Oprah Network Hurts Discovery Earnings

UPDATED: U.S. ad revenues show 13% gain

By Jon Lafayette -- Broadcasting & Cable, 5/8/2012 8:59:46 AM

RELATED: Zaslav: OWN Will Break Even in 2013

Updated 3: 55 p.m. ET

Discovery Communications reported lower first-quarter profits in part because of losses from OWN, its joint venture with Oprah Winfrey.

Net income was $221 million, or 57 cents per share, down 27% from $305 million, or 74 cents per share. Discovery said it began recording OWN's net losses in other expenses and that OWN's operating losses exceeded the equity contributed to OWN. Other expenses -- mainly from OWN -- were $50 million, up from $ 7 million a year ago and cost Discovery $10 million in net income.

A year ago, Discovery also had a $102 million gain from the contribution of the Discovery Health Network to the OWN joint venture. Without the prior year gains, net income was up 9%.

Revenues rose 16% to $1.1 billion.

Discovery stock was down more than 6% to $50.73 a share following the earnings report.

"Discovery is off to a great start in 2012 with strong first quarter results that built upon the consistent financial and operating momentum we generated throughout 2011. Viewers around the world are spending more time with our networks than ever before, and we are leveraging the demand for our programming across a worldwide ad market that remains healthy," David Zaslav, president and CEO, said in a statement.

"The universal appeal of our content is also providing us further opportunities to capitalize on developing distribution systems and an evolving global pay-TV landscape. Investing in our brands to maximize the potential of our unique distribution platform, as well as emerging opportunities, remains a priority and we are focused on doing so while delivering sustained growth and returning capital to shareholders," Zaslav said.

During the company's earnings conference call with analysts, new Discovery CFO Andrew Warren said the during the first quarter -- and earlier than most analysts expected -- Discovery began recording 100% of OWN's net losses as the accumulated operating losses because OWN had fully depleted its equity balance.

"We'll therefore going forward continue to record 100% of the OWN results to equity income, as long as OWN has depleted equity. The net impact for the quarter of recording 100% of the losses was approximately $10 million net of tax, or $0.03 per share," Warren said.

On the call, Zaslav said the $50 million in losses included restructuring costs at OWN and the write-off of cancelled programming, including the Rosie O'Donnell talk show. "Those were unusual events in the first quarter that added to that loss profile, but there will definitely be less losses going forward," he said.

Now, the joint venture is in a better place, Zaslav said. "OWN has taken significant steps recently that will help the network improve its financial position moving forward, including structuring deals with meaningful sub fees with the majority of MSOs, including most recently, expanding and broadening its affiliate relationship with Comcast. In addition, we attacked the cost structure by streamlining the operations and canceled several series that audiences were not connecting with."

He added that the network now has an "appropriate cost structure" and a broad, fee-paying distribution system in place, "we remain confident in the growth potential of this network."

With those conditions in place, "we anticipate funding to OWN in 2012 will be less than 2011 and we expect to achieve cash flow breakeven during the second half of 2013," he said.

Adjusted operating income rose 18% to $385 million at Discovery's U.S. networks. Revenue at the company's U.S. networks rose 16% to $681 million. Advertising revenue rose 13% to $329 million, thanks to improved ratings, price increases and higher sellouts.

Zaslav noted that this was the eight quarter in a row of double-digit ad revenue increases. Because of strong growth last year and an $8 million special item in last year's second quarter, the company is predicted that second quarter ad revenues will be up in the high single digits.

"We recently completed our upfront presentations, and while it is always difficult to predict where the upfront market will ultimately end up, with strong scatter volumes, scatter pricing well above last year's upfront, sustained ratings momentum across our networks, a diverse brand portfolio and the best ad sales team in the business, we expect to see significant increases in this year's upfront," Zaslav said.

Distribution revenues climbed 23% to $337 million, in part due to digital licensing agreements. Without those, distribution revenues were up 5%, the company said.

Discovery increased its guidance for analysts for all of 2012. It expects total revenue to be between $4.55 billion and $4.65 billion, adjusted OIBDA to finish between $2.125 billion and $2.2 billion, and net income available to Discovery stockholders to be between $1 billion and $1.1 billion.

Analyst Anthony DiClemente said that "below-the-line losses at OWN obscured otherwise strong 1Q results from Discovery."

In a report Tuesday afternoon he said that "ad growth was impressive globally, domestic affiliate fees benefited from the recent Amazon deal, international affiliate fees revealed considerable pay-TV penetration runway, and a $1B increase to the buyback program enhanced the return of capital story. Heading into the upfront, we think Discovery has the best positioned cable network portfolio given its strong ratings momentum."