertising sales increased due to the continued growth in audience, driven by growth in subscription units. Increased distribution revenue is primarily due to international networks subscriber growth and favorable exchange rates, partially offset by the disposition of Travel Channel and an increase in contra revenue items. Launch incentives increased in 2007 due to the renewal of long-term distribution agreements for certain U.K. networks which resulted in a payment of $195.8 million, most of which is being amortized over a five-year period. Other revenue increased due to (i) the full year impact of the 2006 acquisition of Antenna Audio and (ii) Discovery’s new Travel Channel representation arrangement.


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In 2006, consolidated revenue increased 13%, as compared to 2005, due to a 20% increase in distribution revenue, a 5% increase in advertising revenue and a 30% increase in other revenue. Increased distribution revenue is primarily due to contractual rate increases, subscriber growth at both U.S. networks and international networks and a reduction in launch support amortization as certain U.S. networks affiliation agreements were extended at no additional cost to Discovery. Distribution revenue also benefited from contractual arrangements in the U.S. networks whereby certain subscribers that were previously covered under free carriage periods with distributors were converted to paying subscribers. Increases in advertising revenue were primarily due to increased advertising rates at the U.S. networks combined with positive developments in international networks advertising sales resulting from continued growth in subscription units. Other revenue increased due to acquisitions in 2006.
Cost of revenue.  Cost of revenue, which includes content amortization and other production related expenses in addition to distribution and merchandising costs, increased 14% in 2007, as compared to 2006. Such increase is primarily a result of higher programming costs, including a fourth quarter 2007 impairment charge of $129,091,000 at U.S. networks where new channel leadership has implemented strategic plans to maximize viewership and ratings across most networks. In the fourth quarter of 2007 and in connection with these initiatives, Discovery evaluated its programming portfolio assets and determined that the carrying values of certain programming assets exceeded their estimated fair values which resulted in such impairment charge. Contributing to the increase in cost of revenue is also the impact of several new networks launched in Europe in 2006 and 2007, and the unfavorable impact of foreign currency exchange rates. Partially offsetting these increases is a decrease due to the disposition of Travel Channel. As a result of the foregoing fluctuations, cost of revenue as a percent of revenue increased to 38% in 2007 from 36% in 2006.
During 2006, cost of revenue increased 14%, as compared to 2005, which is consistent with the 2006 percentage increase in revenue. Such increase in cost of revenue is primarily a result of higher programming costs for Discovery’s U.S. networks due to continued investment in original productions and high profile specials, combined with increases in Europe associated with the launch of several networks including DMAX. Additionally, cost of revenue in 2005 was reduced by a net aggregate benefit of approximately $11 million related to reductions in estimates for music rights accruals.
SG&A expenses.  SG&A expenses, which include personnel, marketing and other general and administrative expenses, increased 4% in 2007, as compared to 2006. Such increase is due to higher personnel costs which resulted from merit, benefit and performance-based compensation increases in U.S. networks and international networks driven by expanding business activity through acquisition, increased international advertising sales coverage, expansion of network teams to support the new brand strategies and digital media. Also contributing to the increase is the impact of unfavorable foreign currency exchange rates. These increases were partially offset by lower marketing expenses at U.S. networks and lower marketing and personnel expenses in the education division as a result of cost cutting measures implemented in 2007. As a percent of revenue, SG&A expense was 37% in 2007, down from 38% in 2006. Although no assurance can be given, Discovery believes that as a result of its ongoing cost containment initiatives, SG&A expense as a percent of revenue will continue to decrease in 2008.
During 2006, SG&A expenses increased 19%, as compared to 2005, due primarily to international infrastructure expansions which increased headcount and office locations to support growth in local advertising sales operations driving increased revenue. Additionally, personnel and marketing costs increased at Discovery’s education division, particularly due to its investment in its Cosmeo homework help service. As a result, SG&A as a percent of revenue increased from 37% in 2005 to 38% in 2006.
Expenses arising from long-term incentive plans.  Expenses arising from long-term incentive plans are related to Discovery’s unit-based, long-term incentive plan, or LTIP, for its employees who meet certain eligibility criteria. Such plan was established in 2005 (the “2005 LTIP Plan”) and replaced the former LTIP Plan under which unit values were tied to Discovery’s equity value. Units are awarded to eligible employees and generally vest at a rate of 25% per year. The value of units in the 2005 LTIP Plan is indexed to the value of DHC Series A common stock and is calculated using the Black Scholes Model. The change in unit value of LTIP awards outstanding is recorded as compensation expense over the period outstanding. Upon redemption of the LTIP awards, participants receive a cash payment based on the value of the award as described in the terms of the 2005 LTIP Plan. In the third quarter of 2007, Discovery amended the 2005 LTIP such that the redemption dates occur annually over a 4 year


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period instead of bi-annually over an 8 year period. Compensation expense aggregated $141,377,000, $39,233,000, and $49,465,000 for the years ended December 31, 2007, 2006, and 2005, respectively. The increase in 2007 is primarily the result of increases in the DHC Series A common stock price offset by a decrease in expense related to the shortened redemption time period under the amended 2005 LTIP Plan. The decrease in 2006 is primarily the result of the change in unit value determination for the 2005 LTIP Plan units. If the remaining vested LTIP awards at December 31, 2007 were redeemed, the aggregate cash payments by Discovery would be approximately $94,190,000.
Restructuring charges.  During 2007, Discovery recorded restructuring charges of $20,424,000 related to a number of organizational and strategic adjustments which consisted mainly of severance due to a reduction in headcount. The purpose of these adjustments was to better align Discovery’s organizational structure with the company’s new strategic priorities and to respond to continuing changes within the media industry. There was no similar restructuring charge in 2006.
Asset impairment.  During the second quarter of 2007, Discovery recorded a $26,174,000 asset impairment charge which represents write-offs of education intangible assets related to its consumer business due to Discovery’s decision to decrease its investment in certain product offerings.
Depreciation and amortization.  The increase in depreciation and amortization in both 2007 and 2006 is due to an increase in intangible assets resulting from acquisitions combined with increases in Discovery’s depreciable asset base resulting from capital expenditures.
Gain from disposition of business.  Discovery recognized a gain from disposition of business of $134,671,000 during 2007 in connection with the Cox Transaction and the sale of the Travel Channel.
Other Income and Expense
Interest Expense.  The increase in interest expense during the years ended December 31, 2006 and 2005 is primarily due to higher levels of outstanding debt in both years combined with increases in interest rates during those periods.


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Interest expense.  On May 14, 2007, Discovery entered into a new $1.5 billion term loan in connection with the Cox Transaction. The increase in interest expense for the twelve months ended December 31, 2007 is primarily a result of the new term loan. The increase in interest expense during the year ended December 31, 2006 is primarily due to higher levels of outstanding debt combined with increases in interest rates during the period.
Unrealized gains from derivative instruments, net.  Unrealized gains from derivative transactions relate, primarily, to Discovery’s use of derivative instruments to modify its exposure to interest rate fluctuations on its debt. These instruments include a combination of swaps, caps, collars and other structured instruments. As a result of unrealized mark to market adjustments, Discovery recognized an unrealized loss of $8,617,000 during the year ended December 31, 2007 and unrealized gains of $10,352,000 and $29,109,000 during the years ended December 31, 2006 and 2005, respectively. The foreign exchange hedging instruments used by Discovery are spot, forward and option contracts. Additionally, Discovery enters into non-designated forward contracts to hedge non-dollar denominated cash flows and foreign currency balances.
Minority interests in consolidated subsidiaries.  Minority interests primarily represent increases and decreases in the estimated redemption value of mandatorily redeemable interests in subsidiaries which are initially recorded at fair value, as well as the portion of earnings of consolidated entities which are allocable to the minority partners.
Other.  Other income in 2007, 2006 and 2005 relates primarily to Discovery’s equity share of earnings of its joint ventures.
Income taxes.  Discovery’s effective tax rate was 21%, 45% and 49% for 2007, 2006 and 2005, respectively. Discovery’s effective tax rate differed from the federal income tax rate of 35% primarily due to the tax-free treatment of the disposition of the Travel Channel and the corresponding reversal of deferred tax liabilities in 2007 and due to foreign and state taxes in 2006 and 2005.


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Loss from discontinued operations.  Summarized financial information for the retail stores business included in discontinued operations is as follows:
             
  Years Ended December 31, 
  2007  2006  2005 
  amounts in thousands 
 
Revenue $57,853   129,317   127,396 
Operating cash flow $(27,904)  (24,343)  (21,106)
Loss from discontinued operations before income taxes $(99,427)  (35,911)  (31,652)
Loss from discontinued operations, net of tax $(65,023)  (22,318)  (20,568)
The 2007 loss from discontinued operations includes $39,904,000 in restructuring costs and $28,264,000 in asset impairment charges, along with normal business operations.
Net earnings.  Discovery’s net earnings were $221,991,000, $207,176,000, and $159,620,000, for 2007, 2006 and 2005, respectively. The changes in net earnings are due to the aforementioned fluctuations in revenue and expense.
Operating Division Results
As noted above, Discovery’s operations are divided into three groups: U.S. networks, international networks and commerce and education. Corporate expenses primarily consist of corporate functions, executive management and administrative support services. Corporate expenses are excluded from segment results to enable executive management to evaluate business segment performance based upon decisions made directly by business segment executives. Certain prior period amounts have been reclassified between segments to conform to Discovery’s 2007 operating structure.
Discovery Consolidated
             
  Years Ended December 31, 
  2007  2006  2005 
  amounts in thousands 
 
Revenue
            
U.S. networks $1,972,321   1,893,808   1,743,358 
International networks  1,033,449   911,445   738,094 
Commerce and education  149,805   107,285   88,576 
Corporate and eliminations  (28,242)  (28,867)  (25,670)
             
Total revenue $3,127,333   2,883,671   2,544,358 
             
Operating Cash Flow
            
U.S. networks $774,268   828,443   745,980 
International networks  210,090   153,127   128,837 
Commerce and education  1,676   (72,599)  (25,285)
Corporate and eliminations  (179,854)  (162,205)  (141,788)
             
Total operating cash flow $806,180   746,766   707,744 
             
Operating cash flow margin  25.8%  25.9%  27.8%
             


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Unrealized Gains from Derivative Instruments, net.  Unrealized gains from derivative transactions relate, primarily, to Discovery’s use of derivative instruments to modify its exposure to interest rate fluctuations on its debt. These instruments include a combination of swaps, caps, collars and other structured instruments. As a result of unrealized mark to market adjustments, Discovery recognized $10,352,000, $29,109,000 and $44,060,000 in unrealized gains on these instruments during the years ended December 31, 2006, 2005 and 2004, respectively. The foreign exchange hedging instruments used by Discovery are spot, forward and option contracts. Additionally, Discovery enters into non-designated forward contracts to hedge non-dollar denominated cash flows and foreign currency balances.U.S. Networks
             
  Years Ended December 31, 
  2007  2006  2005 
  amounts in thousands 
 
Revenue
            
Advertising $1,014,541   965,648   944,770 
Distribution  862,542   865,613   736,713 
Other  95,238   62,547   61,875 
             
Total revenue  1,972,321   1,893,808   1,743,358 
Cost of revenue  (737,892)  (635,874)  (587,370)
SG&A expenses  (460,161)  (429,491)  (410,008)
             
Operating cash flow $774,268   828,443   745,980 
             
Operating cash flow margin  39.3%  43.7%  42.8%
             
As noted above, in May 2007, Discovery exchanged its subsidiary holding the Travel Channel, travelchannel.com and approximately $1.3 billion in cash for Cox’s interest in Discovery. Accordingly, Discovery’s 2007 results of operations do not include Travel Channel for the full year. The disposal of Travel Channel does not meet the requirements for discontinued operations presentation. The following table presents U.S. networks results of operations excluding Travel Channel for all periods. This presentation is not in accordance with GAAP. However, Discovery believes this presentation provides a more meaningful comparison of the U.S. networks results of operations and allows the reader to better understand the U.S. networks ongoing operations.
 
Minority Interests in Consolidated Subsidiaries.  Minority interest represents increases and decreases in the estimated redemption value of mandatorily redeemable interests in subsidiaries which are initially recorded at fair value.
Other.U.S. Networks without Travel Channel  Other income in 2006 relates primarily to Discovery’s equity share of earnings on their joint ventures. Other income in 2005 relates primarily to the gain on sale of one of Discovery’s investments.
Income Taxes.  Discovery’s effective tax rate was 46%, 50% and 46% for 2006, 2005 and 2004, respectively. Discovery’s effective tax rate differed from the federal income tax rate of 35% primarily due to foreign and state taxes.
Liquidity & Capital Resources
Discovery generated $479,911,000, $68,893,000 and $124,704,000 of cash from operations during the years ended December 31, 2006, 2005 and 2004, respectively. Discovery’s payments under its long-term incentive plans were $841,000, $325,756,000 and $240,752,000 for each of the same periods, respectively, driving a significant use of cash in 2005 and 2004. For a further discussion of Discovery’s LTIP, please see Note 14 to the Discovery consolidated financial statements.
One of Discovery’s primary investing activities in 2006, 2005 and 2004 was payments of $180,000,000, $92,874,000 and $148,880,000, respectively, to acquire mandatorily redeemable securities related to minority interests in certain consolidated subsidiaries. In 2006, $100,000,000 and $80,000,000 was paid for the New York Times and the British Broadcasting Corporation mandatorily redeemable securities, respectively. Discovery also spent $90,138,000, $99,684,000 and $88,100,000 on capital expenditures during the years ended December 31, 2006, 2005 and 2004, respectively. During the same periods, Discovery paid $194,905,000, $400,000 and $17,218,000 for business acquisitions, net of cash acquired.
In addition to cash provided by operations, Discovery funds its activities with proceeds borrowed under various debt facilities, including a term loan, two revolving loan facilities and various senior notes payable. During the year ended December 31, 2006, net incremental borrowings under debt facilities aggregated approximately $16,813,000. Total commitments of these facilities were $4,059,000,000 at December 31, 2006. Debt outstanding on these facilities aggregated $2,607,000,000 at December 31, 2006, providing excess debt availability of $1,452,000,000. Discovery’s ability to borrow the unused capacity is dependent on its continuing compliance with its covenants at the time of, and after giving effect to, a requested borrowing.
All term and revolving loans and senior notes are unsecured. The debt facilities contain covenants that require Discovery to meet certain financial ratios and place restrictions on the payment of dividends, sale of assets, additional borrowings, mergers, and purchases of capital stock, assets and investments. Discovery has indicated it is in compliance with all debt covenants at December 31, 2006.
In 2007, Discovery expects to spend approximately $100,000,000 for capital expenditures and $180,000,000 for interest expense. Payments to satisfy LTIP obligations are not expected to be significant in 2007. Discovery believes that its cash flow from operations and borrowings available under its credit facilities will be sufficient to fund its working capital requirements.
Contractual Obligations.  Discovery has agreements covering leases of satellite transponders, facilities and equipment. These agreements expire at various dates through 2020. Discovery is obligated to license programming under agreements with content suppliers that expire over various dates. Discovery also has other contractual commitments arising in the ordinary course of business.


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  Years Ended December 31, 
  2007  2006  2005 
  amounts in thousands 
 
Revenue
            
Advertising $974,552   863,690   852,075 
Distribution  840,262   813,342   693,339 
Other  94,010   58,876   58,197 
             
Total revenue  1,908,824   1,735,908   1,603,611 
Cost of revenue  (710,052)  (560,241)  (523,426)
SG&A expenses  (439,501)  (383,064)  (372,322)
             
Operating cash flow $759,271   792,603   707,863 
             
Operating cash flow margin  39.8%  45.7%  44.1%
             
The following discussion excludes the results of Travel Channel for all periods.
Revenue.  In 2007, advertising revenue increased 13%, distribution revenue increased 3%, and other revenue increased 60%, as compared to 2006. The increase in advertising revenue at the U.S. networks was primarily due to improved advertising sell-out rates, better unit pricing and higher audience delivery on most channels, notably the Discovery Channel and TLC. The advertising market was strong and scatter pricing was well above upfront pricing. Primetime sell-outs on the major networks increased by an average of seven percentage points. Primetime ratings increased on Discovery Channel due to original content such asPlanet Earth,Deadliest Catch, Man vs. Wild, Dirty JobsandMythbusters. TLC Primetime ratings increased due to original content such asLittle People Big World, What Not to WearandL.A. Ink.Advertising revenue growth on certain networks carried on the digital tier was 36% led by The Science Channel and Discovery Times. Distribution revenue was driven by a 6% increase in average paying subscription units, principally from networks carried on the digital tier, partially offset by an increase in contra-revenue items. Contra-revenue items included in distribution revenue, such as launch amortization and


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marketing consideration, increased from $86,399,000 in 2006 to $95,213,000 in 2007. Other revenue primarily increased as a result of increased revenue from Discovery’s representation of the Travel Channel.
In 2006, distribution revenue increased 17% and advertising revenue increased 1%, as compared to 2005. Distribution revenue was driven by a 13% increase in average paying subscription units, principally from networks carried on the digital tier, combined with contractual rate increases, partially offset by an increase in contra-revenue items from $75,705,000 in 2005 to $86,399,000 in 2006. Advertising was flat although ratings were higher compared to 2005. During the fourth quarter of 2006, the advertising sales market began to reflect the ratings turnaround, and advertising revenue in the fourth quarter increased 14%, as compared to the fourth quarter of 2005.
Cost of revenue.  In 2007, cost of revenue increased 27%, as compared to 2006, primarily due to a $122,099,000 increase in content amortization expense, including an impairment charge of $129,091,000. In 2007, following several changes in channel leadership, Discovery undertook strategic reviews to maximize viewership and ratings across most networks. As a result, programming at the Discovery Channel, TLC and Animal Planet is being re-positioned to better align content with these channel brands. In addition, certain other networks are being re-branded, including the transition of the Discovery Times channel to Investigation Discovery, the Discovery Home channel to Planet Green, and the recently announced creation of OWN: The Oprah Winfrey Network, a joint venture between Discovery and Harpo Productions, Inc. on what is currently the Discovery Health channel. In the fourth quarter of 2007 and in connection with these initiatives, Discovery evaluated its programming portfolio assets and determined that the carrying values of certain programming assets exceeded their estimated fair values which resulted in the aforementioned impairment charge. The program impairment was primarily related to content that was capitalized in 2006 and 2007 and would have been amortized over the next 3 years. Excluding the 2007 impairment charge and accelerated amortization of certain programs in 2007 and 2006, content amortization increased due to continued investment in original programs that are aligned with the future strategy and from 2006 acquisitions.
Cost of revenue increased 7% in 2006, as compared to 2005, primarily as a result of a $51,222,000 increase in content amortization expense due to continued investment in original productions on the widely distributed channels and accelerated amortization on certain programs. These increases were partially offset by a decrease of $9,064,000 in transponder and uplink costs due to cost savings associated with Discovery’s launch of its broadcast facility in 2005.
SG&A expenses.  SG&A expenses increased 15% in 2007, as compared to 2006. The increase is due to personnel cost increases of $35,410,000 driven by merit, benefit and performance-based compensation increases, along with the impact of the expansion of its network teams to support the new brand strategies and continued investment in digital media. Also contributing to the increase were higher research expenses of $11,157,000 resulting from contractual increases for ratings research and additional fees associated with providing commercial minute ratings. These increases were partially offset by a decrease in marketing expense of $7,636,000 which coincided with a re-evaluation of the related programming strategies.
The 2006 3% increase in SG&A expenses is primarily due to a 12% or $13,581,000 increase in personnel expense resulting from compensation and benefit increases.
Digital Media Business.  Revenue for the U.S. networks digital media businesses totaled approximately $31 million in 2007 and $19 million in 2006. Operating expenses for these businesses were $43 million and $28 million for 2007 and 2006, respectively. Discovery expects these amounts to increase in the future due to its recent acquisitions of PetFinder.com, TreeHugger.com and HowStuffWorks.com, as well as any future organic investments in this arena, with operating cash flow losses remaining below 5% of Discovery’s consolidated operating cash flow.


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International Networks
             
  Years Ended December 31, 
  2007  2006  2005 
  amounts in thousands 
 
Revenue
            
Advertising $330,300   277,559   242,849 
Distribution  614,937   569,288   462,049 
Other  88,212   64,598   33,196 
             
Total revenue  1,033,449   911,445   738,094 
Cost of revenue  (408,957)  (390,783)  (315,539)
SG&A expenses  (414,402)  (367,535)  (293,718)
             
Operating cash flow $210,090   153,127   128,837 
             
Operating cash flow margin  20.3%  16.8%  17.5%
             
Revenue.  In 2007, advertising revenue increased 19%, as compared to 2006, due primarily to higher viewership in Europe and Latin America combined with an increased subscriber base in most markets worldwide, favorable exchange rate impacts and a full year of activity related to DMAX. These increases were partially offset by a decline in advertising revenue in the U.K. which was driven by lower ratings for Discovery Channel resulting from increased competition and a continuing shift in viewing habits due to channel placement on the Electronic Programming Guide which lists scheduled programs on each channel. Distribution revenue increased 8% in 2007 principally comprised of combined revenue growth in Europe, Latin America and Asia of $71,927,000 and favorable foreign exchange impact of $29,402,000, primarily in the U.K. and Europe, partially offset by a $55,684,000 revenue decline in the U.K. The net increase in revenue resulted from an overall increase in average paying subscription units of 13% primarily due to pay TV subscriber growth in many markets in Europe and Latin America combined with contractual rate increases in certain markets, partially offset by an increase in launch amortization. In January 2007 and 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 U.K. networks and paid a distributor $195.8 million. Most of the payment was attributed to the renewal period and is being amortized over a five year term. As a result, launch amortization at the international networks increased from $6,474,000 in 2006 to $44,291,000 in 2007. Other revenue increased $23,614,000 primarily due to the full year impact of Antenna Audio, which was acquired in March 2006.
In 2006, distribution revenue increased 23%, as compared to 2005, primarily due to combined revenue growth in Europe and Latin America of $79,235,000 resulting from a 27% increase in average paying subscription units, primarily on networks with lower rates, in those markets. Subscriber growth in those markets was driven by increased penetration and distribution along with the full year impact of new channel launches in Italy, France and Germany. Favorable foreign exchange impacts of $6,533,000, primarily in Europe and Latin America, also contributed to the increase in distribution revenue. Advertising revenue increased 14% in 2006 primarily due to higher viewership in Europe and Latin America combined with an increased subscriber base in most markets worldwide. Other revenue increased 95% due primarily to the inclusion of $32,371,000 in revenue from the acquisition of Antenna Audio in April 2006.
Cost of revenue.  In 2007, cost of revenue increased 5%, as compared to 2006, primarily due to the full year impact of $15,613,000 from DMAX and Antenna Audio, which were acquired in 2006.
In 2006, cost of revenue increased 24%, as compared to 2005, primarily from a $27,434,000 increase in content amortization expense. The amortization expense increase is associated with additional programming to support the launch of several lifestyle-focused networks including $10,142,000 related to DMAX and Antenna Audio. Other increases in cost of revenue related to DMAX and Antenna Audio aggregated $23,394,000.
SG&A expenses.  SG&A expenses increased 13% during 2007, as compared to 2006. The increase is primarily due to a $43,507,000 increase in personnel expense, of which $19,428,000 resulted from a full year of activity related to the DMAX and Antenna Audio acquisitions in 2006. Personnel costs in Europe increased


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$18,610,000 due to infrastructure expansions of sales personnel allowing for increased targeting of advertising consistent with geographic demand to support revenue growth.
In 2006, SG&A expenses increased 25%, as compared to 2005, primarily due to a $46,568,000 or 44% increase in personnel expense, resulting from infrastructure expansions in Europe to support revenue growth combined with the acquisition of Antenna Audio. Marketing expense increased $6,087,000 or 7% due to marketing campaigns in Europe and Asia for the launch of new channels. General and administrative expenses increased $21,161,000 or 20% primarily due to the inclusion of Antenna Audio coupled with the unfavorable effect of foreign currency exchange rates.
During the years ended December 31, 2007 and 2006, the international networks revenue and operating cash flow were impacted favorably by changes in the exchange rates of various foreign currencies. In the event the U.S. dollar strengthens against certain foreign currencies in the future, the international networks group’s revenue and operating cash flow will be negatively impacted. Had there been no impact from changes in exchange rates, international networks would have increased revenue and operating expenses 8% and 4%, respectively, during the year ended December 31, 2007, as compared to 2006, and 22% and 23%, respectively, during the year ended December 31, 2006, as compared to 2005.
Commerce and Education
             
  Years Ended December 31, 
  2007  2006  2005 
  amounts in thousands 
 
Revenue $149,805   107,285   88,576 
Cost of revenue  (90,976)  (79,460)  (59,567)
SG&A expenses  (57,153)  (100,424)  (54,294)
             
Operating Cash Flow $1,676   (72,599)  (25,285)
             
Operating cash flow margin  1.1%  (67.7)%  (28.5)%
             
Revenue.  In 2007, commerce and education revenue increased 40%, as compared to 2006, due to a $17,595,000 increase in education revenue as a result of an increase in subscribers and improved pricing for Discovery’s direct-to-school education distribution platform, and a $24,925,000 increase in commerce revenue which was driven by an increase in sales of Planet Earth DVDs following the series premiere in March 2007.
In 2006, Commerce and education revenue increased 21%, as compared to 2005, due to a $10,578,000 increase in revenue related to the education business as a result of a 30% increase in average paying school subscribers and the impact of acquisitions in 2006. Also contributing to the increase was an $8,131,000 increase in revenue related to the commerce business mainly driven by increased ecommerce sales.
Cost of revenue.  During the fourth quarter of 2006, Discovery made a number of organizational and strategic adjustments to its education business to focus resources on the company’s direct-to-school distribution platform,unitedstreaming,as well as the division’s other premium direct-to-school subscription services. In 2007, cost of revenue increased 14%, or $11,516,000, as compared to 2006, primarily due to increased content amortization related to an impairment charge of $9,976,000 as a result of the re-focus of the education business.
In 2006, cost of revenue increased 33%, or $19,893,000, as compared to 2005, primarily as a result of a $14,127,000 investment in education content to accommodate the growth of the education business.
SG&A expenses.  In 2007, SG&A expenses decreased 43%, as compared to 2006, primarily due to a $10,671,000 reduction in personnel expense as a result of business restructuring in commerce and education, combined with a $26,649,000 reduction in marketing expense as Discovery re-focused the direction of the education business. Included in SG&A are approximately $5 million in costs incurred during the fourth quarter of 2007 to transition the back-office and distribution services of the remaining commerce business to Discovery’s headquartersand/or third-party service providers.


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In 2006, SG&A expenses increased 85%, as compared to 2005. Expenses in the education division increased as a result of (i) a 91%, or $18,056,000, increase in personnel expense, resulting primarily from a full year of salary expense for employees hired in 2005 and (ii) a 174%, or $19,142,000, increase in marketing expense resulting primarily from Discovery’s investment in Cosmeo, a new consumer homework help service.
Corporate
Corporate operating cash flow losses increased 11%, or $17,650,000, in 2007, as compared to 2006, primarily due to costs incurred as a result of supporting Discovery’s shareholder transactions combined with increases in performance-based compensation resulting from strong fiscal year financial performance and the impact of changes in executive management including related hiring costs. The 2006 increase of 14% or $20,418,000 was driven primarily by merit, benefit and performance-based compensation increases.
Liquidity and Capital Resources
Discovery’s principal sources of liquidity are cash flows from operations and borrowings under its credit facility, and its principal uses of cash are for capital expenditures, acquisitions, debt service requirements, and other obligations. Discovery anticipates that its operating cash flows, existing cash, cash equivalents and borrowing capacity under its revolving credit facility are sufficient to meet its anticipated cash requirements for at least the next 12 months.
During the year ended December 31, 2007, Discovery’s primary uses of cash were the redemption of Cox’s equity interests ($1,284,544,000), acquisitions ($306,094,000, net of cash acquired) and capital expenditures ($80,553,000). Discovery funded these investing and financing activities with cash from operations of $242,072,000 and bank borrowings of $1,497,639,000.
Discovery’s various debt facilities include two term loans, two revolving loan facilities and various senior notes payable. The second term loan was entered into on May 14, 2007 for $1.5 billion in connection with the Cox Transaction. Total commitments of these facilities were $5,596,398,000 at December 31, 2007. Debt outstanding on these facilities aggregated $4,094,174,000 at December 31, 2007, providing excess debt availability of $1,502,224,000. Discovery’s ability to borrow the unused capacity is dependent on its continuing compliance with its covenants at the time of, and after giving effect to, a requested borrowing.
Discovery’s $1.5 billion term loan is secured by the assets of Discovery, excluding assets held by its subsidiaries. The remaining term loan, revolving loans and senior notes are unsecured. The debt facilities contain covenants that require the respective borrowers to meet certain financial ratios and place restrictions on the payment of dividends, sale of assets, additional borrowings, mergers, and purchases of capital stock, assets and investments. Discovery has indicated that it was in compliance with all debt covenants as of December 31, 2007.
Discovery’s outstanding notes payable and long-term debt at December 31, 2007 consists of the following (amounts in thousands):
     
Term Loan B, due quarterly September 2007 to May 2014 $1,492,500 
Term Loan, due quarterly December 2008 to October 2010  1,000,000 
8.06% Senior Notes, semi annual interest, due March 2008  180,000 
£10,000 Uncommitted Facility, due August 2008  8,785 
€260,000.0 Revolving Loan, due April 2009  94,174 
7.45% Senior Notes, semi annual interest, due September 2009  55,000 
Revolving Loan, due October 2010  337,500 
8.37% Senior Notes, semi annual interest, due March 2011  220,000 
8.13% Senior Notes, semi annual interest, due September 2012  235,000 
Senior Notes, semi annual interest, due December 2012  90,000 
6.01% Senior Notes, semi annual interest, due December 2015  390,000 
     
Total long-term debt $4,102,959 
     


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In 2008, Discovery expects its uses of cash to be approximately $266,285,000 for debt repayments, $90,000,000 for capital expenditures and $260,000,000 for interest expense. Discovery will also be required to make payments under its LTIP Plan. However, amounts expensed and payable under the LTIP are dependent on future annual calculations of unit values which are affected primarily by changes in DHC’s stock price, annual grants of additional units, redemptions of existing units, and changes to the plan. If the remaining vested LTIP awards at December 31, 2007 were redeemed, the aggregate cash payments by Discovery would be approximately $94,190,000. Discovery believes that its cash flow from operations and borrowings available under its credit facilities will be sufficient to fund its cash requirements, including LTIP obligations.
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. The variable to fixed interest rate instruments have a notional principal amount of $2.27 billion and have a weighted average interest rate of 4.68% against 3 month LIBOR at December 31, 2007. 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% against fixed rate private placement debt at December 31, 2007. At December 31, 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%.
Discovery’s access to capital markets can be affected by factors outside of its control. In addition, its cost to borrow is impacted by market conditions and its financial performance as measured by certain credit metrics defined it its credit agreements, including interest coverage and leverage ratios.
Contractual obligations.  Discovery has agreements covering leases of satellite transponders, facilities and equipment. These agreements expire at various dates through 2020. Discovery is obligated to license programming under agreements with content suppliers that expire over various dates. Discovery also has other contractual commitments arising in the ordinary course of business.
 
A summary of all of the expected payments for these commitments as well as future principal payments under the current debt arrangements and minimum payments under capital leases at December 31, 2007 is as follows:
                     
  Payments Due by Period(3) 
     Less than 1
        After
 
  Total  year  1-3 years  3-5 years  5 years 
 
Long-term debt $4,102,959   266,285   1,454,174   575,000   1,807,500 
Interest payments(1)  1,245,596   261,424   449,275   335,673   199,224 
Capital leases  44,107   9,042   15,828   9,202   10,035 
Operating leases  415,384   82,357   122,509   76,777   133,741 
Program license fees  558,183   325,509   110,362   80,843   41,469 
Launch incentives  12,572   4,492   8,080   —   — 
Other(2)  292,339   106,320   157,619   28,000   400 
                     
Total $6,671,140   1,055,429   2,317,847   1,105,495   2,192,369 
                     
(1)Amounts (i) are based on our outstanding debt at December 31, 20062007, (ii) assume the interest rates on our floating rate debt remain constant at the December 31, 2007 rates and (iii) assume that our existing debt is repaid at maturity.
(2)Represents Discovery’s obligations to purchase goods and services whereby the underlying agreements are enforceable, legally binding and specify all significant terms. The more significant purchase obligations include: agreements related to audience ratings, market research, contracts for entertainment talent and other education and service project agreements.
(3)Table does not include certain long-term obligations reflected in the Discovery consolidated balance sheet as follows:the timing of the payments cannot be predicted or the amounts will not be settled in cash. The most significant of these obligations is the $141.7 million accrued under Discovery’s LTIP plans. In addition, amounts accrued in the Discovery consolidated balance sheet related to derivative financial instruments are not included in the table as such amounts may not be settled in cash or the timing of the payments cannot be predicted.


II-24

Discovery is subject to a contractual agreement that may require Discovery to acquire the minority interest of certain of its subsidiaries. The amount and timing of such payments are not currently known. Discovery has recorded an estimated liability as of December 31, 2007 for this redemption right.
 
                     
  Payments due by period(2) 
     Less than
        After 5
 
  Total  1 year  1-3 years  4-5 years  years 
  amounts in thousands 
 
Long-term debt $2,607,300   —   860,300   1,032,000   715,000 
Capital leases  38,900   9,300   14,600   9,600   5,400 
Operating leases  505,228   87,049   141,494   100,615   176,070 
Program license fees  559,633   318,523   109,849   87,424   43,837 
Launch incentives  36,713   21,632   15,081   —   — 
Other(1)  229,451   86,965   116,102   25,264   1,120 
                     
Total $3,977,225   523,469   1,257,426   1,254,903   941,427 
                     
Item 7A.Quantitative and Qualitative Disclosures about Market Risk.
Foreign Currency Risk
We continually monitor our economic exposure to changes in foreign exchange rates and may enter into foreign exchange agreements where and when appropriate. Substantially all of our foreign transactions are denominated in foreign currencies, including the liabilities of our foreign subsidiaries. Although our foreign transactions are not generally subject to significant foreign exchange transaction gains or losses, the financial statements of our foreign subsidiaries are translated into United States dollars as part of our consolidated financial reporting. As a result, fluctuations in exchange rates affect our financial position and results of operations.
 
Item 8.Financial Statements and Supplementary Data.
Our consolidated financial statements are filed under this Item, beginning onPage II-28. The financial statement schedules required byRegulation S-X are filed under Item 15 of this Annual Report onForm 10-K.
Item 9.Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Item 9A.Controls and Procedures.
In accordance with Exchange ActRules 13a-15 and15d-15, the Company carried out an evaluation, under the supervision and with the participation of management, including its chief executive officer, principal accounting officer and principal financial officer (the “Executives”), of the effectiveness of its disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, the Executives concluded that the Company’s disclosure controls and procedures were effective as of December 31, 2007 to provide reasonable assurance that information required to be disclosed in its reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.
 
(1)Represents Discovery’s obligations to purchase goods and services whereby the underlying agreements are enforceable, legally binding and specify all significant terms. The more significant purchase obligations include: agreements related to audience ratings, market research, contracts for entertainment talent and other education and service project agreements.
(2)The table above does not include certain long-term obligations reflected in the Discovery consolidated balance sheet as the timing of the payments cannot be predicted or the amounts will not be settled in cash. The most significant of these obligations is the $84.5 million accrued under Discovery’s LTIP plans. In addition, amounts accrued in the Discovery consolidated balance sheet related to derivative financial instruments are not included in the table as such amounts may not be settled in cash or the timing of the payments cannot be predicted.
Seepage II-26 forManagement’s Report on Internal Control Over Financial Reporting.
Discovery is subject to certain contractual agreements that may require Discovery to acquire the ownership interests of minority partners. At the end of 2006, Discovery estimates its aggregate obligations thereunder at approximately $94.8 million. The put rights are exercisable at various dates. In January 2007, Discovery exercised its rights and paid $44.5 million to acquire certain redeemable equity.
 
Item 7A.Quantitative and Qualitative Disclosures about Market Risk.
Foreign Currency Risk
We continually monitor our economic exposure to changes in foreign exchange rates and may enter into foreign exchange agreements where and when appropriate. Substantially all of our foreign transactions are denominated in foreign currencies, including the liabilities of our foreign subsidiaries. Although our foreign transactions are not generally subject to significant foreign exchange transaction gains or losses, the financial statements of our foreign subsidiaries are translated into United States dollars as part of our consolidated financial reporting. As a result, fluctuations in exchange rates affect our financial position and results of operations.
Item 8.Financial Statements and Supplementary Data.
Our consolidated financial statements are filed under this Item, beginning onPage II-17. The financial statement schedules required byRegulation S-X are filed under Item 15 of this Annual Report onForm 10-K.
Item 9.Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Item 9A.Controls and Procedures.
In accordance with Exchange ActRules 13a-15 and15d-15, the Company carried out an evaluation, under the supervision and with the participation of management, including its chief executive officer, principal accounting officer and principal financial officer (the “Executives”), of the effectiveness of its disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, the Executives concluded that the Company’s disclosure controls and procedures were effective as of December 31, 2006 to provide reasonable assurance that information required to be disclosed in its reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.
Seepage II-15
Seepage II-27 forManagement’s Report on Internal Control Over Financial Reporting.


II-13

Seepage II-16 forReport of Independent Registered Public Accounting Firm for our accountant’s attestation regarding our internal controls over financial reporting.
 
There has been no change in the Company’s internal controls over financial reporting identified in connection with the evaluation described above that occurred during the three months ended December 31, 20062007 that has materially affected, or is reasonably likely to materially affect, its internal controls over financial reporting.
 
Item 9B9B..  Other InformationInformation..
 
None.


II-14II-25

 
MANAGEMENT’S REPORT ON INTERNAL
CONTROL OVER FINANCIAL REPORTING
 
Discovery Holding Company’s management is responsible for establishing and maintaining adequate internal control over the Company’s financial reporting. The Company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the consolidated financial statements and related disclosures in accordance with generally accepted accounting principles. The Company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions of the Company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of the consolidated financial statements and related disclosures in accordance with generally accepted accounting principles; (3) provide reasonable assurance that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (4) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the consolidated financial statements and related disclosures.
 
Because of inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies and procedures may deteriorate.
 
The Company assessed the design and effectiveness of internal control over financial reporting as of December 31, 2006.2007. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) inInternal Control-Integrated Framework.Framework.
 
Based upon our assessment using the criteria contained in COSO, management has concluded that, as of December 31, 2006,2007, Discovery Holding Company’s internal control over financial reporting is effectively designed and operating effectively.
 
Discovery Holding Company’s independent registered public accountants audited the consolidated financial statements and related disclosures in the Annual Report onForm 10-K and have issued an audit report on management’s assessment of the Company’s internal control over financial reporting. This report appears onpage II-16II-27 of this Annual Report onForm 10-K.


II-15II-26

 
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
The Board of Directors and Stockholders
Discovery Holding Company:
 
We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control over Financial Reporting appearing onpage II-15, that Discovery Holding Company maintained effectiveCompany’s internal control over financial reporting as of December 31, 2006,2007, based on the criteria established inInternal Control — Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Management of Discovery Holding CompanyCompany’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting.reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of theCompany’s internal control over financial reporting of Discovery Holding Company based on our audit.
 
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment,assessing the risk that a material weakness exists and testing and evaluating the design and operating effectiveness of internal control andbased on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
 
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements and related disclosure in accordance with generally accepted accounting principles; (3) provide reasonable assuranceprinciples, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (4)(3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
 
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
 
In our opinion, management’s assessment that Discovery Holding Company maintained effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material respects, based on criteria established inInternal Control — Integrated Frameworkissued by COSO. Also, in our opinion, Discovery Holding Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006,2007, based on the criteria established inInternal Control — Integrated Frameworkissued by COSO.the Committee of Sponsoring Organizations of the Treadway Commission.
 
We have also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Discovery Holding Company and subsidiaries as of December 31, 20062007 and 2005,2006, and the related consolidated statements of operations and comprehensive earnings (loss), cash flows and stockholders’ equity for each of the years in the three-year period ended December 31, 2006,2007, and our report, which as it relates to the financial statements of Discovery Communications Holding, LLC (a 662/3 percent and 50 percent owned investee company as of December 31, 2007 and 2006, respectively) is based solely on the report of other auditors, dated February 28, 200714, 2008 expressed an unqualified opinion on those consolidated financial statements.
 
KPMG LLP
Denver, Colorado
February 28, 2007


II-16

Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Discovery Holding Company:
We have audited the accompanying consolidated balance sheets of Discovery Holding Company and subsidiaries as of December 31, 2006 and 2005, and the related consolidated statements of operations and comprehensive earnings (loss), cash flows and stockholders’ equity for each of the years in the three-year period ended December 31, 2006. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We did not audit the financial statements of Discovery Communications, Inc., (a 50 percent owned investee company). The Company’s investment in Discovery Communications, Inc. at December 31, 2006 and 2005, was $3,129,157,000 and $3,018,622,000, respectively, and its equity in earnings of Discovery Communications, Inc. was $103,588,000, $79,810,000 and $84,011,000 for the years ended December 31, 2006, 2005 and 2004, respectively. The financial statements of Discovery Communications, Inc. were audited by other auditors whose report has been furnished to us, and our opinion, insofar as it relates to the amounts included for Discovery Communications, Inc., is based solely on the report of the other auditors.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits and the report of the other auditors provide a reasonable basis for our opinion.
In our opinion, based on our audits and the report of the other auditors, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Discovery Holding Company and subsidiaries as of December 31, 2006 and 2005, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2006, in conformity with U.S. generally accepted accounting principles.
As discussed in note 3 to the accompanying consolidated financial statements, effective January 1, 2006, Discovery Holding Company adopted SFAS No. 123R,Share Based Payment.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Discovery Holding Company’s internal control over financial reporting as of December 31, 2006, based on the criteria established inInternal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 28, 2007 expressed an unqualified opinion on management’s assessment of, and the effective operation of, internal control over financial reporting.
KPMG LLP
Denver, Colorado
February 28, 200714, 2008


II-17II-27

Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Discovery Holding Company:
We have audited the accompanying consolidated balance sheets of Discovery Holding Company and subsidiaries as of December 31, 2007 and 2006, and the related consolidated statements of operations and comprehensive earnings (loss), cash flows and stockholders’ equity for each of the years in the three-year period ended December 31, 2007. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We did not audit the financial statements of Discovery Communications Holding, LLC, (a 662/3 percent and 50 percent owned investee company as of December 31, 2007 and 2006, respectively). The Company’s investment in Discovery Communications Holding, LLC at December 31, 2007 and 2006, was $3,271,553,000 and $3,129,157,000, respectively, and its equity in earnings of Discovery Communications Holding, LLC was $141,781,000, $103,588,000 and $79,810,000 for the years ended December 31, 2007, 2006 and 2005, respectively. The financial statements of Discovery Communications Holding, LLC and its predecessor were audited by other auditors whose report has been furnished to us, and our opinion, insofar as it relates to the amounts included for Discovery Communications Holding, LLC, is based solely on the report of the other auditors.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits and the report of the other auditors provide a reasonable basis for our opinion.
In our opinion, based on our audits and the report of the other auditors, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Discovery Holding Company and subsidiaries as of December 31, 2007 and 2006, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2007, in conformity with U.S. generally accepted accounting principles.
Effective January 1, 2006, Discovery Holding Company adopted SFAS No. 123R,Share-Based Payment.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Discovery Holding Company’s internal control over financial reporting as of December 31, 2007, based on the criteria established inInternal Control — Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 14, 2008 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
KPMG LLP
Denver, Colorado
February 14, 2008


II-28

DISCOVERY HOLDING COMPANY AND SUBSIDIARIES



Consolidated Balance Sheets
December 31, 2007 and 2006
 
        
 December 31,         
 2006 2005  2007 2006 
 amounts in thousands  amounts in thousands 
ASSETS
ASSETS
ASSETS
Current assets:                
Cash and cash equivalents $154,775   250,352  $209,449   154,775 
Trade receivables, net  147,436   134,615   144,342   147,436 
Prepaid expenses  11,522   10,986   14,815   11,522 
Other current assets  3,629   4,433   3,101   3,629 
          
Total current assets  317,362   400,386   371,707   317,362 
Investments in marketable securities  51,837   —   23,545   51,837 
Investment in Discovery Communications, Inc. (“Discovery” or “DCI”) (note 5)  3,129,157   3,018,622 
Property and equipment, net (note 6)  280,775   256,245 
Goodwill (note 7)  2,074,789   2,133,518 
Investment in Discovery Communications Holding, LLC
(“Discovery”) (note 6)		  3,271,553   3,129,157 
Property and equipment, net (note 7)  269,742   280,775 
Goodwill (note 8)  1,909,823   2,074,789 
Other assets, net  17,062   10,465   19,382   17,062 
          
Total assets $5,870,982   5,819,236  $5,865,752   5,870,982 
          
LIABILITIES AND STOCKHOLDERS’ EQUITY
LIABILITIES AND STOCKHOLDERS’ EQUITY
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:                
Accounts payable $43,656   26,854  $26,298   43,656 
Accrued payroll and related liabilities  32,292   21,651   26,127   32,292 
Other accrued liabilities  29,924   27,777   42,761   29,924 
Deferred revenue  16,015   17,491   24,951   16,015 
          
Total current liabilities  121,887   93,773   120,137   121,887 
Deferred income tax liabilities (note 10)  1,174,594   1,127,677 
Deferred income tax liabilities (note 11)  1,228,942   1,174,594 
Other liabilities  25,237   22,361   22,352   25,237 
          
Total liabilities  1,321,718   1,243,811   1,371,431   1,321,718 
          
Commitments and contingencies (notes 14 and 15)        
Stockholders’ equity (note 11):        
Commitments and contingencies (notes 15 and 16)         
Stockholders’ equity (note 12):        
Preferred stock, $.01 par value. Authorized 50,000,000 shares; no shares issued  —   —   —   — 
Series A common stock, $.01 par value. Authorized 600,000,000 shares; issued and outstanding 268,194,966 shares at December 31, 2006 and 268,097,442 shares at December 31, 2005  2,682   2,681 
Series B common stock, $.01 par value. Authorized 50,000,000 shares; issued and outstanding 12,025,088 shares at December 31, 2006 and 12,106,093 shares at December 31, 2005  120   121 
Series A common stock, $.01 par value. Authorized
600,000,000 shares; issued and outstanding
269,159,928 shares at December 31, 2007 and
268,194,966 shares at December 31, 2006		  2,691   2,682 
Series B common stock, $.01 par value. Authorized
50,000,000 shares; issued and outstanding
11,869,696 shares at December 31, 2007 and
12,025,088 shares at December 31, 2006		  119   120 
Series C common stock, $.01 par value. Authorized 600,000,000 shares; no shares issued  —   —   —   — 
Additional paid-in capital  5,714,379   5,712,304   5,728,213   5,714,379 
Accumulated deficit  (1,183,831)  (1,137,821)  (1,253,483)  (1,183,831)
Accumulated other comprehensive earnings (loss)  15,914   (1,860)
Accumulated other comprehensive earnings  16,781   15,914 
          
Total stockholders’ equity  4,549,264   4,575,425   4,494,321   4,549,264 
          
Total liabilities and stockholders’ equity $5,870,982   5,819,236  $5,865,752   5,870,982 
          
 
See accompanying notes to consolidated financial statements.


II-18II-29

DISCOVERY HOLDING COMPANY AND SUBSIDIARIES


Consolidated Statements of Operations and Comprehensive Earnings (Loss)
Years ended December 31, 2007, 2006 and 2005
 
            
 Years Ended December 31,             
 2006 2005 2004  2007 2006 2005 
 amounts in thousands,
  amounts in thousands,
 
 except per share amounts  except per share amounts 
Net revenue $688,087   694,509   631,215  $707,214   688,087   694,509 
              
Operating expenses:                        
Cost of services  454,482   445,839   380,290   491,034   468,057   460,805 
Selling, general, and administrative, including stock-based compensation  177,366   174,428   155,905 
Selling, general, and administrative, including stock-based compensation (notes 13 and 17)  150,687   163,791   159,462 
Restructuring and other charges (note 9)  761   12,092   4,112 
Gain on sale of operating assets  (704)  (2,047)  (4,845)
Depreciation and amortization  67,929   76,377   77,605   67,732   67,929   76,377 
Restructuring and other charges (note 8)  12,092   4,112   — 
Loss (gain) on sale of operating assets  (2,047)  (4,845)  429 
Impairment of goodwill (note 7)  93,402   —   51 
Impairment of goodwill (note 8)  165,347   93,402   — 
              
  803,224   695,911   614,280   874,857   803,224   695,911 
              
Operating income (loss)  (115,137)  (1,402)  16,935 
Operating loss  (167,643)  (115,137)  (1,402)
Other income:                        
Share of earnings of Discovery (note 5)  103,588   79,810   84,011 
Other, net  9,481   3,704   132 
Share of earnings of Discovery (note 6)  141,781   103,588   79,810 
Other income, net  16,627   9,481   3,704 
              
  113,069   83,514   84,143   158,408   113,069   83,514 
              
Earnings (loss) before income taxes  (2,068)  82,112   101,078   (9,235)  (2,068)  82,112 
Income tax expense (note 10)  (43,942)  (48,836)  (34,970)
Income tax expense (note 11)  (59,157)  (43,942)  (48,836)
              
Net earnings (loss) $(46,010)  33,276   66,108  $(68,392)  (46,010)  33,276 
              
Other comprehensive earnings (loss), net of taxes (note 13):            
Other comprehensive earnings (loss), net of taxes (note 14):            
Unrealized holding gains (losses) arising during the period  (148)  651   (1,162)  (6,606)  (148)  651 
Foreign currency translation adjustments  17,922   (14,821)  6,797   7,934   17,922   (14,821)
Minimum pension liability adjustment  (461)  —   — 
              
Other comprehensive earnings (loss)  17,774   (14,170)  5,635   867   17,774   (14,170)
              
Comprehensive earnings (loss) $(28,236)  19,106   71,743  $(67,525)  (28,236)  19,106 
              
Basic and diluted earnings (loss) per common share (note 3) $(0.16)  0.12   0.24 
Basic and diluted earnings (loss) per common share — Series A and Series B (note 4) $(0.24)  (0.16)  0.12 
              
 
See accompanying notes to consolidated financial statements.


II-19II-30

DISCOVERY HOLDING COMPANY AND SUBSIDIARIES


Consolidated Statements of Cash Flows
Years ended December 31, 2007, 2006 and 2005
 
            
 Years Ended December 31,             
 2006 2005 2004  2007 2006 2005 
 amounts in thousands
  amounts in thousands
 
 (see note 4)  (see note 5) 
Cash flows from operating activities:                        
Net earnings (loss) $(46,010)  33,276   66,108  $(68,392)  (46,010)  33,276 
Adjustments to reconcile net earnings (loss) to net cash provided by operating activities:                        
Depreciation and amortization  67,929   76,377   77,605   67,732   67,929   76,377 
Stock-based compensation  1,817   4,383   2,775   1,129   1,817   4,383 
Payments for stock-based compensation  —   (2,139)  —   —   —   (2,139)
Impairment of goodwill  93,402   —   51   165,347   93,402   — 
Share of earnings of Discovery  (103,588)  (79,810)  (84,011)  (141,781)  (103,588)  (79,810)
Gain on lease buyout  (6,992)  —   — 
Deferred income tax expense  42,115   50,363   31,692   56,353   42,115   50,363 
Other non-cash charges (credits), net  (1,342)  (4,684)  706 
Changes in assets and liabilities (net of acquisitions):            
Other non-cash credits, net  (1,559)  (1,342)  (4,684)
Changes in assets and liabilities, net of acquisitions:            
Trade receivables  (9,718)  16,237   (36,405)  3,752   (9,718)  16,237 
Prepaid expenses and other current assets  1,345   10,804   (6,631)  (6,916)  1,345   10,804 
Payables and other liabilities  27,683   (19,516)  32,432   (11,674)  27,683   (19,516)
              
Net cash provided by operating activities  73,633   85,291   84,322   56,999   73,633   85,291 
              
Cash flows from investing activities:                        
Capital expenditures  (77,541)  (90,526)  (49,292)  (47,115)  (77,541)  (90,526)
Cash paid for acquisitions, net of cash acquired  (46,793)  —   (44,238)
Cash paid for acquisition, net of cash acquired  —   (46,793)  — 
Net sales (purchases) of marketable securities  (51,837)  12,800   (12,800)  28,292   (51,837)  12,800 
Cash proceeds from lease buyout  7,138   —   — 
Cash proceeds from dispositions  5,697   15,374   3,978   2,143   5,697   15,374 
Other investing activities, net  992   (394)  73   (5,117)  992   (394)
              
Net cash used in investing activities  (169,482)  (62,746)  (102,279)  (14,659)  (169,482)  (62,746)
              
Cash flows from financing activities:                        
Net cash transfers from Liberty  —   206,044   30,999 
Net cash transfers from Liberty Media Corporation (“Liberty”)  —   —   206,044 
Net cash from option exercises  279   —   —   12,975   279   — 
Payments of long-term debt and capital lease obligations  (7)  (12)  — 
Payment of capital lease obligations  (641)  (7)  (12)
Other financing activities, net  —   134   —   —   —   134 
              
Net cash provided by financing activities  272   206,166   30,999   12,334   272   206,166 
              
Net increase (decrease) in cash and cash equivalents  (95,577)  228,711   13,042   54,674   (95,577)  228,711 
Cash and cash equivalents at beginning of year  250,352   21,641   8,599   154,775   250,352   21,641 
              
Cash and cash equivalents at end of year $154,775   250,352   21,641  $209,449   154,775   250,352 
              
 
See accompanying notes to consolidated financial statements.


II-20II-31

DISCOVERY HOLDING COMPANY AND SUBSIDIARIES


Consolidated Statements of Stockholders’ Equity
Years ended December 31, 2007, 2006 2005 and 20042005
 
                                                                        
               Accumulated
                  Accumulated
   
         Additional
     Other
 Total
          Additional
     Other
 Total
 
 Preferred
 Common Stock Paid-in
 Parent’s
 Accumulated
 Comprehensive
 Stockholders’
  Preferred
 Common Stock Paid-in
 Parent’s
 Accumulated
 Comprehensive
 Stockholders’
 
 Stock Series A Series B Series C Capital Investment Deficit Earnings (loss) Equity  Stock Series A Series B Series C Capital Investment Deficit Earnings (Loss) Equity 
         amounts in thousands          amounts in thousands           
Balance at January 1, 2004 $—   —   —   —   —   5,490,799   (1,237,205)  6,675   4,260,269 
Net earnings  —   —   —   —   —   —   66,108   —   66,108 
Other comprehensive earnings  —   —   —   —   —   —   —   5,635   5,635 
Stock compensation  —   —   —   —   —   2,268   —   —   2,268 
Reallocation of enterprise level goodwill from Liberty (note 5)  —   —   —   —   —   (18,000)  —   —   (18,000)
Net cash transfers from Liberty  —   —   —   —   —   30,999   —   —   30,999 
                   
Balance at December 31, 2004  —   —   —   —   —   5,506,066   (1,171,097)  12,310   4,347,279 
Balance at January 1, 2005 $—   —   —   —   —   5,506,066   (1,171,097)  12,310   4,347,279 
Net earnings  —   —   —   —   —   —   33,276   —   33,276   —   —   —   —   —   —   33,276   —   33,276 
Other comprehensive loss  —   —   —   —   —   —   —   (14,170)  (14,170)  —   —   —   —   —   —   —   (14,170)  (14,170)
Stock compensation  —   —   —   —   640   2,222   —   —   2,862   —   —   —   —   640   2,222   —   —   2,862 
Net cash transfers from Liberty  —   —   —   —   —   206,044   —   —   206,044   —   —   —   —   —   206,044   —   —   206,044 
Change in capitalization in connection with Spin Off (note 2)  —   2,681   121   —   5,711,530   (5,714,332)  —   —   — 
Change in capitalization in connection with 2005 Spin Off (note 3)  —   2,681   121   —   5,711,530   (5,714,332)  —   —   — 
Stock option exercises  —   —   —   —   134   —   —   —   134   —   —   —   —   134   —   —   —   134 
                                      
Balance at December 31, 2005  —   2,681   121   —   5,712,304   —   (1,137,821)  (1,860)  4,575,425   —   2,681   121   —   5,712,304   —   (1,137,821)  (1,860)  4,575,425 
Net loss  —   —   —   —   —   —   (46,010)  —   (46,010)  —   —   —   —   —   —   (46,010)  —   (46,010)
Other comprehensive earnings  —   —   —   —   —   —   —   17,774   17,774   —   —   —   —   —   —   —   17,774   17,774 
Stock compensation  —   —   —   —   1,796   —   —   —   1,796   —   —   —   —   1,796   —   —   —   1,796 
Conversion of Series B to Series A  —   1   (1)  —   —   —   —   —   —   —   1   (1)  —   —   —   —   —   — 
Stock option exercises  —   —   —   —   279   —   —   —   279   —   —   —   —   279   —   —   —   279 
                                      
Balance at December 31, 2006 $—   2,682   120   —   5,714,379   —   (1,183,831)  15,914   4,549,264   —   2,682   120   —   5,714,379   —   (1,183,831)  15,914   4,549,264 
Net loss  —   —   —   —   —   —   (68,392)  —   (68,392)
Other comprehensive earnings  —   —   —   —   —   —   —   867   867 
Stock compensation  —   —   —   —   867   —   —   —   867 
Cumulative effect of accounting change (note 11)  —   —   —   —   —   —   (1,260)  —   (1,260)
Conversion of Series B to Series A  —   1   (1)  —   —   —   —   —   — 
Stock option exercises  —   8   —   —   12,967   —   —   —   12,975 
                                      
Balance at December 31, 2007 $—   2,691   119   —   5,728,213   —   (1,253,483)  16,781   4,494,321 
                   
 
See accompanying notes to consolidated financial statements.


II-21II-32

DISCOVERY HOLDING COMPANY AND SUBSIDIARIES


Notes to Consolidated financial Statements
December 31, 2007, 2006 and 2005
 
Notes to Consolidated Financial Statements
December 31, 2006, 2005 and 2004
(1)  Basis of Presentation
(1)  Basis of Presentation
 
The accompanying consolidated financial statements of Discovery Holding Company and its consolidated subsidiaries (“DHC” or the “Company”) represent a combination of the historical financial information of (1) Ascent Media Group, LLC (“Ascent Media”), a wholly-owned subsidiary of Liberty, and Liberty’s 50% ownership interest in Discovery for periods prior to the July 21, 2005 consummation of the spin off transaction (“the 2005 Spin Off”) described in note 23 and (2) DHCDHC’s wholly-owned subsidiaries and its consolidated subsidiaries (including its 50% share of Discovery’s earnings)interest in Discovery for the period following such date. The 2005 Spin Off has been accounted for at historical cost due to the pro rata nature of the distribution. Accordingly, DHC’s historical financial statements are presented in a manner similar to a pooling of interests.
 
Ascent Media is comprised of two operating segments. Ascent Media’s creative services group provides services necessary to complete the creation of original content, including feature films, mini-series, television shows, television commercials, music videos, promotional and identity campaigns, and corporate communications programming. The group manipulates or enhances original visual images or audio captured in principal photography or creates new three dimensional images, animation sequences, or sound effects. 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 networksnetwork services group provides the facilities and services necessary to assemble and distribute programming content for cable and broadcast networks via fiber, satellite, and the Internet to viewers in North America, Europe, and Asia. Additionally, the networksnetwork services group provides systems integration, design, consulting, engineering and project management services.
 
SubstantiallyIn January 2006, Ascent Media CANS, LLC (dba AccentHealth) (“AccentHealth”) acquired substantially all of the assets of AccentHealth, LLC were acquired by a subsidiary of DHC in January 2006, and areLLC. AccentHealth is included as part of the network services group for financial reporting purposes. AccentHealth operates an advertising-supported captive audience television network in doctor office waiting rooms nationwide.
 
Discovery is a leading global media and entertainment company that provides original and purchased cable and satellite television programming across multiple distribution platforms in the United States and overmore than 170 other countries.countries, including television networks offering customized programming in 35 languages. Discovery also develops and sells branded commerceconsumer and educational product linesproducts and services in the United States.States and internationally.
 
The preparation of financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of revenue and expenses for each reporting period. The significant estimates made in preparation of the Company’s consolidated financial statements primarily relate to valuation of goodwill, other intangible assets, long-lived assets, deferred tax assets, and the amount of the allowance for doubtful accounts. Actual results could differ from the estimates upon which the carrying values were based.
 
(2)  Newhouse Transaction and Ascent Spin Off
In December 2007, DHC announced that it had signed a non-binding letter of intent with Advance/Newhouse Programming Partnership (“Advance/Newhouse”) to combine their respective stakes in Discovery. As currently contemplated by the non-binding letter of intent, the transaction, if completed, would involve the following steps:
• DHC will spin-off to its shareholders a wholly-owned subsidiary holding cash and Ascent Media, except for those businesses of Ascent Media that provide sound, music, mixing, sound effects and other related services (the “Ascent Media Spin Off”);
• Immediately following the spin-off, DHC will combine with a new holding company(“New DHC”), and DHC’s existing stockholders will receive shares of common stock of New DHC;


II-33

(2)DISCOVERY HOLDING COMPANY AND SUBSIDIARIES
Notes to Consolidated financial Statements — (Continued)
• As part of this transaction, Advance/Newhouse will contribute its interests in Discovery and Animal Planet to New DHC in exchange for preferred stock of New DHC that, immediately after the closing of the transactions, will be convertible at any time into shares initially representing one-third of the outstanding shares of common stock of New DHC. The preferred stock held by Advance/Newhouse will entitle it to elect two members to New DHC’s board of directors and to exercise approval rights with respect to the taking of specified actions by New DHC and Discovery.
Although no assurance can be given, consummation of this transaction is expected in the second quarter of 2008. It is currently expected that the Ascent Media Spin Off Transactionwill be effected as a tax-free distribution to DHC’s shareholders and be accounted for at historical cost due to the pro rata nature of the distribution. Subsequent to the completion of the Ascent Media Spin Off, the historical results of operations of Ascent Media prior to the Ascent Media Spin Off will be included in discontinued operations in DHC’s consolidated financial statements. The acquisition of Advance/Newhouse’s interests in Discovery and Animal Planet will result in New DHC owning 100% of Discovery, and accordingly, New DHC will consolidate Discovery’s financial position and results of operations effective with the closing of the transaction. The acquisition of these interests will be accounted for as a step acquisition, and the acquired interests will be recorded by New DHC at their estimated fair values.
(3)  2005 Spin Off Transaction
 
On July 21, 2005 (the “Spin Off Date”), Liberty completed the spin off of the capital stock of DHC. The 2005 Spin Off was effected as a dividend by Liberty to holders of its Series A and Series B common stock of shares of DHC Series A and Series B common stock, respectively. Holders of Liberty common stock on July 15, 2005 received 0.10 of a share of DHC Series A common stock for each share of Liberty Series A common stock owned and 0.10 of a share of DHC Series B common stock for each share of Liberty Series B common stock owned. Approximately 268.1 million shares of DHC Series A common stock and 12.1 million shares of DHC Series B common stock were issued in the 2005 Spin Off. The 2005 Spin Off did not involve the payment of any consideration by the holders of Liberty common stock and iswas intended to qualify as a tax-free transaction.
 
In addition to Ascent Media and its investment in Discovery, Liberty transferred $200 million in cash to a subsidiary of DHC prior to the 2005 Spin Off.
 
Following the 2005 Spin Off, the Company and Liberty operate independently, and neither has any stock ownership, beneficial or otherwise, in the other. In connection with the 2005 Spin Off, the Company and Liberty entered into certain agreements in order to govern certain of the ongoing relationships between the Company and Liberty after the 2005 Spin Off and to provide for an orderly transition. These agreements include a Reorganization Agreement, a Services Agreement and a Tax Sharing Agreement.
 
The Reorganization Agreement provides for, among other things, the principal corporate transactions required to effect the 2005 Spin Off and cross indemnities. Pursuant to the Services Agreement, Liberty provides the Company with office


II-22

DISCOVERY HOLDING COMPANY AND SUBSIDIARIES
Notes to Consolidated Financial Statements — (Continued)

space and certain general and administrative services including legal, tax, accounting, treasury and investor relations support. The Company reimburses Liberty for direct,out-of-pocket expenses incurred by Liberty in providing these services and for the Company’s allocable portion of costs associated with any shared services or personnel. Liberty and DHC have agreed that they will review cost allocations every six months and adjust such charges, if appropriate.
 
Under the Tax Sharing Agreement, Liberty is generally responsible for U.S. federal, state, local and foreign income taxes reported on a consolidated, combined or unitary return that includes the Company or one of its subsidiaries and Liberty or one of its subsidiaries. The Company is responsible for all other taxes that are attributable to the Company or one of its subsidiaries, whether accruing before, on or after the 2005 Spin Off. The Tax Sharing Agreement requires that the Company will not take, or fail to take, any action where such action, or failure to act, would be inconsistent with or prohibit the 2005 Spin Off from qualifying as a tax-free transaction. Moreover, the Company has indemnified Liberty for any loss resulting from (i) such action or failure to act or (ii) any agreement, understanding, arrangement or substantial negotiations entered into by DHC prior to the day after the first anniversary of the 2005 Spin Off, with respect to any transaction pursuant to which any of the other


II-34

DISCOVERY HOLDING COMPANY AND SUBSIDIARIES
Notes to Consolidated financial Statements — (Continued)
shareholders of Discovery would acquire shares of, or other interests in DHC’s capital stock, in each case relating to the qualification of the 2005 Spin Off as a tax-free transaction. As of December 31, 2006,2007, no such loss has been incurred.
 
(3)  Summary of Significant Accounting Policies
(4)  Summary of Significant Accounting Policies
 
Cash and Cash Equivalents
 
The Company considers investments with original purchased maturities of three months or less to be cash equivalents.
 
Trade Receivables
Trade receivables are shown net of an allowance based on historical collection trends and management’s judgment regarding the collectibility of these accounts. These collection trends, as well as prevailing and anticipated economic conditions, are routinely monitored by management, and any adjustments required are reflected in current operations. The allowance for doubtful accounts as of December 31, 2006 and 2005 was $9,045,000 and $7,708,000, respectively.
A summary of activity in the allowance for doubtful accounts is as follows:
                     
  Balance
  Charged
        Balance
 
  Beginning
  (Credited)
     Acquired and
  End of
 
  of Year  to Expense  Write-Offs  Other Activity  Year 
  amounts in thousands 
 
2006 $7,708   1,023   —   314   9,045 
                     
2005 $12,104   (619)  (2,443)  (1,334)  7,708 
                     
2004 $11,580   555   —   (31)  12,104 
                     
Trade receivables are shown net of an allowance based on historical collection trends and management’s judgment regarding the collectibility of these accounts. These collection trends, as well as prevailing and anticipated economic conditions, are routinely monitored by management, and any adjustments required are reflected in current operations. The allowance for doubtful accounts as of December 31, 2007 and 2006 was $8,994,000 and $9,045,000, respectively.
A summary of activity in the allowance for doubtful accounts is as follows:
                     
  Balance
  Charged
        Balance
 
  Beginning
  (Credited)
     Acquired and
  End of
 
  of Year  to Expense  Write-offs  Other Activity  Year 
     amounts in thousands       
 
2007 $9,045   892   —   (943)  8,994 
                     
2006 $7,708   1,023   —   314   9,045 
                     
2005 $12,104   (619)  (2,443)  (1,334)  7,708 
                     
 
Concentration of Credit Risk and Significant Customers
 
For the years ended December 31, 2007, 2006 and 2005, and 2004, no single customer accounted for more than 10% of consolidated revenue.
 
Fair Value of Financial Instruments
Fair values of cash equivalents, current accounts receivable and current accounts payable approximate the carrying amounts because of their short-term nature.
Investment in Discovery
DHC accounts for its 50% ownership interest in Discovery using the equity method of accounting. Under this method, the investment, originally recorded at cost, is adjusted to recognize the Company’s share of the net earnings or losses of Discovery as they occur, rather than as dividends or other distributions are received. The excess of the Company’s carrying value over its proportionate share of Discovery’s equity is accounted for as equity method goodwill, and accordingly, is not amortized, but periodically reviewed for impairment.
Changes in the Company’s proportionate share of the underlying equity of Discovery which result from the issuance of additional equity securities by Discovery are recognized as increases or decreases in stockholders’ equity. No such adjustments were recorded during the three years ended December 31, 2006.


II-23

DISCOVERY HOLDING COMPANY AND SUBSIDIARIES
Notes to Consolidated Financial Statements — (Continued)

The Company periodically compares the carrying value of its investment in Discovery to its estimated fair value to determine if there are any
Effective May 14, 2007, DHC’s ownership interest in Discovery increased from 50% to 662/3%. DHC accounts for its 662/3% ownership interest in Discovery using the equity method of accounting due to governance rights possessed by Advance/Newhouse which restrict DHC’s ability to control Discovery. Under this method, the investment, originally recorded at cost, is adjusted to recognize the Company’s share of the net earnings or losses of Discovery as they occur, rather than as dividends or other distributions are received. The excess of the Company’s carrying value over its proportionate share of Discovery’s equity is accounted for as equity method goodwill, and accordingly, is not amortized, but periodically reviewed for impairment.
Changes in the Company’s proportionate share of the underlying equity of Discovery which result from the issuance of additional equity securities by Discovery are recognized as increases or decreases in stockholders’ equity. No such adjustments were recorded during the three years ended December 31, 2007.


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DISCOVERY HOLDING COMPANY AND SUBSIDIARIES
Notes to Consolidated financial Statements — (Continued)
The Company periodically compares the carrying value of its investment in Discovery to its estimated fair value to determine if there are any other-than-temporary declines in value, which would require an adjustment in the statement of operations. The estimated fair value of the investment in Discovery exceeds its carrying value for all periods presented.
 
Discovery is managed by its members rather than a board of directors. Generally, all significant actions to be taken by Discovery require the approval of the holders of a majority of Discovery’s membership interests. However, pursuant to a Limited Liability Company Agreement, the taking of certain actions (including, among other things, a merger of Discovery, or the issuance of additional membership interests in Discovery or approval of annual business plans) requires the approval of the holders of at least 80% of Discovery’s membership interests. Although DHC’s status as a 662/3% member of Discovery enables DHC to exercise influence over the management and policies of Discovery, such status does not enable DHC to cause any actions to be taken. Advance/Newhouse holds a 331/3% interest in Discovery, which ownership interest enables them to prevent Discovery from taking actions requiring 80% approval.
Property and Equipment
 
Property and equipment are carried at cost and depreciated using the straight-line method over the estimated useful lives of the assets. Leasehold improvements are amortized over the shorter of their estimated useful lives or the term of the underlying lease. Estimated useful lives by class of asset are as follows:
 
  
Buildings20 years
Leasehold improvements15 years or lease term, if shorter
Furniture and fixtures7 years
Computers3 years
Machinery and equipment5 to 7 years 
Buildings20 years
Leasehold improvements15 years or lease term, if shorter
Furniture
Depreciation expense for property and equipment was $66,141,000, $66,435,000 and $74,805,000 for the years ended December 31, 2007, 2006 and fixtures7 yearsComputers3 yearsMachinery and equipment5 to 7 years
Depreciation expense for property and equipment was $66,435,000, $74,805,000 and $74,986,000 for the years ended December 31, 2006, 2005, and 2004, respectively.
 
Goodwill
 
The Company accounts for its goodwill pursuant to the provisions of SFAS No. 142,Goodwill and Other Intangible Assets(“SFAS No. 142”). In accordance with SFAS No. 142, goodwill is not amortized, but is tested for impairment annually and whenever events or changes in circumstances indicate that the carrying value may not be recoverable.
 
SFAS No. 142 requires the Company to consider equity method affiliates as separate reporting units. As a result, $1,771,000,000 of DHC’s enterprise-level goodwill balance has been allocated to a separate reporting unit which includes only its investment in Discovery. This allocation is performed for goodwill impairment testing purposes only and does not change the reported carrying value of the investment. However, to the extent that all or a portion of an equity method investment which is part of a reporting unit containing allocated goodwill is disposed of in the future, the allocated portion of goodwill will be relieved and included in the calculation of the gain or loss on disposal.
 
Other Intangible Assets
In accordance with SFAS No. 142, amortizable other intangible assets are amortized on a straight-line basis over their estimated useful lives of four to five years, and are reviewed for impairment in accordance with SFAS No. 144,Accounting for Impairment or Disposal of Long-Lived Assets (“
In accordance with SFAS No. 142, amortizable other intangible assets are amortized on a straight-line basis over their estimated useful lives of four to five years, and are reviewed for impairment in accordance with SFAS No. 144,Accounting for Impairment or Disposal of Long-Lived Assets(“SFAS No. 144”).


II-36

DISCOVERY HOLDING COMPANY AND SUBSIDIARIES
 
Notes to Consolidated financial Statements — (Continued)
Long-Lived Assets
 
In accordance with SFAS No. 144, management reviews the realizability of its long-lived assets whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In evaluating the value and future benefits of long-term assets, their carrying value is compared to management’s best estimate of undiscounted future cash flows over the remaining economic life. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying value of the assets exceeds the estimated fair value of the assets.
 
Foreign Currency Translation
The functional currencies of the Company’s foreign subsidiaries are their respective local currencies. Assets and liabilities of foreign operations are translated into U.S. dollars using exchange rates on the balance sheet date, and revenues and expenses are translated into U.S. dollars using average exchange rates for the period. The effects of the foreign currency translation adjustments are deferred and are included in stockholder
The functional currencies of the Company’s foreign subsidiaries are their respective local currencies. Assets and liabilities of foreign operations are translated into U.S. dollars using exchange rates on the balance sheet date, and revenue and expenses are translated into U.S. dollars using average exchange rates for the period. The effects of the foreign currency translation adjustments are deferred and are included in stockholders’ equity as a component of accumulated other comprehensive earnings (loss).
 
Revenue Recognition
Revenue from post-production and certain distribution related services is recognized when services are provided. Revenue on other long-term contracts is recorded on the basis of the estimated percentage of completion of individual


II-24

DISCOVERY HOLDING COMPANY AND SUBSIDIARIES
Notes to Consolidated Financial Statements — (Continued)

Revenue from post-production and certain distribution related services is recognized when services are provided. Revenue on other long-term contracts is recorded on the basis of the estimated percentage of completion of individual contracts. Percentage of completion is calculated based upon actual labor and equipment costs incurred compared to total forecasted costs for the contract. Estimated losses on long-term contracts are recognized in the period in which a loss becomes evident.
 
Prepayments received for services to be performed at a later date are reflected in the consolidated balance sheets as deferred revenue until such services are provided.
 
Income Taxes
The Company accounts for income taxes under Statement of Financial Accounting Standards No. 109,Accounting for Income Taxes(“SFAS No. 109”). SFAS No. 109 is
The Company accounts for income taxes under Statement of Financial Accounting Standards No. 109,Accounting for Income Taxes(“SFAS No. 109”). SFAS No. 109 prescribes an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in the Company’s consolidated financial statements or tax returns. In estimating future tax consequences, SFAS No. 109 generally considers all expected future events other than proposed changes in the tax law or rates. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. Income tax expense is the tax payable or refundable for the period plus or minus the change during the period in deferred tax assets and liabilities.
 
Effective January 1, 2007, the Company 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, the Company may record the benefits of such tax position in its consolidated financial statements.
Advertising Costs
 
Advertising costs generally are expensed as incurred. Advertising expense aggregated $4,572,000, $3,990,000 and $3,465,000 for the years ended December 31, 2007, 2006 and $3,303,000 for the years ended December 31, 2006, 2005, and 2004, respectively.


II-37

DISCOVERY HOLDING COMPANY AND SUBSIDIARIES
 
Notes to Consolidated financial Statements — (Continued)
Stock-Based Compensation
As a result of the Spin Off and related adjustments to Liberty’s stock incentive awards, options (“Spin Off DHC Awards”) to acquire an aggregate of approximately 2.0 million shares of DHC Series A common stock and 3.0 million shares of DHC Series B common stock were issued to employees of Liberty. In addition, employees of Ascent Media who held stock options or stock appreciation rights (“SARs”) to acquire shares of Liberty common stock prior to the Spin Off continue to hold such options. Pursuant to the Reorganization Agreement, DHC is responsible for all stock options related to DHC common stock, and Liberty is responsible for all incentive awards related to Liberty common stock. Notwithstanding the foregoing, the Company records stock-based compensation for all stock incentive awards held by DHC’s and its subsidiaries’ employees regardless of whether such awards relate to DHC common stock or Liberty common stock. Any stock-based compensation recorded by DHC with respect to Liberty stock incentive awards is treated as a capital transaction with the offset to stock-based compensation expense reflected as an adjustment of additional paid-in capital.
In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123 (revised 2004),“Share-Based Payments” (“Statement 123R”). Statement 123R, which is a revision of Statement of Financial Accounting Standards No. 123,“Accounting for Stock-Based Compensation”(“Statement 123”) and supersedes Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees”(“APB Opinion No. 25”), establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services, primarily focusing on transactions in which an entity obtains employee services. Statement 123R generally requires companies to measure the cost of employee services received in exchange for an award of equity instruments (such as stock options and restricted stock) based on the grant-date fair value of the award, and to recognize that cost over the period during which the employee is required to provide service (usually the vesting period of the award). Statement 123R also requires companies to measure the cost of employee services received in exchange for an award of liability instruments (such as stock appreciation rights that will be settled in cash) based on the current fair value of the award, and to remeasure the fair value of the award at each reporting date.
The Company adopted Statement 123R effective January 1, 2006. The provisions of Statement 123R allow companies to adopt the standard using the modified prospective method or to restate all periods for which Statement 123 was effective. The Company has adopted Statement 123R using the modified prospective method, and the impact of adoption was not material.
Liberty calculated the grant-date fair value for all of its awards using the Black-Scholes Model. Liberty calculated the expected term of the awards using the methodology included in SEC Staff Accounting Bulletin No. 107. The volatility used in the calculation is based on the implied volatility of publicly traded Liberty options with a similar term (generally 20%-21%). Liberty uses the risk-free rate for Treasury Bonds with a term similar to that of the subject options and has assumed a dividend rate of zero. The Company has allocated the grant-date fair value of the Liberty awards to the Spin Off DHC Awards based on the relative trading prices of DHC and Liberty common stock after the Spin Off.


II-25

As a result of the 2005 Spin Off and related adjustments to Liberty’s stock incentive awards, options (“Spin Off DHC Awards”) to acquire an aggregate of approximately 2.0 million shares of DHC Series A common stock and 3.0 million shares of DHC Series B common stock were issued to employees of Liberty. In addition, employees of Ascent Media who held stock options or stock appreciation rights (“SARs”) to acquire shares of Liberty common stock prior to the 2005 Spin Off continue to hold such options. Pursuant to the Reorganization Agreement, DHC is responsible for all stock options related to DHC common stock, and Liberty is responsible for all incentive awards related to Liberty common stock. The Company records stock-based compensation for all stock incentive awards held by DHC’s and its subsidiaries’ employees.
The Company accounts for stock option awards pursuant to Statement of Financial Accounting Standards No. 123 (revised 2004),“Share-Based Payment” (“Statement 123R”). Statement 123R generally requires companies to measure the cost of employee services received in exchange for an award of equity instruments (such as stock options and restricted stock) based on the grant-date fair value of the award, and to recognize that cost over the period during which the employee is required to provide service (usually the vesting period of the award).
Liberty calculated the grant-date fair value for all of its awards using the Black-Scholes Model. Liberty calculated the expected term of the awards using the methodology included in SEC Staff Accounting Bulletin No. 107. The volatility used in the calculation is based on the implied volatility of publicly traded Liberty options with a similar term (generally 20% — 21%). Liberty used the risk-free rate for Treasury Bonds with a term similar to that of the subject options and has assumed a dividend rate of zero. The Company has allocated the grant-date fair value of the Liberty awards to the Spin Off DHC Awards based on the relative trading prices of DHC and Liberty common stock after the 2005 Spin Off.
Prior to the adoption of Statement 123R, the Company applied the intrinsic-value-based method of accounting prescribed by APB Opinion No. 25, to account for its fixed-plan stock options. Under this method, compensation expense was recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price and was recognized on a straight-line basis over the vesting period.
The following table illustrates the effect on net earnings as if the fair-value-based method of Statement 123R had been applied to all outstanding and unvested awards. Compensation expense for SARs was the same under APB Opinion No. 25 and Statement 123R. Accordingly, no pro forma adjustment for such awards is included in the following table (amounts in thousands, except per share amounts).
     
  Year Ended
 
  December 31,
 
  2005 
 
Net earnings, as reported $33,276 
Add:    
Stock-based employee compensation expense included in reported net earnings, net of taxes  2,309 
Deduct:    
Stock-based employee compensation expense determined under fair value based method for all awards, net of taxes  (8,247)
     
Pro forma net earnings $27,338 
     
Pro forma basic and diluted earnings per common share:    
As reported $.12 
     
Pro forma for fair value stock compensation $.10 
     


II-38

 
DISCOVERY HOLDING COMPANY AND SUBSIDIARIES
Notes to Consolidated financial Statements — (Continued)
 
Notes to Consolidated Financial Statements — (Continued)

Prior to the adoption of Statement 123R, the Company applied the intrinsic-value-based method of accounting prescribed by APB Opinion No. 25, to account for its fixed-plan stock options. Under this method, compensation expense was recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price and was recognized on a straight-line basis over the vesting period.
The following table illustrates the effect on net earnings for the years ended December 31, 2005 and 2004 as if the fair-value-based method of Statement 123R had been applied to all outstanding and unvested awards. Compensation expense for SARs was the same under APB Opinion No. 25 and Statement 123R. Accordingly, no pro forma adjustment for such awards is included in the following table.
         
  Years Ended December 31, 
  2005  2004 
  amounts in thousands, except per share amounts 
 
Net earnings, as reported $33,276   66,108 
Add:        
Stock-based employee compensation expense included in reported net earnings, net of taxes  2,309   2,268 
Deduct:        
Stock-based employee compensation expense determined under fair value based method for all awards, net of taxes  (8,247)  (6,247)
         
Pro forma net earnings $27,338   62,129 
         
Pro forma basic and diluted earnings per common share:        
As reported $.12   .24 
         
Pro forma for fair value stock compensation $.10   .22 
         
Earnings (Loss) Per Common Share — Series A and Series B
 
Basic earnings (loss) per common share (“EPS”) is computed by dividing net earnings (loss) by the weighted average number of common shares outstanding for the period. EPS in the accompanying consolidated statements of operations is based on (1) 280,199,000 shares, which is the number of shares issued in the Spin Off, for all periods prior to the weighted average number of common shares outstanding for the period. EPS in the accompanying consolidated statements of operations is based on (1) 280,199,000 shares, which is the number of shares issued in the 2005 Spin Off, for all periods prior to the 2005 Spin Off and (2) the actual number of shares outstanding for all periods subsequent to the 2005 Spin Off. The weighted average outstanding shares for the years ended December 31, 2007 and 2006 were 280,520,335 and (2) the actual number of shares outstanding for all periods subsequent to the Spin Off. The weighted average outstanding shares for the years ended December 31, 2006 and 2005 were 279,951,000, and 279,557,000, respectively. Dilutive EPS presents the dilutive effect on a per shares basis of potential common shares as if they had been converted at the beginning of the periods presented. Due to the relative insignificance of the dilutive securities in 2006 and 2005, their inclusion does not impact the EPS amount as reported in the accompanying consolidated statements of operations.
 
Estimates
 
The preparation of the consolidated financial statements in conformity with generally accepted accounting principles in the United States of America (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of revenue and expenses for each reporting period. The significant estimates made in preparation of the Company’s consolidated financial statements primarily relate to valuation of goodwill, other intangible assets, long-lived assets, deferred tax assets, and the amount of the allowance for doubtful accounts. Actual results could differ from the estimates upon which the carrying values were based.
 
Recent Accounting Pronouncements
The Financial Accounting Standards Board (“FASB”) has issued interpretation No. 48, “Accounting for Uncertainty in Income Taxes — An Interpretation of FASB Statement No. 109” (“FIN 48”), regarding accounting for, and disclosure of, uncertain tax positions. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, “Accounting for Income Taxes.” FIN 48 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. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting for interim periods, disclosure and transition. FIN 48 is effective for fiscal years


II-26

In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 157,“Fair Value Measurements”(“SFAS No. 157”), which defines fair value, establishes a framework for measuring fair value under GAAP and expands disclosures about fair value measurements. SFAS No. 157 applies to other accounting pronouncements that require or permit fair value measurements. The new guidance is effective for financial statements issued for fiscal years beginning after November 15, 2007, and for interim periods within those fiscal years. DHC does not expect that our adoption of SFAS No. 157 will have a significant impact on the reported amounts of our assets and liabilities that DHC report at fair value in our consolidated balance sheet.
In December 2007, the FASB issued Statement of Financial Accounting Standards No. 141(R),“Business Combinations”(“SFAS No. 141(R)”). The statement will significantly change the accounting for business combinations, and under this statement, an acquiring entity will be required to recognize all the assets acquired and liabilities assumed in a transaction at the acquisition-date fair value with limited exceptions. SFAS No. 141 (R) will change the accounting treatment for certain specific items, including acquisition costs, noncontrolling interests, acquired contingent liabilities, in-process research and development, restructuring costs and changes in deferred tax asset valuation allowances and income tax uncertainties after the acquisition date. The adoption of the requirements of SFAS No. 141 (R) applies prospectively to business combinations for which the acquisition date is on or after fiscal years beginning after December 15, 2008. Early adoption is prohibited.


II-39

 
DISCOVERY HOLDING COMPANY AND SUBSIDIARIES
Notes to Consolidated financial Statements — (Continued)
 
Notes to Consolidated Financial Statements — (Continued)

beginning after December 15, 2006. The Company is in the process of evaluating the potential impact of the adoption of FIN 48 on its consolidated balance sheet and statements of operations and comprehensive earnings (loss), and does not believe this adoption will have a material impact.
(4)  (5)  Supplemental Disclosure of Cash Flow Information
             
  Years Ended December 31, 
  2006  2005  2004 
  amounts in thousands 
 
Cash paid for acquisitions:            
Fair value of assets acquired $48,264   —   60,950 
Net liabilities assumed  (1,471)  —   (17,073)
Deferred tax liability  —   —   361 
             
Cash paid for acquisitions, net of cash acquired $46,793   —   44,238 
             
Cash paid during the year for income taxes $1,871   1,190   1,916 
             
             
  Years Ended December 31, 
  2007  2006  2005 
  amounts in thousands 
 
Cash paid for acquisition:            
Fair value of assets acquired $—   48,264   — 
Net liabilities assumed  —   (1,471)  — 
             
Cash paid for acquisition, net of cash acquired $—   46,793   — 
             
Cash paid during the year for income taxes $1,321   1,871   1,190 
             
Non-cash financing activity:            
Capital lease $5,774   —   — 
             
 
(5)  (6)  Investment in Discovery
The Company has a 50% ownership interest in Discovery and accounts for its investment using the equity method of accounting. Discovery is a global media and entertainment company, that provides original and purchased video programming in the United States and over 170 other countries. Discovery also develops and sells branded commerce and educational product lines in the United States.
DHC’s carrying value for Discovery was $3,129,157,000 at December 31, 2006. In addition, as described in note 7, $1,771,000,000 of enterprise-level goodwill has been allocated to the investment in Discovery.
Prior to the Spin Off, it was necessary for Liberty to periodically reallocate its enterprise level goodwill due to changes in reporting units caused by transactions or by internal reorganizations. These reallocation adjustments were made based on the relative fair values of the remaining reporting units in accordance with SFAS No. 142. As a result, there was an $18,000,000 adjustment to the enterprise level goodwill allocated to DHC in 2004. Such adjustment is reflected in DHC’s consolidated statement of stockholders’ equity.
Discovery was formed in the second quarter of 2007 as part of a restructuring (the “DCI Restructuring”) completed by Discovery Communications, Inc. (“DCI”). In the DCI Restructuring, DCI was converted into a limited liability company and became a wholly-owned subsidiary of Discovery, and the former shareholders of DCI, including DHC, became members of Discovery. Discovery is the successor reporting entity to DCI. In connection with the DCI Restructuring, Discovery applied “pushdown” accounting and each shareholder’s basis in DCI as of May 14, 2007 has been pushed down to Discovery. The result was $4.3 billion in goodwill being recorded by Discovery. Since goodwill is not amortizable, there is no current income statement impact for this change in basis.
Discovery is a leading global media and entertainment company that provides original and purchased programming across multiple distribution platforms in the United States and more than 170 other countries, including television networks offering customized programming in 35 languages. Discovery also develops and sells consumer and educational products and services in the United States and internationally.
On May 14, 2007, Discovery and Cox Communications Holdings, Inc. (“Cox”) completed an exchange of Cox’s 25% ownership interest in Discovery for all of the capital stock of a subsidiary of Discovery that held Travel Channel, travelchannel.com and approximately $1.3 billion in cash. Discovery raised the cash component through additional debt financing, and retired the membership interest previously owned by Cox. Upon completion of this transaction, DHC owns a 662/3% interest in Discovery and Advance/Newhouse owns a 331/3% interest.
DHC continues to account for its investment in Discovery using the equity method of accounting due to governance rights possessed by Advance/Newhouse which restrict DHC’s ability to control Discovery. From January 1, 2006 through May 14, 2007, DHC recorded its 50% share of the earnings of DCI. Subsequent to May 14, 2007, DHC has recorded its 662/3% share of the earnings of Discovery.
DHC does not have access to the cash Discovery generates from its operations, unless Discovery makes a distribution with respect to its membership interests or makes other payments or advances to its members. Prior to May 14, 2007, DCI did not pay any dividends on its capital stock, and since that date, Discovery has not made any distributions to its members, and DHC does not have sufficient voting control to cause Discovery to make distributions or make other payments or advances to DHC.
DHC’s carrying value for Discovery was $3,271,553,000 at December 31, 2007. In addition, as described in note 8, $1,771,000,000 of enterprise-level goodwill has been allocated to the investment in Discovery.


II-40

DISCOVERY HOLDING COMPANY AND SUBSIDIARIES
Notes to Consolidated financial Statements — (Continued)
 
Summarized financial information for Discovery is as follows:
 
Consolidated Balance Sheets
         
  December 31, 
  2007  2006 
  amounts in thousands 
 
Cash and cash equivalents $44,951   52,263 
Other current assets  1,032,282   918,373 
Property and equipment  397,430   424,041 
Goodwill and intangible assets  5,051,843   472,939 
Programming rights, long term  1,048,193   1,253,553 
Other assets  385,731   255,384 
         
Total assets $7,960,430   3,376,553 
         
Current liabilities $850,495   734,524 
Long-term debt  4,109,085   2,633,237 
Other liabilities  243,867   175,255 
Mandatorily redeemable equity in subsidiaries  48,721   94,825 
Members’ equity (deficit)  2,708,262   (261,288)
         
Total liabilities and members’ equity (deficit) $7,960,430   3,376,553 
         
 
         
  December 31, 
  2006  2005 
  amounts in thousands 
 
Cash and cash equivalents $52,263   34,491 
Other current assets  918,373   796,878 
Property and equipment  424,041   397,578 
Goodwill and intangible assets  472,939   397,927 
Programming rights, long term  1,253,553   1,175,988 
Other assets  255,384   371,758 
         
Total assets $3,376,553   3,174,620 
         
Current liabilities $734,524   692,465 
Long-term debt  2,633,237   2,590,440 
Other liabilities  175,255   101,571 
Mandatorily redeemable equity in subsidiaries  94,825   272,502 
Stockholders’ deficit  (261,288)  (482,358)
         
Total liabilities and stockholders’ deficit $3,376,553   3,174,620 
         


II-27

DISCOVERY HOLDING COMPANY AND SUBSIDIARIES
Notes to Consolidated Financial Statements — (Continued)

Consolidated Statements of Operations
             
  Years Ended December 31, 
  2007  2006  2005 
  amounts in thousands 
 
Revenue $3,127,333   2,883,671   2,544,358 
Cost of revenue  (1,172,907)  (1,032,789)  (907,664)
Selling, general and administrative  (1,148,246)  (1,104,116)  (928,950)
Restructuring and other charges  (20,424)  —   — 
Equity-based compensation  (141,377)  (39,233)  (49,465)
Depreciation and amortization  (130,576)  (122,037)  (112,653)
Asset impairment  (26,174)  —   — 
Gain from disposition of business  134,671   —   — 
             
Operating income  622,300   585,496   545,626 
Interest expense, net  (248,757)  (194,255)  (184,585)
Other income (expense), net  (9,063)  28,634   (7,426)
Income tax expense  (77,466)  (190,381)  (173,427)
             
Earnings from continuing operations  287,014   229,494   180,188 
Loss from discontinued operations, net of income tax  (65,023)  (22,318)  (20,568)
             
Net earnings $221,991   207,176   159,620 
             
DHC’s share of Discovery’s net earnings $141,781   103,588   79,810 
             
Note:In the third quarter of 2007, Discovery closed its 103 mall-based and stand-alone Discovery Channel stores. As a result, Discovery’s consolidated statements of operations above have been prepared to reflect the retail store business as discontinued operations.


II-41

DISCOVERY HOLDING COMPANY AND SUBSIDIARIES
Notes to Consolidated financial Statements — (Continued)
 
             
  Years Ended December 31, 
  2006  2005  2004 
  amounts in thousands 
 
Revenue $3,012,988   2,671,754   2,365,346 
Operating expenses  (1,120,377)  (979,765)  (846,316)
Selling, general and administrative  (1,170,187)  (1,005,351)  (856,340)
Equity-based compensation  (39,233)  (49,465)  (71,515)
Depreciation and amortization  (133,634)  (123,209)  (129,011)
Gain on sale of patent  —   —   22,007 
             
Operating income  549,557   513,964   484,171 
Interest expense  (194,227)  (184,575)  (167,420)
Other income (expense)  28,634   (7,426)  (6,930)
Income tax expense  (176,788)  (162,343)  (141,799)
             
Net earnings $207,176   159,620   168,022 
             
DHC’s share of net earnings $103,588   79,810   84,011 
             
(6)  (7)  Property and Equipment
During the year ended December 31, 2006, the Company retired approximated $95 million of fully depreciated property and equipment. Property and equipment at December 31, 2006 and 2005 consist of the following:
         
  2006  2005 
  amounts in thousands 
 
Property and equipment, net:        
Land $42,336   48,365 
Buildings  217,210   186,389 
Equipment  192,208   215,595 
         
   451,754   450,349 
Accumulated depreciation  (170,979)  (194,104)
         
  $280,775   256,245 
         
Property and equipment at December 31, 2007 and 2006 consist of the following:
         
  2007  2006 
  amounts in thousands 
 
Property and equipment, net:        
Land $42,525   42,336 
Buildings  222,375   217,210 
Equipment  231,460   192,208 
         
   496,360   451,754 
Accumulated depreciation  (226,618)  (170,979)
         
  $269,742   280,775 
         
 
(7)  (8)  Goodwill and Other Intangible Assets
 
The following table provides the activity and balances of goodwill:
                 
  Creative
  Network
       
  Services
  Services
       
  Group  Group  Discovery  Total 
  amounts in thousands 
 
Net balance at January 1, 2006 $200,001   162,517   1,771,000   2,133,518 
Acquisition of AccentHealth  —   32,224   —   32,224 
Goodwill impairment  (93,402)  —   —   (93,402)
Foreign exchange and other  —   2,449   —   2,449 
                 
Net balance at December 31, 2006  106,599   197,190   1,771,000   2,074,789 
Goodwill impairment  —   (165,347)  —   (165,347)
Foreign exchange and other  —   381   —   381 
                 
Net balance at December 31, 2007 $106,599   32,224   1,771,000   1,909,823 
                 
In connection with its 2007 annual evaluation of the recoverability of its goodwill, the Company estimated the value of its reporting units using a discounted cash flow analysis. The result of this valuation indicated that the fair value of the network services reporting unit was less than its carrying value. The network services reporting unit fair value was then used to calculate an implied value of the goodwill related to this reporting unit. The $165,347,000 excess of the carrying amount of the network services goodwill over its implied value was recorded as an impairment charge in the fourth quarter of 2007. The impairment charge is the result of lower future expectations for network services operating cash flow due to a continued decline in operating cash flow margins as a percent of revenue, resulting from competitive conditions in the entertainment and media services industries and increasingly complex customer requirements that are expected to continue for the foreseeable future.
On August 18, 2006, Ascent Media announced that it intended to streamline its structure into two global operating divisions — creative services group and network services group — to better align Ascent Media’s organization with the company’s strategic goals and to respond to changes within the industry driven by technology and customer requirements. The operations of the former media management services group were realigned with the other two groups and the realignment was completed in the fourth quarter of 2006. As a result of the restructuring and the declining revenue and operating cash flow performance of the former media management services group, including ongoing operating losses, this group was tested for goodwill impairment in the third quarter of 2006, prior to DHC’s annual goodwill valuation assessment of the entire company. DHC estimated the fair value of that reporting unit principally by using trading multiples of revenue and operating cash flows of similar


II-42

DISCOVERY HOLDING COMPANY AND SUBSIDIARIES
Notes to Consolidated financial Statements — (Continued)
companies in the industry. In September 2006, Ascent Media recognized a goodwill impairment loss for the former media management services group of $93,402,000, which represents the excess of the carrying value over the implied fair value of such goodwill.
Included in other assets at December 31, 2007 are amortizable intangibles with a net book value of $4,120,000 and tradename intangibles (which are not subject to amortization) of $6,040,000.
For the years ended December 31, 2007, 2006 and 2005, the Company recorded $1,591,000, $1,494,000 and balances of goodwill:
                 
  Creative
  Network
       
  Services
  Services
       
  Group  Group  Discovery  Total 
  amounts in thousands 
 
Net balance at January 1, 2005 $200,727   163,719   1,771,000   2,135,446 
Foreign exchange and other  (726)  (1,202)  —   (1,928)
                 
Net balance at December 31, 2005  200,001   162,517   1,771,000   2,133,518 
Acquisition of AccentHealth, LLC  —   32,224   —   32,224 
Goodwill impairment  (93,402)  —   —   (93,402)
Foreign exchange and other  —   2,449   —   2,449 
                 
Net balance at December 31, 2006 $106,599   197,190   1,771,000   2,074,789 
                 
On August 18, 2006, Ascent Media announced that it intended to streamline its structure into two global operating divisions — creative services group and network services group — to better align Ascent Media’s organization with the company’s strategic goals and to respond to changes within the industry driven by technology and customer requirements.


II-28

DISCOVERY HOLDING COMPANY AND SUBSIDIARIES
Notes to Consolidated Financial Statements — (Continued)

The operations of the media management services group were realigned with the other two groups and the realignment was completed in the fourth quarter of 2006.
As technology and customer requirements drove changes in this industry, revenue and operating cash flows had been declining for this group. As a result of the restructuring and the declining financial performance of the media management services group, including ongoing operating losses, the media management services group was tested for goodwill impairment in the third quarter of 2006, prior to DHC’s annual goodwill valuation assessment of the entire company. DHC estimated the fair value of that reporting unit principally by using trading multiples of revenue and operating cash flows of similar companies in the industry. In September 2006, Ascent Media recognized a goodwill impairment loss for the media management services group of $93,402,000, which represents the excess of the carrying value over the implied fair value of such goodwill.
Included in other assets at December 31, 2006 are amortizable intangibles with a net book value of $5,711,000 and tradename intangibles (which are not subject to amortization) of $6,040,000.
For the years ended December 31, 2006, 2005 and 2004, the Company recorded $1,494,000, $1,572,000, and $2,619,000, respectively, of amortization expense for other intangible assets.
 
(8)  (9)  Restructuring Charges
During 2006 and 2005, the Company completed certain restructuring activities designed to improve operating efficiencies and to strengthen its competitive position in the marketplace primarily through cost and expense reductions. In connection with these integration and consolidation initiatives, the Company recorded charges of $12,092,000 and $4,112,000, respectively. The 2006 restructuring charge related primarily to severance in the Corporate and other group in the United States and United Kingdom and to the closure of facilities in the United Kingdom. The 2005 restructuring charge relates primarily to the closure and consolidation of facilities in the United Kingdom.
The following table provides the activity and balances of the restructuring reserve.
                 
  Opening
        Ending
 
  Balance  Additions  Deductions  Balance 
  amounts in thousands 
 
Excess facility costs December 31, 2004 $3,377   —   (788)  2,589 
                 
Excess facility costs December 31, 2005 $2,589   4,112   (2,718)  3,983 
                 
Severance  155   9,005   (2,896)  6,264 
Excess facility costs  3,828   3,087   (2,251)  4,664 
                 
December 31, 2006 $3,983   12,092   (5,147)  10,928 
                 
During 2007, 2006 and 2005, the Company completed certain restructuring activities designed to improve operating efficiencies and to strengthen its competitive position in the marketplace primarily through cost and expense reductions. In connection with these integration and consolidation initiatives, the Company recorded charges of $761,000, $12,092,000 and $4,112,000, respectively. The 2007 restructuring charge related primarily to severance in conjunction with the restructuring efforts within the United Kingdom creative services business. The 2006 restructuring charge related primarily to severance in the Corporate and other group in the United States and United Kingdom and to the closure of facilities in the United Kingdom. The 2005 restructuring charge relates primarily to the closure and consolidation of facilities in the United Kingdom.
The following table provides the activity and balances of the restructuring reserve. Such amounts are recorded in other accrued liabilities and other liabilities.
                 
  Opening
        Ending
 
  Balance  Additions  Deductions  Balance 
  amounts in thousands 
 
Excess facility costs and other                
December 31, 2005 $2,589   4,112   (2,718)  3,983 
                 
Severance  155   9,005   (2,896)  6,264 
Excess facility costs  3,828   3,087   (2,251)  4,664 
                 
December 31, 2006 $3,983   12,092   (5,147)  10,928 
                 
Severance  6,264   761   (5,681)  1,344 
Excess facility costs  4,664   —   (2,703)  1,961 
                 
December 31, 2007 $10,928   761   (8,384)  3,305 
                 
 
(9)  (10)  Acquisitions
 
AccentHealth
Effective January 27, 2006, one of DHC’s subsidiaries acquired substantially all of the assets of AccentHealth, LLC’s (“AccentHealth”) healthcare media business for cash consideration of $46,793,000. AccentHealth operates an advertising-supported captive audience television network in doctor office waiting rooms nationwide. The Company recorded goodwill of $32,224,000 and other intangible assets of $9,800,000 in connection with this acquisition. Other intangible assets are included in Other assets, net on the consolidated balance sheets. The excess purchase price over the fair value of assets acquired is attributable to the growth potential of AccentHealth and expected compatibility with Ascent Media’s existing network services group.
For financial reporting purposes, the acquisition is deemed to have occurred on February 1, 2006, and the results of operations of AccentHealth have been included in DHC’s consolidated results as a part of the network services group since the date of acquisition. On a pro forma basis, the results of operations of AccentHealth are not significant to those of DHC.
Effective January 27, 2006, one of DHC’s subsidiaries acquired substantially all of the assets of AccentHealth’s healthcare media business for cash consideration of $46,793,000. AccentHealth operates an advertising-supported captive audience television network in doctor office waiting rooms nationwide. The Company recorded goodwill of $32,224,000 and other intangible assets of $9,800,000 in connection with this acquisition. Other intangible assets are included in other assets, net on the consolidated balance sheets. The excess purchase price over the fair value of assets acquired is attributable to the growth potential of AccentHealth and expected compatibility with Ascent Media’s existing network services group.
For financial reporting purposes, the acquisition is deemed to have occurred on February 1, 2006, and the results of operations of AccentHealth have been included in DHC’s consolidated results as a part of the network


II-43

DISCOVERY HOLDING COMPANY AND SUBSIDIARIES
II-29

DISCOVERY HOLDING COMPANY AND SUBSIDIARIES
Notes to Consolidated Financial Statements — (Continued)

London Playout Centre
On March 12, 2004, pursuant to an Agreement for the Sale and Purchase, Ascent Media acquired all of the issued share capital of London Playout Centre Limited (“LPC”) from an independent third party for a purchase price of $36,573,000 paid at closing. LPC is a UK-based television channel origination facility. The purchase was funded, in part, by proceeds from Liberty. The financial position and results of operations of LPC have been consolidated since the date of acquisition.
(10)  Income Taxes
Deferred income tax assets and liabilities are computed annually for differences between the financial statement and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future. Such deferred income tax asset and liability computations are based on enacted tax laws and rates applicable to periods in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. Income tax expense is the tax payable or refundable for the period plus or minus the change during the period in deferred tax assets and liabilities. Income tax benefit (expense) is as follows:
             
  Years Ended December 31, 
  2006  2005  2004 
  amounts in thousands 
 
Current:            
Federal $(1,015)  —   — 
State  (1,340)  (637)  502 
Foreign  528   2,164   (3,780)
             
Current  (1,827)  1,527   (3,278)
             
Deferred:            
Federal  (33,711)  (26,402)  (25,221)
State  (7,250)  (20,743)  (7,774)
Foreign  (1,154)  (3,218)  1,303 
             
Deferred  (42,115)  (50,363)  (31,692)
             
Total tax expense $(43,942)  (48,836)  (34,970)
             
Components of pretax income (loss) are as follows:
             
  Years Ended December 31, 
  2006  2005  2004 
  amounts in thousands 
 
Domestic $16,761   76,907   96,470 
Foreign  (18,829)  5,205   4,608 
             
  $(2,068)  82,112   101,078 
             


II-30

DISCOVERY HOLDING COMPANY AND SUBSIDIARIES
Notes to Consolidated Financial Statements — (Continued)

Income tax benefit (expense) differs from the amounts computed by applying the U.S. federal income tax rate of 35% as a result of the following:
             
  Years Ended December 31, 
  2006  2005  2004 
  amounts in thousands 
 
Computed expected tax benefit (expense) $724   (28,739)  (35,377)
State and local income taxes, net of federal income taxes  (4,477)  (3,976)  (5,311)
Change in valuation allowance affecting tax expense  (8,711)  1,630   3,575 
Goodwill impairment not deductible for tax purposes  (26,655)  —   — 
Non-deductible expenses  (2,273)  (2,361)  (476)
Change in estimated state tax rate  —   (15,263)  — 
Other, net  (2,550)  (127)  2,619 
             
Income tax expense $(43,942)  (48,836)  (34,970)
             
Components of deferred tax assets and liabilities as of December 31 are as follows:
         
  2006  2005 
  amounts in thousands 
 
Current assets:        
Accounts receivable reserves $3,572   2,350 
Accrued liabilities  12,821   14,676 
         
   16,393   17,026 
         
Noncurrent assets:        
Net operating loss carryforwards  61,956   59,064 
Property and equipment  2,743   4,771 
Intangible assets  9,497   8,249 
Other  5,784   5,506 
         
   79,980   77,590 
         
Total deferred tax assets, gross  96,373   94,616 
Valuation allowance  (96,223)  (91,235)
         
Total deferred tax assets, net  150   3,381 
         
Current liabilities:        
Prepaid expenses  (139)  (818)
Other  (1,622)  (3,010)
         
   (1,761)  (3,828)
         
Noncurrent liabilities:        
Investments  (1,174,744)  (1,131,058)
         
Total deferred tax liabilities  (1,176,505)  (1,134,886)
         
Net deferred tax liability $(1,176,355)  (1,131,505)
         


II-31

DISCOVERY HOLDING COMPANY AND SUBSIDIARIES
Notes to Consolidated Financial Statements — (Continued)

The Company’s deferred tax assets and liabilities are reported in the accompanying consolidated balance sheets as follows:
         
  December 31, 
  2006  2005 
  amounts in thousands 
 
Current deferred tax liabilities $1,761   3,828 
Long-term deferred tax liabilities, net of deferred tax assets  1,174,594   1,127,677 
         
Net deferred tax liabilities $1,176,355   1,131,505 
         
At December 31, 2006, the Company has $76,080,000 and $482,579,000 in net operating loss carryforwards for federal and state tax purposes, respectively. These net operating losses expire, for federal purposes, as follows: $6,836,000 in 2021; $61,542,000 in 2022 and $7,702,000 in 2025. The state net operating losses expire at various times from 2013 through 2025. In addition, the Company has $751,000 of federal income tax credits, which may be carried forward indefinitely. The Company has $2,584,000 of state income tax credits, of which $2,342,000 will expire in the year 2012.
During the current year, management has determined that it is more likely than not that the Company will not realize the tax benefits associated with certain cumulative net operating loss carryforwards and other deferred tax assets. As such, the Company continues to maintain a valuation allowance of $96,223,000. The total valuation allowance increased $4,988,000 during the year ended December 31, 2006 as a result of an increase in deferred tax assets related to acquisitions of $733,000, an increase of current year deferred tax assets of $8,711,000 which affected tax expense, and a decrease of prior year deferred tax assets of $4,456,000 which did not affect tax expense.
During 2006, 2005 and 2004, the Company provided ($776,000), ($34,000) and $1,636,000, respectively, of U.S. tax expense for future repatriation of cash from its Asia operations pursuant to APB 23. This charge represents all undistributed earnings from Asia not previously taxed in the United States.
The Company has deficits from its United Kingdom and Mexican operations and therefore does not have any undistributed earnings subject to United States taxation.
(11)  Stockholders’ Equity
 
Notes to Consolidated financial Statements — (Continued)
services group since the date of acquisition. On a pro forma basis, the results of operations of AccentHealth are not significant to those of DHC.
(11)  Income Taxes
The Company’s income tax benefit (expense) is as follows:
             
  Years Ended December 31, 
  2007  2006  2005 
  amounts in thousands 
 
Current            
Federal $(584)  (1,015)  — 
State  (2,075)  (1,340)  (637)
Foreign  (145)  528   2,164 
             
   (2,804)  (1,827)  1,527 
             
Deferred            
Federal  (46,079)  (33,711)  (26,402)
State  (9,925)  (7,250)  (20,743)
Foreign  (349)  (1,154)  (3,218)
             
   (56,353)  (42,115)  (50,363)
             
Total tax expense $(59,157)  (43,942)  (48,836)
             
Components of pretax income (loss) are as follows:
             
  Years Ended December 31, 
  2007  2006  2005 
  amounts in thousands 
 
Domestic $10,036   16,761   76,907 
Foreign  (19,271)  (18,829)  5,205 
             
  $(9,235)  (2,068)  82,112 
             
Income tax benefit (expense) differs from the amounts computed by applying the U.S. federal income tax rate of 35% as a result of the following:
             
  Years Ended December 31, 
  2007  2006  2005 
  amounts in thousands 
 
Computed expected tax benefit (expense) $3,232   724   (28,739)
State and local income taxes, net of federal income taxes  (3,015)  (4,477)  (3,976)
Change in valuation allowance affecting tax expense  (25,181)  (8,711)  1,630 
Goodwill impairment not deductible for tax purposes  (26,421)  (26,655)  — 
U.S. taxes on foreign income  (3,503)  776   34 
Non-deductible expenses  (1,960)  (2,273)  (2,361)
Change in estimated state tax rate  —   —   (15,263)
Other, net  (2,309)  (3,326)  (161)
             
Income tax expense $(59,157)  (43,942)  (48,836)
             


II-44

DISCOVERY HOLDING COMPANY AND SUBSIDIARIES
Notes to Consolidated financial Statements — (Continued)
Components of deferred tax assets and liabilities as of December 31 are as follows:
         
  2007  2006 
  amounts in thousands 
 
Current assets:        
Accounts receivable reserves $3,127   3,572 
Accrued liabilities  11,241   12,821 
         
   14,368   16,393 
         
Noncurrent assets:        
Net operating loss carryforwards  58,309   61,956 
Intangible assets  39,971   9,497 
Other  5,809   8,527 
         
   104,089   79,980 
         
Total deferred tax assets, gross  118,457   96,373 
Valuation allowance  (117,551)  (96,223)
         
Total deferred tax assets, net  906   150 
         
Current liabilities:        
Other  (2,000)  (1,761)
         
Noncurrent liabilities:        
Investments  (1,228,965)  (1,174,744)
Other  (883)  — 
         
   (1,229,848)  (1,174,744)
         
Total deferred tax liabilities  (1,231,848)  (1,176,505)
         
Net deferred tax liability $(1,230,942)  (1,176,355)
         
The Company’s deferred tax assets and liabilities are reported in the accompanying consolidated balance sheets as follows:
         
  December 31, 
  2007  2006 
  amounts in thousands 
 
Current deferred tax liabilities $2,000   1,761 
Long-term deferred tax liabilities, net of deferred tax assets  1,228,942   1,174,594 
         
Net deferred tax liabilities $1,230,942   1,176,355 
         
At December 31, 2007, the Company has $53,084,000 and $536,608,000 in net operating loss carryforwards for federal and state tax purposes, respectively. These net operating losses expire, for federal purposes, as follows: $45,382,000 in 2022 and $7,702,000 in 2025. The state net operating losses expire at various times from 2013 through 2026. In addition, the Company has $1,181,000 of federal income tax credits, which may be carried forward indefinitely. The Company has $2,584,000 of state income tax credits, of which $2,342,000 will expire in the year 2012.
For tax years prior to the 2005 Spin Off, DHC was included in the consolidated tax returns of Liberty. The tax provisions included in the historical financial statements of DHC for these periods were prepared on a separate return basis. To the extent Liberty used net operating losses and capital losses (collectively, “NOLs”) generated by


II-45

DISCOVERY HOLDING COMPANY AND SUBSIDIARIES
Notes to Consolidated financial Statements — (Continued)
DHC, such usage was reflected as a dividend from DHC to Liberty. However, because DHC was not expected to be able to use such NOLs, a full valuation allowance had been recorded by DHC and there was no impact to equity when the NOLs were dividended to Liberty. As required by federal and state tax regulations, a portion of the NOLs were allocated to DHC on the Spin Off Date. These NOLs remain subject to adjustments made by the respective taxing authorities. In the event that the NOLs are adjusted due to IRS or other tax authority audits or settlements, the amount of the NOLs allocated to DHC could be changed. In connection with its adoption of FIN 48, Liberty recorded reserves for tax positions related to periods prior to the 2005 Spin Off, which resulted in a reduction of its NOL’s for financial reporting purposes. As a result, the amount of DHC’s NOL’s utilized by Liberty while DHC was part of its consolidated income tax return is increased which in turn reduces the amount of NOLs allocated to DHC in the 2005 Spin Off. Accordingly, DHC reversed deferred tax assets of $4,157,000 and an offsetting amount in its valuation allowance with no net impact to its consolidated financial statements.
Subsequent to December 31, 2007, Liberty entered into an agreement with the IRS for certain tax issues related to periods prior to the 2005 Spin Off, which has the effect of reducing DHC’s federal and state NOLs by approximately $27 million and $54 million, respectively.
During the current year, management has determined that it is more likely than not that the Company will not realize the tax benefits associated with certain cumulative net operating loss carryforwards and other deferred tax assets. As such, the Company continues to maintain a valuation allowance of $117,551,000. The total valuation allowance increased $21,328,000 during the year ended December 31, 2007 as a result of an increase of $25,181,000, which affected tax expense, a decrease of $4,157,000 for the reversal of deferred tax assets allocated from Liberty as described above, and foreign exchange rate changes of $304,000.
Upon adoption of FIN 48 on January 1, 2007, the Company reversed $255,000 of tax liabilities included in its December 31, 2006 consolidated balance sheet with a corresponding decrease to accumulated deficit. Discovery recorded a $5,011,000 net tax liability upon adoption of FIN 48, and the Company recorded its 50% share, or $1,515,000, directly to accumulated deficit, net of a $991,000 deferred tax impact.
As of December 31, 2007, the Company’s tax reserves related to unrecognized tax benefits for uncertain tax positions were not significant. The Company does not expect that the total amounts of unrecognized tax benefits will significantly increase or decrease during the year ended December 31, 2008.
When the tax law requires interest to be paid on an underpayment of income taxes, the Company recognizes interest expense from the first period the interest would begin accruing according to the relevant tax law. Such interest expense is included in other income, net in the accompanying consolidated statements of operations. Any accrual of penalties related to underpayment of income taxes on uncertain tax positions is included in Other income, net in the accompanying consolidated statements of operations. As of December 31, 2007, accrued interest and penalties related to uncertain tax positions were not significant.
As of December 31, 2007, the Company’s tax returns for the period July 21, 2005 through December 31, 2007 remain subject to examination by the IRS for federal income tax purposes.
During 2007, 2006 and 2005, the Company provided $3,503,000, ($776,000) and ($34,000), respectively, of U.S. tax expense (benefit) for future repatriation of cash from its Singapore operations pursuant to APB 23. This charge represents all undistributed earnings from Singapore not previously taxed in the United States.
The Company has deficits from its United Kingdom and Mexican operations and therefore does not have any undistributed earnings subject to United States taxation.


II-46

DISCOVERY HOLDING COMPANY AND SUBSIDIARIES
Notes to Consolidated financial Statements — (Continued)
(12)  Stockholders’ Equity
Preferred Stock
DHC’s preferred stock is issuable, from time to time, with such designations, preferences and relative participating, optional or other rights, qualifications, limitations or restrictions thereof, as shall be stated and expressed in a resolution or resolutions providing for the issue of such preferred stock adopted by DHC’s Board of Directors. As of December 31, 2006,
DHC’s preferred stock is issuable, from time to time, with such designations, preferences and relative participating, optional or other rights, qualifications, limitations or restrictions thereof, as shall be stated and expressed in a resolution or resolutions providing for the issue of such preferred stock adopted by DHC’s Board of Directors. As of December 31, 2007, no shares of preferred stock were issued.
 
Common Stock
Holders of DHC Series A common stock are entitled to one vote for each share held, and holders of DHC Series B common stock are entitled to 10 votes for each share held. Holders of DHC Series C common stock are not entitled to any voting powers, except as required by Delaware law. As of December 31, 2006,
Holders of DHC Series A common stock are entitled to one vote for each share held, and holders of DHC Series B common stock are entitled to 10 votes for each share held. Holders of DHC Series C common stock are not entitled to any voting powers, except as required by Delaware law. As of December 31, 2007, no shares of DHC Series C common stock were issued. Each share of the Series B common stock is convertible, at the option of the holder, into one share of Series A common stock. The Series A and Series B common stock participate on an equal basis with respect to dividends and distributions.
As of December 31, 2007, there were 1,152,292 shares of DHC Series A common stock and 2,996,525 shares of DHC Series B common stock reserved for issuance under exercise privileges of outstanding stock options.
 
As of December 31, 2006, there were 1,943,804 shares of DHC Series A common stock and 2,996,525 shares of DHC Series B common stock reserved for issuance under exercise privileges of outstanding stock options.
(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 GovernanceExhibits 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:
Management’s Report on Internal Control over Financial Reporting
II-15
Report of Independent Registered Public Accounting Firm
II-16
Report of Independent Registered Public Accounting Firm
II-17
Consolidated Balance Sheets, December 31, 2006 and 2005
II-18
Consolidated Statements of Operations and Comprehensive Earnings (Loss), Years ended December 31, 2006, 2005 and 2004
II-19
Consolidated Statements of Cash Flows, Years Ended December 31, 2006, 2005 and 2004
II-20
Consolidated Statements of Stockholders’ Equity, Years ended December 31, 2006, 2005 and 2004
II-21
Notes to Consolidated Financial Statements, December 31, 2006, 2005 and 2004
II-22Certain 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.
 
Report of Independent Registered Public Accounting Firm
(a) (1)  Financial Statements
Included in Part II of this Report:
IV-3
Consolidated Balance Sheets, December 31, 2006 and 2005
IV-4
Consolidated Statements of Operations, Years ended December 31, 2006, 2005 and 2004
IV-5
Consolidated Statements of Cash Flows, Years ended December 31, 2006, 2005 and 2004
IV-6
Consolidated Statements of Changes in Stockholders’ Deficit, Years ended December 31, 2006, 2005 and 2004
IV-7
Page No.
Discovery Holding Company:
Management’s Report on Internal Control over Financial Reporting
II-26
Report of Independent Registered Public Accounting Firm
II-27
Report of Independent Registered Public Accounting Firm
II-28
Consolidated Balance Sheets, December 31, 2007 and 2006
II-29
Consolidated Statements of Operations and Comprehensive Earnings (Loss), Years ended December 31, 2007, 2006 and 2005
II-30
Consolidated Statements of Cash Flows, Years Ended December 31, 2007, 2006 and 2005
II-31
Consolidated Statements of Stockholders’ Equity, Years ended December 31, 2007, 2006 and 2005
II-32 
Notes to Consolidated Financial Statements, December 31, 2007, 2006 and 2005
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:
Report of Independent Registered Public Accounting Firm
IV-3
Report of Independent Registered Public Accounting Firm
IV-4
Consolidated Balance Sheets, December 31, 2007 and 2006
IV-5
Consolidated Statements of Operations, Years ended December 31, 2007, 2006 and 2005
IV-6
Consolidated Statements of Cash Flows, Years ended December 31, 2007, 2006 and 2005
IV-7
Consolidated Statements of Changes in Members’ Equity and Stockholders’ Deficit, Years ended December 31, 2007, 2006 and 2005
  IV-8 
Notes to Consolidated Financial Statements
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:
10.1Amended 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.
10.2Form of Tax Sharing Agreement between Liberty Media Corporation and DHC (incorporated by reference to Exhibit 10.6 to the Form 10).
10.3Discovery 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).
10.4Discovery 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).
10.5Discovery 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).
10.6Agreement between DHC and John C. Malone (incorporated by reference to Exhibit 10.10 to the Form 10).
10.7Agreement, dated June 24, 2005, between Discovery and DHC (incorporated by reference to Exhibit 10.11 to the Form 10).
10.8Indemnification Agreement, dated as of June 24, 2005, between Cox and DHC (incorporated by reference to Exhibit 10.12 to the Form 10).
10.9Indemnification Agreement, dated as of June 24, 2005, between NewChannels and DHC (incorporated by reference to Exhibit 10.13 to the Form 10).
10.10Form 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.
23.1Consent of KPMG LLP, filed herewith.
23.2Consent of PricewaterhouseCoopers LLP, filed herewith.
31.1Rule 13a-14(a)/15d — 14(a) Certification, filed herewith.
31.2Rule 13a-14(a)/15d — 14(a) Certification, filed herewith.
31.3Rule 13a-14(a)/15d — 14(a) Certification, filed herewith.
32 — Section 1350 Certification, filed herewith.

IV-2

10 — Material Contracts:
10.1The 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 reference
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 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).
10.2First 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).
10.3Second 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).
10.4Third 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).
10.5Fourth 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).
10.6Form of Tax Sharing Agreement between Liberty Media Corporation and DHC (incorporated by reference to Exhibit 10.6 to the Form 10).
10.7Discovery Holding Company 2005 Incentive Plan (incorporated by reference to Exhibit 10.7 to the Form 10).
10.8Discovery Holding Company 2005 Non-Employee Director Plan (incorporated by reference to Exhibit 10.8 to the Form 10).
10.9Discovery Holding Company Transitional Stock Adjustment Plan (incorporated by reference to Exhibit 10.9 to the Form 10).
10.10Agreement between DHC and John C. Malone (incorporated by reference to Exhibit 10.10 to the Form 10).
10.11Agreement, dated June 24, 2005, between Discovery and DHC (incorporated by reference to Exhibit 10.11 to the Form 10).
10.12Indemnification Agreement, dated as of June 24, 2005, between Cox and DHC (incorporated by reference to Exhibit 10.12 to the Form 10).
10.13Indemnification Agreement, dated as of June 24, 2005, between NewChannels and DHC (incorporated by reference to Exhibit 10.13 to the Form 10).
10.14Form 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.
23.1Consent of KPMG LLP, filed herewith.
23.2Consent of PricewaterhouseCoopers LLP, filed herewith.
31.1Rule 13a-14(a)/15d — 14(a) Certification, filed herewith.
31.2Rule 13a-14(a)/15d — 14(a) Certification, filed herewith.
31.3Rule 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.
Consolidated Balance Sheets
         
  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.
Consolidated Statements of Operations
             
  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.
Consolidated Statements of Cash Flows
             
  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.
Consolidated Statements of Changes in Stockholders’ Deficit
                                 
              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.
Notes to Consolidated Financial Statements
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
Consolidated Balance Sheets
          
  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
Consolidated Statements of Operations
                  
  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
Consolidated Statements of Cash Flows
                  
  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
Consolidated Statements of Changes in Member’s Equity and Stockholders’ Deficit
                                 
              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
Notes to Consolidated Financial Statements
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 
4.  Business Combinations
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)
6.  Content Rights
 
        
         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
9.  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,
11.  Debt
          
  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)

16.  15.  Income Taxes
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, 2007By
/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.
 10.2First 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).
10.3Second 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).
10.4Third 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).
10.5Fourth 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.
31.2Rule 13a-14(a)/15d — 14(a) Certification, filed herewith.
 31.231.3  Rule 13a-14(a)/15d — 14(a) Certification, filed herewith.
31.3Rule 13a-14(a)/15d — 14(a) Certification, filed herewith.
32 — Section 1350 Certification, filed herewith.