Document

 
 
 
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2019
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to             
Commission File Number: 001-34177
 
http://api.tenkwizard.com/cgi/image?quest=1&rid=23&ipage=12876958&doc=13
Discovery, Inc.
(Exact name of Registrant as specified in its charter)
 
Delaware
 
35-2333914
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
8403 Colesville Road
Silver Spring, Maryland
 
20910
(Address of principal executive offices)
 
(Zip Code)
(240) 662-2000
(Registrant’s telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year, if changed since last report.)


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 (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ý    No  o
Indicate by check mark whether the Registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit such files).    Yes  ý    No  ¨



Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
ý
Accelerated filer
¨
Non-accelerated filer
o
Smaller reporting company
¨
 
 
Emerging growth company
¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  ý
Securities Registered Pursuant to Section 12(b) of the Act:

Title of Each Class
Trading Symbols
Name of Each Exchange on Which Registered
Series A Common Stock
DISCA
Nasdaq
Series B Common Stock
DISCB
Nasdaq
Series C Common Stock
DISCK
Nasdaq
Total number of shares outstanding of each class of the Registrant’s common stock as of April 22, 2019:
Series A Common Stock, par value $0.01 per share
157,848,790

Series B Common Stock, par value $0.01 per share
6,512,378

Series C Common Stock, par value $0.01 per share
360,553,643

 
 
 
 
 




DISCOVERY, INC.
FORM 10-Q
TABLE OF CONTENTS

 
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


3


PART I. FINANCIAL INFORMATION
ITEM 1. Unaudited Financial Statements.
DISCOVERY, INC.
CONSOLIDATED BALANCE SHEETS
(unaudited; in millions, except par value)

 
March 31, 2019
 
December 31, 2018
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
745

 
$
986

Receivables, net
2,625

 
2,620

Content rights, net
364

 
313

Prepaid expenses and other current assets
291

 
312

Total current assets
4,025

 
4,231

Noncurrent content rights, net
3,098

 
3,069

Property and equipment, net
802

 
800

Goodwill, net
13,037

 
13,006

Intangible assets, net
9,366

 
9,674

Equity method investments, including note receivable (See Note 3)
955

 
935

Other noncurrent assets
1,161

 
835

Total assets
$
32,444

 
$
32,550

LIABILITIES AND EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
314

 
$
325

Accrued liabilities
1,538

 
1,604

Deferred revenues
236

 
249

Current portion of debt
1,387

 
1,819

Total current liabilities
3,475

 
3,997

Noncurrent portion of debt
14,956

 
14,974

Deferred income taxes
1,700

 
1,811

Other noncurrent liabilities
1,573

 
1,251

Total liabilities
21,704

 
22,033

Commitments and contingencies (See Note 18)





Redeemable noncontrolling interests
440

 
415

Equity:
 
 
 
Discovery, Inc. stockholders’ equity:
 
 
 
Series A-1 convertible preferred stock: $0.01 par value; 8 shares authorized, issued and outstanding

 

Series C-1 convertible preferred stock: $0.01 par value; 6 shares authorized, issued and outstanding

 

Series A common stock: $0.01 par value; 1,700 shares authorized; 161 and 160 shares issued; and 158 and 157 shares outstanding
2

 
2

Series B convertible common stock: $0.01 par value; 100 shares authorized; 7 shares issued and outstanding

 

Series C common stock: $0.01 par value; 2,000 shares authorized; 525 and 524 shares issued; and 361 and 360 shares outstanding
5

 
5

Additional paid-in capital
10,670

 
10,647

Treasury stock, at cost: 167 shares
(6,737
)
 
(6,737
)
Retained earnings
5,663

 
5,254

Accumulated other comprehensive loss
(895
)
 
(785
)
Total Discovery, Inc. stockholders' equity
8,708

 
8,386

Noncontrolling interests
1,592

 
1,716

Total equity
10,300

 
10,102

Total liabilities and equity
$
32,444

 
$
32,550

The accompanying notes are an integral part of these consolidated financial statements.

4


DISCOVERY, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited; in millions, except per share amounts)


 

Three Months Ended March 31,
 

2019

2018
Revenues:


Advertising

1,415


$
1,012

Distribution

1,224


1,051

Other

68


244

Total revenues

2,707


2,307

Costs and expenses:




Costs of revenues, excluding depreciation and amortization

930


1,060

Selling, general and administrative

626


609

Depreciation and amortization

372


193

Restructuring and other charges

5


241

Total costs and expenses

1,933


2,103

Operating income

774


204

Interest expense, net

(182
)

(177
)
Loss on extinguishment of debt

(5
)


Income (loss) from equity investees, net

11


(22
)
Other expense, net

(27
)

(22
)
Income (loss) before income taxes

571


(17
)
Income tax (expense) benefit

(153
)

20

Net income

418


3

Net income attributable to noncontrolling interests

(29
)

(5
)
Net income attributable to redeemable noncontrolling interests

(5
)

(6
)
Net income (loss) available to Discovery, Inc.

$
384


$
(8
)
Net income (loss) per share allocated to Discovery, Inc. Series A, B and C common stockholders:




Basic

$
0.53


$
(0.01
)
Diluted

$
0.53


$
(0.01
)
Weighted average shares outstanding:




Basic

524


422

Diluted

714


609

The accompanying notes are an integral part of these consolidated financial statements.

5


DISCOVERY, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(unaudited; in millions)


 
 
Three Months Ended March 31,
 
 
2019
 
2018
Net income
 
$
418

 
$
3

Other comprehensive income (loss) adjustments, net of tax:
 
 
 
 
Currency translation
 
(69
)
 
3

Derivatives
 
(11
)
 
(5
)
Comprehensive income
 
338

 
1

Comprehensive income (loss) attributable to noncontrolling interests
 
(29
)
 
(5
)
Comprehensive income (loss) attributable to redeemable noncontrolling interests
 
(5
)
 
(6
)
Comprehensive income (loss) attributable to Discovery, Inc.
 
$
304

 
$
(10
)
The accompanying notes are an integral part of these consolidated financial statements.

6


DISCOVERY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited; in millions)

    
 
Three Months Ended March 31,
 
2019

2018
Operating Activities



Net income
$
418


$
3

Adjustments to reconcile net income to cash provided by operating activities:



Share-based compensation expense
30


15

Depreciation and amortization
372


193

Content rights amortization and impairment
697


751

Remeasurement gain on previously held equity interest
(8
)


Equity in earnings of equity method investee companies, net of cash distributions
3


36

Deferred income taxes
(43
)

(35
)
Other, net
44


67

Changes in operating assets and liabilities, net of acquisitions and dispositions:



Receivables, net
(10
)

(36
)
Content rights and payables, net
(816
)

(698
)
Accounts payable and accrued liabilities
(211
)

(171
)
Prepaid income taxes and income taxes receivable
41


(42
)
Foreign currency and other, net
25


77

Cash provided by operating activities
542


160

Investing Activities



Business acquisitions, net of cash acquired
(22
)

(8,565
)
Payments for investments, net
(34
)

(22
)
Purchases of property and equipment
(44
)

(48
)
Proceeds from (payments for) derivative instruments, net
5


(42
)
Other investing activities, net
1


2

Cash used in investing activities
(94
)

(8,675
)
Financing Activities



Borrowings under term loan facilities


2,000

Principal repayments of debt, including discount payment and premiums to par value
(453
)


Principal repayments of finance lease obligations
(17
)

(13
)
Distributions to noncontrolling interests and redeemable noncontrolling interests
(163
)

(2
)
Share-based plan (payments) proceeds, net
(15
)

23

(Repayments) borrowings under program financing line of credit, net
(3
)

22

Other financing activities, net
(1
)

(11
)
Cash (used in) provided by financing activities
(652
)

2,019

Effect of exchange rate changes on cash and cash equivalents
(37
)

(1
)
Net change in cash and cash equivalents
(241
)

(6,497
)
Cash and cash equivalents, beginning of period
986


7,309

Cash and cash equivalents, end of period
$
745


$
812

The accompanying notes are an integral part of these consolidated financial statements.

7

DISCOVERY, INC.
CONSOLIDATED STATEMENT OF EQUITY
(unaudited; in millions)

 
 
Preferred Stock
 
Common Stock
 
Additional
Paid-In
Capital
 
Treasury
Stock
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Loss
 
Discovery,
Inc. Stockholders’
Equity
 
Noncontrolling
Interests
 
Total
Equity
 
Shares
 
Par Value
Shares
 
Par Value
December 31, 2018
 
14

 
$

 
691

 
$
7

 
$
10,647

 
$
(6,737
)
 
$
5,254

 
$
(785
)
 
$
8,386

 
$
1,716

 
$
10,102

Cumulative effect of accounting changes (See Note 1)
 

 

 

 

 

 

 
30

 
(30
)
 

 

 

Net income available to Discovery, Inc. and attributable to noncontrolling interests
 

 

 

 

 

 

 
384

 

 
384

 
29

 
413

Other comprehensive loss
 

 

 

 

 

 

 

 
(80
)
 
(80
)
 

 
(80
)
Share-based compensation
 

 

 

 

 
38

 

 

 

 
38

 

 
38

Tax settlements associated with share-based compensation
 

 

 

 

 
(21
)
 

 

 

 
(21
)
 

 
(21
)
Dividends paid to noncontrolling interests
 

 

 

 

 

 

 

 

 

 
(153
)
 
(153
)
Issuance of stock in connection with share-based plans
 

 

 
2

 

 
6

 

 

 

 
6

 

 
6

Redeemable noncontrolling interest adjustments to redemption value
 

 

 

 

 

 

 
(5
)
 

 
(5
)
 

 
(5
)
March 31, 2019
 
14

 
$

 
693

 
$
7

 
$
10,670

 
$
(6,737
)
 
$
5,663

 
$
(895
)
 
$
8,708

 
$
1,592

 
$
10,300

The accompanying notes are an integral part of these consolidated financial statements.

8

DISCOVERY, INC.
CONSOLIDATED STATEMENT OF EQUITY
(unaudited; in millions)

 
 
Preferred Stock
 
Common Stock
 
Additional
Paid-In
Capital
 
Treasury
Stock
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Loss
 
Discovery,
Inc. Stockholders’
Equity
 
Noncontrolling
Interests
 
Total
Equity
 
 
Shares
 
Par Value
 
Shares
 
Par Value
 
 
 
 
 
 
 
December 31, 2017
 
14

 
$

 
547

 
$
5

 
$
7,295

 
$
(6,737
)
 
$
4,632

 
$
(585
)
 
$
4,610

 
$

 
$
4,610

Cumulative effect of accounting change
 

 

 

 

 

 

 
33

 
(26
)
 
7

 

 
7

Net (loss) income available to Discovery, Inc. and attributable to noncontrolling interests
 

 

 

 

 

 

 
(8
)
 

 
(8
)
 
5

 
(3
)
Other comprehensive loss
 

 

 

 

 

 

 

 
(2
)
 
(2
)
 

 
(2
)
Share-based compensation
 

 

 

 

 
41

 

 

 

 
41

 

 
41

Tax settlements associated with share-based compensation
 

 

 

 

 
(16
)
 

 

 

 
(16
)
 

 
(16
)
Issuance of stock and noncontrolling interest in connection with the acquisition of Scripps Networks Interactive, Inc. ("Scripps Networks")
 

 

 
139

 
1

 
3,217

 

 

 

 
3,218

 
1,700

 
4,918

Issuance of stock in connection with share-based plans
 

 

 
4

 

 
39

 

 

 

 
39

 

 
39

March 31, 2018
 
14

 
$

 
690

 
$
6

 
$
10,576

 
$
(6,737
)
 
$
4,657

 
$
(613
)
 
$
7,889

 
$
1,705

 
$
9,594

The accompanying notes are an integral part of these consolidated financial statements.

9


DISCOVERY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)




NOTE 1. DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION
Description of Business
Discovery, Inc. (“Discovery” or the “Company”) is a global media company that provides content across multiple distribution platforms, including linear platforms such as pay-television ("pay-TV"), free-to-air ("FTA") and broadcast television, authenticated GO applications, digital distribution arrangements and content licensing agreements. The Company also operates a portfolio of digital direct-to-consumer products and production studios. As further discussed in Note 2, on March 6, 2018, the Company acquired Scripps Networks Interactive, Inc. ("Scripps Networks") and changed its name from "Discovery Communications, Inc." to "Discovery, Inc." The Company presents the following business units: U.S. Networks, consisting principally of domestic television networks and digital content services, and International Networks, consisting principally of international television networks and digital content services; and Other, consisting of a production studio and previously consolidated curriculum-based education business that was sold on April 30, 2018. Financial information for Discovery’s reportable segments is discussed in Note 19.
Principles of Consolidation and Basis of Presentation
The consolidated financial statements include the accounts of Discovery and its majority-owned subsidiaries in which a controlling interest is maintained. For each non-wholly owned subsidiary, the Company evaluates its ownership and other interests to determine whether it should consolidate the entity or account for its ownership interest as an equity method investment or an equity investment without a readily determinable fair value. As part of its evaluation, the Company makes judgments in determining whether the entity is a variable interest entity ("VIE") and, if so, whether it is the primary beneficiary of the VIE and is thus required to consolidate the entity. (See Note 3.) Inter-company accounts and transactions between consolidated entities have been eliminated in consolidation.
Unaudited Interim Financial Statements
These consolidated financial statements are unaudited; however, in the opinion of management, they reflect all adjustments consisting only of normal recurring adjustments necessary to state fairly the financial position, results of operations and cash flows for the periods presented in conformity with U.S. generally accepted accounting principles (“GAAP”) applicable to interim periods. The results of operations for the interim periods presented are not necessarily indicative of results for the full year or future periods. These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in Discovery’s Annual Report on Form 10-K for the year ended December 31, 2018 (the “2018 Form 10-K”).
Use of Estimates
The preparation of financial statements in accordance with GAAP requires management to make estimates, judgments and assumptions that affect the amounts and disclosures reported in the consolidated financial statements and accompanying notes. Management continually re-evaluates its estimates, judgments and assumptions, and management’s evaluation could change as actual results may differ materially from those estimates. These estimates are sometimes complex, sensitive to changes in assumptions and may require fair value determinations using Level 3 fair value measurements. Estimates and judgments inherent in the preparation of the consolidated financial statements include accounting for asset impairments, revenue recognition, allowances for doubtful accounts, content rights, depreciation and amortization, business combinations, share-based compensation, defined benefit plans, income taxes, other financial instruments, contingencies and the determination of whether the Company is the primary beneficiary of entities in which it holds variable interests.

10


DISCOVERY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)



Accounting and Reporting Pronouncements Adopted
Leases
In February 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2016-02, which requires lessees to recognize almost all of their leases on the balance sheet by recording a right-of-use asset and lease liability. The guidance also requires improved disclosures to help users of the financial statements better understand the amount, timing, and uncertainty of cash flows arising from leases. The Company adopted ASU 2016-02 effective January 1, 2019 and elected to apply the guidance at the effective date without recasting the comparative periods presented. Additionally, the Company elected to apply practical expedients allowing it to not reassess 1) whether any expired or existing contracts previously assessed as not containing leases are, or contain, leases; 2) the lease classification for any expired or existing leases; and 3) initial direct costs for any existing leases. The Company also elected to not separate lease components from non-lease components across all lease categories. Instead, each separate lease component and non-lease component are accounted for as a single lease component. The Company did not elect to apply the practical expedient to use hindsight in determining the lease term and in assessing the right-of-use assets for impairment. Additionally, the Company did not elect to apply the short-term lease scope exemption.
The adoption of ASU 2016-02 resulted in recognition of operating lease right-of-use assets of $342 million (included in “Other noncurrent assets”) and operating lease liabilities of $372 million (included in “Accrued liabilities” and “Other noncurrent liabilities”). The operating lease right-of use assets recorded upon adoption were offset by prepaid and deferred rent balances and ASC 420 liabilities totaling approximately $30 million. In addition, capital lease obligations totaling $252 million as of December 31, 2018 (known as finance lease liabilities effective January 1, 2019) were reclassified from current and noncurrent debt to components of "Accrued liabilities" and "Other noncurrent liabilities" on the consolidated balance sheet to conform with the new presentation. The adoption did not affect the pattern of expense recognition, cash flow presentation, or the Company's ability to meet its financial covenants. See Note 7 for further information.
Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income
In February 2018, the FASB issued ASU 2018-02, which permits entities to reclassify tax effects stranded in accumulated other comprehensive income as a result of the 2017 Tax Cuts and Jobs Act ("TCJA") to retained earnings for each period in which the effect of the change is recorded. The update also requires entities to disclose their accounting policy for releasing income tax effects from accumulated other comprehensive income. The Company adopted ASU 2018-02 effective January 1, 2019, which resulted in a reclassification of $30 million between accumulated other comprehensive loss and retained earnings on the consolidated balance sheet and the consolidated statement of equity. Tax effects unrelated to the TCJA are released from accumulated other comprehensive loss using either the specific identification approach or the portfolio approach based on the nature of the underlying item.
Targeted Improvements to Accounting for Hedging Activities
In August 2017, the FASB issued ASU 2017-12, which includes significant amendments that expand the eligibility for hedge accounting to more financial and nonfinancial hedging strategies. The guidance is intended to align hedge accounting with companies’ risk management strategies, simplify the application of hedge accounting, and increase transparency as to the scope and results of hedging programs. In addition, the guidance amends the presentation and disclosure requirements and changes how companies assess effectiveness. The updated guidance is effective for fiscal years beginning after December 15, 2018, with early adoption permitted. The Company early adopted the pronouncement on July 1, 2018. As a result, the Company changed the method by which it assesses effectiveness for net investment hedges from the forward-method to the spot-method. The Company believes the spot method better matches the spot rate changes of the net investment. Previous net losses of $87 million incurred under the forward method related to net investment hedges will remain in other comprehensive loss under the currency translation adjustments component and will be reclassified to earnings when the net investment is sold or liquidated. The adoption of ASU 2017-12 did not result in a material impact to our consolidated results of operations; however, the Company has expanded its disclosures of its derivative activities in Note 8.
Accounting and Reporting Pronouncements Not Yet Adopted
Targeted Improvements to Accounting for Financial Instruments, Credit Losses, and Hedging Activities
In April 2019, the FASB issued ASU 2019-04, Codification Improvements to Topic 326, Financial Instruments - Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments. The new ASU provides narrow-scope amendments to help apply these recent standards. The Company will be required to adopt the provisions of this ASU on January 1, 2020, with early adoption permitted for certain amendments. The Company is currently assessing the impact that this pronouncement will have on its consolidated financial statements.


11


DISCOVERY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)



Content
In March 2019, the FASB issued ASU 2019-02, which aligns the accounting for production costs of episodic television series with the accounting for production costs of films. In addition, ASU 2019-02 modifies certain aspects of the capitalization, impairment, presentation and disclosure requirements in Accounting Standards Codification (“ASC”) 926-20 and the impairment, presentation and disclosure requirements in ASC 920-350. This ASU must be adopted on a prospective basis and is effective for annual periods beginning after December 15, 2019, including interim periods within those years, with early adoption permitted. The Company is currently evaluating the impact that this pronouncement will have on its consolidated financial statements.
Goodwill
In January 2017, the FASB issued ASU 2017-04, which simplifies the subsequent measurement of goodwill by eliminating Step 2 from the former two-step goodwill impairment test and eliminating the requirements for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment. Therefore, an entity will recognize impairment charges for the amount by which the carrying amount exceeds the reporting unit's fair value not to exceed the amount of goodwill recorded for that reporting unit. Goodwill impairment will no longer be measured as the excess of the carrying amount of goodwill over its implied fair value determined by assigning the fair value of a reporting unit to all of its assets and liabilities as if it had been acquired in a business combination. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. This ASU must be adopted on a prospective basis for the annual or any interim goodwill impairment tests beginning after December 15, 2019. The Company is currently evaluating the impact that this pronouncement will have on its consolidated financial statements.
Financial Instruments - Credit Losses
In June 2016, the FASB issued ASU 2016-03, which changes the impairment model for most financial assets and certain other instruments, including trade and other receivables, held-to-maturity debt securities and loans, and requires entities to use a new, forward-looking “expected loss” model that would generally result in the earlier recognition of allowances for losses. This ASU is effective for annual periods beginning after December 15, 2019, including interim periods within those years, with early adoption permitted. Adoption of the standard will be applied using a modified retrospective approach through a cumulative-effect adjustment to retained earnings as of the effective date to align our credit loss methodology with the new standard. The Company is currently evaluating the impact of this standard on its consolidated financial statements, including accounting policies, processes, and systems.
Concentrations Risk
Customers
The Company has long-term contracts with distributors around the world. For the U.S. Networks segment, approximately 97% of distribution revenue comes from the Company's largest 10 distributors in the U.S. For the International Networks segment, approximately 39% of distribution revenue comes from the Company's largest 10 distributors outside of the U.S. Agreements in place with the 10 largest cable and satellite operators in the U.S. Networks and International Networks expire at various times from 2019 through 2023. Although the Company seeks to renew its agreements with its distributors prior to expiration of a contract, a delay in securing a renewal that results in a service disruption, a failure to secure a renewal or a renewal on less favorable terms may have a material adverse effect on the Company’s financial condition and results of operations. Not only could the Company experience a reduction in distribution revenue, but it could also experience a reduction in advertising revenue, as viewership is impacted by affiliate subscriber levels.
No individual customer accounted for more than 10% of total consolidated revenues for the three months ended March 31, 2019 or 2018. As of March 31, 2019 and December 31, 2018, the Company’s trade receivables did not represent a significant concentration of credit risk as the customers and markets in which the Company operates are varied and dispersed across many geographic areas.

12


DISCOVERY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)



NOTE 2. ACQUISITIONS
Scripps Networks
On March 6, 2018, Discovery acquired Scripps Networks pursuant to the Agreement and Plan of Merger (the "Merger Agreement") by and among Discovery, Scripps Networks and Skylight Merger Sub, Inc. dated July 30, 2017 (the "acquisition of Scripps Networks"). The acquisition of Scripps Networks allows the Company to offer complementary brands with an extensive library of original programming to consumers and to create a scale player with the ability to compete for audiences and advertising revenue. The acquisition is intended to extend Scripps Networks' content to a broader international audience through Discovery's global distribution infrastructure. Finally, the acquisition of Scripps Networks is expected to create cost synergies for the Company.
The consideration paid for the acquisition of Scripps Networks consisted of (i) for Scripps Networks shareholders that did not make an election or elected to receive the mixed consideration, $65.82 in cash and 1.0584 shares of Discovery Series C common stock for each Scripps Networks share, (ii) for Scripps Networks shareholders that elected to receive the cash consideration, $90.00 in cash for each Scripps Networks share, (iii) for Scripps Networks shareholders that elected to receive the stock consideration, 3.9392 shares of Discovery Series C common stock for each Scripps Networks share, subject to the terms and conditions set forth in the Merger Agreement and (iv) transaction costs that Discovery paid for costs incurred by Scripps Networks in conjunction with the acquisition. The following table summarizes the components of the aggregate consideration paid for the acquisition of Scripps Networks (in millions of dollars and shares, except for per share amounts, share conversion ratio and stock option conversion ratio) as of March 6, 2018.
Scripps Networks equity
 
 
Scripps Networks shares outstanding
 
131

Cash consideration per Scripps Networks share
 
$
65.82

Cash portion of consideration
 
$
8,590

 
 
 
Scripps Networks shares outstanding
 
131

Share conversion ratio per Scripps Networks share
 
1.0584

Discovery Series C common stock
 
138

Discovery Series C common stock price per share
 
$
23.01

Equity portion of consideration
 
$
3,179

 
 
 
Shares awarded under Scripps Networks share-based compensation programs
 
3

Scripps Networks share-based compensation awards converting to cash
 
2

Average cash consideration per share awarded less applicable exercise price
 
$
46.90

Cash portion of consideration
 
$
88

 
 
 
Scripps Networks share-based compensation awards
 
1

Share-based compensation conversion ratio (based on intrinsic value per award)
 
3

Discovery Series C common stock issued (1) or share-based compensation converted (2)
 
3

Average equity value (intrinsic value of Discovery Series C common stock or options to be issued)
 
$
15.19

Share-based compensation equity value
 
$
51

Less: post-combination compensation expense
 
(12
)
Equity portion of consideration
 
39

 
 
 
Scripps Networks transaction costs paid by Discovery
 
117

 
 
 
Total consideration paid
 
$
12,013

Balances reflect rounding of dollar and share amounts to millions, which may result in differences for recalculated standalone amounts compared with the amounts presented above.

13


DISCOVERY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)



The Company applied the acquisition method of accounting to Scripps Networks' business, whereby the excess of the fair value of the business over the fair value of identifiable net assets was allocated to goodwill. Goodwill reflects workforce and synergies expected from cost savings, operations and revenue enhancements of the combined company that are expected to result from the acquisition. The goodwill recorded as part of this acquisition was allocated to the U.S. Networks and International Networks reportable segments in the amounts of $5.3 billion and $817 million, respectively, and is not amortizable for tax purposes.
The Company used discounted cash flow ("DCF") analyses, which represent Level 3 fair value measurements, to assess certain components of its purchase price allocation. The fair value of equity interests previously held by Scripps Networks was determined using the discounted cash flow and market value methods. The fair value of trade-names and trademarks was determined using an income approach based on the relief from royalty method; the remaining intangibles were determined using an income approach based on the excess earnings method. The fair value of interest-bearing debt was determined using publicly-traded prices. For the fair value estimates, the Company used: (i) projected discounted cash flows, (ii) historical and projected financial information, (iii) synergies including cost savings and (iv) attrition rates, as relevant, that market participants would consider when estimating fair values. During the three months ended March 31, 2019, the Company finalized the fair value of assets acquired and liabilities assumed. Measurement period adjustments were reflected in the periods in which the adjustments occurred. The adjustments resulted from the receipt of additional financial projections associated with certain equity method investments, contingent liability estimates, deferred income tax adjustments, and true-ups for estimated working capital balances. The fair value of assets acquired and liabilities assumed, measurement period adjustments, as well as a reconciliation to consideration paid is presented in the table below (in millions).
 
 
Preliminary
March 6, 2018
 
Measurement Period Adjustments
 
Final
March 6, 2018
Accounts receivable
 
$
783

 
$

 
$
783

Other current assets
 
421

 
(9
)
 
412

Content rights
 
1,088

 
(14
)
 
1,074

Property and equipment
 
315

 

 
315

Goodwill
 
6,003

 
154

 
6,157

Intangible assets
 
9,175

 

 
9,175

Equity method investments, including note receivable
 
870

 
(157
)
 
713

Other noncurrent assets
 
111

 
4

 
115

Current liabilities assumed
 
(494
)
 
(105
)
 
(599
)
Debt assumed
 
(2,481
)
 

 
(2,481
)
Deferred income taxes
 
(1,695
)
 
123

 
(1,572
)
Other noncurrent liabilities
 
(383
)
 
4

 
(379
)
Noncontrolling interests
 
(1,700
)
 

 
(1,700
)
Total consideration paid
 
$
12,013

 
$

 
$
12,013


The table below presents a summary of intangible assets acquired (in millions) and weighted average estimated useful life of these assets.
 
 
Fair Value
 
Weighted Average Useful Life in Years
Trademarks and trade names
 
$
1,225

 
10
Advertiser relationships
 
4,995

 
10
Advertising backlog
 
280

 
1
Affiliate relationships
 
2,455

 
12
Broadcast licenses
 
220

 
6
Total intangible assets acquired
 
$
9,175

 
 

14


DISCOVERY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)



Other
On January 8, 2019, the Company paid $41 million in cash to acquire a controlling interest in Play Sports Group Limited ("PSG"), increasing Discovery's ownership stake from 20.1% to 70.7%. The Company recognized a gain of $8 million, which represents the difference between the carrying value and the fair value of the previously held 20.1% equity method investment. The gain is included in other expense, net in the Company's consolidated statement of operations (see Note 16). The Company consolidated PSG under the voting interest model upon the closing of the transaction and as a result, the accounting for PSG was changed from an equity method investment to a consolidated subsidiary. The Company applied the acquisition method of accounting to PSG, whereby the excess of the fair value of the business over the fair value of identifiable net assets was allocated to goodwill. The Company recorded preliminary net assets of $79 million, subject to adjustment based on the final assessment of the fair values of the assets acquired and liabilities assumed, including cash of $19 million, intangible assets of $29 million, redeemable noncontrolling interest of $25 million, and goodwill of $37 million. Intangible assets consist of trademarks and trade names, advertiser relationships, affiliate backlog and broadcast licenses. The goodwill reflects the workforce and synergies expected from broader exposure to the cycling entertainment sector. The goodwill recorded as part of this acquisition is included in the International Networks reportable segment and is not amortizable for tax purposes.
Pro Forma Financial Information
The following unaudited pro forma information has been presented as if the acquisition of Scripps Networks occurred on January 1, 2017. The information is based on the historical results of operations of the acquired business, adjusted for:
1.
The allocation of purchase price and related adjustments, including adjustments to amortization expense related to the fair value of intangible assets acquired and the recognition of the noncontrolling interests;
2.
Impacts of debt financing, including interest for debt issued and amortization associated with the fair value adjustments of debt assumed;
3.
The movement and allocation of all acquisition-related costs incurred during the three months ended March 31, 2018 to the three months ended March 31, 2017;
4.
Associated tax-related impacts of adjustments; and
5.
Changes to align accounting policies.
The pro forma results do not necessarily represent what would have occurred if the acquisition of Scripps Networks had taken place on January 1, 2017, nor do they represent the results that may occur in the future. The pro forma adjustments were based on available information and upon assumptions that the Company believes are reasonable to reflect the impact of this acquisition on the Company's historical financial information on a supplemental pro forma basis (in millions). The following table presents the Company's pro forma combined revenues and net income (in millions, except per share value). Pro forma results for the three months ended March 31, 2019 are not presented below because the results for Scripps Networks are included in the Company's March 31, 2019 unaudited consolidated statement of operations for the quarterly period.
 
 
Three months ended March 31, 2018
Revenues
 
$
2,930

Net income available to Discovery, Inc.
 
88

Net income per share - basic
 
0.08

Net income per share - diluted
 
0.08


15


DISCOVERY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)



Impact of Business Combination
The operations of Scripps Networks discussed above were included in the consolidated financial statements as of the acquisition date of March 6, 2018. The following table presents their revenue and earnings as reported within the consolidated financial statements (in millions).
 
 
Three months ended March 31, 2018
Revenues:
 
 
Advertising
 
$
195

Distribution
 
69

Other
 
10

Total revenues
 
$
274

Net loss available to Discovery, Inc.
 
$
(49
)
NOTE 3. INVESTMENTS
The Company’s investments consisted of the following (in millions).
Category
 
Balance Sheet Location
 
March 31, 2019
 
December 31, 2018
Time deposits
 
Cash and cash equivalents
 
2

 
$

Equity securities:
 
 
 
 
 
 
Money market funds
 
Cash and cash equivalents
 
200

 
286

Mutual funds and company-owned life insurance contracts
 
Prepaid and other current assets
 
25

 
28

Mutual funds and company-owned life insurance contracts
 
Other noncurrent assets
 
206

 
188

Equity method investments:
 
 
 
 
 
 
Equity investments
 
Equity method investment
 
857

 
841

Note receivable
 
Equity method investment
 
98

 
94

Equity Investments:
 
 
 
 
 
 
Common stock investments with readily determinable fair values
 
Other noncurrent assets
 
77

 
77

Equity investments without readily determinable fair value
 
Other noncurrent assets
 
382

 
379

Total investments
 
 
 
$
1,847

 
$
1,893

Money Market Funds and Time Deposits
Money market funds and time deposits represent cash equivalents with original maturities of 90 days or less.
Equity Securities
Equity securities include investments in mutual funds held in separate trusts, which are owned as part of the Company’s supplemental retirement plans and company-owned life insurance contracts. (See Note 4.)
Equity Method Investments
The Company makes investments that support its underlying business strategy and enable it to enter new markets and develop programming. Certain of the Company's equity method investments are VIEs, for which the Company is not the primary beneficiary. As of March 31, 2019, the Company’s maximum exposure for all its unconsolidated VIEs, including the investment carrying values, unfunded contractual commitments, and guarantees made on behalf of VIEs, was approximately $590 million. The Company's maximum estimated exposure excludes the non-contractual future funding of VIEs. The aggregate carrying values of these VIE investments were $546 million and $528 million as of March 31, 2019 and December 31, 2018, respectively. The Company recognized its portion of VIE operating results with net gains of $3 million and net losses of $11 million for the three months ended March 31, 2019 and 2018, respectively.

16


DISCOVERY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)



UKTV
In connection with the acquisition of Scripps Networks, the Company acquired a 50% ownership interest in UKTV, a British multi-channel broadcaster jointly owned with BBC Studios (“BBC”). UKTV was formed on March 26, 1992, through a joint venture arrangement between BBC and Virgin Media Inc. ("VMED"). On August 11, 2011, Scripps Networks acquired VMED's 50% equity interest in UKTV along with a note receivable for debt instruments provided by VMED to UKTV. The Company has determined that UKTV is a VIE as the entity is unable to fund its activities without additional subordinated financial support provided by the note receivable. While the Company and BBC have equal voting rights in the management committee, which is the governing body of UKTV, power is not shared equally because BBC holds operational rights related to programming and creative development that significantly impact UKTV’s economic performance. Therefore, Discovery is not the primary beneficiary. The Company determined that its 50% equity interest in UKTV gives the Company the ability to exercise significant influence over the entity's operating and financial policies. Accordingly, the Company accounts for its investment in UKTV using the equity method. As of March 31, 2019 and December 31, 2018, the Company’s investment in UKTV totaled $402 million and $386 million, respectively, including a note receivable of $98 million and $94 million, respectively.
On April 1, 2019, the Company announced a series of agreements with BBC , which included a ten-year licensing agreement, a new co-production deal and dissolution of the UKTV joint venture in which the Company will take full control of three lifestyle channels - Good Food, Home, and Really. BBC will make payments to the Company totaling approximately $240 million based on exchange rates in effect on April 1, 2019, which includes payment related to the channels acquisition, repayment of a portion of the debt that is currently financed by the Company, and a portion of the cash currently on UKTV's balance sheet. The transaction for the dissolution of the UKTV joint venture is expected to close in the second quarter of 2019.
nC+
In connection with the acquisition of Scripps Networks, the Company acquired a 32% ownership interest in nC+, a Polish satellite distributor of television content. nC+ is controlled by Group Canal+ S.A, a French broadcaster. The Company applies the equity method of accounting to its 32% investment in nC+ ordinary shares, which provide the ability to exercise significant influence over the operating and financial policies of nC+. The Company's investment in nC+ totaled $185 million and $180 million as of March 31, 2019 and December 31, 2018, respectively.
Renewable Energy Investments
During the three months ended March 31, 2018, the Company invested $17 million in limited liability companies that sponsor renewable energy projects related to solar energy. No investments were made in these companies during the three months ended March 31, 2019. As of March 31, 2019 and December 31, 2018, the Company's carrying value of renewable energy investments was $90 million and $89 million, respectively. The Company has $4 million of future funding commitments for these investments as of March 31, 2019, which are cancelable under limited circumstances. The Company expects these investments to result in tax benefits that reduce the Company's future tax liability and provide cash flows from the operations of the investees.
These investments are considered VIEs of the Company and are accounted for under the equity method of accounting. While the Company possesses rights that allow it to exercise significant influence over the investments, the Company does not have the power to direct the activities that will most significantly impact their economic performance, such as the investee's ability to obtain sufficient customers or control solar panel assets. Once a stipulated return on investment is earned by the Company, the investment allocations to the Company are significantly reduced. Accordingly, the Company applies the Hypothetical Liquidation at Book Value ("HLBV") methodology for allocating earnings, which is a generally accepted method under the equity method of accounting when a substantive profit-sharing arrangement exists. The Company accounts for investment tax credits utilizing the flow through method. The renewable energy investments income, losses and associated tax effects were not material for the three months ended March 31, 2019 and March 31, 2018.
Other Equity Method Investments
At March 31, 2019 and December 31, 2018, the Company's other equity method investments included production companies such as All3Media, a Russian cable television business, Mega TV in Chile and certain joint ventures in Canada. Other equity method investments acquired in conjunction with the acquisition of Scripps Networks include joint ventures in Canada, and HGTV and Food Network Magazines.

17


DISCOVERY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)



Investor Basis Differential
With the exception UKTV, nC+ and certain investments in renewable energy projects for which the Company uses the HLBV methodology for allocating earnings, the carrying values of the Company’s remaining equity method investments are consistent with its ownership in the underlying net assets of the investees. A portion of the purchase prices associated with the investments in UKTV and nC+ was attributed to amortizable intangible assets, which are included in their carrying values. Earnings from these equity investees were reduced by the amortization of these intangibles of $1 million and $7 million during the period March 6, 2018 to March 31, 2018 and the three months ended March 31, 2019, respectively. Amortization that reduces the Company's equity in earnings of equity method investees for future periods is expected to be approximately $290 million.
Significant Subsidiaries
The table set forth below presents selected financial information for investments accounted for under the equity method. Because renewable energy projects discussed above are accounted for under the HLBV equity method of accounting, the Company's equity method losses do not directly correlate with the GAAP results of the investees presented below. The selected statement of operations information for each of the three months ended March 31, 2019 and 2018 (in millions) is summarized in the table below.

 
 
Three Months Ended March 31,


2019

2018
Selected Statement of Operations Information:




Revenues

$
500


$
286

Cost of revenues

341


201

Operating income

159


12

Pre-tax income from continuing operations

55


7

After-tax net income

43


4

Net income attributable to the entity

43


4


Common Stock Investments with Readily Determinable Fair Value
The Company owns 5 million shares of common stock of Lions Gate Entertainment Corp. ("Lionsgate"), an entertainment company. Upon the adoption of ASU 2016-01 on January 1, 2018, the shares are measured at fair value, with gains and losses recorded in other expense, net, as the shares have a readily determinable fair value and the Company has the intent to retain the investment. The Company recorded a transition adjustment to reclassify accumulated other comprehensive income associated with Lionsgate shares in the amount of $32 million pre-tax ($26 million, net of tax) to retained earnings. Previously, amounts were recorded as a component of other comprehensive income.
The unrealized gains and losses related to the Company's common stock investments with readily determinable fair values held at March 31, 2018 and 2019 are summarized in the table below (in millions).
 
 
Three Months Ended March 31,
 
 
2019
 
2018
Net gains and losses recognized during the period on equity securities
 
$

 
$
39

Less: Net gains and losses recognized on equity securities sold
 

 

Unrealized gains and losses recognized during reporting period on equity securities still held at the reporting date
 
$

 
$
39

The Company hedged 50% of the Lionsgate shares with an equity collar (the "Lionsgate Collar") and pledged those shares as collateral to the derivative counterparty. Upon adoption of ASU 2016-01, the Lionsgate Collar no longer receives the hedge accounting designation and as such, all changes in the fair value of the Lionsgate Collar are reflected as a component of other expense, net on the consolidated statements of operations. (See Note 4 and Note 8.)

18


DISCOVERY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)



Equity investments without readily determinable fair values assessed under the measurement alternative
The Company's equity investments without readily determinable fair values assessed under the measurement alternative as of March 31, 2019 primarily include its 42% minority interest in Group Nine Media on an outstanding shares basis recorded at $212 million. Discovery has significant influence through its voting rights in the preferred stock of Group Nine Media, however, this ownership interest has liquidation preferences that do not allow the investment to meet the definition of in-substance common stock. The Company accounts for its ownership interest in Group Nine Media as an equity investment without a readily determinable fair value assessed under the measurement alternative. The Company also has similar investments in an educational website, an electric car racing series and certain investments to enhance the Company's digital distribution strategies, such as a $35 million investment in Refinery29. The Company completed its quarterly qualitative assessment and concluded that its other equity investments without readily determinable fair values had no indicators that a change in fair value had taken place as of March 31, 2019.
NOTE 4. FAIR VALUE MEASUREMENTS
Fair value is defined as the amount that would be received for selling an asset or paid to transfer a liability in an orderly transaction between market participants. Assets and liabilities carried at fair value are classified in the following three categories:
Level 1
Quoted prices for identical instruments in active markets.
Level 2
Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets.
Level 3
Valuations derived from techniques in which one or more significant inputs are unobservable.

19


DISCOVERY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)



The tables below present assets and liabilities measured at fair value on a recurring basis (in millions).
 
 
 
 
March 31, 2019
Category
 
Balance Sheet Location
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets
 
 
 
 
 
 
 
 
 
 
Equity securities:
 
 
 
 
 
 
 
 
 
 
Money market funds
 
Cash and cash equivalents
 
$
200

 
$

 
$

 
$
200

Mutual funds
 
Prepaid expenses and other current assets
 
13

 

 

 
13

Company-owned life insurance contracts
 
Prepaid expenses and other current assets
 

 
12

 

 
12

Mutual funds
 
Other noncurrent assets
 
172

 

 

 
172

Company-owned life insurance contracts
 
Other noncurrent assets
 

 
34

 

 
34

Equity investments with readily determinable fair value:
 
 
 
 
 
 
 
 
 
 
Common stock
 
Other noncurrent assets
 
77

 

 

 
77

Derivatives:
 
 
 
 
 
 
 
 
 
 
Cash flow hedges:
 
 
 
 
 
 
 
 
 
 
Foreign exchange
 
Prepaid expenses and other current assets
 

 
14

 

 
14

Net investment hedges:
 
 
 
 
 
 
 
 
 
 
Cross-currency swaps
 
Other noncurrent assets
 

 
60

 

 
60

No hedging designation:
 
 
 
 
 
 
 
 
 
 
Equity (Lionsgate Collar)
 
Prepaid expenses and other current assets
 

 
15

 

 
15

Equity (Lionsgate Collar)
 
Other noncurrent assets
 

 
28

 

 
28

Total
 
 
 
$
462

 
$
163

 
$

 
$
625

Liabilities
 
 
 
 
 
 
 
 
 
 
Deferred compensation plan
 
Accrued liabilities
 
$
33

 
$

 
$

 
$
33

Deferred compensation plan
 
Other noncurrent liabilities
 
197

 

 

 
197

Derivatives:
 
 
 
 
 
 
 
 
 
 
Cash flow hedges:
 
 
 
 
 
 
 
 
 
 
Foreign exchange
 
Accrued liabilities
 

 
4

 

 
4

Interest rate swaps
 
Accrued liabilities
 

 
15

 

 
15

Net investment hedges:
 
 
 
 
 
 
 
 
 
 
Cross-currency swaps
 
Accrued liabilities
 

 
20

 

 
20

Cross-currency swaps
 
Other noncurrent liabilities
 

 
82

 

 
82

No hedging designation:
 
 
 
 
 
 
 
 
 


Foreign exchange
 
Other noncurrent liabilities
 

 
23

 

 
23

Cross-currency swaps
 
Accrued liabilities
 

 
1

 

 
1

Cross-currency swaps
 
Other noncurrent liabilities
 

 
1

 

 
1

Total
 
 
 
$
230

 
$
146

 
$

 
$
376


20


DISCOVERY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)



 
 
 
 
December 31, 2018
Category
 
Balance Sheet Location
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets
 
 
 
 
 
 
 
 
 
 
Equity securities:
 
 
 
 
 
 
 
 
 
 
Money market funds
 
Cash and cash equivalents
 
$
286

 
$

 
$

 
$
286

Mutual funds
 
Prepaid expenses and other current assets
 
13

 

 

 
13

Company-owned life insurance contracts
 
Prepaid expenses and other current assets
 

 
15

 

 
15

Mutual funds
 
Other noncurrent assets
 
158

 

 

 
158

Company-owned life insurance contracts
 
Other noncurrent assets
 

 
30

 

 
30

Equity investments with readily determinable fair value:
 
 
 
 
 
 
 
 
 
 
Common stock
 
Other noncurrent assets
 
77

 

 

 
77

Derivatives:
 
 
 
 
 
 
 
 
 
 
Cash flow hedges:
 
 
 
 
 
 
 
 
 
 
Foreign exchange
 
Prepaid expenses and other current assets
 

 
13

 

 
13

Net investment hedges:
 
 
 
 
 
 
 
 
 
 
Cross-currency swaps
 
Other noncurrent assets
 

 
41

 

 
41

Foreign exchange
 
Other noncurrent assets
 

 
1

 

 
1

No hedging designation:
 
 
 
 
 
 
 
 
 
 
Equity (Lionsgate Collar)
 
Prepaid expenses and other current assets
 

 
14

 

 
14

Equity (Lionsgate Collar)
 
Other noncurrent assets
 

 
27

 

 
27

Foreign exchange
 
Other noncurrent assets
 

 
11

 

 
11

Total
 
 
 
$
534

 
$
152

 
$

 
$
686

Liabilities
 
 
 
 
 
 
 
 
 
 
Deferred compensation plan
 
Accrued liabilities
 
$
37

 
$

 
$

 
$
37

Deferred compensation plan
 
Other noncurrent liabilities
 
178

 

 

 
178

Derivatives:
 
 
 
 
 
 
 
 
 
 
Cash flow hedges:
 
 
 
 
 
 
 
 
 
 
Foreign exchange
 
Accrued liabilities
 

 
3

 

 
3

Net investment hedges:
 
 
 
 
 
 
 
 
 
 
Cross-currency swaps
 
Accrued liabilities
 

 
39

 

 
39

Cross-currency swaps
 
Other noncurrent liabilities
 

 
81

 

 
81

No hedging designation:
 
 
 
 
 
 
 
 
 
 
Cross-currency swaps
 
Accrued liabilities
 

 
1

 

 
1

Total
 
 
 
$
215

 
$
124

 
$

 
$
339

The fair value of Level 1 equity securities was determined by reference to the quoted market price per share in active markets multiplied by the number of shares held without consideration of transaction costs. (See Note 3.) The fair value of the deferred compensation plan liability was determined based on the fair value of the related investments elected by employees. Changes in the fair value of the investments are offset by changes in the fair value of the deferred compensation obligation. (See Note 3.)
Common stock investments with readily determinable fair values are recorded by reference to the quoted market price per unit in active markets multiplied by the number of units held without consideration of transaction costs. (See Note 3.)
Company-owned life insurance contracts are recorded at their cash surrender value, which approximates fair value.
Derivative financial instruments are comprised of foreign exchange, interest rate, credit and equity contracts. (See Note 8.) The fair value of Level 2 derivative financial instruments was determined using a market-based approach.

21


DISCOVERY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)



In addition to the financial instruments listed in the tables above, the Company holds other financial instruments, including cash deposits, accounts receivable, accounts payable, borrowings under the revolving credit facility, finance and operating lease liabilities, and senior notes. The carrying values for such financial instruments, other than the senior notes, each approximated their fair values as of March 31, 2019 and December 31, 2018. The estimated fair value of the Company’s outstanding senior notes using quoted prices from over the counter markets, considered Level 2 inputs, was $16 billion as of March 31, 2019 and December 31, 2018.
NOTE 5. CONTENT RIGHTS
The table below presents the components of content rights (in millions). 
 
 
March 31, 2019
 
December 31, 2018
Produced content rights:
 
 
 
 
Completed
 
$
5,849

 
$
5,609

In-production
 
639

 
612

Coproduced content rights:
 
 
 
 
Completed
 
707

 
682

In-production
 
62

 
53

Licensed content rights:
 
 
 
 
Acquired
 
985

 
1,007

Prepaid (a)
 
287

 
154

Content rights, at cost
 
8,529

 
8,117

Accumulated content rights expense
 
(5,067
)
 
(4,735
)
Total content rights, net
 
3,462

 
3,382

Current portion
 
(364
)
 
(313
)
Noncurrent portion
 
$
3,098

 
$
3,069

(a) Prepaid licensed content rights includes payments for rights to the Olympic games of $145 million and $65 million reflected as noncurrent content rights on the consolidated balance sheet as of March 31, 2019 and December 31, 2018, respectively.

22


DISCOVERY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)



NOTE 6. DEBT
The table below presents the components of outstanding debt (in millions).
 
 
March 31, 2019
 
December 31, 2018
5.625% Senior notes, semi-annual interest, due August 2019
 
$

 
$
411

2.200% Senior notes, semi-annual interest, due September 2019
 
500

 
500

Floating rate notes, quarterly interest, due September 2019
 
400

 
400

2.750% Senior notes, semi-annual interest, due November 2019
 
477

 
500

2.800% Senior notes, semi-annual interest, due June 2020
 
600

 
600

5.050% Senior notes, semi-annual interest, due June 2020
 
789

 
789

4.375% Senior notes, semi-annual interest, due June 2021
 
640

 
650

2.375% Senior notes, euro denominated, annual interest, due March 2022
 
337

 
344

3.300% Senior notes, semi-annual interest, due May 2022
 
496

 
500

3.500% Senior notes, semi-annual interest, due June 2022
 
400

 
400

2.950% Senior notes, semi-annual interest, due March 2023
 
1,185

 
1,185

3.250% Senior notes, semi-annual interest, due April 2023
 
350

 
350

3.800% Senior notes, semi-annual interest, due March 2024
 
450

 
450

2.500% Senior notes, sterling denominated, annual interest, due September 2024
 
525

 
507

3.900% Senior notes, semi-annual interest, due November 2024
 
497

 
497

3.450% Senior notes, semi-annual interest, due March 2025
 
300

 
300

3.950% Senior notes, semi-annual interest, due June 2025
 
500

 
500

4.900% Senior notes, semi-annual interest, due March 2026
 
700

 
700

1.900% Senior notes, euro denominated, annual interest, due March 2027
 
674

 
688

3.950% Senior notes, semi-annual interest, due March 2028
 
1,700

 
1,700

5.000% Senior notes, semi-annual interest, due September 2037
 
1,250

 
1,250

6.350% Senior notes, semi-annual interest, due June 2040
 
850

 
850

4.950% Senior notes, semi-annual interest, due May 2042
 
500

 
500

4.875% Senior notes, semi-annual interest, due April 2043
 
850

 
850

5.200% Senior notes, semi-annual interest, due September 2047
 
1,250

 
1,250

Revolving credit facility
 
225

 
225

Program financing line of credit
 
19

 
22

Total debt (a)
 
16,464

 
16,918

Unamortized discount, premium and debt issuance costs, net (b)
 
(121
)
 
(125
)
Debt, net of unamortized discount, premium and debt issuance costs
 
16,343

 
16,793

Current portion of debt
 
(1,387
)
 
(1,819
)
Noncurrent portion of debt
 
$
14,956

 
$
14,974

(a) As a result of the adoption of ASU 2016-02, capital lease obligations totaling $252 million as of December 31, 2018 (known as finance lease liabilities effective January 1, 2019) were reclassified from current and noncurrent debt to components of "Accrued liabilities" and "Other noncurrent liabilities" on the consolidated balance sheet to conform with the new presentation. (See Note 1 and Note 7.)
(b) Current portion of unamortized discount, premium, and debt issuance costs, net is $3 million.
Senior Notes
On March 21, 2019, the Company redeemed $411 million aggregate principal amount of its 5.625% senior notes that had an original maturity of August 15, 2019. The repayment included $5 million for premium over par on the 5.625% senior notes and resulted in a loss on extinguishment of debt of $5 million, which is presented as a separate line item on the Company's consolidated statement of operations.

23


DISCOVERY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)



In connection with the acquisition of Scripps Networks on March 6, 2018, the Company assumed $2.5 billion aggregate principal amount of Scripps Networks 2.750% senior notes due 2019, 2.800% senior notes due 2020, 3.500% senior notes due 2022, 3.900% senior notes due 2024 and 3.950% senior notes due 2025 (the "Scripps Networks Senior Notes"). As part of accounting for the acquisition of Scripps Networks, the Scripps Networks Senior Notes were adjusted to fair value using observable trades as of the acquisition date. (See Note 2.) The fair value adjustment resulted in an opening balance sheet carrying value that is $19 million less than the face amount of the senior notes. For the three months ended March 31, 2019, fair value adjustments of $2 million were amortized to interest expense.
On April 3, 2018, pursuant to the Offering Memorandum and Consent Solicitation Statement to Exchange dated March 5, 2018, Discovery Communications, LLC ("DCL"), a wholly-owned subsidiary of the Company, completed the exchange of $2.3 billion aggregate principal amount of Scripps Networks Senior Notes, for $2.3 billion aggregate principal amount of DCL's 2.750% senior notes due 2019 (the "2019 Notes"), 2.800% senior notes due 2020 (the "2020 Notes"), 3.500% senior notes due 2022 (the "2022 Notes"), 3.900% senior notes due 2024 (the "2024 Notes") and 3.950% senior notes due 2025 (the "2025 Notes"). Interest on the 2019 Notes and the 2024 Notes is payable semi-annually in arrears on May 15 and November 15 of each year. Interest on the 2020 Notes, the 2022 Notes and the 2025 Notes is payable semi-annually in arrears on June 15 and December 15 of each year. The exchange was accounted for as a debt modification and, as a result, third-party issuance costs were expensed as incurred.
On September 21, 2017, DCL issued $500 million principal amount of 2.200% senior notes due 2019, $1.2 billion principal amount of 2.950% senior notes due 2023, $1.7 billion principal amount of 3.950% senior notes due 2028, $1.3 billion principal amount of 5.000% senior notes due 2037, $1.3 billion principal amount of 5.200% senior notes due 2047 (collectively, the “Senior Fixed Rate Notes”) and $400 million principal amount of floating rate senior notes due 2019 (the “Senior Floating Rate Notes” and, together with the Senior Fixed Rate Notes, the “USD Notes”). Interest on the Senior Fixed Rate Notes is payable on March 20 and September 20 of each year. Interest on the Senior Floating Rate Notes is payable on March 20, June 20, September 20 and December 20 of each year. The USD Notes are fully and unconditionally guaranteed by the Company. On September 21, 2017, DCL also issued £400 million principal amount ($540 million at issuance based on the exchange rate of $1.35 per pound at September 21, 2017) of 2.500% senior notes due 2024 (the “Sterling Notes”). Interest on the Sterling Notes is payable on September 20 of each year. The proceeds received by DCL from the USD Notes and the Sterling Notes were net of an $11 million issuance discount and $57 million of debt issuance costs. The net proceeds from the issuance of these senior notes were used to finance a portion of the Scripps Networks acquisition. (See Note 2.)
On March 13, 2017, DCL issued $450 million principal amount of 3.80% senior notes due March 13, 2024 (the "2017 USD Notes") and an additional $200 million principal amount of its existing 4.90% senior notes due March 11, 2026 (the "2016 USD Notes"). Interest on the 2017 USD Notes is payable semi-annually on March 13 and September 13 of each year. Interest on the 2016 USD Notes is payable semi-annually on March 11 and September 11 of each year. The proceeds received by DCL from the 2017 USD Notes were net of a $1 million issuance discount and $4 million of debt issuance costs. The proceeds received by DCL from the 2016 USD Notes included a $10 million issuance premium and were net of $2 million of debt issuance costs.
As of March 31, 2019, all senior notes are fully and unconditionally guaranteed by the Company and Scripps Networks, except for $243 million of un-exchanged Scripps Networks Senior Notes acquired in conjunction with the acquisition of Scripps Networks. (See Note 22.)
Term Loans
On August 11, 2017, DCL entered into a three-year delayed draw tranche and a five-year delayed draw tranche unsecured term loan credit facility (the "Term Loans"), each with a principal amount of up to $1 billion. The term of each delayed draw loan commenced on March 6, 2018 when Discovery used these funds to finance a portion of the Scripps Networks acquisition. The Term Loans' interest rates are based, at the Company's option, on either adjusted LIBOR plus a margin, or an alternate base rate plus a margin. The Company paid a commitment fee of 20 basis points per annum for each loan, based on its then-current credit rating, beginning September 28, 2017 through March 6, 2018. As of December 31, 2018, the Company had used cash from operations and borrowings under the commercial paper program to fully repay the Term Loan borrowings.
Revolving Credit Facility
On August 11, 2017, DCL amended its $2.0 billion revolving credit facility to allow DCL and certain designated foreign subsidiaries of DCL to borrow up to $2.5 billion, including a $100 million sublimit for the issuance of standby letters of credit and a $50 million sublimit for Euro-denominated swing line loans. Borrowing capacity under this credit facility is reduced by any outstanding borrowings under the commercial paper program. The revolving credit facility agreement amendment extends the maturity date from February 4, 2021 to August 11, 2022. The original agreement includes the option for up to two additional 364-day renewal periods.

24


DISCOVERY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)



The credit agreement governing the revolving credit facility contains customary representations, warranties and events of default, as well as affirmative and negative covenants. In addition to the change in the revolver's capacity on August 11, 2017, the financial covenants were modified to increase the maximum consolidated leverage ratio financial covenant to 5.50 to 1.00, with step-downs to 5.00 to 1.00 and to 4.50 to 1.00, one year and two years after the closing of the Scripps Networks acquisition, respectively. As of March 31, 2019, the Company's subsidiary, DCL, was in compliance with all covenants and there were no events of default under the revolving credit facility.
As of March 31, 2019, the Company had outstanding U.S. dollar-denominated borrowings under the revolving credit facility of $225 million at a weighted average interest rate of 3.79%. As of December 31, 2018, the Company had outstanding U.S. dollar-denominated borrowings under the revolving credit facility of $225 million at a weighted average interest rate of 3.82%. The interest rate on borrowings under the revolving credit facility is variable based on DCL's then-current credit ratings for its publicly traded debt and changes in financial index rates. For U.S. dollar-denominated borrowings, the interest rate is based, at the Company's option, on either adjusted LIBOR plus a margin, or an alternate base rate plus a margin. The Company may also borrow in foreign currencies under the credit facility, at an interest rate based on adjusted LIBOR, plus a margin. The current margins are 1.300% and 0.300%, respectively, per annum for adjusted LIBOR and alternate base rate borrowings. The Company had no borrowings under the credit facility in foreign currencies as of March 31, 2019 or December 31, 2018. A monthly facility fee is charged based on the total capacity of the facility, and interest is charged based on the amount borrowed on the facility. The current facility fee rate is 0.200% per annum and subject to change based on DCL's then-current credit ratings. All obligations of DCL and the other borrowers under the revolving credit facility are unsecured and are fully and unconditionally guaranteed by Discovery.
Program Financing Line of Credit
On January 12, 2018, the Company entered into a secured line of credit for an aggregate principal amount of $26 million to finance content production costs. Interest rates on this line of credit are based on the Company’s option to elect either an adjusted LIBOR or a variable prime rate. Interest on the outstanding balance is due quarterly commencing on October 15, 2018 with a final payment due on October 15, 2020. As of March 31, 2019, the Company has an outstanding balance of $19 million.
NOTE 7. LEASES
The Company has operating and finance leases for transponders, office space, studio facilities, and other equipment. The Company's leases have remaining lease terms of up to 15 years, some of which include options to extend the leases for up to ten additional years. Most leases are not cancelable prior to their expiration.
The Company determines if an arrangement is a lease at its inception. Operating lease right-of-use ("ROU") assets are included in "Other noncurrent assets" and operating lease liabilities are included in “Accrued liabilities” and “Other noncurrent liabilities” in our March 31, 2019 consolidated balance sheet. Finance lease ROU assets are included in "Property and equipment, net" and finance lease liabilities are included in “Accrued liabilities” and “Other noncurrent liabilities” in our March 31, 2019 consolidated balance sheet. A rate implicit in the lease when readily determinable is used in arriving at the present value of lease payments. As most of the Company's leases do not provide an implicit rate, the Company uses an incremental borrowing rate based on information available at lease commencement date for the majority of its leases. The incremental borrowing rate is based on the Company's U.S. dollar denominated senior unsecured borrowing curves using public credit ratings adjusted down to a collateralized basis using a combination of recovery rate and credit notching approaches, and translated into major contract currencies as applicable. The Company's lease terms may include options to extend or terminate the lease when it is reasonably certain that it will exercise that option. Variable lease payments that are based on an index or rate are included in measurement of ROU assets and lease liabilities at lease inception. All other variable lease payments are expensed as incurred and are not included in measurement of ROU assets and lease liabilities.
Lease expense for operating leases is recognized on a straight-line basis. For finance leases, the Company recognizes interest expense on lease liabilities using the effective interest method and amortization of ROU assets on a straight-line basis.
Because the Company elected a practical expedient allowing it not to allocate contract consideration between lease and non-lease components, these components are accounted for together under Topic 842 as lease components across all lease categories.

25


DISCOVERY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)



The components of lease cost were as follows (in millions):
 
Three Months Ended March 31, 2019
Operating lease cost
$
26

 
 
Finance lease cost:
 
Amortization of right-of-use assets
$
11

Interest on lease liabilities
2

Total finance lease cost
$
13


Supplemental cash flow information related to leases was as follows (in millions):
 
Three Months Ended March 31, 2019
Cash paid for amounts included in the measurement of lease liabilities:
 
Operating cash flows from operating leases
$
21

Financing cash flows from finance leases
17

 
 
Right-of-use assets obtained in exchange for lease obligations:
 
Operating leases
$
4

Finance leases
2


Supplemental balance sheet information related to leases was as follows (in millions):
Category
 
Location on
Balance Sheet
 
March 31, 2019
Operating Leases
 
 
 
 
Operating lease right-of-use assets
 
Other noncurrent assets
 
$
326

 
 
 
 
 
Operating lease liabilities (current)
 
Accrued liabilities
 
$
76

Operating lease liabilities (noncurrent)
 
Other noncurrent liabilities
 
279

Total operating lease liabilities
 
 
 
$
355

 
 
 
 
 
Finance Leases
 
 
 
 
Finance lease right-of-use assets
 
Property and equipment, net
 
$
228

 
 
 
 
 
Finance lease liabilities (current)
 
Accrued liabilities
 
$
45

Finance lease liabilities (noncurrent)
 
Other noncurrent liabilities
 
197

Total finance lease liabilities
 
 
 
$
242


 
 
March 31, 2019
Weighted average remaining lease term:
 
 
Operating leases
 
7 years

Finance leases
 
7 years

 
 
 
Weighted average discount rate:
 
 
Operating leases
 
3.19
%
Finance leases
 
3.60
%


26


DISCOVERY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)



Maturities of lease liabilities as of March 31, 2019 were as follows (in millions):
 
 
Operating Leases
 
Finance Leases
April 1, 2019 to March 31, 2020
 
$
93

 
$
49

April 1, 2020 to March 31, 2021
 
76

 
45

April 1, 2021 to March 31, 2022
 
54

 
40

April 1, 2022 to March 31, 2023
 
33

 
33

April 1, 2023 to March 31, 2024
 
27

 
32

Thereafter
 
128

 
69

Total lease payments
 
411

 
268

Less: Imputed interest
 
(56
)
 
(26
)
Total
 
$
355

 
$
242


As of March 31, 2019, the Company has additional operating leases that have not yet commenced, primarily related to moving its global headquarters from Silver Spring, Maryland to New York City in 2019, with undiscounted lease payments totaling approximately $515 million. These operating leases will commence between fiscal year 2019 and fiscal year 2021 with lease terms of 2 years to 18 years and include options to extend the term for up to 10 additional years.
NOTE 8. DERIVATIVE FINANCIAL INSTRUMENTS
The Company uses derivative financial instruments to modify its exposure to market risks from changes in foreign currency exchange rates and interest rates. At the inception of a derivative contract, the Company designates the derivative as one of four types based on the Company's intentions and belief as to its likely effectiveness as a hedge. These four types are: (1) a hedge of a forecasted transaction or the variability of cash flows to be received or paid related to a recognized asset or liability ("cash flow hedge"), (2) a hedge of net investments in foreign operations ("net investment hedge"), (3) a hedge of the fair value of a recognized asset or liability or of an unrecognized firm commitment ("fair value hedge"), or (4) an instrument with no hedging designation. The Company does not enter into or hold derivative financial instruments for speculative trading purposes.
Unsettled derivative contracts are recorded at their gross fair values on the consolidated balance sheets. (See Note 4.) The portion of the fair value that represents cash flows occurring within one year is classified as current, and the portion related to cash flows occurring beyond one year is classified as noncurrent. Gains and losses on designated cash flow and net investment hedges are initially recognized as components of accumulated other comprehensive loss on the consolidated balance sheets and reclassified into the statements of operations in the same line item in which the hedged item is recorded and in the same period as the hedged item affects earnings. The cash flows from the designated derivative instruments used as hedges are classified in the consolidated statements of cash flows in the same section as the cash flows of the hedged item. The Company records gains and losses for instruments that receive no hedging designation, as a component of other expense, net on the consolidated statements of operations.
Effective July 1, 2018, the Company early adopted ASU 2017-12. As a result, the Company changed the method by which it assesses effectiveness for net investment hedges from the forward-method to the spot-method. Management believes the spot method better matches the spot rate changes of the net investment. The entire change in the fair value of derivatives that qualify as net investment hedges is initially recorded in the currency translation component of other comprehensive income. While the change in fair value attributable to hedge effectiveness remains in accumulated other comprehensive income (loss) until the net investment is sold or liquidated, the change in fair value attributable to components excluded from the assessment of hedge effectiveness (e.g., forward points, cross currency basis, etc.) is reflected as a component of interest expense, net in the current period. Previous net losses of $87 million incurred under the forward method related to net investment hedges will remain in other comprehensive loss under the currency translation component and will be reclassified to earnings when the net investment is sold or liquidated. Additionally, as a result of ASU 2017-12, for foreign exchange forward contracts accounted for as cash flow hedges, the ineffective portion (if any) will not be separately recorded, as the entire change in the fair value of the forward contract will be recorded in other comprehensive income (loss) and reclassified into the statement of operations in the same line item in which the hedged item is recorded and in the same period as the hedged item affects earnings.
During the three months ended March 31, 2019, the Company executed two forward starting swap agreements with an aggregate $500 million notional amount. The swaps were designated as cash flow hedges and will hedge the interest rate risk and overall variability of proceeds received from a potential issuance of fixed rate debt later in 2019.

27


DISCOVERY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)



The following table summarizes the impact of derivative financial instruments on the Company's consolidated balance sheets (in millions). There were no amounts eligible to be offset under master netting agreements as of March 31, 2019 and December 31, 2018.
 
March 31, 2019
 
December 31, 2018
 
 
 
Fair Value
 
 
 
Fair Value
 
Notional
 
Prepaid expenses and other current assets
 
Other non-
current assets
 
Accrued liabilities
 
Other non-
current liabilities
 
Notional
 
Prepaid expenses and other current assets
 
Other non-
current assets
 
Accrued liabilities
 
Other non-
current liabilities
Cash flow hedges: