Third Quarter Earnings Down for Discovery - Broadcasting & Cable

Third Quarter Earnings Down for Discovery

Updated: Distribution revenues fall after big payment a year ago
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Updated: 4:12 p.m. ET

Discovery Communications' third-quarter profits were lower
than a year ago, when the company signed a big streaming deal with Netflix.

Net income fell to $205 million, or 57 cents a share, from
$237 million, or 60 cents a share, a year ago. In addition to the Netflix deal,
Discovery was also hurt by foreign exchange swings and increased losses at
equity investments including the Oprah Winfrey Network.

Revenues dipped slightly to $1.08 billion, with U.S.
revenues dropping 4%, more than offsetting a 7% gain in international revenues.

Discovery CFO Andy Warren told analysts on the company's
earnings call that while OWN's losses were higher in the quarter, they were
non-cash losses. Part of OWN's losses resulted from  higher marketing spending, but that spending
paid off in a 60% increase in ratings during the quarter, Warren said.

"The second part the losses that flowed through our other
income line were content write-offs at OWN as the new content is performing so
well, we're just writing off some of the library product."

Warren added that as OWN's performance improves, Discovery
has to pour less money into the channel and expects to invest less in it in
2012 than it did in 2011.

"Clearly the business is performing better than we had hoped"
when Discovery forecast OWN would break even in the second half of 2013,"
Warren said. "We're right in line with, again, if not better than we had thought.

Discovery also said it was less optimistic about its revenue
for 2012, lowering its full year guidance for revenue.

Discovery now expects total revenue to be between $4.475
billion and $4.525 billion, partly because of the sale of its Creative Sound
Services unit, which generated $75 million in revenue but was profit neutral
according to Warren. In February it said it expected revenue to be between
$4.450 billion and $4.575 billion.

Discovery also said it expects operating income before
depreciation and amortization to be between $2.125 billion and $2.15 billion, compared
to its earlier guidance of $2.050 and $2.15 billion. It expects net income of
$975 million to $1.025 billion vs. a $975 million to $1.075 billion range.

Free cash flow is still expected to be about $1 billion for
2012, Warren said.

After ramping up program spending in 2012, next year, Warren
said, Discovery will have a $50 million to $60 million increase in content
expense next year as it amortizes the content. Warren said Discovery expects to
growth in programming spending to slow in 2013. In both years, spending growth
will be in the double-digit range.

Adjusted income at Discovery's U.S. Networks group increased
2% to $386 million. The company said that operating expenses were down 13%.
Revenues dropped 4% compared to the year ago quarter, when the company realized
gains from an extended and expanded licensing agreement to stream programming.

"Advertising revenues grew 7% to $343 million as ratings and
prices rose. Advertising this quarter was negatively impacted by the Olympics
as well as our soft July ratings," Warren said.  "Current ad market trends continue to be
encouraging with sustained double-digit scatter pricing on top of the gains we
garnered during this year's upfront negotiations. We have seen some pockets of
softness with regard to volume but the overall environment remains relatively
healthy." He said volume has picked up since early October, when sales were
slow.

"The domestic advertising market it feels quite strong now,"
added CEO David Zaslav. "There was a period for about two weeks where the
pricing was there, but the volume wasn't there. We did hold price, but the
volume has come back and the price is still more than double-digit over high
double-digit over upfront and so we're feeling good about that domestically."

Total distribution revenue fell 14% to $300 million.
"Higher rates and subscriber growth primarily from networks carried on the
digital tier were more than offset by revenues from an extended and expanded
licensing agreement in the third quarter of 2011," the company said in its
earnings announcement. "Excluding licensing revenues, distribution
revenues grew 5% compared with the third quarter a year ago."

Income at Discovery's international networks was up 11% to $173
million. Excluding the impact of foreign currency, income was up 16%.

Overall, Discovery's results were below Wall Street
expectations.

Todd Juenger of Bernstein Research said the surprises could
be grouped in two buckets.

Some were operational, including an international
advertising revenue drop because of the Olympics and OWN's losses. "The
operational surprises were one-time (and furthermore, OWN was non-cash) and do
not affect the growth profile of the business going forward," Juenger said.

The other surprises involved management decisions, including
the sale of Creative Sound Services and a tax restructuring.

"The management decisions sacrifice some short-term earnings
(tax) and/or revenue (CSS) but will improve the growth and profitability going
forward," Juenger said.

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