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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 |
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For the fiscal year ended December 31, 2005 |
or |
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 |
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For the transition period
from to |
Commission File Number 000-51205
Discovery Holding Company
(Exact name of Registrant as specified in its charter)
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State of Delaware |
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20-2471174 |
(State or other jurisdiction of
incorporation or organization) |
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(I.R.S. Employer Identification No.) |
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12300 Liberty Boulevard
Englewood, Colorado |
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80112
(Zip Code) |
(Address of principal executive offices) |
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Registrants telephone number, including area code:
(720) 875-4000
Securities registered pursuant to Section 12(b) of the
Act:
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Name of exchange on |
Title of each class |
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which registered |
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Series A Common Stock, par value $.01 per share
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Nasdaq |
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Series B Common Stock, par value $.01 per share
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Nasdaq |
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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 o No þ
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 of
Regulation S-K is
not contained herein, and will not be contained, to the best of
Registrants knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this
Form 10-K or any
amendment to this
Form 10-K.
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Indicate by check mark whether the Registrant is a large
accelerated filer, an accelerated filer, or a non-accelerated
filer (as defined in
Rule 12b-2 of the
Act).
Large accelerated
filer o Accelerated
filer o Non-accelerated
filer þ
Indicate by check mark whether the Registrant is a shell company
(as defined in
Rule 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 February 28, 2006, was approximately
$4.1 billion.
The number of shares outstanding of Discovery Holding
Companys common stock as of February 28, 2006 was:
Series A Common Stock 268,097,442; and
Series B Common Stock 12,106,093 shares.
DOCUMENTS INCORPORATED BY REFERENCE
The Registrants definitive proxy statement for its 2006
Annual Meeting of Shareholders is hereby incorporated by
reference into Part III of this Annual Report on
Form 10-K
DISCOVERY HOLDING COMPANY
2005 ANNUAL REPORT ON
FORM 10-K
Table of Contents
PART I.
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(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 Libertys 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 is intended to qualify as a
tax-free transaction.
We are a holding company. Through our wholly owned subsidiary,
Ascent Media Group, LLC, and our 50% owned equity affiliate
Discovery Communications, Inc., 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,
media management and network services to the media and
entertainment industries. Our subsidiaries and affiliates
operate in the United States, Europe, Latin America and Asia.
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 allow 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 160 countries across six continents,
with over 1 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, we acquired AccentHealth LLC for cash
consideration of $45 million, plus working capital
adjustments of $2.0 million. Accent Health operates an
advertising-supported captive audience television network in
approximately 11,000 doctor office waiting rooms nationwide.
* * * * *
Certain statements in this Annual Report on
Form 10-K
constitute forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995. To the extent
that statements in this Annual Report are not recitations of
historical fact, such statements constitute forward-looking
statements which, by definition, involve risks and
uncertainties. In some cases, you can identify these statements
by our use of forward-looking words such as may,
should, anticipate,
estimate, expect, plan,
believe, predict, potential,
intend and other words of similar substance. In
particular, statements under Item 1. Business,
Item 1A. Risk Factors, Item 2.
Properties, Item 3. Legal
Proceedings, Item 7. Managements
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
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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:
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general economic and business conditions and industry trends
including the timing of, and spending on, feature film and
television production; |
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spending on domestic and foreign television advertising and
spending on domestic and foreign first-run and existing content
libraries; |
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the regulatory and competitive environment of the industries in
which we, and the entities in which we have interests, operate; |
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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; |
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changes in the distribution and viewing of television
programming, including the expanded deployment of personal video
recorders and other technology, and their impact on television
advertising revenue; |
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rapid technological changes; |
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uncertainties associated with product and service development
and market acceptance, including the development and provision
of programming for new television and telecommunications
technologies; |
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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; |
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the ability of suppliers and vendors to deliver products,
equipment, software and services; |
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the outcome of any pending or threatened litigation; |
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availability of qualified personnel; |
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the possibility of an industry-wide strike or other job action
affecting a major entertainment industry union; |
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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; |
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changes in the nature of key strategic relationships with
partners and joint venturers; |
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competitor responses to our products and services, and the
products and services of the entities in which we have
interests; and |
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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.
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(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
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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 four reportable segments
are our Creative Services Group, Media Management Group and
Network Services Group, which are all operating segments of
Ascent Media, and Discovery, which is an equity affiliate.
Financial information related to our operating segments can be
found in note 18 to our consolidated financial statements
found in Part II of this report.
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(c) |
Narrative Description of Business |
Ascent Media provides a wide variety of creative, media
management and network services to the media and entertainment
industries. Ascent Medias clients include the major motion
picture studios, independent producers, broadcast networks,
programming networks, advertising agencies and other companies
that produce, own and/or distribute entertainment, news, sports,
corporate, educational, industrial and advertising content.
Ascent Medias operations are organized into three main
categories: creative services, media management services and
network services.
Ascent Medias 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.
Ascent Media markets its creative services under various
well-known brand names, including Company 3, Design
Music Group (DMG), Digital Symphony, Encore Hollywood, FilmCore,
Level 3 Post, Method, Modern Music, One Post, POP Sound,
R!OT, Rushes, Soho Images, Soundelux, Sound One, St. Annes
Post, and Todd-AO. The creative services client base
comprises the major domestic film studios, independent
television production companies, broadcast networks, advertising
agencies, creative editorial companies and corporate media
producers. The principal facilities of the creative services
group are in Los Angeles, New York, Atlanta, San Francisco,
Mexico City and London.
Key services provided by Ascent Medias creative services
group include the following:
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Dailies. Clients require daily screening of their
previous days recorded work in order to evaluate technical
and aesthetic qualities of the production and to begin the
creative editorial process. Ascent Media provides the film
development, digital transfer from film to video and video
processing necessary for clients to view principal photography
on a daily basis, also known as dailies. For clients
that record their productions on film, Ascent Media processes
and prints film negatives for film projection. The company also
delivers dailies that are transferred from film to digital media
using telecine equipment. The transfer process is technically
challenging and is used 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 processed in
high definition or standard definition video and can be screened
in a nonlinear manner on a variety of playback equipment. |
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Telecine. Telecine is the process of transferring film
into video (in either analog 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 Media also provides
live telecine services via satellite, using a secure closed
network able |
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to accurately transmit subtle color changes to connect its
telecine artists with client offices or other affiliated
post-production facilities. |
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Digital intermediates. Ascent Medias digital
intermediates 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 file can then
be converted back to film. |
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Creative editorial. After principal photography has been
completed, Ascent Medias editors assemble the various
elements into a cohesive story consistent with the messaging,
branding and creative direction by Ascent Medias
advertising agency clients. Ascent Media provides the tools and
talent required to support its clients through all stages of the
editing process, beginning with the low-resolution digital
images 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, Ascent Media is able to offer expanded communications
infrastructure to provide digital images directly from the
film-to-tape transfer
process to a workstation through dedicated data lines. |
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Visual effects. Visual effects are used to enhance the
viewing audiences experience by supplementing images
obtained in principal photography with computer-generated
imagery and graphical elements. Visual effects are typically
used to create images that cannot be created by any other
cost-effective means. Ascent Media also provides services on an
array of graphics and animation workstations using a variety of
software to accomplish unique effects, including
three-dimensional animation. |
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Assembly, formatting 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
program to meet specific network requirements, including time
compression and commercial breaks. Finally, Ascent Media creates
multiple master videotapes for delivery to the network for
broadcast, archival and other purposes designated by the
customer. |
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Distribution. Once a television commercial has been
completed, Ascent Media provides broadcast and support services,
including complete video and audio duplication, distribution,
and storage and asset management, for advertising agencies,
corporate advertisers and entertainment companies. Ascent Media
uses domestic and international satellite, fiber and Integrated
Services Digital Network, or ISDN, Internet access, 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. Ascent Medias commercial television
distribution facilities in Los Angeles and San Francisco,
California enable Ascent Media to service any regional or
national client. |
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Sound supervision, sound design and sound editorial.
Ascent Media provides creative talent, state of the art
facilities and support services to 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 Medias 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). |
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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. |
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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 of 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, |
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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. |
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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 companys intranet and remotely via the
Internet. The company also owns several production music
libraries through its Hollywood Edge brand. Ascent Medias
clients use the sound effects and music libraries in feature
films, television shows, commercials, interactive and multimedia
games. The company actively continues to add new, original
recordings to its library. |
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Media Management Services |
Ascent Medias media management services group provides
owners of content libraries with a full complement of facilities
and services necessary to optimize, archive, manage and
repurpose media assets for global distribution via freight,
satellite, fiber and the Internet. Ascent Medias media
facilities are located in Burbank, Hollywood and Santa Monica,
California; Northvale, New Jersey; and London, England. The
media management services client base includes the major motion
picture studios and their international divisions as well as
independent owners of television and film libraries and emerging
new media distribution channels.
In 2005, Ascent Media completed construction of its
100,000 square foot Digital Media Data Center, or DMDC, in
Burbank, California. The DMDC now contains a significant portion
of Ascent Medias media management services business in
Southern California.
Key services provided by Ascent Medias media management
services group include the following:
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Negative developing and cutting. Ascent Medias film
laboratories provide negative developing for television shows
such as one-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. |
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Restoration, preservation and asset protection of existing
and damaged content. Through its recently-acquired facility,
Cinetech, and its other laboratory facilities, Ascent Media
provides film restoration, preservation and asset protection
services. Ascent Medias technicians use photochemical and
digital processes to clean, repair and rebuild a films
elements in order to return the content to its original and
sometimes improved image quality. Ascent Media also protects
film element content from future degradation by transferring the
films 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. |
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Transferring film to analog video or digital media. A
considerable amount of film content is ultimately distributed to
the home video, broadcast, cable or pay-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 Medias film transfer business. Ascent Media also
digitally removes dirt and scratches from a damaged film master
that is transferred to a digital file format. |
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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 |
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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 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 and pay-per-view programmers, broadcast
networks, television stations, airlines, home video duplicators
and foreign distributors. Ascent Medias duplication and
standards conversion facilities are technically advanced with
unique characteristics that significantly increase equipment
capacity while reducing error rates and labor cost. |
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Syndicated television distribution. Ascent Medias
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. |
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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 as
video-on-demand and
interactive television. |
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Storage of original elements and working masters. Ascent
Medias 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 Medias 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
Medias operations. |
Ascent Medias network services group provides services to
broadcast, cable and satellite programming networks, local
television channels, broadcast syndicators, satellite
broadcasters, other broadband telecommunications companies and
corporations that operate private networks. Ascent Medias
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 Medias network services
group include the following:
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Network origination and master control. The network
services group provides videotape and file-based playback and
origination to cable, satellite and pay-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. Ascent Media also operates industry-standard
encryption and/or compression systems as needed for customer
satellite transmission and offers quality control, tape storage
and trafficking services. Ascent Media operates television
production studios with
live-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. For programming
designed for export to other markets, Ascent Media provides
language translation, subtitling and voice dubbing. Currently,
over two hundred 24/ 7 programming feeds are supported by Ascent
Medias facilities in the United States, London and
Singapore. |
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Satellite transport. Ascent Media operates satellite
earth station facilities in Singapore, California, New York, New
Jersey, Minnesota, Connecticut and Florida. Ascent Medias
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
Medias teleports are high-bandwidth
communications gateways with video switches and facilities for
satellite, optical fiber and microwave transmission. Ascent
Medias facilities offer satellite antennae capable of
transmitting and receiving feeds in both
C-Band and
Ku-Band frequencies.
Ascent Media also provides transportable services, including
point-to-point
microwave transmission, transportable up-link and downlink
transmission and broadcast quality teleconference services. |
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Engineering and systems integration. Ascent Media
designs, builds, installs and services advanced video systems
for the broadcast, cable television and other broadband
telecommunications industries and other professional and
corporate markets. Ascent Medias engineering and systems
integration clients include major broadcast networks, numerous
cable channels, corporate television networks, a major
telecommunications company as well as multiple production and
post-production facilities. |
The entertainment services industry has been historically
fragmented with numerous providers offering discrete,
geographically-limited, non-integrated services. Ascent
Medias services, however, span the entirety of the value
chain from the creation and management of content to the
delivery of 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; common best
practices operations management across the Ascent Media
enterprise; and integration of financial and administrative
functions. In Ascent Medias media management and network
services businesses, and with large institutional clients that
utilize a broad range of its services, Ascent Media intends to
build brand awareness on a global basis and promote its
integrated suites of services, while continuing to support the
identity and customer loyalty associated with Ascent
Medias established boutique brands in the
creative services industry. Ascent Media intends to optimize its
position in the market by pursuing the following strategies:
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Increase scale of operations. Ascent Media intends to
increase the scale of its operations through a combination of
internal investment in facilities and capital expenditures 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. |
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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 gradually attracting new
customers with unique service needs that are less susceptible to
competitive threats. One growth initiative is to expand Ascent
Medias service offerings for a growing number of
non-traditional networks, also referred to as captive audience
networks. DHCs acquisition of AccentHealth a
health media company with a captive audience network that
reaches 19 million consumers per month in over 11,000
physician waiting rooms nationwide will be managed
by Ascent Media and will help enhance Ascent Medias
services to captive audience networks. |
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Optimize the organization. In order to reach the first
two strategic goals described above, Ascent Media also plans to
improve its internal organization. Specifically, Ascent Media
intends to re-align its
divisional structure to become more compatible with its
diversified customer base and the integrated file-based
solutions that they seek. Ascent Media also intends to focus on
its content security initiative, |
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creating greater efficiency when it provides parallel tape-based
and file-based solutions, invest additional resources in its
facilities, develop relationships with other companies and/or
form joint ventures. |
The demand for Ascent Medias 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 in the
winter and summer. Similarly, demand for Ascent Medias
television program services, primarily in its creative services
group, is higher in the first and fourth quarters and lower in
the summer, or third quarter. Demand for Ascent Medias
commercial services, primarily in its creative services group,
are fairly consistent with slightly higher activity in the third
quarter. However, recent trends in the demand for television
program services may result in increased business for Ascent
Media in the summer. In addition, the timing of projects in
Ascent Medias media management services group and network
services group are beginning to offset the quarters in which
there has been historically lower demand for Ascent Medias
motion picture and television services. Accordingly, Ascent
Media expects to experience less dramatic quarterly fluctuations
in its operating performance in the future.
Discovery Communications, Inc. 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 160 countries across six
continents, with over 1 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.
Discoverys relationships and agreements with the
distributors of its channels are critical to its business as
they provide Discoverys 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 operators in the United States in recent years, with
over 90% 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 the sale of advertising on its
networks, from global delivery of its programming pursuant to
affiliation agreements with cable television and
direct-to-home
satellite operators (which is described as distribution revenue
throughout this report), and from product sales in its commerce
and education outlets. Distribution revenue includes all
components of revenue earned through affiliation agreements.
Discoverys affiliation agreements typically have terms of
3 to 10 years and provide for payments based on the number
of subscribers that receive Discoverys services. No single
distributor represented more than 10% of Discoverys
consolidated revenue for the year ended December 31, 2005.
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 Discoverys channels for extended free
periods. In the United States, Discovery has developed the
necessary audience and ratings for its programming such that
advertising sales now 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.
Discoverys principal operating costs consist of
programming expense, sales and marketing expense, personnel
expense and general and administrative expenses. Programming is
Discoverys largest expense. Costs incurred and capitalized
for the direct production of programming content are amortized
over varying
I-8
periods based on the expected realization of revenue from the
underlying programs. Licensed programming is amortized over the
contract period based on the expected realization of revenue.
Discovery incurs sales and marketing expense to promote brand
recognition and to secure quality distribution channels
worldwide.
Discovery produces original programming and acquires content
from numerous producers worldwide that is tailored to the
specific needs 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 worlds 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 adapt its significant programming
library to international markets for relatively low costs is one
of its competitive advantages. Discovery is also developing
programming applications designed to position the company to
take advantage of emerging distribution technologies including
video-on-demand,
IP-delivered
programming, wireless and mobile.
Discoverys other properties consist of Discovery.com and
over 100 retail outlets that offer lifestyle, health, science
and education oriented products, as well as products related to
other programming offered by Discovery. Additionally,
Discoverys newest division, Discovery Education,
distributes video-based educational materials to schools in the
United States and in many countries around the world.
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. currently operates 12 channels and
provides distribution and advertising sales services for BBC
America. The divisions channels include Discovery Channel,
TLC, Animal Planet, Travel Channel, Discovery Health Channel and
the following emerging digital tier networks: The Science
Channel, Discovery Kids, The Military Channel, Discovery Home,
Discovery Times, Fit TV and Discovery HD Theater, which we refer
to collectively as the emerging networks. All of these channels
are wholly owned by Discovery other than Animal Planet, in which
Discovery has a 60% ownership interest and Discovery Times, in
which Discovery has a 50% ownership interest. The division also
operates web sites related to its channel businesses and various
other new media businesses, including a
video-on-demand
offering distributed by various cable operators.
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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 97 separate feeds in 33 languages with
channel feeds customized according to language needs and
advertising sales opportunities. Most of the divisions
channels are wholly owned by Discovery with the exception of
(1) the international Animal Planet channels, which are
generally 50-50 joint ventures with the BBC, (2) People +
Arts, which operates in Latin America and Iberia as a 50-50
joint venture with the BBC and (3) several channels in
Japan and Canada, which operate as joint ventures with
strategically important local partners. As with the
U.S. networks division, the international networks operate
web sites and other new media businesses. In 2004, the group
undertook a
I-9
major new initiative to re-launch certain existing networks and
launch several new networks to create a package of three
lifestyle-focused networks for distribution on a global basis.
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Discovery Commerce, Education & Other |
This group includes Discovery commerce, which operates a chain
of retail stores in the United States that offer lifestyle,
health, science and education-oriented products, as well as
products specifically related to programming on Discoverys
networks. This division also operates a catalog and electronic
commerce business selling products similar to that sold in the
Discovery Channel Stores, as well as a licensing 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. Since 2003,
Discovery has acquired three companies which were involved in
the video streaming business. 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 and began streaming educational
video material into schools via the Internet. Discovery
education now operates United Streaming, a leading educational
broadband streaming service in the United States. This service
earns revenue through annual subscription fees paid by schools
and school districts which use the service.
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Discovery Stockholders 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 Agreement. We
own 50%, and Cox Communications and Advance/ Newhouse each own
25%, of Discovery. Mr. Hendricks is the record holder of
one share of capital stock of Discovery; however,
Mr. Hendricks cannot transfer this share, the share is
subject to an irrevocable proxy in favor of Advance/ Newhouse
and the share is subject to a call arrangement pursuant to which
Advance/ Newhouse can purchase the share. Accordingly, we treat
such share as being owned by Advance/ Newhouse for purposes of
Advance/ Newhouses 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 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 Discoverys equity
securities, approval of transactions between Discovery, on the
one hand, and any of its stockholders, on the other hand, and
adoption of Discoverys annual business plan, 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 Discoverys outstanding capital
stock.
Because we own 50%, Cox Communications owns 25% and Advance/
Newhouse owns 25% of the stock of Discovery, any 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 Agreement also restricts, subject to
certain exceptions, the ability of a stockholder to transfer its
shares 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. If all of the offered shares are not
purchased by the other stockholders, then the selling
stockholder may sell all of the offered shares to the third
party that originally offered to purchase such shares 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 Agreement. In addition, in the event that
either Cox Communications or Advance/ Newhouse proposes to
transfer shares, Cox Communications or Advance/
I-10
Newhouse, whichever is not proposing to transfer, would have a
preemptive right to buy the others 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 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 the spin off, 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, Advance/ Newhouse and the BBC.
The Stockholders 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
Agreement is qualified by reference to the full text of the
agreement and amendments.
Some of Ascent Medias 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 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.
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.
The Cable Television Consumer Protection 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
I-11
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 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 justify adequately the channel carriage limit,
vacated the FCCs decision and remanded the rule to the FCC
for further consideration. In response to the Courts
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
Discoverys 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
systems 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. On February 10, 2005, the FCC denied mandatory
dual carriage of a television stations analog and digital
signals during the digital television transition and mandatory
carriage of all digital signals, other than its
primary signal. Television station owners have
petitioned the FCC to reconsider its decision and are seeking
legislative change.
In 2004, the FCCs 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 cannot mandate
a la carte sales, its endorsement 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 to and/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
I-12
and there can be no assurance that our business will not be
adversely affected by future legislation, new regulation or
deregulation.
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International Regulatory Matters |
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 Medias customers, can perform
similar services in-house with substantially greater financial
resources than Ascent Medias, 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.
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 Discoverys networks,
subjecting more of Discoverys subscriber fees to volume
discounts and increasing the distributors bargaining power
in negotiating new affiliation agreements. Once distribution is
obtained, Discoverys 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.
Our 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, 2005, Ascent Media had approximately
3,800 employees, most of which worked on a full-time basis.
Approximately 2,400 of Ascent Medias employees were
employed in the United States, with the remaining
1,400 employed outside the United States, principally
in the United Kingdom and the Republic of Singapore.
Approximately 420 of Ascent Medias 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.
I-13
As of December 31, 2005, Discovery had approximately 4,000
employees.
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(d) |
Financial Information About Geographic Areas |
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 our
Form 10-Ks,
Form 10-Qs and
Form 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.
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 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 Discovery generates
from its operating activities. Discovery generated
approximately $69 million, $125 million and
$154 million of cash from its operations during the years
ended December 31, 2005, 2004 and 2003, 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 Discoverys 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
Discoverys cash.
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
I-14
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 actions to be taken by
Discovery require the approval of the holders of a majority of
Discoverys 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 Discoverys 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 Discoverys 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
Discoverys 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 Discoverys 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 Communications and/or 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.
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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 50% ownership interest in
Discovery using the equity method of accounting and,
accordingly, in our financial statements we record our share of
Discoverys net income or loss. Because we do not control
Discoverys 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.
A loss of any of Ascent Medias large customers would
reduce our revenue. Although Ascent Media serviced over
4,000 customers during the year ended December 31, 2005,
its ten largest customers accounted for approximately 55% of its
consolidated revenue and Ascent Medias single largest
customer accounted for approximately 9% 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 Medias 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 Medias clients for the services offered by Ascent
Media. Ascent Medias 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 Medias
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
Medias business. Factors that could impact television
advertising and the general demand for original entertainment
content include the growing use of personal video recorders and
video-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 Medias. 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 Medias
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
I-16
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 Medias role as a provider of motion picture and
television production services. If Ascent Medias
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 Medias 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 and
video-on-demand and
changes in television viewing habits facilitated by these or
other technologies could have an adverse effect on
Discoverys 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.
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 Medias 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
Medias services.
Discovery airs certain entertainment programs that are dependent
on specific on-air talent, and Discoverys 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 Medias business. Some of Ascent
Medias 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 Medias 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 Medias costs or
damages or Ascent Medias 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.
Discoverys 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
publics reception toward programs or programming genres
can decline. An adverse change in any of these factors could
have a negative effect on Discoverys revenue in any given
period. Ascent Medias business is also dependent in part
on the
I-17
advertising industry, as a significant portion of Ascent
Medias revenue is derived from the sale of services to
agencies and/or the producers of television advertising.
Discoverys 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.
Discoverys five core networks, Discovery Channel, TLC,
Animal Planet, Travel Channel and Discovery Health, and the
other networks in which Discovery has an ownership interest,
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 networks.
Discoverys 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
Discoverys 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 publics
continuing acceptance of, and willingness to pay for upgrades
to, digital cable, as well as Discoverys 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 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 Medias
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 and media management 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 Medias 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
I-18
services in-house.
These studios also have substantially greater financial
resources than Ascent Medias, 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
Medias. 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 Medias other clients either established
in-house
post-production facilities or significantly expanded their
in-house capabilities, Ascent Medias 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 of
direct-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.
Discoverys 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 Discoverys
advertising and subscription revenue. In addition, the cable
television and
direct-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 on commercially reasonable
terms or at all.
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 Liberty
and/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 Liberty and/or LGI
have fiduciary duties to such companys 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 Liberty and/or LGI stock and options
to purchase Liberty and/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 Libertys
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, creation and/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 Libertys
board of directors can be amended, modified or rescinded by
Libertys board of directors in its sole
I-19
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 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. 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 Medias 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 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.
If we are unable to satisfy the requirements of
Section 404 of the Sarbanes-Oxley Act of 2002, or our
internal control over financial reporting is not effective, the
reliability of our financial statements may be questioned and
our stock price may suffer. Section 404 of the
Sarbanes-Oxley Act of 2002 requires any company subject to the
reporting requirements of the U.S. securities laws to do a
comprehensive evaluation of its and its consolidated
subsidiaries internal control over financial reporting. To
comply with this statute, we will be required to document and
test our internal control procedures; our management will be
required to assess and issue a report concerning our internal
control over financial reporting; and our independent auditors
will be required to issue an opinion on managements
assessment of those matters. Our compliance with
Section 404 of the Sarbanes-Oxley Act will first be tested
in connection with the filing of our Annual Report on
Form 10-K for the
fiscal year ending December 31, 2006. The rules governing
the standards that must be met for management to assess our
internal control over financial reporting are new and complex
and require significant documentation, testing and possible
remediation to meet the detailed standards under the rules.
During the course of its testing, our management may identify
material weaknesses or deficiencies which may not be remedied in
time to meet the deadline imposed by the Sarbanes-Oxley Act. If
our management cannot favorably assess the effectiveness of our
internal control over financial reporting or our auditors
identify material weaknesses in our internal control, investor
confidence in our financial results may weaken, and our stock
price may suffer. In addition, our internal controls must
necessarily rely in part upon the adequacy of Discoverys
internal controls. However, Discovery, as a private company, is
not subject to the requirements of the Sarbanes-Oxley Act in
this regard, and we cannot control, or require Discovery to
change, its internal controls.
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:
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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; |
I-20
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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; |
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classifying our board of directors with staggered three-year
terms, which may lengthen the time required to gain control of
our board of directors; |
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limiting who may call special meetings of shareholders; |
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prohibiting shareholder action by written consent (subject to
certain exceptions), thereby requiring shareholder action to be
taken at a meeting of the shareholders; |
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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; |
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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; |
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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 |
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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. 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.
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Item 1B. |
Unresolved Staff Comments. |
None
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 Medias operations are conducted at over 100
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
I-21
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, the media management services group 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
350,000 square feet. In the United States, Ascent
Medias leased properties total approximately
1.1 million square feet and have terms expiring between
March 2006 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
Medias international leases have terms that expire between
March 2006 and August 2019, and are also used for technical
operations, office space and media storage. Over half of the
international leases have extension clauses. Approximately
240,000 square feet of Ascent Medias owned properties
are located in Southern California, with another
80,000 square feet located in Northvale, New Jersey,
Atlanta, Georgia, Minneapolis, Minnesota and Stamford,
Connecticut. In addition, Ascent Media owns approximately
50,000 square feet in London, England. Nearly all of Ascent
Medias owned properties are purpose-built for its
technical and creative service operations. Ascent Medias
facilities are adequate to support its current near term growth
needs.
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Item 3. |
Legal Proceedings. |
Paul J. Dujardin v. Liberty Media Corporation and Ascent
Media. On November 30, 2001, Paul Dujardin filed a
complaint against Liberty and Ascent Media in the
U.S. District Court for the Southern District of New York,
alleging violations of Section 10(b),
Rule 10b-5 and
Section 20(a) of the Securities Exchange Act of 1934,
common law fraud, negligent misrepresentation, breach of the
earnout provisions of an acquisition agreement involving the
sale of Mr. Dujardins company, Triumph
Communications, Inc., to Ascent Media in July 2000, and breach
of contract for failure to make Mr. Dujardin head of what
was then known as Ascent Medias networks
group. On March 15, 2005, the court dismissed with
prejudice the securities fraud claims based on allegations that
Ascent Media and Liberty engaged in transactions designed to
conceal the value of Ascent Medias stock, and the breach
of contract claim for failure to make Mr. Dujardin head of
the networks group. The court then dismissed, but without
prejudice, the securities fraud and common law fraud claims
based on allegations that Ascent Media falsely promised to
appoint Mr. Dujardin president of the networks group and
granted Mr. Dujardin permission to reassert these fraud
claims in an amended complaint. On April 4, 2005,
Mr. Dujardin filed an amended complaint against Ascent
Media and Liberty alleging a violation of Section 10(b),
Rule 10b-5 and
Section 20 of the Securities Exchange Act of 1934, and a
common law fraud claim, each based solely on allegations that
Ascent Media falsely promised to appoint Mr. Dujardin
president of the networks group. On December 20, 2005, the
parties executed a confidential settlement agreement. Ascent
Media entered into the agreement without admission of liability.
The Court dismissed the case with prejudice on January 4,
2006.
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Item 4. |
Submission of Matters to a Vote of Security
Holders. |
None.
I-22
PART II.
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Item 5. |
Market for Registrants Common Equity, Related
Stockholder Matters and Issuer Purchases of Equity
Securities. |
Market Information
We have two series 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.
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Series A | |
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Series B | |
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High | |
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Low | |
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High | |
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Low | |
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2005
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July 21, 2005 through September 30, 2005
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$ |
16.30 |
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$ |
13.51 |
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$ |
16.77 |
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$ |
14.40 |
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Fourth quarter
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$ |
16.23 |
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$ |
13.69 |
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$ |
16.80 |
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$ |
13.59 |
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Holders
As of January 31, 2006, there were approximately 128,000
and 1,100 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 2006 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 Libertys 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 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.
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|
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|
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|
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|
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|
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|
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|
|
|
|
December 31, | |
|
|
| |
|
|
2005 | |
|
2004 | |
|
2003 | |
|
2002 | |
|
2001 | |
|
|
| |
|
| |
|
| |
|
| |
|
| |
|
|
Amounts in thousands | |
Summary Balance Sheet Data(1):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment in Discovery Communications, Inc.
|
|
$ |
3,018,622 |
|
|
$ |
2,945,782 |
|
|
$ |
2,863,003 |
|
|
$ |
2,816,513 |
|
|
$ |
2,899,824 |
|
Goodwill
|
|
$ |
2,133,518 |
|
|
$ |
2,135,446 |
|
|
$ |
2,130,897 |
|
|
$ |
2,104,705 |
|
|
$ |
2,034,102 |
|
Total assets
|
|
$ |
5,819,236 |
|
|
$ |
5,564,828 |
|
|
$ |
5,396,627 |
|
|
$ |
5,373,150 |
|
|
$ |
5,399,702 |
|
Long-term debt
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
401,984 |
|
|
$ |
443,685 |
|
Subordinated notes payable to Liberty
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
205,299 |
|
|
$ |
183,685 |
|
Stockholders equity
|
|
$ |
4,575,425 |
|
|
$ |
4,347,279 |
|
|
$ |
4,260,269 |
|
|
$ |
3,617,417 |
|
|
$ |
3,578,364 |
|
II-1
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|
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|
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|
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|
Years Ended December 31, | |
|
|
| |
|
|
2005 | |
|
2004 | |
|
2003 | |
|
2002 | |
|
2001 | |
|
|
| |
|
| |
|
| |
|
| |
|
| |
|
|
Amounts in thousands, except per share amounts | |
Summary Statement of Operations Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$ |
694,509 |
|
|
$ |
631,215 |
|
|
$ |
506,103 |
|
|
$ |
539,333 |
|
|
$ |
592,732 |
|
Operating income (loss)(1)
|
|
$ |
(1,402 |
) |
|
$ |
16,935 |
|
|
$ |
(2,404 |
) |
|
$ |
(61,452 |
) |
|
$ |
(350,628 |
) |
Share of earnings (losses) of Discovery(2)
|
|
$ |
79,810 |
|
|
$ |
84,011 |
|
|
$ |
37,271 |
|
|
$ |
(32,046 |
) |
|
$ |
(277,919 |
) |
Net earnings (loss)(1)
|
|
$ |
33,276 |
|
|
$ |
66,108 |
|
|
$ |
(52,394 |
) |
|
$ |
(129,275 |
) |
|
$ |
(608,261 |
) |
Basic and diluted earnings (loss) per common share(3)
|
|
$ |
.12 |
|
|
$ |
0.24 |
|
|
$ |
(0.19 |
) |
|
$ |
(0.46 |
) |
|
$ |
(2.17 |
) |
|
|
(1) |
Includes impairment of goodwill and other long-lived assets of
$51,000, $562,000, $83,718,000 and $307,932,000 for the years
ended December 31, 2004, 2003, 2002 and 2001, respectively. |
|
(2) |
Effective January 1, 2002, we adopted Statement of
Financial Accounting Standards No. 142, Goodwill and
Other Intangible Assets (Statement 142),
which among other matters, provides that excess costs that are
considered equity method goodwill no longer be amortized. Share
of losses of Discovery includes excess basis amortization of
$188,570,000 for the year ended December 31, 2001. |
|
(3) |
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 outstanding shares for all
periods subsequent to the spin off. |
Item 7. Managements
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 Media Corporation
(Liberty) completed a spin off transaction pursuant
to which our capital stock was distributed as a dividend to
holders of Libertys 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 is 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), which we account
for using the equity method of accounting. Accordingly, as
described below, Discoverys 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, media management and network
services to the media and entertainment industries. Ascent
Medias clients include major motion picture studios,
independent producers, broadcast networks, cable programming
networks, advertising agencies and other companies that produce,
own and/or distribute entertainment, news, sports, corporate,
educational, industrial and advertising content. Ascent
Medias operations are organized into the following four
groups: creative services, media management services, network
services and corporate and other. Ascent Media has few long-term
or exclusive agreements with its creative services and media
management services customers.
In 2006, 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. With facilities in the U.S.,
the United Kingdom and Asia, Ascent Media also hopes to increase
its services to multinational companies. The challenges that
Ascent Media faces include differentiating its
II-2
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 160 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
Discoverys results of operations and financial condition
below.
Acquisitions
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 Medias media management 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 Medias network services group.
Sony Electronics System Integration Center. On
December 31, 2003, Ascent Media acquired the operations of
Sony Electronics 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 Medias wholly
owned subsidiary, AF Associates, Inc. and SIC. The value of 20%
of the combined business of AF Associates and SIC was estimated
at $6,000,000. SIC is included in Ascent Medias 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). 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 of 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,
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.
Results of Operations
Our consolidated results of operations include general and
administrative expenses incurred at the DHC corporate level,
100% of Ascent Medias results and our 50% share of
earnings of Discovery.
Ascent Medias 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.
The media management services group provides owners of film
libraries a broad range of restoration, preservation, archiving,
professional mastering and duplication services. The scope of
media management
II-3
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.
Additionally, the media management services group includes
Ascent Medias digital media center which is developing new
products and businesses in areas such as digital imaging,
digital media and interactive media.
The network services groups 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
groups 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 55% of network services groups 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.
Each of Cinetech, LPC and SIC are included in Ascent
Medias consolidated results of operations for the full
year in 2005, and Ascent Medias consolidated results of
operations for the year ended December 31, 2004, include
twelve months of results for SIC, approximately nine months of
results of LPC and approximately two months of results of
Cinetech.
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|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31, | |
|
|
| |
|
|
2005 | |
|
2004 | |
|
2003 | |
|
|
| |
|
| |
|
| |
|
|
Amounts in thousands | |
Segment Revenue
|
|
|
|
|
|
|
|
|
|
|
|
|
Creative services group
|
|
$ |
304,393 |
|
|
$ |
295,841 |
|
|
$ |
270,830 |
|
Media management services group
|
|
|
118,489 |
|
|
|
109,982 |
|
|
|
107,070 |
|
Network services group
|
|
|
271,627 |
|
|
|
225,392 |
|
|
|
128,203 |
|
Corporate and other
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
694,509 |
|
|
$ |
631,215 |
|
|
$ |
506,103 |
|
|
|
|
|
|
|
|
|
|
|
Segment Operating Cash Flow
|
|
|
|
|
|
|
|
|
|
|
|
|
Creative services group
|
|
$ |
57,323 |
|
|
$ |
55,847 |
|
|
$ |
43,786 |
|
Media management services group
|
|
|
13,481 |
|
|
|
17,430 |
|
|
|
22,074 |
|
Network services group
|
|
|
55,781 |
|
|
|
62,163 |
|
|
|
43,221 |
|
Corporate and other
|
|
|
(47,960 |
) |
|
|
(37,645 |
) |
|
|
(32,901 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
$ |
78,625 |
|
|
$ |
97,795 |
|
|
$ |
76,180 |
|
|
|
|
|
|
|
|
|
|
|
Revenue. Ascent Medias total revenue increased
10.0% and 24.7% for the years ended December 31, 2005 and
2004, respectively, as compared to the corresponding prior year.
In 2005, the creative services group revenue increased
$8,552,000 as a result of higher commercial revenue and strong
features and television in the U.S. partially offset by
declining revenue at sound services, and continued weakness in
commercial and feature film activity in the U.K. The media
management services group revenue increased $8,507,000 in 2005
as a result of higher lab revenue of $9,906,000 primarily driven
by the acquisition of Cinetech and an increase in new digital
services, partially offset by declines in the U.S. due to
lower studio volumes from traditional business and lower
subtitling business and DVD volumes in the U.K. The network
services groups 2005 revenue increased $46,235,000 due to
$9,423,000 of revenue related to the LPC acquisition, higher
number of large engineering and systems integration projects and
higher origination business and other new initiatives, partially
offset by lower renewal rates on certain ongoing broadcast
services contracts.
II-4
In 2004, the creative services group revenue increased
$25,011,000 as a result of higher feature film related revenue
driven by the expansion in digital intermediate services in the
U.S. and UK, expansion of creative sound services in the UK,
growth in television post production activity and changes in
foreign currency exchange rates of $6,382,000. The media
management services group revenue increased $2,912,000 in 2004
as a result of higher lab revenue of $2,229,000 due to the
acquisition of Cinetech, higher demand for DVD mastering
services and changes in foreign currency exchange rates of
$3,684,000, offset by the commoditization of traditional media
services leading to a decline in rates and difficult market
conditions primarily in the United Kingdom. The network services
groups 2004 revenue increased $97,189,000, reflecting the
full year impact of the SIC acquisition ($27,100,000), the nine
month impact of the LPC acquisition ($39,619,000) and changes in
foreign currency exchange rates ($1,979,000). The remaining
increase is driven by the timing of various large systems
integration projects and higher network origination and
installation projects.
Cost of Services. Ascent Medias costs of services
increased 17.2% and 26.3% for the years ended December 31,
2005 and 2004, respectively, as compared to the corresponding
prior year. 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. Media management
services group cost of services has increased at a faster rate
than revenue. The group has increased spending on development of
digital technologies and new services. Additionally, media
managements projects have become increasingly more
integrated, with complex work flows requiring higher levels of
production labor and project management. This increase in labor
costs, combined with investment in new technologies, has
resulted in higher cost of services and decreasing operating
cash flow margin.
The 2004 increase is attributed to the 2004 acquisitions
discussed above, which contributed $48,331,000 of the increase
in cost of services, higher costs across all of its groups
primarily in production material, production personnel and
equipment expenses as a result of the increased revenue and
production activity noted above and changes in foreign currency
exchange rates, which resulted in an increase of $6,321,000.
Selling, General and Administrative. Ascent Medias
selling, general and administrative expenses increased 6.8% and
18.8% for the years ended December 31, 2005 and 2004,
respectively, as compared to the corresponding prior year. The
2005 increase is primarily attributable to the impact of the
2004 acquisitions of $5,270,000 and the growth in revenue
driving higher labor, facility and selling expenses. The 2004
increase is primarily attributable to growth in the business
driving higher personnel, facility and selling costs, the impact
of the 2004 acquisitions of $5,528,000 and changes in foreign
currency exchange rates of $4,222,000.
Corporate and Other operating cash flow (which includes DHC
corporate general and administrative expenses of $6,467,000 in
2005) decreased $10,315,000 and $4,744,000 in 2005 and 2004,
respectively, as compared to the corresponding prior year. The
2005 decrease is due to the DHC corporate expenses, which
primarily relate to the Spin Off ($5,072,000) and charges
pursuant to the services agreement with Liberty subsequent to
the Spin Off ($876,000), and higher Ascent Media corporate
expenses ($3,848,000) as a result of higher labor, facility, and
professional services costs related to reengineering activities
and a legal settlement. The 2004 increase is due to higher
corporate expenses in the U.K. from the continued development of
corporate infrastructure and acquisition of LPC, higher
management incentive plan costs and changes in foreign currency
exchange rates of $872,300, offset by lower severance and lease
abandonment charges.
Depreciation and Amortization. Depreciation and
amortization were comparable in 2005 and 2004. The increase in
depreciation and amortization expense in 2004, as compared to
2003, is due to an increase in the depreciable asset base due to
capital expenditures and acquisitions.
Stock Compensation. 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 Libertys acquisition in
2003 of the Ascent Media shares that it did not already own.
Ascent
II-5
Media is amortizing the
in-the-money
value of the Ascent Media Options over the
5-year vesting period.
Certain Ascent Media employees also hold options and stock
appreciation rights granted by companies acquired by Ascent
Media prior to 2003 and exchanged for Liberty options and SARs.
Ascent Media records 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 year to date 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.
Restructuring Charges. 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. During the
year ended December 31, 2003, Ascent Media recorded a
restructuring charge of $3,476,000 related to the closing of
certain facilities and corresponding reductions in headcount.
These restructuring activities were implemented to improve
operating efficiencies and effectiveness primarily in its
creative services group. There was no restructuring charge in
2004.
Interest Expense. Interest expense in 2003 related
primarily to interest on Ascent Medias bank debt and
subordinated notes payable due to Liberty. In December 2003,
Ascent Media repaid all principal and interest under its bank
credit facility with cash provided by Liberty. In addition,
Liberty contributed all amounts due under the subordinated notes
payable to the equity of Ascent Media. As a result of the
cancellation of the bank credit facility and the subordinated
notes payable, Ascent Media incurred no interest expense in 2005
or 2004.
Share of Earnings of Discovery. Our share of earnings of
Discovery decreased $4,201,000 or 5% in 2005 and increased over
100% in 2004. Discoverys 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.
Discoverys net income improved in 2004 primarily due to
higher revenue and improved operating margins. Prior to June
2003, John Hendricks, Discoverys Founder and Chairman,
held shares of Discovery common stock that were redeemable on
demand. Changes in the redemption value of such shares were
recorded by Discovery as adjustments to equity similar to
dividends on preferred stock. We included in our share of
earnings (losses) of Discovery 50% of the equity adjustments
related to the redeemable common stock as those adjustments
represented an adjustment in earnings available to common
shareholders. The redeemable common stock was redeemed in June
2003. Our share of earnings (losses) of Discovery included gains
of $5,700,000 for the year ended December 31, 2003 related
to changes in the redemption value of the redeemable common
stock and other equity transactions.
For a more detailed discussion of Discoverys results of
operations, see Managements Discussion
and Analysis of Financial Condition and Results of Operations of
Discovery.
Income Taxes. 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 Libertys
blended weighted average state tax rate. Subsequent to our spin
off, we assessed such rate in light of the fact that we 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 was higher than the federal income
tax rate of 35% due to state and foreign tax expense. Although
we incurred a pre-tax loss of $32,238,000 in 2003, we recognized
tax expense of
II-6
$20,156,000 due to an increase in our valuation allowance,
interest expense that is not deductible for tax purposes and
state tax expense.
Liquidity and Capital Resources
Prior to our spin off, our primary sources of funds were cash
from operating activities and advances or contributions from
Liberty. During the year ended December 31, 2005, our
primary use of cash was capital expenditures ($90,526,000),
which we funded with our available cash and cash generated by
operating activities ($85,291,000). Of the foregoing 2005
capital expenditures, $41,192,000 relates to the buildout of
Ascent Medias existing facilities for specific customer
contracts and the construction of Ascent Medias Digital
Media Center in Burbank, California. The remainder of Ascent
Medias capital expenditures relates to purchases of new
equipment and the upgrade of existing facilities and equipment.
For the year ended December, 31, 2004, our primary uses of
cash were acquisitions ($44,238,000) and capital expenditures
($49,292,000). We funded these investing activities with cash
from operating activities of $84,322,000 and capital
contributions from Liberty of $30,999,000. In connection with
the spin off, Liberty transferred to one of our subsidiaries
$200 million in cash. Subsequent to the spin off, Liberty
will no longer be a long-term source of liquidity for us.
Subsequent to December 31, 2005, we acquired AccentHealth
LLC for approximately $45 million in cash. We funded such
acquisition with a portion of our available cash on hand. In
addition, we expect to provide $20 million of funding to
AccentHealth in 2006 for expansion of their network. 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.
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 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.
Off-Balance Sheet Arrangements and Contractual
Obligations
Information concerning the amount and timing of required
payments under our contractual obligations at December 31,
2005 is summarized below:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payments Due by Period | |
|
|
| |
|
|
Less Than | |
|
|
|
After | |
|
|
|
|
1 Year | |
|
1-3 Years | |
|
4-5 Years | |
|
5 Years | |
|
Total | |
|
|
| |
|
| |
|
| |
|
| |
|
| |
|
|
Amounts in thousands | |
Operating leases
|
|
$ |
30,563 |
|
|
$ |
54,677 |
|
|
$ |
43,159 |
|
|
$ |
47,033 |
|
|
$ |
175,432 |
|
Other
|
|
|
|
|
|
|
6,100 |
|
|
|
|
|
|
|
|
|
|
|
6,100 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Contractual Obligations
|
|
$ |
30,563 |
|
|
$ |
60,777 |
|
|
$ |
43,159 |
|
|
$ |
47,033 |
|
|
$ |
181,532 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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.
II-7
Recent Accounting Pronouncements
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 123 and supersedes 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) based
on the current fair value of the award, and to remeasure the
fair value of the award at each reporting date.
Public companies are required to adopt Statement 123R as of
the beginning of the registrants next fiscal year, or
January 1, 2006 for calendar-year companies, such as us.
Accordingly, the provisions of Statement 123R will affect
the accounting for all awards granted, modified, repurchased or
cancelled after January 1, 2006. The accounting for awards
granted, but not vested, prior to January 1, 2006 will also
be impacted. The provisions of Statement 123R allow
companies to adopt the standard on a prospective basis or to
restate all periods for which Statement 123 was effective.
We expect to adopt Statement 123R on a prospective basis,
and will provide pro forma information as though the standard
had been adopted for all periods presented.
While we have not yet quantified the impact of adopting
Statement 123R, we do not believe that such adoption will
have a significant effect on our operating income and net
earnings in the future.
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 and Non-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
II-8
receivables balance was $134,615,000, net of allowance for
doubtful accounts of $7,708,000, as of December 31, 2005.
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 a portion of our tax benefits
associated with certain cumulative net operating loss carry
forwards and impairment reserves, and as such, we have reserved
for a portion of our deferred income tax assets. The valuation
allowance as of December 31, 2005 and 2004 was $91,235,000
and $88,067,000, respectively.
Discovery
We hold a 50% ownership interest in Discovery and account for
this investment using the equity method of accounting.
Accordingly, in our financial statements we record our share of
Discoverys 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, 2005, 2004 and
2003 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, 2005 included elsewhere herein. The following
discussion and analysis of Discoverys 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 Discoverys management to prepare their own
managements discussion and analysis for our purposes.
Accordingly, we note that the material presented in this section
might be different if Discoverys management had prepared
it.
The following discussion of Discoverys results of
operations is presented on a consolidated basis. In order to
provide a better understanding of Discoverys operations,
we have also included a summarized presentation of revenue and
operating cash flow of Discoverys 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 Discoverys largest division. It
owns and operates 12 cable and satellite channels and
provides distribution and advertising sales services for BBC
America. 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 Discoverys
retail chain store operations and other direct consumer
marketing activities as well as Discovery education which was
recently formed to manage Discoverys distribution of
education content.
II-9
|
|
|
Consolidated Results of Discovery |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31, | |
|
|
| |
|
|
2005 | |
|
2004 | |
|
2003 | |
|
|
| |
|
| |
|
| |
|
|
Amounts in thousands | |
Revenue
|
|
|
|
|
|
|
|
|
|
|
|
|
Advertising
|
|
$ |
1,187,823 |
|
|
$ |
1,133,807 |
|
|
$ |
1,010,585 |
|
Distribution
|
|
|
1,198,686 |
|
|
|
976,362 |
|
|
|
747,927 |
|
Other
|
|
|
285,245 |
|
|
|
255,177 |
|
|
|
236,535 |
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue
|
|
|
2,671,754 |
|
|
|
2,365,346 |
|
|
|
1,995,047 |
|
|
|
|
|
|
|
|
|
|
|
Expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of revenue
|
|
|
(979,765 |
) |
|
|
(846,316 |
) |
|
|
(751,578 |
) |
SG&A expense
|
|
|
(1,005,351 |
) |
|
|
(856,340 |
) |
|
|
(735,017 |
) |
|
|
|
|
|
|
|
|
|
|
|
Operating cash flow
|
|
|
686,638 |
|
|
|
662,690 |
|
|
|
508,452 |
|
|
|
|
|
|
|
|
|
|
|
Expenses arising from long-term incentive plans
|
|
|
(49,465 |
) |
|
|
(71,515 |
) |
|
|
(74,119 |
) |
Depreciation & amortization
|
|
|
(123,209 |
) |
|
|
(129,011 |
) |
|
|
(120,172 |
) |
Gain on sale of patents
|
|
|
|
|
|
|
22,007 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income
|
|
|
513,964 |
|
|
|
484,171 |
|
|
|
314,161 |
|
|
|
|
|
|
|
|
|
|
|
Other Income (Expense)
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense, net
|
|
|
(184,575 |
) |
|
|
(167,420 |
) |
|
|
(159,409 |
) |
Realized and unrealized gains from derivative instruments, net
|
|
|
22,499 |
|
|
|
45,540 |
|
|
|
21,405 |
|
Minority interests in consolidated subsidiaries
|
|
|
(43,696 |
) |
|
|
(54,940 |
) |
|
|
(35,965 |
) |
Other
|
|
|
13,771 |
|
|
|
2,470 |
|
|
|
(2,170 |
) |
|
|
|
|
|
|
|
|
|
|
|
Income before income taxes
|
|
|
321,963 |
|
|
|
309,821 |
|
|
|
138,022 |
|
Income tax expense
|
|
|
(162,343 |
) |
|
|
(141,799 |
) |
|
|
(74,785 |
) |
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$ |
159,620 |
|
|
$ |
168,022 |
|
|
$ |
63,237 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Business Segment Results of Discovery |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31, | |
|
|
| |
|
|
2005 | |
|
2004 | |
|
2003 | |
|
|
| |
|
| |
|
| |
|
|
Amounts in thousands | |
Revenue
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. networks
|
|
$ |
1,743,358 |
|
|
$ |
1,599,678 |
|
|
$ |
1,345,097 |
|
International networks
|
|
|
731,352 |
|
|
|
588,416 |
|
|
|
480,129 |
|
Discovery commerce, education & other
|
|
|
197,044 |
|
|
|
177,252 |
|
|
|
169,821 |
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue
|
|
$ |
2,671,754 |
|
|
$ |
2,365,346 |
|
|
$ |
1,995,047 |
|
|
|
|
|
|
|
|
|
|
|
Operating Cash Flow
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. networks
|
|
$ |
643,366 |
|
|
$ |
597,922 |
|
|
$ |
482,747 |
|
International networks
|
|
|
108,543 |
|
|
|
99,105 |
|
|
|
72,272 |
|
Discovery commerce, education & other
|
|
|
(65,271 |
) |
|
|
(34,337 |
) |
|
|
(46,567 |
) |
|
|
|
|
|
|
|
|
|
|
|
Total operating cash flow
|
|
$ |
686,638 |
|
|
$ |
662,690 |
|
|
$ |
508,452 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Note: |
Discovery commerce, education & other includes
intercompany eliminations. Certain prior period amounts have
been reclassified to conform to the current period presentation. |
Revenue. Discoverys consolidated revenue increased
13% and 19% for the years ended December 31, 2005 and 2004,
respectively, as compared to the corresponding prior year.
Increased revenue was primarily due
II-10
to increases of 23% and 31% in distribution revenue for 2005 and
2004, respectively, as well as increases of 5% and 12% in
advertising revenue for the same periods. Other revenue
increased 12% and 8% for 2005 and 2004.
Distribution revenue increased $130,609,000 or 22% and
$167,390,000 or 38% at the U.S. networks during the years
ended December 31, 2005 and 2004, respectively. These
increases are due to a 10% and 14% increase in paying
subscription units for the years ended December 31, 2005
and 2004, respectively, combined with contractual rate
increases. U.S. networks distribution benefited from
contractual arrangements whereby certain subscribers that were
previously covered under free carriage periods with distributors
were converted to paying subscribers. U.S. networks
distribution revenue increases were also helped by reduced
launch fee amortization, a contra-revenue item, as a result of
extensions of certain affiliation agreements. Launch
amortization at the U.S. networks has declined during the
most recent two years from $118,888,000 during 2003 to
$93,763,000 in 2004 and $67,750,000 in 2005, primarily due to
these extensions. At the international networks, distribution
revenue increased 25% and 20% during 2005 and 2004,
respectively. Such increases were principally comprised of
combined revenue growth in Europe and Asia of $79,767,000 during
2005 and $56,832,000 during 2004 resulting from increases in
paying subscription units combined with contractual rate
increases in certain markets.
The increase in advertising revenue during 2005, which includes
revenue from paid programming, 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, 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. 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, 2005, 2004, and
2003.
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, 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.
During 2004, the increase in advertising was primarily due to a
9% increase at the U.S. networks and a 31% increase at the
international networks. The increase at the U.S. networks
was primarily attributable to higher advertising sell-out and
rates at most of the networks. The increase in advertising
revenue at the international networks was due to a $33,769,000
increase resulting from higher advertising rates and higher
viewership ratings in the Europe region, combined with a
$6,033,000 increase as a result of increased distribution in
Asia.
The increase in other revenue during 2005 was primarily due to a
$10,959,000 increase in education revenue due to acquisitions
and organic growth in the business combined with a 5% or
$9,163,000 increase in commerce revenue, which resulted
primarily from an increase in direct to consumer sales. The
increase in other revenue during the year ended
December 31, 2004 was primarily due to a $9,409,000
increase in education revenue due to acquisitions, offset by a
5% or $6,695,000 decrease in store revenue. The decrease in
store revenue was due to the closure of certain unprofitable
stores, which resulted in a 15% reduction in the average number
of stores. Discovery began an initiative in 2003 to close stores
that were not profitable. Lower revenue as a result of fewer
stores was partially offset by a 4% improvement in same store
sales.
Cost of Revenue. Cost of revenue increased 16% and 13%
for the years ended December 31, 2005 and 2004,
respectively. As a percent of revenue, cost of revenue was 37%,
36% and 38% for the years ended December 31, 2005, 2004 and
2003, respectively. 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
II-11
productions and high profile specials and continued investment
in the lifestyles category internationally, particularly in
Europe. These increases were offset partially by a net aggregate
benefit of approximately $11 million related to changes in
estimates for music rights accruals.
The 2004 increase in cost of revenue was also primarily related
to increased programming costs, particularly at the
U.S. networks. Discovery also began investing in an
initiative during the fourth quarter of 2004 to highlight and
strengthen its lifestyles category, particularly in Europe,
which contributed to the increase in cost of revenue during
2004. The decrease in cost of revenue as a percent of revenue in
2004 was due to a 15% reduction in the average number of stores
as the company continued its efforts to close unprofitable
stores.
SG&A Expenses. SG&A expenses increased 17% during
each of the years ended December 31, 2005 and 2004,
respectively. As a percent of revenue, SG&A expense was 38%,
36% and 37% for the years ended December 31, 2005, 2004 and
2003, respectively. Within the different business segments,
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, during
2005. The increase at the international networks was caused by a
$26,326,000 increase in personnel expense resulting from adding
headcount as the business expands, particularly in the U.K. and
Europe combined with a $27,275,000 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 Discoverys education business.
During 2004, SG&A expense increased 13%, 35%, and 3% at the
U.S. networks, the international networks and Discovery
commerce, education and other, respectively. The increase at the
U.S. networks was due to a $58,467,000 increase in
marketing expenses and other variable costs. Marketing expense
increased as the company continued to invest in brand promotion
and gaining audience share in a highly competitive market. Other
variable expenses increased as a result of the increase in
revenue. The increase at Discoverys international networks
of $59,777,000 was due to a 20% increase in personnel costs and
a 40% increase in marketing expenses. Increases in personnel
expense are the result of adding headcount as the business
expands particularly in the U.K. and Europe. Higher marketing
expenses were experienced across all of the regions as the
division began implementing the lifestyles category initiative
during the fourth quarter of 2004.
Expenses Arising from Long-term Incentive Plans. Expenses
arising from long-term incentive plans are related to
Discoverys unit-based, long-term incentive plans, or LTIP,
for its employees who meet certain eligibility criteria. Units
are awarded to eligible employees and generally vest at a rate
of 25% per year. Upon exercise, participants receive a cash
payment for the increase in value of the units from the unit
value on the date of issuance. The appreciation in unit value of
LTIP awards outstanding is recorded as compensation expense over
the period outstanding. In August 2005, Discovery discontinued
one of its plans and settled all amounts with cash. Discovery
established a new long-term incentive plan in October 2005 (the
2005 LTIP Plan) where participants in
Discoverys remaining plan could elect to (1) continue
in such plan or (2) exercise vested units and receive units
in the 2005 LTIP Plan. The cash-out value of the units exercised
was based on the plan valuation at the end of 2004, resulting in
lower expense for 2005, as compared to 2004. The 31% or
$22,050,000 decrease in LTIP expense in 2005 is the result of
this effect, offset by additional expenses related to the
termination of one of Discoverys long-term incentive plans
as well as current year vesting and appreciation under the 2005
LTIP Plan. Discovery made aggregate cash payments of
$325,756,000 to participants who exercised units during 2005.
The aggregate number of units that are currently authorized to
be granted under the 2005 LTIP Plan approximates a 6% sharing in
the change in Discoverys equity value.
Depreciation and Amortization. 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. The increase in
depreciation and amortization in 2004 is due to an increase in
intangible assets resulting from acquisitions combined with
increases in Discoverys depreciable asset base resulting
from capital expenditures.
II-12
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 sales in the future.
Interest Expense. The increase in interest expense during
the years ended December 31, 2005 and 2004 is primarily due
to higher levels of outstanding debt in both years combined with
increases in interest rates during those periods.
Unrealized Gains from Derivative Instruments, net.
Unrealized gains from derivative transactions relate, primarily,
to Discoverys 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 $29,109,000,
$44,060,000 and $21,548,000 in gains on these instruments during
the years ended December 31, 2005, 2004 and 2003,
respectively. The foreign exchange hedging instruments used by
Discovery are spot, forward and option contracts. Additionally,
Discovery enters into forward contracts to hedge non-dollar
denominated cash flows and foreign currency balances.
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.
Income Taxes. Discoverys effective tax rate was
50%, 46% and 54% for 2005, 2004 and 2003, respectively.
Discoverys effective tax rate differed from the federal
income tax rate of 35% primarily due to foreign and state taxes.
|
|
|
Liquidity & Capital Resources |
Discovery generated $68,893,000, $124,704,000 and $154,296,000
of cash from operations during the years ended December 31,
2005, 2004 and 2003, respectively. The decrease in cash from
operations in 2005 is primarily due to an increase in payments
of LTIP obligations in the amount of $325,756,000, offset
partially by favorable working capital changes. In 2004, the
decrease in cash provided by operations was due to payments of
LTIP obligations partially offset by improved net income. As
part of his long-term incentive plan with Discovery, John
Hendricks, Discoverys Founder and Chairman, had a ten-year
incentive agreement that granted him a cash award equal to 1.6%
of the difference between Discoverys value at
December 31, 1993 and December 31, 2003 for his
services as Chairman and Chief Executive Officer during the
period. This cash award was paid out to Mr. Hendricks in
two installments, one in December 2003 and one in February 2004.
The portion of the cash award that was paid out in February 2004
along with payments to other members of the Discovery management
team during 2004 totaled $240,752,000 in connection with the
redemption of units pursuant to the terms of the LTIP. For a
further discussion of Discoverys LTIP, please see
Note 15 to the Discovery consolidated financial statements.
In addition to previous long-term incentive plans that have
expired and have been paid out as described herein,
Mr. Hendricks is a participant in the 2005 LTIP Plan and
has been awarded long-term compensation units, which provide
Mr. Hendricks with a total 1.3% participation in
Discoverys increase in valuation in accordance with
Discoverys LTIP.
During the years ended December 31, 2005 and 2004,
Discovery paid $92,874,000 and $148,880,000, respectively, to
acquire mandatorily redeemable securities related to minority
interests in certain consolidated subsidiaries. Discovery also
spent $99,684,000 on capital expenditures during 2005.
In addition to cash provided by operations, Discovery funds its
activities with proceeds borrowed under various debt facilities,
including a term loan, a revolving loan facility and various
senior notes payable. During the year ended December 31,
2005, net incremental borrowings under debt facilities
aggregated approximately $95,000,000. Total commitments of these
facilities were $4,025,000,000 at December 31, 2005. Debt
II-13
outstanding on these facilities aggregated $2,573,000,000 at
December 31, 2005, providing excess debt availability of
$1,452,000,000. Discoverys 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.
They 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 they are in compliance with all debt covenants at
December 31, 2005.
In 2006, Discovery expects to spend approximately $115,000,000
for capital expenditures and $190,000,000 for interest expense.
Payments to satisfy LTIP obligations are not expected to be
significant in 2006. 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.
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, 2005 is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payments Due by Period(2) | |
|
|
| |
|
|
|
|
Less Than | |
|
|
|
After | |
|
|
Total | |
|
1 Year | |
|
1-3 Years | |
|
4-5 Years | |
|
5 Years | |
|
|
| |
|
| |
|
| |
|
| |
|
| |
|
|
Amounts in thousands | |
Long-term debt
|
|
$ |
2,573,000 |
|
|
$ |
320,000 |
|
|
$ |
242,500 |
|
|
$ |
1,075,500 |
|
|
$ |
935,000 |
|
Capital leases
|
|
|
28,167 |
|
|
|
6,488 |
|
|
|
9,478 |
|
|
|
5,316 |
|
|
|
6,885 |
|
Operating leases
|
|
|
435,414 |
|
|
|
63,403 |
|
|
|
125,634 |
|
|
|
76,992 |
|
|
|
169,385 |
|
Program license fees
|
|
|
620,403 |
|
|
|
357,728 |
|
|
|
121,101 |
|
|
|
97,632 |
|
|
|
43,942 |
|
Launch incentives
|
|
|
71,520 |
|
|
|
36,156 |
|
|
|
33,219 |
|
|
|
2,145 |
|
|
|
|
|
Other(1)
|
|
|
253,890 |
|
|
|
73,401 |
|
|
|
127,087 |
|
|
|
41,541 |
|
|
|
11,861 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$ |
3,982,394 |
|
|
$ |
857,176 |
|
|
$ |
659,019 |
|
|
$ |
1,299,126 |
|
|
$ |
1,167,073 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
Represents Discoverys 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 $46.1 million accrued under
Discoverys 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. |
Discovery is subject to certain contractual agreements that may
require Discovery to acquire the ownership interests of minority
partners. At the end of 2005, Discovery estimates its aggregate
obligations thereunder at approximately $272,502,000. The put
rights are exercisable at various dates, certain of which have
already been exercised at December 31, 2005. The amounts
due associated with the put rights that have already been
exercised is $80,000,000.
In connection with the execution of long-term distribution
agreements for certain of its European cable networks, Discovery
is committed to pay a distributor a percentage increase in the
value of these networks, if any, on June 30, 2006, six
months prior to the termination of the contract on
December 31, 2006. Discovery
II-14
adjusts its recorded liability for changes in the value of these
networks each period. However, Discovery is currently unable to
predict the likelihood or the terms and conditions of any
renewal of the distribution agreements. Discovery will record
the effect of a renewed distribution agreement when such terms
are in place. The effect of a renewed agreement could result in
a payment for an amount significantly greater than the amount
currently accrued.
|
|
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 on Page II-16. The financial statement schedules
required by
Regulation S-X are
filed under Item 15 of this Annual Report on
Form 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 Act
Rules 13a-15 and
15d-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 Companys disclosure controls
and procedures were effective as of December 31, 2005 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
Commissions rules and forms.
There has been no change in the Companys internal controls
over financial reporting that occurred during the three months
ended December 31, 2005 that has materially affected, or is
reasonably likely to materially affect, its internal controls
over financial reporting.
|
|
Item 9B. |
Other Information. |
None.
II-15
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING
FIRM
The Stockholders and Board of Directors
Discovery Holding Company:
We have audited the accompanying balance sheets of Discovery
Holding Company and subsidiaries as of December 31, 2005
and 2004, and the related consolidated statements of operations
and comprehensive earnings (loss), stockholders equity,
and cash flows for each of the years in the three-year period
ended December 31, 2005. These financial statements are the
responsibility of the Companys management. Our
responsibility is to express an opinion on these financial
statements based on our audits. We did not audit the financial
statements of Discovery Communications, Inc., (a 50 percent
owned investee company). The Companys investment in
Discovery Communications, Inc. at December 31, 2005 and
2004, was $3,018,622,000 and $2,945,782,000, respectively, and
its equity in earnings of Discovery Communications, Inc. was
$79,810,000, $84,011,000 and $37,271,000 for the years 2005,
2004 and 2003, 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 consideration
of internal control over financial reporting as a basis for
designing audit procedures that are appropriate in the
circumstances, but not for the purpose of expressing an opinion
on the effectiveness of the Companys internal control over
financial reporting. Accordingly, we express no such opinion. An
audit also 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, 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, 2005 and 2004, and the results of their
operations and their cash flows for each of the years in the
three-year period ended December 31, 2005, in conformity
with U.S. generally accepted accounting principles.
Denver, Colorado
March 23, 2006
II-16
DISCOVERY HOLDING COMPANY
Consolidated Balance Sheets
December 31, 2005 and 2004
|
|
|
|
|
|
|
|
|
|
|
|
|
2005 | |
|
2004 | |
|
|
| |
|
| |
|
|
Amounts in thousands | |
ASSETS |
Current assets:
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$ |
250,352 |
|
|
$ |
21,641 |
|
|
Trade receivables, net
|
|
|
134,615 |
|
|
|
151,120 |
|
|
Prepaid expenses
|
|
|
10,986 |
|
|
|
17,399 |
|
|
Other current assets
|
|
|
4,433 |
|
|
|
8,809 |
|
|
|
|
|
|
|
|
|
|
Total current assets
|
|
|
400,386 |
|
|
|
198,969 |
|
|
Investment in Discovery Communications, Inc.
(Discovery) (note 5)
|
|
|
3,018,622 |
|
|
|
2,945,782 |
|
|
Property, plant, and equipment, net (note 6)
|
|
|
256,245 |
|
|
|
258,741 |
|
|
Goodwill (note 7)
|
|
|
2,133,518 |
|
|
|
2,135,446 |
|
|
Other assets, net
|
|
|
10,465 |
|
|
|
25,890 |
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$ |
5,819,236 |
|
|
$ |
5,564,828 |
|
|
|
|
|
|
|
|
|
LIABILITIES AND STOCKHOLDERS EQUITY |
Current liabilities:
|
|
|
|
|
|
|
|
|
|
Accounts payable
|
|
$ |
26,854 |
|
|
$ |
33,327 |
|
|
Accrued payroll and related liabilities
|
|
|
21,651 |
|
|
|
23,632 |
|
|
Other accrued liabilities
|
|
|
23,949 |
|
|
|
29,606 |
|
|
Deferred revenue
|
|
|
17,491 |
|
|
|
20,858 |
|
|
Due to Liberty Media Corporation (Liberty)
|
|
|
|
|
|
|
1,104 |
|
|
|
|
|
|
|
|
|
|
Total current liabilities
|
|
|
89,945 |
|
|
|
108,527 |
|
Deferred income tax liabilities (note 11)
|
|
|
1,131,505 |
|
|
|
1,083,964 |
|
Other liabilities
|
|
|
22,361 |
|
|
|
25,058 |
|
|
|
|
|
|
|
|
|
|
Total liabilities
|
|
|
1,243,811 |
|
|
|
1,217,549 |
|
|
|
|
|
|
|
|
Commitments and contingencies (note 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
268,097,442 shares at December 31, 2005
|
|
|
2,681 |
|
|
|
|
|
|
Series B common stock, $.01 par value. Authorized
50,000,000 shares; issued and outstanding
12,106,093 shares at December 31, 2005
|
|
|
121 |
|
|
|
|
|
|
Series C common stock, $.01 par value. Authorized
600,000,000 shares; no shares issued
|
|
|
|
|
|
|
|
|
|
Additional paid-in capital
|
|
|
5,712,304 |
|
|
|
|
|
|
Parents investment
|
|
|
|
|
|
|
5,506,066 |
|
|
Accumulated deficit
|
|
|
(1,137,821 |
) |
|
|
(1,171,097 |
) |
|
Accumulated other comprehensive earnings (loss)
|
|
|
(1,860 |
) |
|
|
12,310 |
|
|
|
|
|
|
|
|
|
|
Total stockholders equity
|
|
|
4,575,425 |
|
|
|
4,347,279 |
|
|
|
|
|
|
|
|
|
|
Total liabilities and stockholders equity
|
|
$ |
5,819,236 |
|
|
$ |
5,564,828 |
|
|
|
|
|
|
|
|
See accompanying notes to consolidated financial statements.
II-17
DISCOVERY HOLDING COMPANY
Consolidated Statements of Operations and Comprehensive
Earnings (Loss)
Years ended December 31, 2005, 2004 and 2003
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2005 | |
|
2004 | |
|
2003 | |
|
|
| |
|
| |
|
| |
|
|
Amounts in thousands | |
Net revenue
|
|
$ |
694,509 |
|
|
$ |
631,215 |
|
|
$ |
506,103 |
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of services
|
|
|
445,839 |
|
|
|
380,290 |
|
|
|
301,005 |
|
|
Selling, general, and administrative (SG&A)
|
|
|
170,045 |
|
|
|
153,130 |
|
|
|
128,918 |
|
|
Depreciation and amortization
|
|
|
76,377 |
|
|
|
77,605 |
|
|
|
70,526 |
|
|
Stock compensation SG&A
|
|
|
4,383 |
|
|
|
2,775 |
|
|
|
2,602 |
|
|
Restructuring and other charges
|
|
|
4,112 |
|
|
|
|
|
|
|
3,476 |
|
|
Loss (gain) on sale of operating assets
|
|
|
(4,845 |
) |
|
|
429 |
|
|
|
1,418 |
|
|
Impairment of goodwill
|
|
|
|
|
|
|
51 |
|
|
|
562 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
250,072 |
|
|
|
233,990 |
|
|
|
207,502 |
|
|
|
|
|
|
|
|
|
|
|
|
Operating income (loss)
|
|
|
(1,402 |
) |
|
|
16,935 |
|
|
|
(2,404 |
) |
Other income (expense):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Share of earnings of Discovery
|
|
|
79,810 |
|
|
|
84,011 |
|
|
|
37,271 |
|
|
Interest expense third party
|
|
|
|
|
|
|
|
|
|
|
(47,489 |
) |
|
Interest to parent
|
|
|
|
|
|
|
|
|
|
|
(24,689 |
) |
|
Other, net
|
|
|
3,704 |
|
|
|
132 |
|
|
|
2,821 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
83,514 |
|
|
|
84,143 |
|
|
|
(32,086 |
) |
|
|
|
|
|
|
|
|
|
|
|
Earnings (loss) before income taxes and minority interest
|
|
|
82,112 |
|
|
|
101,078 |
|
|
|
(34,490 |
) |
Income tax expense
|
|
|
(48,836 |
) |
|
|
(34,970 |
) |
|
|
(20,156 |
) |
Minority interests in losses of subsidiaries
|
|
|
|
|
|
|
|
|
|
|
2,252 |
|
|
|
|
|
|
|
|
|
|
|
|
Net earnings (loss)
|
|
$ |
33,276 |
|
|
$ |
66,108 |
|
|
$ |
(52,394 |
) |
|
|
|
|
|
|
|
|
|
|
Other comprehensive earnings (loss), net of taxes (note 14):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unrealized holding gains (losses) arising during the period
|
|
|
651 |
|
|
|
(1,162 |
) |
|
|
1,770 |
|
|
|
Foreign currency translation adjustments
|
|
|
(14,821 |
) |
|
|
6,797 |
|
|
|
7,528 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Other comprehensive earnings (loss)
|
|
|
(14,170 |
) |
|
|
5,635 |
|
|
|
9,298 |
|
|
|
|
|
|
|
|
|
|
|
Comprehensive earnings (loss)
|
|
$ |
19,106 |
|
|
$ |
71,743 |
|
|
$ |
(43,096 |
) |
|
|
|
|
|
|
|
|
|
|
Basic and diluted earnings (loss) per common share (note 3)
|
|
$ |
0.12 |
|
|
$ |
0.24 |
|
|
$ |
(0.19 |
) |
|
|
|
|
|
|
|
|
|
|
See accompanying notes to consolidated financial statements.
II-18
DISCOVERY HOLDING COMPANY
Consolidated Statements of Cash Flows
Years ended December 31, 2005, 2004 and 2003
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2005 | |
|
2004 | |
|
2003 | |
|
|
| |
|
| |
|
| |
|
|
Amounts in thousands | |
|
|
(see note 4) | |
Cash flows from operating activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net earnings (loss)
|
|
$ |
33,276 |
|
|
$ |
66,108 |
|
|
$ |
(52,394 |
) |
|
Adjustments to reconcile net earnings (loss) to net cash
provided by operating activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
|
76,377 |
|
|
|
77,605 |
|
|
|
70,526 |
|
|
|
Stock compensation
|
|
|
4,383 |
|
|
|
2,775 |
|
|
|
2,602 |
|
|
|
Payments for stock compensation
|
|
|
(2,139 |
) |
|
|
|
|
|
|
|
|
|
|
Impairment of goodwill
|
|
|
|
|
|
|
51 |
|
|
|
562 |
|
|
|
Noncash interest expense
|
|
|
|
|
|
|
|
|
|
|
26,218 |
|
|
|
Amortization of debt discount
|
|
|
|
|
|
|
|
|
|
|
19,044 |
|
|
|
Share of earnings of Discovery
|
|
|
(79,810 |
) |
|
|
(84,011 |
) |
|
|
(37,271 |
) |
|
|
Deferred income tax expense
|
|
|
50,363 |
|
|
|
31,692 |
|
|
|
17,653 |
|
|
|
Other non-cash charges (credits), net
|
|
|
(4,684 |
) |
|
|
706 |
|
|
|
(3,149 |
) |
|
Changes in assets and liabilities (net of acquisitions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Trade receivables
|
|
|
16,237 |
|
|
|
(36,405 |
) |
|
|
(4,040 |
) |
|
|
Prepaid expenses and other current assets
|
|
|
10,804 |
|
|
|
(6,631 |
) |
|
|
(3,069 |
) |
|
|
Payables and other liabilities
|
|
|
(19,516 |
) |
|
|
32,432 |
|
|
|
(7,000 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by operating activities
|
|
|
85,291 |
|
|
|
84,322 |
|
|
|
29,682 |
|
|
|
|
|
|
|
|
|
|
|
Cash flows from investing activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital expenditures
|
|
|
(90,526 |
) |
|
|
(49,292 |
) |
|
|
(25,863 |
) |
|
Cash paid for acquisitions
|
|
|
|
|
|
|
(44,238 |
) |
|
|
|
|
|
Net sales (purchases) of marketable securities
|
|
|
12,800 |
|
|
|
(12,800 |
) |
|
|
|
|
|
Cash proceeds from dispositions
|
|
|
15,374 |
|
|
|
3,978 |
|
|
|
5,453 |
|
|
Other investing activities, net
|
|
|
(394 |
) |
|
|
73 |
|
|
|
177 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash used in investing activities
|
|
|
(62,746 |
) |
|
|
(102,279 |
) |
|
|
(20,233 |
) |
|
|
|
|
|
|
|
|
|
|
Cash flows from financing activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash transfers from Liberty
|
|
|
206,044 |
|
|
|
30,999 |
|
|
|
|
|
|
Borrowings of long-term debt
|
|
|
|
|
|
|
|
|
|
|
2,945 |
|
|
Payments of long-term debt and capital lease obligations
|
|
|
(12 |
) |
|
|
|
|
|
|
(406,820 |
) |
|
Borrowings under convertible subordinated notes with Liberty
|
|
|
|
|
|
|
|
|
|
|
391,027 |
|
|
Other financing activities
|
|
|
134 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by (used in) financing activities
|
|
|
206,166 |
|
|
|
30,999 |
|
|
|
(12,848 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net increase (decrease) in cash and cash equivalents
|
|
|
228,711 |
|
|
|
13,042 |
|
|
|
(3,399 |
) |
Cash and cash equivalents at beginning of year
|
|
|
21,641 |
|
|
|
8,599 |
|
|
|
11,998 |
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents at end of year
|
|
$ |
250,352 |
|
|
$ |
21,641 |
|
|
$ |
8,599 |
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes to consolidated financial statements.
II-19
DISCOVERY HOLDING COMPANY
Consolidated Statements of Stockholders Equity
Years ended December 31, 2005, 2004 and 2003
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated | |
|
|
|
|
|
|
Common Stock |
|
Additional | |
|
|
|
|
|
Other | |
|
Total | |
|
|
Preferred |
|
|
|
Paid-In | |
|
Parents | |
|
Accumulated | |
|
Comprehensive | |
|
Stockholders | |
|
|
Stock |
|
Series A | |
|
Series B | |
|
Series C |
|
Capital | |
|
Investment | |
|
Deficit | |
|
Earnings (Loss) | |
|
Equity | |
|
|
|
|
| |
|
| |
|
|
|
| |
|
| |
|
| |
|
| |
|
| |
|
|
|
|
|
|
|
|
|
|
Amounts in thousands | |
|
|
|
|
|
|
Balance at January 1, 2003
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
4,804,212 |
|
|
$ |
(1,184,811 |
) |
|
$ |
(1,984 |
) |
|
$ |
3,617,417 |
|
|
Net loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(52,394 |
) |
|
|
|
|
|
|
(52,394 |
) |
|
Other comprehensive earnings
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
9,298 |
|
|
|
9,298 |
|
|
Issuance of stock for interest on convertible subordinated notes
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
11,129 |
|
|
|
|
|
|
|
|
|
|
|
11,129 |
|
|
Conversion of debt to equity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
654,330 |
|
|
|
|
|
|
|
|
|
|
|
654,330 |
|
|
Reallocation of enterprise level goodwill from Liberty
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
15,000 |
|
|
|
|
|
|
|
|
|
|
|
15,000 |
|
|
Acquisition of Ascent Medias minority interest
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5,811 |
|
|
|
|
|
|
|
|
|
|
|
5,811 |
|
|
Other
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
317 |
|
|
|
|
|
|
|
(639 |
) |
|
|
(322 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2003
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(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 |
|
|
Net earnings
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
33,276 |
|
|
|
|
|
|
|
33,276 |
|
|
Other comprehensive loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(14,170 |
) |
|
|
(14,170 |
) |
|
Stock compensation
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
640 |
|
|
|
2,222 |
|
|
|
|
|
|
|
|
|
|
|
2,862 |
|
|
Net cash transfers from Liberty
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
206,044 |
|
|
|
|
|
|
|
|
|
|
|
206,044 |
|
|
Change in capitalization in connection with Spin Off
(note 2)
|
|
|
|
|
|
|
2,681 |
|
|
|
121 |
|
|
|
|
|
|
|
5,711,530 |
|
|
|
(5,714,332 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock option exercises
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
134 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
134 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2005
|
|
$ |
|
|
|
$ |
2,681 |
|
|
$ |
121 |
|
|
$ |
|
|
|
$ |
5,712,304 |
|
|
$ |
|
|
|
$ |
(1,137,821 |
) |
|
$ |
(1,860 |
) |
|
$ |
4,575,425 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes to consolidated financial statements.
II-20
DISCOVERY HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005, 2004 and 2003
|
|
(1) |
Basis of Presentation |
The accompanying consolidated financial statements of Discovery
Holding Company (DHC or the Company)
represent a combination of the historical financial information
of (1) Ascent Media Group, LLC (f/k/a Ascent Media Group,
Inc., Ascent Media), a wholly-owned subsidiary of
Liberty, and Libertys 50% ownership interest in Discovery
for periods prior to the July 21, 2005 consummation of the
spin off transaction (the Spin Off) described in
note 2 and (2) DHC and its consolidated subsidiaries
for the period following such date. The Spin Off has been
accounted for at historical cost due to the pro rata nature of
the distribution. Accordingly, DHCs historical financial
statements are presented in a manner similar to a pooling of
interests.
Ascent Media is comprised of three operating divisions or
groups. Ascent Medias 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. The Media
Management Services group provides owners of content libraries
with an entire complement of facilities and services necessary
to optimize, archive, manage, and repurpose media assets for
global distribution via freight, satellite, fiber, and the
Internet. The Networks 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 Networks Services group provides systems
integration, design, consulting, engineering and project
management services.
Discovery is a global media and entertainment company that
provides original and purchased cable and satellite television
programming in the United States and over 160 other countries.
Discovery also develops and sells branded commerce and
educational product lines in the United States.
During the first quarter of 2005, the Board of Directors of
Liberty (the Board) approved a resolution to spin
off the capital stock of DHC to the holders of Liberty
Series A and Series B common stock. The 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 (the
Record Date) 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 Spin Off. The Spin Off did not involve the payment
of any consideration by the holders of Liberty common stock and
is 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 Spin Off.
Following the Spin Off, the Company and Liberty operate
independently, and neither has any stock ownership, beneficial
or otherwise, in the other. In connection with the 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 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 Spin
Off and cross indemnities. Pursuant to the Services Agreement,
Liberty provides
II-21
DISCOVERY HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
the Company with office 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
Companys 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 will generally be
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 will be
responsible for all other taxes that are attributable to the
Company or one of its subsidiaries, whether accruing before, on
or after the 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 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 Spin Off, with respect to any
transaction pursuant to which any of the other shareholders of
Discovery would acquire shares of, or other interests in
DHCs capital stock, in each case relating to the
qualification of the Spin Off.
|
|
(3) |
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 are shown net of an allowance based on
historical collection trends and managements 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, 2005 and
2004 was $7,708,000 and $12,104,000, respectively.
A summary of activity in the allowance for doubtful accounts is
as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance | |
|
Charged | |
|
Acquired or | |
|
|
|
Balance | |
|
|
Beginning | |
|
(Credited) | |
|
Charged to | |
|
Write-Offs | |
|
End of | |
|
|
of Year | |
|
to Expense | |
|
Other Accounts | |
|
and Other | |
|
Year | |
|
|
| |
|
| |
|
| |
|
| |
|
| |
|
|
Amounts in thousands | |
2005
|
|
$ |
12,104 |
|
|
$ |
(619 |
) |
|
$ |
(768 |
) |
|
$ |
(3,009 |
) |
|
$ |
7,708 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2004
|
|
$ |
11,580 |
|
|
$ |
555 |
|
|
$ |
(403 |
) |
|
$ |
372 |
|
|
$ |
12,104 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2003
|
|
$ |
9,013 |
|
|
$ |
(5 |
) |
|
$ |
2,004 |
|
|
$ |
568 |
|
|
$ |
11,580 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Concentration of Credit Risk and Significant
Customers |
For the years ended December 31, 2005, 2004 and 2003, no
single customer accounted for more than 10% of consolidated
revenue.
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 Companys share of the
II-22
DISCOVERY HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
net earnings or losses of Discovery as they occur, rather than
as dividends or other distributions are received. The excess of
the Companys carrying value over its proportionate share
of Discoverys equity is accounted for as equity method
goodwill, and accordingly, is not amortized, but periodically
reviewed for impairment.
Changes in the Companys 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, 2005.
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.
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:
|
|
|
|
|
Buildings
|
|
|
20 years |
|
Leasehold improvements
|
|
|
15 years or lease term, if shorter |
|
Furniture and fixtures
|
|
|
7 years |
|
Computers
|
|
|
3 years |
|
Machinery and equipment
|
|
|
5 to 7 years |
|
Depreciation expense for property and equipment was $74,805,000,
$74,986,000 and $68,032,000 for the years ended
December 31, 2005, 2004 and 2003, respectively.
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, the Company reviews the impairment
of goodwill annually and whenever events or changes in
circumstances indicate that the carrying value may not be
recoverable.
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).
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 managements best estimate of undiscounted future cash
flows over the remaining amortization period. 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.
II-23
DISCOVERY HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
|
Foreign Currency Translation |
The functional currencies of the Companys 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 equity as a component
of accumulated other comprehensive loss.
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.
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.
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 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 Companys 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.
Advertising costs generally are expensed as incurred.
Advertising expense aggregated $3,465,000, $3,303,000 and
$3,089,000 for the years ended December 31, 2005, 2004 and
2003, respectively.
Employees of the Company hold stock options and stock
appreciation rights (SARs) with respect to shares of
Liberty Series A common stock. In addition, executive
officers of the Company hold stock options with respect to
shares of DHC common stock. The Company applies the
intrinsic-value-based method of accounting prescribed by
Accounting Principles Board (APB) Opinion No. 25,
Accounting for Stock Issued to Employees, and related
interpretations including FASB Interpretation No. 44,
Accounting for Certain Transactions involving Stock
Compensation, an interpretation of APB Opinion No. 25,
to account for its fixed-plan stock options. Under this method,
compensation expense is recorded on the date of grant only if
the current market price of the underlying stock exceeds the
exercise price and is recognized on a straight-line basis over
the vesting period. SFAS No. 123, Accounting for
Stock-Based Compensation, established accounting and
disclosure requirements using a fair-value-based method of
accounting for stock-based employee compensation plans. As
allowed by SFAS No. 123, the Company has elected to
continue to apply the intrinsic-value-based method of accounting
described above and has adopted only the disclosure requirements
of SFAS No. 123.
The following table illustrates the effect on net earnings
(loss) if the fair-value-based method had been applied to all
outstanding and unvested awards in each period. Compensation
expense for SARs is the same
II-24
DISCOVERY HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
under APB Opinion No. 25 and SFAS No. 123.
Accordingly, no pro forma adjustment for such awards is included
in the following table.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31, | |
|
|
| |
|
|
2005 | |
|
2004 | |
|
2003 | |
|
|
| |
|
| |
|
| |
|
|
Amounts in thousands, except | |
|
|
per share amounts | |
Net earnings (loss), as reported
|
|
$ |
33,276 |
|
|
$ |
66,108 |
|
|
$ |
(52,394 |
) |
Add:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock-based employee compensation expense included in reported
net earnings (loss)
|
|
|
2,309 |
|
|
|
2,268 |
|
|
|
2,452 |
|
Deduct:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock-based employee compensation expense determined under fair
value based method for all awards
|
|
|
(8,247 |
) |
|
|
(6,247 |
) |
|
|
(4,817 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
Pro forma net earnings (loss)
|
|
$ |
27,338 |
|
|
$ |
62,129 |
|
|
$ |
(54,759 |
) |
|
|
|
|
|
|
|
|
|
|
Basic and diluted earnings (loss) per common share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As reported
|
|
$ |
.12 |
|
|
$ |
.24 |
|
|
$ |
(.19 |
) |
|
Pro forma
|
|
$ |
.10 |
|
|
$ |
.22 |
|
|
$ |
(.20 |
) |
|
|
|
Earnings (Loss) Per Common Share |
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 Spin Off
and (2) the actual number of shares outstanding for all
periods subsequent to the Spin Off. The weighted average
outstanding shares for the year ended December 31, 2005 was
279,557,000. 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 2005 and
2004, their inclusion does not impact the EPS amount as reported
in the accompanying consolidated statements of operations.
The preparation of the consolidated financial statements in
conformity with accounting principles generally accepted 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 Companys
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 |
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 123 and supersedes 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
II-25
DISCOVERY HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
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) based
on the current fair value of the award, and to remeasure the
fair value of the award at each reporting date.
Public companies are required to adopt Statement 123R as of
the beginning of the registrants next fiscal year, or
January 1, 2006 for calendar-year companies such as DHC.
The provisions of Statement 123R will affect the accounting
for all awards granted, modified, repurchased or cancelled after
December 31, 2005. The accounting for awards granted, but
not vested, prior to January 1, 2006 will also be impacted.
The provisions of Statement 123R allow companies to adopt
the standard on a prospective basis or to restate all periods
for which Statement 123 was effective. The Company expects
to adopt Statement 123R on a prospective basis, and will
include in its financial statements for periods that begin after
December 31, 2005 pro forma information as though the
standard had been adopted for all periods presented.
While the Company has not yet quantified the impact of adopting
Statement 123R, it does not believe that such adoption will
have a significant impact on its operating income and net
earnings in the future.
|
|
(4) |
Supplemental Disclosure of Cash Flow Information |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31, | |
|
|
| |
|
|
2005 | |
|
2004 | |
|
2003 | |
|
|
| |
|
| |
|
| |
|
|
Amounts in thousands | |
Cash paid for acquisitions:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair value of assets acquired
|
|
$ |
|
|
|
$ |
60,950 |
|
|
$ |
11,811 |
|
|
Net liabilities assumed
|
|
|
|
|
|
|
(17,073 |
) |
|
|
(6,000 |
) |
|
Deferred tax liability
|
|
|
|
|
|
|
361 |
|
|
|
|
|
|
Issuance of Liberty common stock
|
|
|
|
|
|
|
|
|
|
|
(5,811 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
Cash paid for acquisitions, net of cash acquired
|
|
$ |
|
|
|
$ |
44,238 |
|
|
$ |
|
|
|
|
|
|
|
|
|
|
|
|
Cash paid during the year for:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
|
|
$ |
|
|
|
$ |
|
|
|
$ |
25,206 |
|
|
|
|
|
|
|
|
|
|
|
|
Income taxes
|
|
$ |
1,190 |
|
|
$ |
1,916 |
|
|
$ |
731 |
|
|
|
|
|
|
|
|
|
|
|
Noncash investing and financing activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock issued for payment of interest on convertible
subordinated notes
|
|
$ |
|
|
|
$ |
|
|
|
$ |
11,129 |
|
|
|
|
|
|
|
|
|
|
|
|
Conversion of subordinated notes to parents investment
|
|
$ |
|
|
|
$ |
|
|
|
$ |
654,330 |
|
|
|
|
|
|
|
|
|
|
|
|
|
(5) |
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 160 other countries.
DHCs carrying value for Discovery was $3,018,622,000 at
December 31, 2005. In addition, as described in
note 3, $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
II-26
DISCOVERY HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
SFAS No. 142. As a result, there were adjustments to
the enterprise level goodwill allocated to DHC in 2003 and 2004.
Such adjustments are reflected in DHCs consolidated
statement of stockholders equity.
Included in the Companys share of earnings of Discovery in
2003 is the Companys 50% share of adjustments to the
redemption value of redeemable common stock held by an officer
of Discovery. Such adjustments were recorded as reductions to
equity by Discovery. These shares were redeemed in June 2003.
Summarized financial information for Discovery is as follows:
Consolidated Balance Sheets
|
|
|
|
|
|
|
|
|
|
|
|
December 31, | |
|
|
| |
|
|
2005 | |
|
2004 | |
|
|
| |
|
| |
|
|
Amounts in thousands | |
Current assets
|
|
$ |
831,369 |
|
|
$ |
835,450 |
|
Property and equipment
|
|
|
397,578 |
|
|
|
380,290 |
|
Goodwill and intangible assets
|
|
|
397,927 |
|
|
|
445,221 |
|
Programming rights, long term
|
|
|
1,175,988 |
|
|
|
1,027,379 |
|
Other assets
|
|
|
371,758 |
|
|
|
547,346 |
|
|
|
|
|
|
|
|
|
Total assets
|
|
$ |
3,174,620 |
|
|
$ |
3,235,686 |
|
|
|
|
|
|
|
|
Current liabilities
|
|
$ |
692,465 |
|
|
$ |
880,561 |
|
Long-term debt
|
|
|
2,590,440 |
|
|
|
2,498,287 |
|
Other liabilities
|
|
|
101,571 |
|
|
|
165,197 |
|
Mandatorily redeemable equity in subsidiaries
|
|
|
272,502 |
|
|
|
319,567 |
|
Stockholders deficit
|
|
|
(482,358 |
) |
|
|
(627,926 |
) |
|
|
|
|
|
|
|
|
Total liabilities and stockholders deficit
|
|
$ |
3,174,620 |
|
|
$ |
3,235,686 |
|
|
|
|
|
|
|
|
Consolidated Statements of Operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31, | |
|
|
| |
|
|
2005 | |
|
2004 | |
|
2003 | |
|
|
| |
|
| |
|
| |
|
|
Amounts in thousands | |
Revenue
|
|
$ |
2,671,754 |
|
|
$ |
2,365,346 |
|
|
$ |
1,995,047 |
|
Operating expenses
|
|
|
(979,765 |
) |
|
|
(846,316 |
) |
|
|
(751,578 |
) |
Selling, general and administrative
|
|
|
(1,005,351 |
) |
|
|
(856,340 |
) |
|
|
(735,017 |
) |
Equity-based compensation
|
|
|
(49,465 |
) |
|
|
(71,515 |
) |
|
|
(74,119 |
) |
Depreciation and amortization
|
|
|
(123,209 |
) |
|
|
(129,011 |
) |
|
|
(120,172 |
) |
Gain on sale of patent
|
|
|
|
|
|
|
22,007 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income
|
|
|
513,964 |
|
|
|
484,171 |
|
|
|
314,161 |
|
Interest expense
|
|
|
(184,575 |
) |
|
|
(167,420 |
) |
|
|
(159,409 |
) |
Other expense
|
|
|
(7,426 |
) |
|
|
(6,930 |
) |
|
|
(16,730 |
) |
Income tax expense
|
|
|
(162,343 |
) |
|
|
(141,799 |
) |
|
|
(74,785 |
) |
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$ |
159,620 |
|
|
$ |
168,022 |
|
|
$ |
63,237 |
|
|
|
|
|
|
|
|
|
|
|
II-27
DISCOVERY HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
(6) |
Property and Equipment |
During the year ended December 31, 2005, the Company
retired approximated $83 million of fully depreciated
property and equipment. Property and equipment at
December 31, 2005 and 2004 consist of the following:
|
|
|
|
|
|
|
|
|
|
|
|
2005 | |
|
2004 | |
|
|
| |
|
| |
|
|
Amounts in thousands | |
Property and equipment, net:
|
|
|
|
|
|
|
|
|
|
Land
|
|
$ |
48,365 |
|
|
$ |
58,048 |
|
|
Buildings
|
|
|
186,389 |
|
|
|
183,985 |
|
|
Equipment
|
|
|
215,595 |
|
|
|
226,188 |
|
|
Accumulated depreciation
|
|
|
(194,104 |
) |
|
|
(209,480 |
) |
|
|
|
|
|
|
|
|
|
$ |
256,245 |
|
|
$ |
258,741 |
|
|
|
|
|
|
|
|
|
|
(7) |
Goodwill and Other Intangible Assets |
SFAS No. 142 prescribes the financial accounting and
reporting for acquired goodwill and other intangible assets.
Under SFAS No. 142, goodwill is not amortized, but is
tested annually for impairment. SFAS No. 142 also
requires that intangible assets with estimable useful lives be
amortized over their respective estimated useful lives to their
estimated residual values, and be reviewed for impairment in
accordance with SFAS No. 144.
In fiscal 2004 and 2003, the Company recorded impairment charges
of $51,000 and $562,000, respectively, as a result of the annual
impairment test of goodwill in accordance with
SFAS No. 142. The fair value of each reporting unit
was determined through the use of an outside independent
valuation consultant. The consultant used both the income
approach and market approach in determining fair value.
SFAS No. 142 requires the Company to consider equity
method affiliates as separate reporting units. As a result, a
portion of DHCs 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.
The following table provides the activity and balances of
goodwill:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Media | |
|
|
|
|
|
|
|
|
Creative | |
|
Management | |
|
Network | |
|
|
|
|
|
|
Services | |
|
Services | |
|
Services | |
|
|
|
|
|
|
Group | |
|
Group | |
|
Group | |
|
Discovery | |
|
Total | |
|
|
| |
|
| |
|
| |
|
| |
|
| |
|
|
Amounts in thousands | |
Net balance at January 1, 2004
|
|
$ |
107,428 |
|
|
$ |
88,025 |
|
|
$ |
146,444 |
|
|
$ |
1,789,000 |
|
|
$ |
2,130,897 |
|
|
Acquisitions
|
|
|
|
|
|
|
5,325 |
|
|
|
17,379 |
|
|
|
|
|
|
|
22,704 |
|
|
Foreign exchange and other
|
|
|
|
|
|
|
|
|
|
|
(104 |
) |
|
|
(18,000 |
) |
|
|
(18,104 |
) |
|
2004 Impairment
|
|
|
(51 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(51 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net balance at December 31, 2004
|
|
|
107,377 |
|
|
|
93,350 |
|
|
|
163,719 |
|
|
|
1,771,000 |
|
|
|
2,135,446 |
|
|
Foreign exchange and other
|
|
|
(778 |
) |
|
|
52 |
|
|
|
(1,202 |
) |
|
|
|
|
|
|
(1,928 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net balance at December 31, 2005
|
|
$ |
106,599 |
|
|
$ |
93,402 |
|
|
$ |
162,517 |
|
|
$ |
1,771,000 |
|
|
$ |
2,133,518 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
II-28
DISCOVERY HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
Included in other assets at December 31, 2005 are
amortizable intangibles with a net book value of $1,442,000 and
a tradename intangible (which is not subject to amortization) of
$2,440,000.
For the years ended December 31, 2005, 2004 and 2003, the
Company recorded $1,572,000, $2,619,000 and $2,494,000,
respectively, of amortization expense for other intangible
assets.
|
|
(8) |
Restructuring Charges |
During 2005 and 2003, 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 $4,112,000 and $3,476,000,
respectively. The 2005 restructuring charge relates primarily to
the closure and consolidation of facilities in the United
Kingdom. The 2003 restructuring charge is related to the
consolidation of facilities and closure-related costs in the
Creative Services group both domestically and 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
|
|
$ |
2,227 |
|
|
$ |
2,130 |
|
|
$ |
(980 |
) |
|
$ |
3,377 |
|
Employee separations
|
|
|
|
|
|
|
1,170 |
|
|
|
(1,170 |
) |
|
|
|
|
Contract exit costs
|
|
|
|
|
|
|
176 |
|
|
|
(176 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2003
|
|
$ |
2,227 |
|
|
$ |
3,476 |
|
|
$ |
(2,326 |
) |
|
$ |
3,377 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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.
The following unaudited pro forma information for the years
ended December 31, 2004 and 2003 was prepared assuming the
acquisition of LPC occurred on January 1, 2003. However,
those pro forma amounts are not necessarily indicative of
operating results that would have occurred if the LPC
acquisition had occurred on January 1, 2003 (amounts in
thousands, except per share amounts):
|
|
|
|
|
|
|
|
|
|
|
2004 | |
|
2003 | |
|
|
| |
|
| |
Revenue
|
|
$ |
639,718 |
|
|
$ |
547,912 |
|
Net earnings (loss)
|
|
$ |
65,317 |
|
|
$ |
(53,194 |
) |
Basic and diluted net earnings (loss) per common share
|
|
$ |
0.23 |
|
|
$ |
(0.19 |
) |
II-29
DISCOVERY HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
|
|
|
Liberty Subordinated Credit Agreement |
In December 2000, when Ascent Media was a publicly traded
company and had a senior bank credit facility, Liberty and
Ascent Media entered into a subordinated credit agreement
pursuant to which Liberty agreed to make subordinated
convertible loans to Ascent Media. From December 2000 through
December 2003, Ascent Media borrowed funds under the
subordinated credit agreement as needed, and as agreed to by its
senior lenders, for acquisitions, capital expenditures, working
capital and payments under its senior bank credit facility. From
December 2000 through June 2003, at which time Liberty acquired
the minority interest in Ascent Media held by the public, Ascent
Media paid interest at the rate of 10% per annum on the
subordinated debt primarily with shares of its common stock.
From June 2003 through December 2003, accrued interest was added
to the principal amount of debt. In December 2003, Liberty
contributed the total amount of debt and accrued interest of
$654,330,000 to equity and the subordinated credit agreement was
cancelled.
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, | |
|
|
| |
|
|
2005 | |
|
2004 | |
|
2003 | |
|
|
| |
|
| |
|
| |
|
|
Amounts in thousands | |
Current
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
State
|
|
|
(637 |
) |
|
|
502 |
|
|
|
(1,100 |
) |
Foreign
|
|
|
2,164 |
|
|
|
(3,780 |
) |
|
|
(1,403 |
) |
|
|
|
|
|
|
|
|
|
|
|
Current
|
|
|
1,527 |
|
|
|
(3,278 |
) |
|
|
(2,503 |
) |
|
|
|
|
|
|
|
|
|
|
Deferred
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal
|
|
|
(26,402 |
) |
|
|
(25,221 |
) |
|
|
(15,628 |
) |
State
|
|
|
(20,743 |
) |
|
|
(7,774 |
) |
|
|
(3,494 |
) |
Foreign
|
|
|
(3,218 |
) |
|
|
1,303 |
|
|
|
1,469 |
|
|
|
|
|
|
|
|
|
|
|
|
Deferred
|
|
|
(50,363 |
) |
|
|
(31,692 |
) |
|
|
(17,653 |
) |
|
|
|
|
|
|
|
|
|
|
|
Total tax expense
|
|
$ |
(48,836 |
) |
|
$ |
(34,970 |
) |
|
$ |
(20,156 |
) |
|
|
|
|
|
|
|
|
|
|
Components of pretax income (loss) are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31, | |
|
|
| |
|
|
2005 | |
|
2004 | |
|
2003 | |
|
|
| |
|
| |
|
| |
|
|
Amounts in thousands | |
Domestic
|
|
$ |
76,907 |
|
|
$ |
96,470 |
|
|
$ |
(28,772 |
) |
Foreign
|
|
|
5,205 |
|
|
|
4,608 |
|
|
|
(3,466 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
$ |
82,112 |
|
|
$ |
101,078 |
|
|
$ |
(32,238 |
) |
|
|
|
|
|
|
|
|
|
|
II-30
DISCOVERY HOLDING COMPANY
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, | |
|
|
| |
|
|
2005 | |
|
2004 | |
|
2003 | |
|
|
| |
|
| |
|
| |
|
|
Amounts in thousands | |
Computed expected tax benefit (expense)
|
|
$ |
(28,739 |
) |
|
$ |
(35,377 |
) |
|
$ |
11,283 |
|
State and local income taxes, net of federal income taxes
|
|
|
(3,976 |
) |
|
|
(5,311 |
) |
|
|
(2,986 |
) |
Change in valuation allowance affecting tax expense
|
|
|
1,630 |
|
|
|
3,575 |
|
|
|
(14,719 |
) |
Change in estimated state tax rate
|
|
|
(15,263 |
) |
|
|
|
|
|
|
|
|
Disallowed interest expense
|
|
|
|
|
|
|
|
|
|
|
(13,963 |
) |
Other, net
|
|
|
(2,488 |
) |
|
|
2,143 |
|
|
|
229 |
|
|
|
|
|
|
|
|
|
|
|
|
Income tax expense
|
|
$ |
(48,836 |
) |
|
$ |
(34,970 |
) |
|
$ |
(20,156 |
) |
|
|
|
|
|
|
|
|
|
|
Components of deferred tax assets and liabilities as of
December 31 are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
2005 | |
|
2004 | |
|
|
| |
|
| |
|
|
Amounts in thousands | |
Current assets:
|
|
|
|
|
|
|
|
|
|
Accounts receivable reserves
|
|
$ |
2,350 |
|
|
$ |
2,423 |
|
|
Accrued liabilities
|
|
|
14,676 |
|
|
|
11,987 |
|
|
|
|
|
|
|
|
|
|
|
17,026 |
|
|
|
14,410 |
|
|
|
|
|
|
|
|
Noncurrent assets:
|
|
|
|
|
|
|
|
|
|
Net operating loss carryforwards
|
|
|
59,064 |
|
|
|
59,819 |
|
|
Property and equipment
|
|
|
4,771 |
|
|
|
|
|
|
Intangible assets
|
|
|
8,249 |
|
|
|
13,310 |
|
|
Other
|
|
|
5,506 |
|
|
|
10,280 |
|
|
|
|
|
|
|
|
|
|
|
77,590 |
|
|
|
83,409 |
|
|
|
|
|
|
|
|
|
Total deferred tax assets, gross
|
|
|
94,616 |
|
|
|
97,819 |
|
|
Valuation allowance
|
|
|
(91,235 |
) |
|
|
(88,067 |
) |
|
|
|
|
|
|
|
|
Total deferred tax assets, net
|
|
|
3,381 |
|
|
|
9,752 |
|
|
|
|
|
|
|
|
Current liabilities:
|
|
|
|
|
|
|
|
|
|
Prepaid expenses
|
|
|
(818 |
) |
|
|
(1,204 |
) |
|
Other
|
|
|
(3,010 |
) |
|
|
(2,802 |
) |
|
|
|
|
|
|
|
|
|
|
(3,828 |
) |
|
|
(4,006 |
) |
|
|
|
|
|
|
|
Noncurrent liabilities:
|
|
|
|
|
|
|
|
|
|
Property and equipment
|
|
|
|
|
|
|
(2,760 |
) |
|
Investments
|
|
|
(1,131,058 |
) |
|
|
(1,086,950 |
) |
|
|
|
|
|
|
|
|
|
|
(1,131,058 |
) |
|
|
(1,089,950 |
) |
|
|
|
|
|
|
|
|
Total deferred tax liabilities
|
|
|
(1,134,886 |
) |
|
|
(1,093,716 |
) |
|
|
|
|
|
|
|
|
Net deferred tax liability
|
|
$ |
(1,131,505 |
) |
|
$ |
(1,083,964 |
) |
|
|
|
|
|
|
|
II-31
DISCOVERY HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
At December 31, 2005, the Company has $86,860,000 and
$463,311,000 in net operating loss carryforwards for federal and
state tax purposes, respectively. These net operating losses
expire, for federal purposes, as follows: $24,216,000 in 2021;
$60,711,000 in 2022 and $1,933,000 in 2025. The state net
operating losses expire at various times through 2025. In
addition, the Company has $636,000 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
$91,235,000. The total valuation allowance increased $3,168,000
during the year ended December 31, 2005 as a result of
deferred tax assets related to acquisitions of $4,798,000 and a
decrease of $1,630,000 which affected tax expense.
During 2004, the Company provided $1,636,000 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.
|
|
(12) |
Stockholders Equity |
DHCs 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 DHCs Board of Directors. As of
December 31, 2005, no shares of preferred stock were issued.
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, 2005, 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.
As of December 31, 2005, there were 1,937,616 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 and warrants.
In connection with the Spin Off, employees of DHC, directors of
Liberty and employees of Liberty who held Liberty stock options
or Liberty stock appreciation rights (pre-Spin Off
Awards) and who were expected to provide services to DHC
pursuant to the Services Agreement received an option (DHC
Option) to purchase common stock of DHC equal to 0.10
times the number of shares of Liberty common stock subject to
the pre-Spin Off Awards held by the option holder. The exercise
price of the DHC Options was based on an allocation of the
exercise price of the pre-Spin Off Award. Approximately
2.0 million options to purchase DHC Series A common
stock and 3.0 million options to purchase DHC Series B
common stock were issued in the Spin Off, and no options have
been issued by DHC subsequent to the Spin Off.
Pursuant to the terms of the Reorganization Agreement, DHC is
responsible for settlement of all DHC Options. Liberty accounted
for its pre-Spin Off Awards as variable awards under
APB 25. Accordingly, DHC also accounts for the DHC Options
as variable awards. DHC records stock compensation for the DHC
II-32
DISCOVERY HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
Options held by its executive officers. Liberty records stock
compensation for all DHC Options held by Liberty employees and
directors.
In addition, certain employees of Ascent Media who held Liberty
pre-Spin Off Awards, continue to hold such awards. Ascent Media
records stock compensation related to such awards.
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 | |
|
|
| |
|
| |
|
| |
|
| |
Options issued in Spin Off
|
|
|
1,954,275 |
|
|
$ |
15.43 |
|
|
|
2,996,525 |
|
|
$ |
18.87 |
|
Exercises
|
|
|
(11,381 |
) |
|
$ |
11.77 |
|
|
|
|
|
|
|
|
|
Cancellations
|
|
|
(5,278 |
) |
|
$ |
15.05 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at December 31, 2005
|
|
|
1,937,616 |
|
|
$ |
15.43 |
|
|
|
2,996,525 |
|
|
$ |
18.87 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at December 31, 2005
|
|
|
1,116,354 |
|
|
$ |
16.44 |
|
|
|
2,323,633 |
|
|
$ |
19.06 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(14) |
Other Comprehensive Earnings (Loss) |
Accumulated other comprehensive earnings (loss) included in
DHCs consolidated balance sheets and consolidated
statements of stockholders equity reflect the aggregate of
foreign currency translation adjustments and unrealized holding
gains and losses on available-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 Gains | |
|
Comprehensive | |
|
|
Translation | |
|
(Losses) on | |
|
Earnings (Loss), | |
|
|
Adjustments | |
|
Securities | |
|
Net of Taxes | |
|
|
| |
|
| |
|
| |
|
|
Amounts in thousands | |
Balance at January 1, 2003
|
|
$ |
(2,034 |
) |
|
$ |
50 |
|
|
$ |
(1,984 |
) |
|
Other comprehensive earnings
|
|
|
7,528 |
|
|
|
1,770 |
|
|
|
9,298 |
|
|
Other activity
|
|
|
(258 |
) |
|
|
(381 |
) |
|
|
(639 |
) |
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2003
|
|
|
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 |
) |
|
|
|
|
|
|
|
|
|
|
II-33
DISCOVERY HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
The components of other comprehensive earnings (loss) are
reflected in DHCs 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, 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 |
|
|
|
|
|
|
|
|
|
|
|
Year ended December 31, 2003:
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign currency translation adjustments
|
|
$ |
12,341 |
|
|
$ |
(4,813 |
) |
|
$ |
7,528 |
|
Unrealized holding gains on securities arising during period
|
|
$ |
2,902 |
|
|
$ |
(1,132 |
) |
|
$ |
1,770 |
|
|
|
|
|
|
|
|
|
|
|
Other comprehensive earnings
|
|
$ |
15,243 |
|
|
$ |
(5,945 |
) |
|
$ |
9,298 |
|
|
|
|
|
|
|
|
|
|
|
|
|
(15) |
Employee Benefit Plans |
Ascent Media offers a 401(k) defined contribution plan covering
most of its full-time domestic employees 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
Medias board of directors. The plans are funded by
employee and employer contributions. Total pension plan expenses
for the years ended December 31, 2005, 2004 and 2003 were
$7,109,000, $6,485,000 and $6,380,000, respectively.
|
|
(16) |
Commitments and Contingencies |
Future minimum lease payments under scheduled operating leases
that have initial or remaining noncancelable terms in excess of
one year are as follows (in thousands):
|
|
|
|
|
|
Year ended December 31:
|
|
|
|
|
|
2006
|
|
$ |
30,563 |
|
|
2007
|
|
$ |
28,791 |
|
|
2008
|
|
$ |
25,886 |
|
|
2009
|
|
$ |
23,894 |
|
|
2010
|
|
$ |
19,265 |
|
|
Thereafter
|
|
$ |
47,033 |
|
Rent expense for noncancelable operating leases for real
property and equipment was $31,643,000, $26,487,000 and
$21,909,000 for the years ended December 31, 2005, 2004 and
2003, respectively. Various lease arrangements contain options
to extend terms and are subject to escalation clauses.
II-34
DISCOVERY HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
At December 31, 2005, the Company is committed to
compensation under long-term employment agreements with its
certain executive officers of Ascent Media as follows: 2006,
$2,442,000; 2007, $1,354,000; and 2008, $579,000.
The Company is involved in litigation and similar claims
incidental to the conduct of its business. In managements
opinion, none of the pending actions is likely to have a
material adverse impact on the Companys financial position
or results of operations.
|
|
(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 $5,948,000 for the year ended December 31, 2005.
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, 2005, 2004 and 2003
aggregated $34,189,000, $41,785,000 and $13,355,000,
respectively.
|
|
(18) |
Information About Operating Segments |
The Companys chief operating decision maker, or his
designee (the CODM), has identified the
Companys reportable segments based on (i) financial
information reviewed by the CODM and (ii) those operating
segments that represent more than 10% of the Companys
combined revenue or earnings before taxes. In addition, those
equity investments whose share of earnings represent more than
10% of the Companys earnings before taxes are considered
reportable segments.
Based on the foregoing criteria, the Companys business
units have been aggregated into four reportable segments: the
Creative Services Group, the Media Management Services Group,
and the Network Services Group, which are all 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 post-production services,
which are comprised of services necessary to complete the
creation of original content including feature films, television
shows, movies of the week/mini series, television commercials,
music videos, promotional and identity campaigns and corporate
communications programming. The Media Management Services Group
provides (i) content storage services, which are comprised
of facilities and services necessary to optimize, archive,
manage and repurpose media assets for global distribution via
freight, satellite, fiber and the Internet, (ii) access to
all forms of content, duplication and formatting services,
(iii) language conversions and laybacks,
(iv) restoration and preservation of old or damaged
content, (v) mastering from motion picture film to high
resolution or data formats, (vi) digital audio and video
encoding services and (vii) digital media management
services for global home video, broadcast, pay-per-view and
emerging new media distribution channels. 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 and Asia. 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
II-35
DISCOVERY HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
and selling, general and administrative expenses (excluding
stock and other equity-based compensation). 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 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 Companys 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 Companys
reportable segments is presented in the following tables:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Media | |
|
|
|
|
|
|
|
|
|
|
Creative | |
|
Management | |
|
Network | |
|
|
|
|
|
Equity | |
|
|
Services | |
|
Services | |
|
Services | |
|
Corporate | |
|
Consolidated | |
|
Affiliate- | |
|
|
Group | |
|
Group | |
|
Group(1) | |
|
and Other | |
|
Total | |
|
Discovery | |
|
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
|
Amounts in thousands | |
Year ended December 31, 2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue from external customers
|
|
$ |
304,393 |
|
|
$ |
118,489 |
|
|
$ |
271,627 |
|
|
$ |
|
|
|
$ |
694,509 |
|
|
$ |
2,671,754 |
|
|
Operating cash flow
|
|
$ |
57,323 |
|
|
$ |
13,481 |
|
|
$ |
55,781 |
|
|
$ |
(47,960 |
) |
|
$ |
78,625 |
|
|
$ |
686,638 |
|
|
Capital expenditures
|
|
$ |
22,795 |
|
|
$ |
25,252 |
|
|
$ |
37,608 |
|
|
$ |
4,871 |
|
|
$ |
90,526 |
|
|
$ |
99,684 |
|
|
Depreciation and amortization
|
|
$ |
30,951 |
|
|
$ |
7,731 |
|
|
$ |
27,008 |
|
|
$ |
10,687 |
|
|
$ |
76,377 |
|
|
$ |
123,209 |
|
|
Total assets
|
|
$ |
297,664 |
|
|
$ |
173,637 |
|
|
$ |
322,470 |
|
|
$ |
5,025,465 |
|
|
$ |
5,819,236 |
|
|
$ |
3,174,620 |
|
Year ended December 31, 2004
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue from external customers
|
|
$ |
295,841 |
|
|
$ |
109,982 |
|
|
$ |
225,392 |
|
|
$ |
|
|
|
$ |
631,215 |
|
|
$ |
2,365,346 |
|
|
Operating cash flow
|
|
$ |
55,847 |
|
|
$ |
17,430 |
|
|
$ |
62,163 |
|
|
$ |
(37,645 |
) |
|
$ |
97,795 |
|
|
$ |
662,690 |
|
|
Capital expenditures
|
|
$ |
18,677 |
|
|
$ |
4,142 |
|
|
$ |
23,114 |
|
|
$ |
3,359 |
|
|
$ |
49,292 |
|
|
$ |
88,100 |
|
|
Depreciation and amortization
|
|
$ |
31,026 |
|
|
$ |
7,750 |
|
|
$ |
27,074 |
|
|
$ |
11,755 |
|
|
$ |
77,605 |
|
|
$ |
129,011 |
|
|
Total assets
|
|
$ |
298,613 |
|
|
$ |
171,588 |
|
|
$ |
294,328 |
|
|
$ |
4,800,299 |
|
|
$ |
5,564,828 |
|
|
$ |
3,235,686 |
|
Year ended December 31, 2003
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue from external customers
|
|
$ |
270,830 |
|
|
$ |
107,070 |
|
|
$ |
128,203 |
|
|
$ |
|
|
|
$ |
506,103 |
|
|
$ |
1,995,047 |
|
|
Operating cash flow
|
|
$ |
43,786 |
|
|
$ |
22,074 |
|
|
$ |
43,221 |
|
|
$ |
(32,901 |
) |
|
$ |
76,180 |
|
|
$ |
508,452 |
|
|
Capital expenditures
|
|
$ |
13,132 |
|
|
$ |
4,751 |
|
|
$ |
5,207 |
|
|
$ |
2,773 |
|
|
$ |
25,863 |
|
|
$ |
109,956 |
|
|
Depreciation and amortization
|
|
$ |
28,975 |
|
|
$ |
11,481 |
|
|
$ |
22,171 |
|
|
$ |
7,899 |
|
|
$ |
70,526 |
|
|
$ |
120,172 |
|
|
Total assets
|
|
$ |
305,576 |
|
|
$ |
174,916 |
|
|
$ |
239,939 |
|
|
$ |
4,676,196 |
|
|
$ |
5,396,627 |
|
|
$ |
3,194,211 |
|
|
|
(1) |
Included in Network Services Group revenue is broadcast services
revenue of $148,483,000, $135,883,000 and $89,065,000 and
systems integration revenue of $123,144,000, $89,509,000 and
$39,138,000 in 2005, 2004 and 2003, respectively. |
II-36
DISCOVERY HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS (Continued)
The following table provides a reconciliation of segment
operating cash flow to earnings (loss) before income taxes and
minority interest.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31, | |
|
|
| |
|
|
2005 | |
|
2004 | |
|
2003 | |
|
|
| |
|
| |
|
| |
|
|
Amounts in thousands | |
Segment operating cash flow
|
|
$ |
78,625 |
|
|
$ |
97,795 |
|
|
$ |
76,180 |
|
Stock compensation
|
|
|
(4,383 |
) |
|
|
(2,775 |
) |
|
|
(2,602 |
) |
Depreciation and amortization
|
|
|
(76,377 |
) |
|
|
(77,605 |
) |
|
|
(70,526 |
) |
Share of earnings of Discovery
|
|
|
79,810 |
|
|
|
84,011 |
|
|
|
37,271 |
|
Interest expense
|
|
|
|
|
|
|
|
|
|
|
(72,178 |
) |
Other, net
|
|
|
4,437 |
|
|
|
(348 |
) |
|
|
(2,635 |
) |
|
|
|
|
|
|
|
|
|
|
Earnings (loss) before income taxes and minority interest
|
|
$ |
82,112 |
|
|
$ |
101,078 |
|
|
$ |
(34,490 |
) |
|
|
|
|
|
|
|
|
|
|
Information as to the Companys operations in different
geographic areas is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31, | |
|
|
| |
|
|
2005 | |
|
2004 | |
|
2003 | |
|
|
| |
|
| |
|
| |
|
|
Amounts in thousands | |
Revenue
|
|
|
|
|
|
|
|
|
|
|
|
|
|
United States
|
|
$ |
525,288 |
|
|
$ |
460,070 |
|
|
$ |
390,220 |
|
|
United Kingdom
|
|
|
149,928 |
|
|
|
148,002 |
|
|
|
92,523 |
|
|
Other countries
|
|
|
19,293 |
|
|
|
23,143 |
|
|
|
23,360 |
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
694,509 |
|
|
$ |
631,215 |
|
|
$ |
506,103 |
|
|
|
|
|
|
|
|
|
|
|
|
|
(19) |
Quarterly Financial Information (Unaudited) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1st Quarter | |
|
2nd Quarter | |
|
3rd Quarter | |
|
4th Quarter | |
|
|
| |
|
| |
|
| |
|
| |
|
|
Amounts in thousands, except per share amounts | |
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 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2004:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$ |
145,943 |
|
|
$ |
160,477 |
|
|
$ |
151,924 |
|
|
$ |
172,871 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income
|
|
$ |
5,914 |
|
|
$ |
5,663 |
|
|
$ |
3,464 |
|
|
$ |
1,894 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net earnings
|
|
$ |
11,920 |
|
|
$ |
22,257 |
|
|
$ |
16,186 |
|
|
$ |
15,745 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted net earnings per common share
|
|
$ |
.04 |
|
|
$ |
.08 |
|
|
$ |
.06 |
|
|
$ |
.06 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
II-37
PART III.
The following required information is incorporated by reference
to our definitive proxy statement for our 2006 Annual Meeting of
Shareholders presently scheduled to be held in the second
quarter of 2006:
|
|
Item 10. |
Directors and Executive Officers of the
Registrant |
|
|
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 |
|
|
Item 14. |
Principal Accounting Fees and Services |
We will file our definitive proxy statement for our 2006 Annual
Meeting of shareholders with the Securities and Exchange
Commission on or before April 30, 2006.
III-1
PART IV.
Item 15. Exhibits and
Financial Statement Schedules.
(a)(1) Financial Statements
Included in Part II of this Report:
|
|
|
|
|
|
|
|
Page | |
|
|
No. | |
|
|
| |
Discovery Holding Company:
|
|
|
|
|
|
|
|
|
II-16 |
|
|
|
|
|
II-17 |
|
|
|
|
|
II-18 |
|
|
|
|
|
II-19 |
|
|
|
|
|
II-20 |
|
|
|
|
|
II-21 |
|
(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, Inc.: |
|
|
|
|
|
|
|
|
IV-4 |
|
|
|
|
IV-5 |
|
|
|
|
IV-6 |
|
|
|
|
IV-7 |
|
|
|
|
IV-8 |
|
|
|
|
IV-9 |
|
(a)(3) Exhibits
Listed below are the exhibits which are filed as a part of this
Report (according to the number assigned to them in
Item 601 of
Regulation 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
DHCs Registration Statement on Form 10, dated
July 15, 2005 (File No. 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). |
10 Material Contracts:
|
|
|
|
|
|
10.1 |
|
|
The Shareholders Agreement, dated as of November 30, 1991
(the Stockholders Agreement), by and among
Discovery Communications, Inc. (Discovery), Cox
Discovery, Inc. (Cox), NewsChannels TDC Investments,
Inc. (NewChannels), TCI Cable Education, Inc.
(TCID) and John S. Hendricks (Hendricks)
(incorporated by reference to Exhibit 10.1 to the Form 10). |
|
10.2 |
|
|
First Amendment to the Stockholders Agreement, dated as of
December 20, 1996, by and among Discovery, Cox
Communications Holdings, Inc. (the successor to Cox), Newhouse
Broadcasting Corporation ( the successor to NewChannels), TCID,
Hendricks and for the purposes stated therein only, LMC Animal
Planet, Inc. (LMC) and Liberty Media Corporation, a
Colorado corporation (Liberty) (incorporated by
reference to Exhibit 10.2 to the Form 10). |
|
10.3 |
|
|
Second Amendment to the Stockholders Agreement, dated as
of September 7, 2000, by and among Discovery, Cox
Communications Holdings, Inc. (the successor to Cox),
Advance/Newhouse Programming Partnership (the successor to
NewChannels), LMC Discovery, Inc. (formerly known as TCID) and
Hendricks (incorporated by reference to Exhibit 10.3 to the
Form 10). |
|
10.4 |
|
|
Third Amendment to the Stockholders Agreement, dated as of
September, 2001, by and among Discovery, Cox, NewChannels, TCID,
Hendricks and Advance Programming Holdings Corp. (incorporated
by reference to Exhibit 10.4 to the Form 10). |
|
10.5 |
|
|
Fourth Amendment to the Stockholders Agreement, dated as
of June 23, 2003, by and among Discovery, Cox NewChannels,
TCID, Liberty Animal, Inc. (the successor in interest to LMC)
for the purposes stated in the First Amendment to the
Stockholders Agreement, and Hendricks (incorporated by
reference to Exhibit 10.5 to the Form 10). |
|
10.6 |
|
|
Form of Tax Sharing Agreement between Liberty Media Corporation
and DHC (incorporated by reference to Exhibit 10.6 to the
Form 10). |
|
10.7 |
|
|
Discovery Holding Company 2005 Incentive Plan (incorporated by
reference to Exhibit 10.7 to the Form 10). |
|
10.8 |
|
|
Discovery Holding Company 2005 Non-Employee Director Plan
(incorporated by reference to Exhibit 10.8 to the Form 10). |
|
10.9 |
|
|
Discovery Holding Company Transitional Stock Adjustment Plan
(incorporated by reference to Exhibit 10.9 to the Form 10). |
|
10.10 |
|
|
Agreement between DHC and John C. Malone (incorporated by
reference to Exhibit 10.10 to the Form 10). |
|
10.11 |
|
|
Agreement, dated June 24, 2005, between Discovery and DHC
(incorporated by reference to Exhibit 10.11 to the Form 10). |
|
10.12 |
|
|
Indemnification Agreement, dated as of June 24, 2005,
between Cox and DHC (incorporated by reference to
Exhibit 10.12 to the Form 10). |
|
10.13 |
|
|
Indemnification Agreement, dated as of June 24, 2005,
between NewChannels and DHC (incorporated by reference to
Exhibit 10.13 to the Form 10). |
|
10.14 |
|
|
Form of Indemnification Agreement with Directors and Executive
Officers (incorporated by reference to Exhibit 10.14 to the
Form 10). |
IV-2
|
|
|
|
|
|
21 |
|
|
Subsidiaries of Discovery Holding Company, filed herewith. |
|
23.1 |
|
|
Consent of KPMG LLP, filed herewith. |
|
23.2 |
|
|
Consent of PricewaterhouseCoopers LLP, filed herewith. |
|
31.1 |
|
|
Rule 13a-14(a)/15d-14(a) Certification, filed herewith. |
|
31.2 |
|
|
Rule 13a-14(a)/15d-14(a) Certification, filed herewith. |
|
31.3 |
|
|
Rule 13a-14(a)/15d-14(a) Certification, filed herewith. |
|
32 |
|
|
Section 1350 Certification, filed herewith. |
IV-3
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
the 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,
2005 and December 31, 2004, and the results of their
operations and their cash flows for each of the three years in
the period ended December 31, 2005 in conformity with
accounting principles generally accepted in the
United States of America. These financial statements are
the responsibility of the Companys 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 9 to the consolidated financial
statements, the Company adopted Financial Accounting Standards
Board Interpretation No. 46R, Consolidation of
Variable Interest Entities, an Interpretation of ARB
No. 51 in 2005.
PricewaterhouseCoopers LLP
McLean, VA
March 3, 2006
IV-4
Discovery Communications, Inc.
Consolidated Balance Sheets
|
|
|
|
|
|
|
|
|
|
|
|
December 31, | |
|
|
| |
|
|
2005 | |
|
2004 | |
|
|
| |
|
| |
|
|
(In thousands, except | |
|
|
share data) | |
ASSETS |
Current assets
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$ |
34,491 |
|
|
$ |
24,282 |
|
|
Accounts receivable, less allowances of $35,079 and $24,375
|
|
|
565,407 |
|
|
|
527,659 |
|
|
Inventories
|
|
|
30,714 |
|
|
|
32,567 |
|
|
Deferred income taxes
|
|
|
88,765 |
|
|
|
144,606 |
|
|
Content rights, net
|
|
|
55,125 |
|
|
|
50,578 |
|
|
Other current assets
|
|
|
56,867 |
|
|
|
55,758 |
|
|
|
|
|
|
|
|
Total current assets
|
|
|
831,369 |
|
|
|
835,450 |
|
|
|
|
|
|
|
|
Property and equipment, net
|
|
|
397,578 |
|
|
|
380,290 |
|
Content rights, net, less current portion
|
|
|
1,175,988 |
|
|
|
1,027,379 |
|
Deferred launch incentives
|
|
|
255,259 |
|
|
|
314,601 |
|
Goodwill
|
|
|
254,989 |
|
|
|
257,460 |
|
Intangibles, net
|
|
|
142,938 |
|
|
|
187,761 |
|
Investments in and advances to unconsolidated affiliates
|
|
|
11,528 |
|
|
|
74,450 |
|
Deferred income taxes
|
|
|
69,316 |
|
|
|
114,673 |
|
Other assets
|
|
|
35,655 |
|
|
|
43,622 |
|
|
|
|
|
|
|
|
TOTAL ASSETS
|
|
$ |
3,174,620 |
|
|
$ |
3,235,686 |
|
|
|
|
|
|
|
|
|
LIABILITIES AND STOCKHOLDERS DEFICIT |
Current liabilities
|
|
|
|
|
|
|
|
|
|
Accounts payable and accrued liabilities
|
|
$ |
371,326 |
|
|
$ |
333,390 |
|
|
Launch incentives payable
|
|
|
22,655 |
|
|
|
33,509 |
|
|
Content rights payable
|
|
|
97,075 |
|
|
|
94,969 |
|
|
Current portion of long-term incentive plan liabilities
|
|
|
20,690 |
|
|
|
261,627 |
|
|
Current portion of long-term debt
|
|
|
6,470 |
|
|
|
9,736 |
|
|
Income taxes payable
|
|
|
51,226 |
|
|
|
21,123 |
|
|
Unearned revenue
|
|
|
89,803 |
|
|
|
95,585 |
|
|
Other current liabilities
|
|
|
33,220 |
|
|
|
30,622 |
|
|
|
|
|
|
|
|
Total current liabilities
|
|
|
692,465 |
|
|
|
880,561 |
|
|
|
|
|
|
|
|
Long-term debt, less current portion
|
|
|
2,590,440 |
|
|
|
2,498,287 |
|
Derivative financial instruments, less current portion
|
|
|
18,592 |
|
|
|
46,541 |
|
Launch incentives payable, less current portion
|
|
|
21,910 |
|
|
|
34,328 |
|
Long-term incentive plan liabilities, less current portion
|
|
|
25,380 |
|
|
|
60,735 |
|
Content rights payable, less current portion
|
|
|
4,380 |
|
|
|
8,027 |
|
Other liabilities
|
|
|
31,309 |
|
|
|
15,566 |
|
|
|
|
|
|
|
|
Total liabilities
|
|
|
3,384,476 |
|
|
|
3,544,045 |
|
|
|
|
|
|
|
|
Mandatorily redeemable interests in subsidiaries
|
|
|
272,502 |
|
|
|
319,567 |
|
|
|
|
|
|
|
|
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 at December 31, 2005 and 2004
|
|
|
|
|
|
|
|
|
Additional paid-in capital
|
|
|
21,093 |
|
|
|
21,093 |
|
Accumulated deficit
|
|
|
(513,311 |
) |
|
|
(672,931 |
) |
Accumulated other comprehensive income
|
|
|
9,859 |
|
|
|
23,911 |
|
|
|
|
|
|
|
|
Total stockholders deficit
|
|
|
(482,358 |
) |
|
|
(627,926 |
) |
|
|
|
|
|
|
|
TOTAL LIABILITIES AND STOCKHOLDERS DEFICIT
|
|
$ |
3,174,620 |
|
|
$ |
3,235,686 |
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these
consolidated financial statements.
IV-5
Discovery Communications, Inc.
Consolidated Statements of Operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, | |
|
|
| |
|
|
2005 | |
|
2004 | |
|
2003 | |
|
|
| |
|
| |
|
| |
|
|
(In thousands) | |
OPERATING REVENUE
|
|
|
|
|
|
|
|
|
|
|
|
|
Advertising
|
|
$ |
1,187,823 |
|
|
$ |
1,133,807 |
|
|
$ |
1,010,585 |
|
Distribution
|
|
|
1,198,686 |
|
|
|
976,362 |
|
|
|
747,927 |
|
Other
|
|
|
285,245 |
|
|
|
255,177 |
|
|
|
236,535 |
|
|
|
|
|
|
|
|
|
|
|
Total operating revenue
|
|
|
2,671,754 |
|
|
|
2,365,346 |
|
|
|
1,995,047 |
|
|
|
|
|
|
|
|
|
|
|
Cost of revenue
|
|
|
979,765 |
|
|
|
846,316 |
|
|
|
751,578 |
|
Selling, general & administrative
|
|
|
1,005,351 |
|
|
|
856,340 |
|
|
|
735,017 |
|
Long-term incentive plans
|
|
|
49,465 |
|
|
|
71,515 |
|
|
|
74,119 |
|
Depreciation & amortization
|
|
|
123,209 |
|
|
|
129,011 |
|
|
|
120,172 |
|
Gain on sale of long-lived asset
|
|
|
|
|
|
|
(22,007 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses
|
|
|
2,157,790 |
|
|
|
1,881,175 |
|
|
|
1,680,886 |
|
|
|
|
|
|
|
|
|
|
|
INCOME FROM OPERATIONS
|
|
|
513,964 |
|
|
|
484,171 |
|
|
|
314,161 |
|
|
|
|
|
|
|
|
|
|
|
OTHER INCOME (EXPENSE)
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest, net
|
|
|
(184,575 |
) |
|
|
(167,420 |
) |
|
|
(159,409 |
) |
Realized and unrealized gains from derivative instruments, net
|
|
|
22,499 |
|
|
|
45,540 |
|
|
|
21,405 |
|
Minority interests in consolidated subsidiaries
|
|
|
(43,696 |
) |
|
|
(54,940 |
) |
|
|
(35,965 |
) |
Equity in earnings (losses) of unconsolidated affiliates
|
|
|
4,660 |
|
|
|
171 |
|
|
|
(4,477 |
) |
Other, net
|
|
|
9,111 |
|
|
|
2,299 |
|
|
|
2,307 |
|
|
|
|
|
|
|
|
|
|
|
Total other expense, net
|
|
|
(192,001 |
) |
|
|
(174,350 |
) |
|
|
(176,139 |
) |
|
|
|
|
|
|
|
|
|
|
INCOME BEFORE INCOME TAXES
|
|
|
321,963 |
|
|
|
309,821 |
|
|
|
138,022 |
|
|
|
|
|
|
|
|
|
|
|
Income tax expense
|
|
|
162,343 |
|
|
|
141,799 |
|
|
|
74,785 |
|
|
|
|
|
|
|
|
|
|
|
NET INCOME
|
|
$ |
159,620 |
|
|
$ |
168,022 |
|
|
$ |
63,237 |
|
|
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these
consolidated financial statements.
IV-6
Discovery Communications, Inc.
Consolidated Statements of Cash Flows
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, | |
|
|
| |
|
|
2005 | |
|
2004 | |
|
2003 | |
|
|
| |
|
| |
|
| |
|
|
(In thousands) | |
OPERATING ACTIVITIES
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$ |
159,620 |
|
|
$ |
168,022 |
|
|
$ |
63,237 |
|
Adjustments to reconcile net income to cash provided by
operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
|
123,209 |
|
|
|
129,011 |
|
|
|
120,172 |
|
|
Amortization of deferred launch incentives and representation
rights
|
|
|
83,411 |
|
|
|
107,757 |
|
|
|
131,980 |
|
|
Provision for losses on accounts receivable
|
|
|
12,217 |
|
|
|
959 |
|
|
|
11,413 |
|
|
Expenses arising from long-term incentive plans
|
|
|
49,465 |
|
|
|
71,515 |
|
|
|
74,119 |
|
|
Equity in (earnings) losses of unconsolidated affiliates
|
|
|
(4,660 |
) |
|
|
(171 |
) |
|
|
4,477 |
|
|
Deferred income taxes
|
|
|
109,383 |
|
|
|
105,522 |
|
|
|
42,280 |
|
|
Realized and unrealized gains on derivative financial
instruments, net
|
|
|
(22,499 |
) |
|
|
(45,540 |
) |
|
|
(21,405 |
) |
|
Non-cash minority interest charges
|
|
|
43,696 |
|
|
|
54,940 |
|
|
|
35,965 |
|
|
Gain on sale of investments
|
|
|
(12,793 |
) |
|
|
|
|
|
|
|
|
|
Gain on sale of long-lived assets
|
|
|
|
|
|
|
(22,007 |
) |
|
|
|
|
|
Other non-cash (income) charges
|
|
|
9,675 |
|
|
|
(2,681 |
) |
|
|
541 |
|
|
Changes in assets and liabilities, net of business
combinations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts receivable
|
|
|
(37,207 |
) |
|
|
(60,841 |
) |
|
|
(52,753 |
) |
|
|
Inventories
|
|
|
1,853 |
|
|
|
4,555 |
|
|
|
22,978 |
|
|
|
Other assets
|
|
|
(18,748 |
) |
|
|
(3,711 |
) |
|
|
(5,064 |
) |
|
|
Content rights, net of payables
|
|
|
(108,155 |
) |
|
|
(122,433 |
) |
|
|
(139,387 |
) |
|
|
Accounts payable and accrued liabilities
|
|
|
47,913 |
|
|
|
55,734 |
|
|
|
27,646 |
|
|
|
Representation rights
|
|
|
(6,000 |
) |
|
|
(479 |
) |
|
|
(11,250 |
) |
|
|
Deferred launch incentives
|
|
|
(35,731 |
) |
|
|
(74,696 |
) |
|
|
(99,630 |
) |
|
|
Long-term incentive plan liabilities
|
|
|
(325,756 |
) |
|
|
(240,752 |
) |
|
|
(51,023 |
) |
|
|
|
|
|
|
|
|
|
|
Cash provided by operations
|
|
|
68,893 |
|
|
|
124,704 |
|
|
|
154,296 |
|
|
|
|
|
|
|
|
|
|
|
INVESTING ACTIVITIES
|
|
|
|
|
|
|
|
|
|
|
|
|
Acquisition of property and equipment
|
|
|
(99,684 |
) |
|
|
(88,100 |
) |
|
|
(109,956 |
) |
Business combinations, net of cash acquired
|
|
|
(400 |
) |
|
|
(17,218 |
) |
|
|
(46,541 |
) |
Purchase of intangibles
|
|
|
(583 |
) |
|
|
|
|
|
|
|
|
Investments in and advances to unconsolidated affiliates
|
|
|
(363 |
) |
|
|
(17,433 |
) |
|
|
(13,074 |
) |
Redemption of interests in subsidiaries
|
|
|
(92,874 |
) |
|
|
(148,880 |
) |
|
|
|
|
Proceeds from sale of investments
|
|
|
14,664 |
|
|
|
|
|
|
|
|
|
Proceeds from sale of long-lived assets
|
|
|
|
|
|
|
22,007 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash used by investing activities
|
|
|
(179,240 |
) |
|
|
(249,624 |
) |
|
|
(169,571 |
) |
|
|
|
|
|
|
|
|
|
|
FINANCING ACTIVITIES
|
|
|
|
|
|
|
|
|
|
|
|
|
Proceeds from issuance of long-term debt
|
|
|
1,785,955 |
|
|
|
1,848,000 |
|
|
|
|
|
Principal payments of long-term debt
|
|
|
(1,697,068 |
) |
|
|
(1,699,215 |
) |
|
|
(12,638 |
) |
Deferred financing fees
|
|
|
(4,810 |
) |
|
|
(8,499 |
) |
|
|
(56 |
) |
Contributions from minority shareholders
|
|
|
603 |
|
|
|
3,146 |
|
|
|
21,652 |
|
Increase in note receivable from stockholder
|
|
|
|
|
|
|
|
|
|
|
(5,238 |
) |
Collection of note receivable from stockholder
|
|
|
|
|
|
|
|
|
|
|
23,600 |
|
Repurchase of Class A common stock
|
|
|
|
|
|
|
|
|
|
|
(55,334 |
) |
Other financing
|
|
|
32,153 |
|
|
|
(30,840 |
) |
|
|
42,325 |
|
|
|
|
|
|
|
|
|
|
|
Cash provided by financing activities
|
|
|
116,833 |
|
|
|
112,592 |
|
|
|
14,311 |
|
|
|
|
|
|
|
|
|
|
|
Effect of exchange rate changes on cash
|
|
|
3,723 |
|
|
|
2,535 |
|
|
|
1,215 |
|
CHANGE IN CASH AND CASH EQUIVALENTS
|
|
|
10,209 |
|
|
|
(9,793 |
) |
|
|
251 |
|
Cash and cash equivalents, beginning of year
|
|
|
24,282 |
|
|
|
34,075 |
|
|
|
33,824 |
|
CASH AND CASH EQUIVALENTS, END OF YEAR
|
|
$ |
34,491 |
|
|
$ |
24,282 |
|
|
$ |
34,075 |
|
|
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these
consolidated financial statements.
IV-7
Discovery Communications, Inc.
Consolidated Statements of Changes in Stockholders
Deficit
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other Comprehensive Income (Loss) | |
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
Class A | |
|
Additional | |
|
|
|
Foreign | |
|
Unrealized | |
|
Unamortized | |
|
|
|
|
| |
|
Paid-In | |
|
Accumulated | |
|
Currency | |
|
Gain (Loss) on | |
|
Gain on | |
|
|
|
|
At Par | |
|
Redeemable | |
|
Capital | |
|
Deficit | |
|
Translation | |
|
Investments | |
|
Derivatives | |
|
Total | |
|
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
|
(In thousands) | |
Balance, December 31, 2002
|
|
$ |
1 |
|
|
$ |
50,696 |
|
|
$ |
21,093 |
|
|
$ |
(915,590 |
) |
|
$ |
4,296 |
|
|
$ |
|
|
|
$ |
|
|
|
$ |
(839,504 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
63,237 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign currency translation, net of tax of $5.7 million
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
10,027 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unrealized gain on investments, net of tax of $2.4 million
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3,771 |
|
|
|
|
|
|
|
|
|
Total comprehensive income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
77,035 |
|
Decrease in loan to stockholder
|
|
|
|
|
|
|
18,362 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
18,362 |
|
Reduction of compensation from redeemable Class A common
stock
|
|
|
|
|
|
|
(2,324 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(2,324 |
) |
Decretion of redeemable Class A common stock
|
|
|
|
|
|
|
(11,400 |
) |
|
|
|
|
|
|
11,400 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Repurchase of Class A common stock treasury shares
|
|
|
|
|
|
|
(55,334 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(55,334 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these
consolidated financial statements.
IV-8
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, Travel & Living, and Discovery Real Time.
Commerce operates approximately 120 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.
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 Companys 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 BBC are operated under
interim or unfinalized agreements, which contributes 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 fair value of derivative financial instruments, and the
adequacy of reserves associated with accounts receivable and
retail inventory.
The Company derives revenues from four primary sources:
(1) advertising revenue for commercial spots aired on the
Companys 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 the
point-of-sale or upon
IV-9
Discovery Communications, Inc.
Notes to Consolidated Financial
Statements (Continued)
product shipment. Educational product and service sales are
generally recognized ratably over the term of the agreement or
as the product is delivered.
The Company expenses advertising costs as incurred. The Company
incurred advertising costs of $208.6 million,
$170.3 million and $140.2 million in 2005, 2004 and
2003.
|
|
|
Cash and Cash Equivalents |
Highly liquid investments with original maturities of ninety
days or less are recorded as cash equivalents. The Company had
$3.9 million and $4.3 million in restricted cash
included in other assets as of December 31, 2005 and 2004.
Book overdrafts representing outstanding checks in excess of
funds on deposit are a component of accounts payable and total
$40.9 million, $12.1 million in 2005 and 2004.
|
|
|
Derivative Financial Instruments |
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. Substantially all of the
Companys financial instruments were not designated as a
hedge in 2005, and none were designated as a hedge in 2004 and
2003.
Inventories are carried at the lower of cost or market and
include inventory acquisition costs. Cost is determined using
the weighted average cost method.
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.
The costs of produced and co-produced content airing on the
Companys 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 educational ventures are
amortized straight-line over a three to seven 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.
IV-10
Discovery Communications, Inc.
Notes to Consolidated Financial
Statements (Continued)
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 software development costs occurs during the
application development stage. Costs incurred during the pre and
post implementation stages are expensed as incurred. Capitalized
software is amortized on a straight-line basis over its
estimated useful lives of one to five years. Unamortized
capitalized software costs totaled $59.1 million and
$55.2 million at December 31, 2005 and 2004. The
Company capitalized software costs of $23.2 million,
$28.6 million, and $18.3 million in 2005, 2004 and
2003. Amortization of capitalized software costs totaled
$19.3 million, $18.4 million, and $15.5 million
during 2005, 2004 and 2003. Write-offs of capitalized software
totaled $4.0 million in 2004; there were no write-offs for
capitalized software costs during 2005 and 2003.
|
|
|
Recoverability of Long-Lived Assets, Goodwill, and
Intangible Assets |
The Company periodically reviews the carrying value of its
acquired intangible assets, including goodwill, and its other
long-lived assets, including deferred launch incentives, to
determine whether an impairment may exist. Goodwill impairment
is determined 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 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. Generally, the
Companys reporting units and asset groups consist of the
individual networks or other operating units.
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 $74.1 million,
$98.4 million and $122.7 million in 2005, 2004 and
2003.
IV-11
Discovery Communications, Inc.
Notes to Consolidated Financial
Statements (Continued)
|
|
|
Foreign Currency Translation |
The Companys 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.
|
|
|
Long-term Compensation Programs |
Prior to October 2005, the Company maintained two unit-based,
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 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, marking to 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 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 all
mark-to-mark
adjustments in each period as compensation expense.
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 records interest expense
as earned.
Treasury stock is accounted for using the cost method. The
repurchased shares are held in treasury and are presented as if
retired. Treasury stock activity for the three years ended
December 31, 2005 is presented in the Consolidated
Statements of Stockholders Deficit.
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-12
Discovery Communications, Inc.
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 not be realized.
The 2004 and 2003 Statements of Cash Flows have been revised for
foreign currency effects on changes in cash, which had
previously been included as a component of other non-cash items,
minority interest contributions, which had previously been
included as a component of investing cash flows, and dividends
from equity investments, which had previously been included as a
component of investing cash flows, to conform to the 2005
presentation. The 2004 Balance Sheet has been revised to include
deferred rent, which had previously been included as a component
of accounts payable and accrued liabilities, as a component of
other long-term liabilities.
|
|
3. |
Supplemental Disclosures to Consolidated Statements of Cash
Flows |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, | |
|
|
| |
|
|
2005 | |
|
2004 | |
|
2003 | |
|
|
| |
|
| |
|
| |
|
|
(In thousands) | |
Cash paid for acquisitions:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair value of assets acquired
|
|
$ |
400 |
|
|
$ |
21,414 |
|
|
$ |
50,509 |
|
|
Net liabilities assumed
|
|
|
|
|
|
|
(4,196 |
) |
|
|
(3,968 |
) |
|
|
Cash paid for acquisitions, net of cash acquired
|
|
|
400 |
|
|
|
17,218 |
|
|
|
46,541 |
|
Cash paid for interest
|
|
|
171,151 |
|
|
|
166,584 |
|
|
|
162,904 |
|
Cash paid for income taxes
|
|
|
27,678 |
|
|
|
28,999 |
|
|
|
32,395 |
|
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.
During 2003, the Company completed two acquisitions, one in its
Education division and one in its International Networks
division. In connection with these acquisitions, the Company
acquired customer lists valued at $27.7 million, which are
being amortized over their useful lives of three years. The
Company also acquired deferred launch incentives valued at
$16.7 million. Of these, $13.2 million are being
amortized over the five-year term of the agreements, and
$3.5 million relate to a penalty for non-renewal in 2008.
If no renewal is effectuated in 2008, the acquiree will refund
the Company. If renewed, the Company will amortize this amount
over the renewal period.
During 2005, changes in goodwill result solely from fluctuations
in foreign currency. Purchase price in excess of the fair value
of the assets and liabilities acquired of $1.1 million and
$6.0 million was recorded to goodwill in 2004 and 2003.
IV-13
Discovery Communications, Inc.
Notes to Consolidated Financial
Statements (Continued)
|
|
|
|
|
|
|
|
|
|
|
|
December 31, | |
|
|
| |
Content Rights, |
|
2005 | |
|
2004 | |
|
|
| |
|
| |
|
|
(In thousands) | |
Produced content rights
|
|
|
|
|
|
|
|
|
|
Completed
|
|
$ |
1,339,705 |
|
|
$ |
1,099,483 |
|
|
In process
|
|
|
122,366 |
|
|
|
100,086 |
|
Co-produced content rights
|
|
|
|
|
|
|
|
|
|
Completed
|
|
|
792,184 |
|
|
|
698,758 |
|
|
In process
|
|
|
53,704 |
|
|
|
38,575 |
|
Licensed content rights
|
|
|
|
|
|
|
|
|
|
Acquired
|
|
|
225,769 |
|
|
|
189,662 |
|
|
Prepaid
|
|
|
3,371 |
|
|
|
4,232 |
|
|
|
|
|
|
|
|
Content rights, at cost
|
|
|
2,537,099 |
|
|
|
2,130,796 |
|
Accumulated amortization
|
|
|
(1,305,986 |
) |
|
|
(1,052,839 |
) |
|
|
|
|
|
|
|
Content rights, net
|
|
|
1,231,113 |
|
|
|
1,077,957 |
|
Current portion, licensed content rights
|
|
|
(55,125 |
) |
|
|
(50,578 |
) |
|
|
|
|
|
|
|
Non-current portion
|
|
$ |
1,175,988 |
|
|
$ |
1,027,379 |
|
|
|
|
|
|
|
|
Amortization of content rights was $601.1 million,
$494.2 million and $413.9 million in 2005, 2004 and
2003, and is recorded as a component of cost of revenue.
The Company estimates that approximately 91% of unamortized
costs of content rights at December 31, 2005 will be
amortized within the next three years. The Company expects to
amortize $471.7 million of unamortized content rights, not
including in-process and prepaid productions, during the next
twelve months.
|
|
6. |
Property and Equipment |
|
|
|
|
|
|
|
|
|
|
|
December 31, | |
|
|
| |
Property and Equipment, |
|
2005 | |
|
2004 | |
|
|
| |
|
| |
|
|
(In thousands) | |
Equipment and software
|
|
$ |
347,667 |
|
|
$ |
344,525 |
|
Land
|
|
|
28,781 |
|
|
|
28,781 |
|
Buildings
|
|
|
157,896 |
|
|
|
136,088 |
|
Furniture, fixtures, leasehold improvements and other
|
|
|
187,589 |
|
|
|
160,418 |
|
Assets in progress
|
|
|
16,824 |
|
|
|
60,806 |
|
|
|
|
|
|
|
|
Property and equipment, at cost
|
|
|
738,757 |
|
|
|
730,618 |
|
Accumulated depreciation and amortization
|
|
|
(341,179 |
) |
|
|
(350,328 |
) |
|
|
|
|
|
|
|
Property and equipment, net
|
|
$ |
397,578 |
|
|
$ |
380,290 |
|
|
|
|
|
|
|
|
The cost and accumulated depreciation of satellite transponders
under capital leases were $23.5 million and
$7.0 million at December 31, 2005, and
$23.5 million and $4.1 million at December 31,
2004. Depreciation and amortization of property and equipment,
including equipment under capital lease, was $85.0 million,
$85.4 million and $86.4 million in 2005, 2004 and 2003.
IV-14
Discovery Communications, Inc.
Notes to Consolidated Financial
Statements (Continued)
During 2005, the Company completed construction of a media
uplink facility and transferred the final asset balances for
building and furniture costs of $24.0 million and equipment
costs of $24.0 million from assets in progress.
|
|
7. |
Sale of Equity Investments and Long-lived Assets |
In January 2005, the Company recorded a gain of
$12.8 million as a component of other non-operating
expenses for the sale of certain equity investments, previously
accounted for under the cost method. The gain represents 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, 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.
|
|
8. |
Goodwill and Intangible Assets |
|
|
|
|
|
|
|
|
|
|
|
December 31, | |
|
|
| |
Goodwill and Intangible Assets, |
|
2005 | |
|
2004 | |
|
|
| |
|
| |
|
|
(In thousands) | |
Goodwill
|
|
$ |
254,989 |
|
|
$ |
257,460 |
|
Trademarks
|
|
|
12,327 |
|
|
|
13,383 |
|
Customer lists, net of amortization of $111,954 and $86,406
|
|
|
38,561 |
|
|
|
64,109 |
|
Non-compete and other, net of amortization of $41,107 and $43,021
|
|
|
24,207 |
|
|
|
33,068 |
|
Representation rights, net of amortization of $69,886 and $60,528
|
|
|
67,843 |
|
|
|
77,201 |
|
|
|
|
|
|
|
|
Goodwill and intangible assets, net
|
|
$ |
397,927 |
|
|
$ |
445,221 |
|
|
|
|
|
|
|
|
Goodwill and trademarks are not amortized. 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 three to
seven years. Other intangibles are amortized on a straight-line
basis over the estimated useful lives of three to ten years.
Representation rights are amortized on a straight-line basis
over the contractual term of fifteen years.
During 2004, the Company reduced its estimate of certain
pre-acquisition contingencies associated with certain
contractual distribution arrangements acquired as part of the
acquisition of FitTV (f.k.a. The Health Network). These
revisions resulted in a reduction of goodwill of
$8.0 million at December 31, 2004.
The Company has the exclusive right to represent BBC America
(BBCA), a cable network, in sales, marketing,
distribution and other operational activities through 2013. As a
part of this agreement, the Company will receive a percentage of
revenues earned and collected by BBCA during the representation
term. The cost of acquiring the representation rights is being
amortized on a straight-line basis over the fifteen-year term of
the agreement, and is reported as a reduction of other revenue.
Amortization of intangible assets, including the BBC
Representation rights, totaled $45.0 million,
$41.8 million and $33.8 million in 2005, 2004 and 2003.
The Company estimates that unamortized costs of intangible
assets at December 31, 2005 will be amortized over the next
five years as follows: $41.2 million in 2006,
$28.7 million in 2007, $20.1 million in 2008,
$9.7 million in 2009, and $9.7 million in 2010.
IV-15
Discovery Communications, Inc.
Notes to Consolidated Financial
Statements (Continued)
The following table outlines the Companys joint ventures
and the method of accounting during 2005:
|
|
|
|
|
|
|
Accounting | |
Affiliates: |
|
Method | |
|
|
| |
Joint Ventures with the British Broadcasting Corporation
(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:
|
|
|
|
|
Discovery Times Channel (see Note 11)
|
|
|
Consolidated |
|
Discovery Canada
|
|
|
Equity |
|
Discovery Japan
|
|
|
Equity |
|
Discovery Health Canada
|
|
|
Equity |
|
Discovery Kids Canada
|
|
|
Equity |
|
Discovery Civilization Canada
|
|
|
Equity |
|
Meteor Studios
|
|
|
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 ventures and consolidates them
accordingly. However, as the BBC does not have risk of loss, no
losses were allocated to minority interest for consolidated
joint ventures with the BBC, and the Company recognizes both its
own and the BBCs share of earnings in the equity method
venture with the BBC.
In connection with the adoption of FIN 46R, the Company
concluded that JVP and APJ are VIEs and the Company is the
primary beneficiary. Therefore, on January 1, 2005, the
Company began consolidating these entities, which had fair value
net asset balances of $58.0 million, combined. There is no
minority interest for JVP; minority interest for APJ is a
benefit of $1.4 million and is reported as a component of
minority interest expense. Previously, the Company has accounted
for JVP and APJ under the equity method of accounting. Other
equity investments do not require consolidation as either they
are not VIEs, or in the event that they are VIEs, the Company is
not the primary beneficiary.
|
|
|
Variable Interest Entities |
The Company is a partner in other international joint venture
cable and satellite television networks in which the Company has
a variable interest. The Companys funding to these joint
ventures totaled
IV-16
Discovery Communications, Inc.
Notes to Consolidated Financial
Statements (Continued)
$0.2 million, $3.3 million and $7.5 million
during 2005, 2004 and 2003. At December 31, 2005, the
Companys maximum exposure to loss as a result of its
involvement with these joint ventures is the $11.5 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.
Combined financial information of the Companys
unconsolidated ventures (amounts do not reflect eliminations of
activity with the Company):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, | |
|
|
| |
Operating Results, |
|
2005 | |
|
2004 | |
|
2003 | |
|
|
| |
|
| |
|
| |
|
|
(In thousands) | |
Net Revenue
|
|
$ |
111,872 |
|
|
$ |
163,630 |
|
|
$ |
145,786 |
|
Income from operations
|
|
|
41,934 |
|
|
|
26,201 |
|
|
|
13,278 |
|
Net income
|
|
|
24,634 |
|
|
|
8,688 |
|
|
|
1,155 |
|
|
|
|
|
|
|
|
|
|
|
|
December 31, | |
|
|
| |
Balance Sheets, |
|
2005 | |
|
2004 | |
|
|
| |
|
| |
|
|
(In thousands) | |
Current assets
|
|
$ |
68,529 |
|
|
$ |
68,554 |
|
Total assets
|
|
|
80,365 |
|
|
|
136,703 |
|
Current liabilities
|
|
|
24,204 |
|
|
|
21,817 |
|
Total liabilities
|
|
|
33,578 |
|
|
|
46,683 |
|
Total shareholders equity or partners capital
|
|
|
46,787 |
|
|
|
90,020 |
|
|
|
|
|
|
|
|
|
|
|
|
December 31, | |
|
|
| |
Long-Term Debt, |
|
2005 | |
|
2004 | |
|
|
| |
|
| |
|
|
(In thousands) | |
$1,000.0 Term Loan, due quarterly December 2008 to October 2010
|
|
$ |
1,000,000 |
|
|
$ |
|
|
$1,555.0 Revolving Loan, due October 2010
|
|
|
103,000 |
|
|
|
|
|
$2,500.0 Term Loan and Revolving Loans, paid 2005
|
|
|
|
|
|
|
1,488,000 |
|
7.81% Senior Notes, semi annual interest, due March 2006
|
|
|
300,000 |
|
|
|
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 |
|
|
|
|
|
6.01% Senior Notes, semi annual interest, due December 2015
|
|
|
390,000 |
|
|
|
|
|
Obligations under capital leases
|
|
|
23,910 |
|
|
|
25,125 |
|
Other notes payable
|
|
|
|
|
|
|
4,898 |
|
|
|
|
|
|
|
|
Total long-term debt
|
|
|
2,596,910 |
|
|
|
2,508,023 |
|
Current portion
|
|
|
(6,470 |
) |
|
|
(9,736 |
) |
|
|
|
|
|
|
|
Non-current portion
|
|
$ |
2,590,440 |
|
|
$ |
2,498,287 |
|
|
|
|
|
|
|
|
In October 2005, the Company refinanced its syndicated bank
credit agreement, replacing the existing Term Loan and the
Revolving Loans, with principal payments beginning in 2007 and
final maturity in 2009, with a new Term Loan and Revolving
Facility, with principal payments beginning in 2008 and final
maturity
IV-17
Discovery Communications, Inc.
Notes to Consolidated Financial
Statements (Continued)
in 2010. 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 Company
capitalized $4.8 million in deferred financing costs 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. The Company intends to borrow additional
funds available under the expanded Revolving Facility to
refinance the $300.0 million 7.81% Senior Notes due
March 2006; as a result, the Company has classified the
outstanding amount as long-term debt.
In June 2004, the Company refinanced the Term Loan and the
Revolving Facility, maturing in 2004 and 2005, with a new Term
Loan and Revolving Facility. The Company capitalized
$8.5 million in deferred financing costs as part of the new
Term Loan and Revolving Facility and expensed $6.3 million
in capitalized costs associated with the previous Term Loan and
Revolving Facility.
All Term and Revolving Loans are unsecured. Interest, which is
payable quarterly at a minimum, is based on the London Interbank
Offered Rate (LIBOR) or prime rate plus a margin
based on the Companys leverage ratios. The weighted
average interest rate on these facilities was 5.3% and 3.7% at
December 31, 2005 and 2004, and the interest rate averaged
4.41% and 2.8% during 2005 and 2004. The cost of the Revolving
Facility includes a fee on the revolving commitment (ranging
from 0.1% to 0.3%) based on the Companys leverage ratios.
The interest rate on the floating rate Senior Notes was 5.33%
through the period and at December 31, 2005. 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. The Company was in compliance
with all debt covenants at December 31, 2005.
Future principal payments under the current debt arrangements,
excluding obligations under capital leases and other notes
payable, are as follows: $320 million in 2006, none in
2007, $242.5 million in 2008, $430 million in 2009 and
$645.5 million in 2010, and $935.0 million from 2011
to 2015. Future minimum payments under capital leases are as
follows: $6.5 million in 2006, $5.7 million in 2007,
$3.8 million in 2008, $3.8 million in 2009,
$1.5 million in 2010 and $6.9 million thereafter.
|
|
11. |
Mandatorily Redeemable Interests in Subsidiaries |
|
|
|
|
|
|
|
|
|
|
|
December 31, | |
|
|
| |
Mandatorily Redeemable Interests in Subsidiaries, |
|
2005 | |
|
2004 | |
|
|
| |
|
| |
|
|
(In thousands) | |
Discovery Times
|
|
$ |
106,862 |
|
|
$ |
125,763 |
|
FitTV (f.k.a. The Health Network)
|
|
|
|
|
|
|
92,874 |
|
Animal Planet LLC
|
|
|
80,000 |
|
|
|
50,000 |
|
Animal Planet LP
|
|
|
48,840 |
|
|
|
48,730 |
|
People & Arts Latin America and Animal Planet Channel
Group
|
|
|
36,800 |
|
|
|
2,200 |
|
|
|
|
|
|
|
|
Mandatorily redeemable interests in subsidiaries
|
|
$ |
272,502 |
|
|
$ |
319,567 |
|
|
|
|
|
|
|
|
In April 2002, the Company sold a 50% interest in Discovery
Times Channel to the New York Times (NYT) for
$100 million. Due to the NYTs redemption rights, this
transaction resulted in no gain or loss to the Company. The NYT
has the right in April 2006, to put its interest back to the
Company for a value
IV-18
Discovery Communications, Inc.
Notes to Consolidated Financial
Statements (Continued)
determined by a specified formula, with a floor of
$80 million and a ceiling of $135 million. The Company
accretes or decretes the mandatorily redeemable interest in a
subsidiary through the redemption date to its estimated
redemption value, never decreting below the NYTs estimated
minority interest. The Company updates its estimate of the
redemption value and estimated minority interest each period and
based on its most recent calculations, the Company will ratably
adjust to an amount representing the NYTs calculated
minority interest of $103.1 million. The Company recorded
decretion of $19.5 million in 2005 and accretion of
$1.3 million and $7.0 million to minority interest
expense in 2004 and 2003.
After 2006, the NYT has certain other protective rights that, if
triggered and not cured, could require the Company to repurchase
the NYTs interest for a value determined by a specified
formula.
|
|
|
FitTV (f.k.a. 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 and recorded accretion of
$8.5 million in 2003 to minority interest expense.
In April 2004, the BBC notified the Company of its intention to
put its interest in Animal Planet LLC back to the Company. The
estimated redemption value of this interest is
$80.0 million based on current negotiated terms. The
Company has recorded accretion of $30.0 million and
$50.0 million in 2005 and 2004 to minority interest expense.
One of the Companys stockholders holds 44,000 senior
preferred partnership units of Animal Planet LP
(APLP) that have a redemption value of
$44.0 million and carry a rate of return ranging from 8.75%
to 13%. Payments are made quarterly and totaled
$4.6 million, $4.6 million and $5.8 million
during 2005, 2004 and 2003. APLPs senior preferred
partnership units may be called by APLP during the period
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. At December 31, 2005, and
2004, the Company has recorded this security at the redemption
value of $44.0 million plus accrued returns of
$4.8 million and $4.7 million. Preferred returns are
recorded as a component of interest expense and aggregated
$4.7 million in 2005, 2004 and 2003.
|
|
|
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, to achieve certain financial
performance benchmarks to put its interests back to the Company
for a value determined by a specified formula. The Company
accretes or decretes the mandatorily redeemable equity in a
subsidiary to its estimated redemption value through the 2005
redemption date. The redemption value estimate is based on a
contractual formula utilizing projected results of each network
within the channel group. Based on calculated performance
benchmarks, the BBC has the right to put. Although this right
has not been exercised, the BBC has 90 days following the
valuation of the Channel Groups by an independent appraiser to
exercise this right. The Company has estimated a redemption
value of $36.8 million at December 31, 2005. Accretion
to the redemption value has been recorded as a component of
minority interest expense of $34.6 million and
$2.2 million in 2005 and 2004.
IV-19
Discovery Communications, Inc.
Notes to Consolidated Financial
Statements (Continued)
|
|
|
Discovery Health Channel (DHC) |
During the second quarter of 2004, Comcast put its DHC interests
back to the Company for $148.9 million. The Company
recorded accretion of $5.1 million to minority interest
expense in 2004.
|
|
12. |
Stockholder Put Right |
In June 2003, the Companys founder, John Hendricks, put
215 outstanding shares of Class A Common Stock to the
Company in exchange for $55.3 million. Concurrent with this
transaction, outstanding loans, secured by
Mr. Hendricks shares and vested compensation units,
of $23.6 million to Mr. Hendricks were repaid to the
Company with interest. Prior to this purchase, the value of
these shares had been recorded as redeemable common stock and
changes in value had been recorded to stockholders deficit.
The Company received a third party valuation in connection with
the transactions. The valuation reflected a lower value for the
Company than had been previously estimated and, as a result, the
Company decreased the carrying value of the stock by
$13.7 million and reduced compensation expense recorded in
prior years associated with the loans by $2.3 million in
connection with the settlement.
|
|
13. |
Commitments and Contingencies |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ending December 31, | |
|
|
| |
Future Minimum Payments, |
|
Leases | |
|
Content | |
|
Other | |
|
Total | |
|
|
| |
|
| |
|
| |
|
| |
|
|
(In thousands) | |
2006
|
|
$ |
63,403 |
|
|
$ |
260,653 |
|
|
$ |
73,401 |
|
|
$ |
397,457 |
|
2007
|
|
|
64,818 |
|
|
|
59,762 |
|
|
|
74,308 |
|
|
|
198,888 |
|
2008
|
|
|
60,816 |
|
|
|
56,959 |
|
|
|
52,779 |
|
|
|
170,554 |
|
2009
|
|
|
42,610 |
|
|
|
52,488 |
|
|
|
22,711 |
|
|
|
117,809 |
|
2010
|
|
|
34,382 |
|
|
|
45,144 |
|
|
|
18,830 |
|
|
|
98,356 |
|
Thereafter
|
|
|
169,385 |
|
|
|
43,942 |
|
|
|
11,861 |
|
|
|
225,188 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$ |
435,414 |
|
|
$ |
518,948 |
|
|
$ |
253,890 |
|
|
$ |
1,208,252 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expenses recorded in connection with operating leases, including
rent expense, were $142.1 million, $127.8 million and
$128.7 million for the years ended December 31, 2005,
2004 and 2003. 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 Companys
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 Companys
deferred rent balance was $29.8 million and
$15.6 million at December 31, 2005 and 2004. The lease
term begins on the date the Company has access to the leased
property.
In August 2005, the Company subleased rented property and
guaranteed third party performance under the lease. The
guarantee for the $7.6 million value of the lease is full
and unconditional.
In connection with the long-term distribution agreements for
certain of its European cable networks, the Company is committed
to pay a satellite system operator 25% to 49% of the increase in
value of these networks, if any, prior to the termination of the
contract on December 31, 2006. The value of the networks,
and the Companys liability thereon, are materially
impacted by the terms of future renewed distribution agreements
with the satellite system operator. The Commitment was designed
as an incentive to enter into a renewed agreement. However, the
Company is currently unable to predict the terms and conditions
of any renewal of the distribution agreements. The Company has
recorded a liability associated with this arrangement based on
the estimated value of the networks at the termination of the
agreement if no renewal is in
IV-20
Discovery Communications, Inc.
Notes to Consolidated Financial
Statements (Continued)
place and adjusts such liability each period for changes in
value. However, if the current distribution agreement is renewed
before the expiration of the existing agreement, amounts to be
paid in 2007 to this system operator could be significantly
higher than amounts currently accrued. The Company will record
the effect of a renewed distribution agreement when such terms
are in place.
The Company is solely responsible for providing financial,
operational and administrative support to the JVP, JVN, Animal
Planet United States, 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 2006.
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 Companys 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 and does not
expect the outcome of such litigation and negotiations to have a
material adverse effect on the Companys results of
operations, cash flows, or financial position.
|
|
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 $8.2 million, $6.8 million and
$5.5 million during 2005, 2004 and 2003.
|
|
15. |
Long-term Incentive Plans |
Prior to October 2005, the Company 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 Companys value as estimated by an
external investment-banking firm utilizing a specified formula
of Company 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 Company discontinued one of its 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. In October 2005, the Company established a
new long-term incentive plan. At inception of the plan, eligible
participants in the remaining plan 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
prior 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 and
appreciation similar to units in the old 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
quarter of the units awarded will expire and the employee will
receive a cash payment for the increase in value throughout an
eight-year period after the grant date. The Company has
authorized the issuance of up to 31.9 million units under
this plan.
IV-21
Discovery Communications, Inc.
Notes to Consolidated Financial
Statements (Continued)
Upon voluntary termination of employment, the Company
distributes 75% of the intrinsic value of the participants
vested units, as participants are required to comply with
post-employment obligations for one year in order to receive
remaining benefits. There were no payments during 2005 related
to the new plan.
Compensation expense under the prior plans was
$20.4 million, $68.8 million, and $101.7 million
in 2005, 2004 and 2003. The Companys cash disbursements
under the prior plans aggregated $325.8 million,
$45.9 million and $27.9 million during 2005, 2004 and
2003. The accrued value of units based on the Companys
vesting schedule was $322.4 million at December 31,
2004.
The following table summarizes information about unit
transactions (units in millions) for prior plans:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2005 | |
|
2004 | |
|
2003 | |
|
|
| |
|
| |
|
| |
|
|
|
|
Weighted | |
|
|
|
Weighted | |
|
|
|
Weighted | |
|
|
|
|
Average | |
|
|
|
Average | |
|
|
|
Average | |
|
|
|
|
Exercise | |
|
|
|
Exercise | |
|
|
|
Exercise | |
|
|
Units | |
|
Price | |
|
Units | |
|
Price | |
|
Units | |
|
Price | |
|
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Outstanding at January 1
|
|
|
25.6 |
|
|
$ |
24.10 |
|
|
|
19.1 |
|
|
$ |
18.18 |
|
|
|
17.2 |
|
|
$ |
15.12 |
|
Units exchanged
|
|
|
(7.8 |
) |
|
|
34.31 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Units granted
|
|
|
0.5 |
|
|
|
37.35 |
|
|
|
8.7 |
|
|
|
34.22 |
|
|
|
4.1 |
|
|
|
29.02 |
|
Units redeemed/cancelled
|
|
|
(18.3 |
) |
|
|
20.53 |
|
|
|
(2.2 |
) |
|
|
13.49 |
|
|
|
(2.2 |
) |
|
|
14.18 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at December 31
|
|
|
|
|
|
|
|
|
|
|
25.6 |
|
|
|
24.10 |
|
|
|
19.1 |
|
|
|
18.18 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Vested at December 31
|
|
|
|
|
|
$ |
|
|
|
|
17.5 |
|
|
$ |
19.76 |
|
|
|
16.5 |
|
|
$ |
16.65 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The fair value of the units issued under the new plan has been
determined using the Black-Scholes option-pricing model. The
weighted average assumptions used in the Black-Scholes model are
a risk-free interest rate of 4.36%, a contractual term of
4.75 years, an expected volatility of 30.36%, and a
dividend yield of zero. 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 was determined based on an
analysis of DHCs industry peer group over the
corresponding periods.
All units under the new plan were granted on October 1,
2005 with a weighted average grant date fair value of $5.83. The
weighted average fair value of units outstanding is $6.63 at
December 31, 2005. Compensation expense in connection with
the new plan was $29.1 million in 2005, including
$12.8 million related to the exchange of partially vested
units from the prior plan. This charge reflects the difference
between the fair value of the award and the intrinsic value of
the award attributable to prior vesting. The accrued fair value
of units outstanding under the new plan was $45.5 million
at December 31, 2005.
The Company has classified as a current liability
$20.7 million for the intrinsic value 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, 2005 is $50.1 million. At
December 31, 2005, there was $115.0 million of
unrecognized compensation cost related to unvested units, which
the Company expects to recognize over a weighted average period
of 2.9 years.
During 2005, 7.8 million units, with a weighted average
grant price of $12.77, were granted to replace units exchanged
from the prior plan, and the Company granted 16.4 million
new units, with a weighted average grant price of $15.81. No
units from the new plan were redeemed or cancelled.
IV-22
Discovery Communications, Inc.
Notes to Consolidated Financial
Statements (Continued)
The following table summarizes information about unit awards
outstanding at December 31, 2005 (units in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding | |
|
Vested | |
|
|
| |
|
| |
|
|
|
|
Weighted Average | |
|
|
|
Weighted Average | |
|
|
Number of | |
|
Remaining Years of | |
|
Number of | |
|
Remaining Years of | |
Unit Price |
|
Units | |
|
Contractual Life | |
|
Units | |
|
Contractual Life | |
|
|
| |
|
| |
|
| |
|
| |
$3.48
|
|
|
0.1 |
|
|
|
4.75 |
|
|
|
0.1 |
|
|
|
4.75 |
|
$7.06
|
|
|
0.6 |
|
|
|
4.75 |
|
|
|
0.3 |
|
|
|
2.75 |
|
$12.52
|
|
|
5.2 |
|
|
|
4.75 |
|
|
|
1.6 |
|
|
|
3.75 |
|
$15.81
|
|
|
18.3 |
|
|
|
4.74 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
24.2 |
|
|
|
4.74 |
|
|
|
2.0 |
|
|
|
3.60 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unit Appreciation and Incentive Agreement |
As part of his long-term incentive plan with the Company, the
Companys Founder, John Hendricks, had a
10-year incentive
agreement with the Company that granted him a cash award equal
to 1.6% of the difference between the Companys value at
December 31, 1993 and December 31, 2003 for his
services as Chairman and Chief Executive Officer during the
period. This cash award was paid out to Mr. Hendricks in
two installments, one in December 2003 and one in February 2004.
The final determination of value was based on an appraisal from
an investment banking firm using a consistent valuation
methodology both at the beginning and the end of the
10-year term. The
estimated change in value of this incentive was recorded as a
component of compensation expense during the term of the
agreement.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, | |
|
|
| |
Income Tax Expense, |
|
2005 | |
|
2004 | |
|
2003 | |
|
|
| |
|
| |
|
| |
|
|
(In thousands) | |
Current
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal
|
|
$ |
(1,479 |
) |
|
$ |
(231 |
) |
|
$ |
2,813 |
|
|
State
|
|
|
(3,205 |
) |
|
|
3,952 |
|
|
|
6,722 |
|
|
Foreign
|
|
|
57,644 |
|
|
|
32,556 |
|
|
|
22,970 |
|
|
|
|
|
|
|
|
|
|
|
Total current income tax provision
|
|
|
52,960 |
|
|
|
36,277 |
|
|
|
32,505 |
|
|
|
|
|
|
|
|
|
|
|
Deferred
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal
|
|
|
95,098 |
|
|
|
95,761 |
|
|
|
33,963 |
|
|
State
|
|
|
16,298 |
|
|
|
7,723 |
|
|
|
5,175 |
|
|
Foreign
|
|
|
(3,851 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total deferred income tax expense
|
|
|
107,545 |
|
|
|
103,484 |
|
|
|
39,138 |
|
|
|
|
|
|
|
|
|
|
|
Change in valuation allowance
|
|
|
1,838 |
|
|
|
2,038 |
|
|
|
3,142 |
|
|
|
|
|
|
|
|
|
|
|
Total income tax expense
|
|
$ |
162,343 |
|
|
$ |
141,799 |
|
|
$ |
74,785 |
|
|
|
|
|
|
|
|
|
|
|
IV-23
Discovery Communications, Inc.
Notes to Consolidated Financial
Statements (Continued)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, | |
|
|
| |
|
|
2005 | |
|
2004 | |
|
|
| |
|
| |
Deferred Income Tax Assets and Liabilities |
|
Current | |
|
Non-Current | |
|
Current | |
|
Non-Current | |
|
|
| |
|
| |
|
| |
|
| |
|
|
(In thousands) | |
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss carryforwards
|
|
$ |
43,470 |
|
|
$ |
61,974 |
|
|
$ |
1,148 |
|
|
$ |
20,090 |
|
|
Compensation
|
|
|
15,185 |
|
|
|
12,432 |
|
|
|
102,595 |
|
|
|
22,745 |
|
|
Accrued expenses
|
|
|
17,769 |
|
|
|
|
|
|
|
26,474 |
|
|
|
|
|
|
Reserves and allowances
|
|
|
10,392 |
|
|
|
463 |
|
|
|
8,720 |
|
|
|
10,132 |
|
|
Tax credits
|
|
|
|
|
|
|
3,823 |
|
|
|
4,330 |
|
|
|
|
|
|
Derivative financial instruments
|
|
|
|
|
|
|
7,052 |
|
|
|
|
|
|
|
16,979 |
|
|
Investments
|
|
|
|
|
|
|
86,039 |
|
|
|
|
|
|
|
69,729 |
|
|
Intangibles
|
|
|
|
|
|
|
41,401 |
|
|
|
|
|
|
|
31,627 |
|
|
Other
|
|
|
3,689 |
|
|
|
11,732 |
|
|
|
3,066 |
|
|
|
8,342 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
90,505 |
|
|
|
224,916 |
|
|
|
146,333 |
|
|
|
179,644 |
|
|
Valuation allowance
|
|
|
|
|
|
|
(21,392 |
) |
|
|
|
|
|
|
(19,554 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total deferred income tax assets
|
|
|
90,505 |
|
|
|
203,524 |
|
|
|
146,333 |
|
|
|
160,090 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accelerated depreciation
|
|
|
|
|
|
|
(11,948 |
) |
|
|
|
|
|
|
(20,908 |
) |
|
Programming costs
|
|
|
|
|
|
|
(109,009 |
) |
|
|
|
|
|
|
|
|
|
Foreign currency translation
|
|
|
|
|
|
|
(4,103 |
) |
|
|
|
|
|
|
(13,687 |
) |
|
Unrealized gains on investments
|
|
|
|
|
|
|
(1,920 |
) |
|
|
|
|
|
|
(720 |
) |
|
Other
|
|
|
(1,740 |
) |
|
|
(7,228 |
) |
|
|
(1,727 |
) |
|
|
(10,102 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total deferred income tax liabilities
|
|
|
(1,740 |
) |
|
|
(134,208 |
) |
|
|
(1,727 |
) |
|
|
(45,417 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred income tax assets, net
|
|
$ |
88,765 |
|
|
$ |
69,316 |
|
|
$ |
144,606 |
|
|
$ |
114,673 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, | |
|
|
| |
Reconciliation of Effective Tax Rate, |
|
2005 | |
|
2004 | |
|
2003 | |
|
|
| |
|
| |
|
| |
Federal statutory rate
|
|
|
35.0 |
% |
|
|
35.0 |
% |
|
|
35.0 |
% |
Increase (decrease) in tax rate arising from:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
State income taxes, net of Federal benefit
|
|
|
3.0 |
|
|
|
2.4 |
|
|
|
7.9 |
|
|
Foreign income taxes, net of Federal benefit
|
|
|
9.3 |
|
|
|
6.4 |
|
|
|
12.2 |
|
|
Other
|
|
|
3.1 |
|
|
|
2.0 |
|
|
|
(0.9 |
) |
|
|
|
|
|
|
|
|
|
|
Effective income tax rate
|
|
|
50.4 |
% |
|
|
45.8 |
% |
|
|
54.2 |
% |
|
|
|
|
|
|
|
|
|
|
The Company has Federal operating loss carryforwards of
$231.1 million that begin to expire in 2021 and state
operating loss carryforwards of $682.9 million in various
state jurisdictions available to offset future taxable income
that expire in various amounts through 2025. The Company also
has $3.8 million of alternative minimum tax credits that do
not have an expiration date.
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.
IV-24
Discovery Communications, Inc.
Notes to Consolidated Financial
Statements (Continued)
|
|
17. |
Financial Instruments |
|
|
|
Derivative 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 Companys 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 instrument
contracts include a combination of swaps, caps, collars, and
other structured instruments to modify interest rate exposure.
At December 31, 2005, the variable to fixed interest rate
instruments have a notional principal amount of
$1,200 million and have a weighted average interest rate of
5.82%. At December 31, 2005, the fixed to variable interest
rate agreements have a notional principal amount of
$225 million and have a weighted average interest rate of
8.39%. At December 31, 2005, the Company held an
unexercised option to extend an interest rate swap contract with
a notional amount of $375 million at a fixed rate of 5.28%
and an unexercised interest rate swap put right held by a bank
had a notional amount of $25.0 million at a fixed rate of
5.44%. As a result of unrealized mark to market adjustments, the
Company recorded $29.1 million, $44.1 million and
$21.6 million in gains on these instruments during 2005,
2004 and 2003. 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.
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,
2005, the notional amount of foreign exchange derivative
contracts was $91.4 million. As a result of unrealized mark
to market adjustments, the Company recognized $2.3 million,
$0.4 million and $0.1 million in losses on these
instruments during 2005, 2004 and 2003. 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 balance has been
recorded as a component of Other Comprehensive Income (Loss),
net of taxes and amortization to interest expense.
|
|
|
Fair Value of Financial Instruments |
The fair values of cash and cash equivalents, receivables, and
accounts payable approximate their carrying values. Investments
are carried at fair value and fluctuations in fair value are
recorded through other comprehensive income. Losses on
investments that are other than temporary declines in value are
recorded in the statement of operations.
The carrying amount of the Companys borrowings was
$2,597 million and the fair value was $2,674 million
at December 31, 2005. The carrying amount of the
Companys borrowings was $2,508 million and the fair
value was $2,616 million at December 31, 2004.
The carrying amount of all derivative instruments represents
their fair value. The net fair value of the Companys short
and long-term derivative instruments is $(19.8) million at
December 31, 2005; 6.5%, 38.6%, 35.2%, 2.4%, 6.7% and 10.6%
of these derivative instrument contracts will expire in 2006,
2007, 2008, 2009, 2010 and thereafter. The fair value of the
Companys derivative instruments totaled
$(44.8) million at December 31, 2004.
IV-25
Discovery Communications, Inc.
Notes to Consolidated Financial
Statements (Continued)
The fair value of derivative contracts was estimated by
obtaining interest rate and volatility market data from brokers.
As of December 31, 2005, an estimated 100 basis point
parallel shift in the interest rate yield curve would change the
fair value of the Companys portfolio by approximately
$7.7 million.
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 Companys trade receivables and investments do not
represent a significant concentration of credit risk at
December 31, 2005 due to the wide variety of customers and
markets in which the Company operates and their dispersion
across many geographic areas.
|
|
18. |
Related Party Transactions |
The Company identifies related parties as investors and their
consolidated businesses, equity investment companies, and
executive management. The most significant transactions with
related parties result from companies that distribute networks,
produce content, or provide media uplink services. Gross revenue
earned from related parties was $73.7 million,
$71.8 million and $209.2 million in 2005, 2004 and
2003. Accounts receivable from these entities were
$17.0 million and $10.9 million at December 31,
2005 and 2004. Purchases from related parties totaled
$71.4 million, $133.2 million, and $164.7 million
in 2005, 2004, and 2003; of these $23.1 million,
$91.0 million and $101.1 million relate to capitalized
assets. Amounts payable to these parties totaled
$2.3 million and $4.3 million at December 31,
2005 and 2004.
In December 2005, the Company signed an agreement to acquire 98%
of a free-to-air
channel in Germany. The purchase has several significant
contingencies for completion. However, the Company expects to
complete the purchase during the 1st Quarter of 2006. The
estimated purchase price of the acquisition is
50.0 million,
approximately $60.0 million, including distribution
arrangements and other assets.
IV-26
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: /s/ Charles Y. Tanabe |
|
|
|
Charles
Y. Tanabe |
|
Senior
Vice President and |
|
General
Counsel |
Dated: March 23, 2006
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.
|
|
|
|
|
|
|
Signature |
|
Title |
|
Date |
|
|
|
|
|
|
/s/ John C. Malone
John C. Malone |
|
Chairman of the Board, Director and Chief Executive Officer |
|
March 23, 2006 |
|
/s/ Robert R. Bennett
Robert R. Bennett |
|
Director and President |
|
March 23, 2006 |
|
/s/ Paul A. Gould
Paul A. Gould |
|
Director |
|
March 23, 2006 |
|
/s/ M. LaVoy Robison
M. LaVoy Robison |
|
Director |
|
March 23, 2006 |
|
/s/ J. David Wargo
J. David Wargo |
|
Director |
|
March 23, 2006 |
|
/s/ David J.A. Flowers
David J.A. Flowers |
|
Senior Vice President and Treasurer (Principal Financial Officer) |
|
March 23, 2006 |
|
/s/ Christopher W. Shean
Christopher W. Shean |
|
Senior Vice President and Controller (Principal Accounting
Officer) |
|
March 23, 2006 |
IV-27
INDEX TO EXHIBITS
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
DHCs Registration Statement on Form 10, dated
July 15, 2005 (File No. 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 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 to Exhibit 10.1 to the Form 10). |
|
10.2 |
|
|
First Amendment to the Stockholders Agreement, dated as of
December 20, 1996, by and among Discovery, Cox
Communications Holdings, Inc. (the successor to Cox), Newhouse
Broadcasting Corporation ( the successor to NewChannels), TCID,
Hendricks and for the purposes stated therein only, LMC Animal
Planet, Inc. (LMC) and Liberty Media Corporation, a
Colorado corporation (Liberty) (incorporated by
reference to Exhibit 10.2 to the Form 10). |
|
10.3 |
|
|
Second Amendment to the Stockholders Agreement, dated as
of September 7, 2000, by and among Discovery, Cox
Communications Holdings, Inc. (the successor to Cox),
Advance/Newhouse Programming Partnership (the successor to
NewChannels), LMC Discovery, Inc. (formerly known as TCID) and
Hendricks (incorporated by reference to Exhibit 10.3 to the
Form 10). |
|
10.4 |
|
|
Third Amendment to the Stockholders Agreement, dated as of
September, 2001, by and among Discovery, Cox, NewChannels, TCID,
Hendricks and Advance Programming Holdings Corp. (incorporated
by reference to Exhibit 10.4 to the Form 10). |
|
10.5 |
|
|
Fourth Amendment to the Stockholders Agreement, dated as
of June 23, 2003, by and among Discovery, Cox NewChannels,
TCID, Liberty Animal, Inc. (the successor in interest to LMC)
for the purposes stated in the First Amendment to the
Stockholders Agreement, and Hendricks (incorporated by
reference to Exhibit 10.5 to the Form 10). |
|
10.6 |
|
|
Form of Tax Sharing Agreement between Liberty Media Corporation
and DHC (incorporated by reference to Exhibit 10.6 to the
Form 10). |
|
10.7 |
|
|
Discovery Holding Company 2005 Incentive Plan (incorporated by
reference to Exhibit 10.7 to the Form 10). |
|
10.8 |
|
|
Discovery Holding Company 2005 Non-Employee Director Plan
(incorporated by reference to Exhibit 10.8 to the Form 10). |
|
10.9 |
|
|
Discovery Holding Company Transitional Stock Adjustment Plan
(incorporated by reference to Exhibit 10.9 to the Form 10). |
|
10.10 |
|
|
Agreement between DHC and John C. Malone (incorporated by
reference to Exhibit 10.10 to the Form 10). |
|
|
|
|
|
|
10.11 |
|
|
Agreement, dated June 24, 2005, between Discovery and DHC
(incorporated by reference to Exhibit 10.11 to the Form 10). |
|
10.12 |
|
|
Indemnification Agreement, dated as of June 24, 2005,
between Cox and DHC (incorporated by reference to
Exhibit 10.12 to the Form 10). |
|
10.13 |
|
|
Indemnification Agreement, dated as of June 24, 2005,
between NewChannels and DHC (incorporated by reference to
Exhibit 10.13 to the Form 10). |
|
10.14 |
|
|
Form of Indemnification Agreement with Directors and Executive
Officers (incorporated by reference to Exhibit 10.14 to the
Form 10). |
|
21 |
|
|
Subsidiaries of Discovery Holding Company, filed
herewith. |
|
23.1 |
|
|
Consent of KPMG LLP, filed herewith. |
|
23.2 |
|
|
Consent of PricewaterhouseCoopers LLP, filed herewith. |
|
31.1 |
|
|
Rule 13a-14(a)/15d-14(a) Certification, filed herewith. |
|
31.2 |
|
|
Rule 13a-14(a)/15d-14(a) Certification, filed herewith. |
|
31.3 |
|
|
Rule 13a-14(a)/15d-14(a) Certification, filed herewith. |
|
32 |
|
|
Section 1350 Certification, filed herewith. |