華納兄弟探索 (WBD) 2009 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Discovery Communications, Inc. second quarter 2009 earnings call. My name is Becky, and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the presentation over to your host for today's call, Mr. Craig Felenstein, Senior Vice President of Investor Relations. Please proceed.

Thank you, Becky. Good morning, everyone, and welcome to Discovery Communications' second quarter 2009 earnings call. Joining me today is David Zaslav our President and Chief Executive Officer, Mark Hollinger, our Chief Operating Officer, and Brad Singer, our Chief Financial Officer. Hopefully you have all received our earnings release. But if not, feel free to access it on our website at www.discoverycommunications.com. We'll begin today's call with some opening comments from David and Brad, after which we will open the call up for your questions. Before we begin, I would like to remind you that the comments today regarding the Company's future business plans, prospects, and financial performance are forward-looking statements that we make pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995.

These statements are made based on management's current knowledge and assumptions about future events and they involve risks and uncertainties that could cause actual results to differ materially from our expectations. In providing projections and other forward-looking statements, the Company disclaims any intent or obligation to update them. For additional information on important factors that could affect these expectations, please see our form 10-K for the year ended December 31, 2008, and our subsequent filings made with the U.S. Securities and Exchange Commission. And with that, I'll turn the all over to Brad.

Thanks, Craig. We appreciate the opportunity to discuss our second quarter performance and current operating environment with you. Discovery demonstrated the ability to execute on our key operating initiatives during the second quarter, growing ratings, driving our revenues, and thoughtfully controlling our operating costs to take advantage of the operating leverage inherent in the cable network business model. Strategically we also took a step forward in realizing value in our underdeveloped Discovery Kids Network, as well as bringing in a strong partner to better position the network in the future. Total revenues decreased modestly compared to the prior year, with US network growth offset by a decline in our international network revenues driven by a $34 million unfavorable currency impact. Adjusted OIBDA grew 13% to $381million, as we continue to work hard to drive the efficiency of our resources and cost structure.

We offset the $16 million increase in cost of revenue with $48 million lowered SG&A costs, as well as a $25 million benefit from foreign currency. Our ability to moderate our cost structure enabled us to expand our adjusted OIBDA margins by 500 basis points to over 43% from the prior year. Excluding the impact of foreign currency, we grew total revenues 3% and adjusted OIBDA at 17%. Our operating income increased to $486 million, with the vast majority of the increase from the $250 million -- $252 million pretax gain recognized from the sale of our 50% interest in the Discovery Kids Network, partially offset by $26 million in asset impairment. Please note the results of our operations reflect the sale and the deconsolidation of the Discovery Kids Network, which reduced revenues by $5 million and adjusted OIBDA by $3 million and includes $7 million of operating expenses and $5 million of restructuring expenses related to the Oprah Winfrey Network.

Our net income available to Discovery increased to $183 million due to improved operating performance. The net gains from the kids transaction, lower interest and depreciation expense, offset by higher long-term incentive compensation as a result of our share price performance. Most impressively, we efficiently translated our increase in adjusted OIBDA to free cash flow, which increased almost 75% to $166 million for the quarter from the prior year. Our US operations performed well in a difficult operating environment during the second quarter. Second quarter domestic revenues grew 2% with distribution revenues increasing 5% from higher rates and expanded distribution of our digital network, offset by the deconsolidation of the kids network and an $8 million positive onetime item in the prior year. Adjusting for these items, the affiliate revenue growth was 10% compared to the prior year.

Our domestic [adsok] team did a terrific job growing revenues 1% in a challenging market. Strong ratings and higher pricing than the prior year were offset by lower demand, making it difficult for our [adsok] team to fully monetize our programming success. The domestic advertising performance continues to demonstrate the attractive value proposition cable holds for advertisers compared to national broadcasters and the quality of our programming and sales efforts. Our domestic operating team demonstrates strong operating discipline with cost of revenue increasing 2% due to higher content amortization offset by a 21% decrease in marketing and general and administrative costs. The net result was a 10% decrease in overall costs despite the inclusion of $7 million in expenses related to the Oprah Winfrey Network.

With the solid revenue performance and thoughtful cost controls, adjusted OIBDA for our US networks increased 11% to $330 million and domestic margin expanded 500 basis points to 59%. Our international operations also performed well despite the economy and currency impact on our top-line. Total reported revenues decreased 5%, which included a 9% increase in affiliate revenues and a 3% increase in advertising revenues, offset by $34 million or 12% unfavorable foreign exchange hit compared to the prior year. Excluding Fx, all regions contributed to the revenue growth, with EMEA and Latin America continuing to provide the largest increases, as well as the UK due to increased audience monetization. Excluding the $25 million positive currency impact to our expenses, cost of revenue increased 23% from the prior year, primarily due to a content writeoff of $12 million in our German operations.

Operating expenses without the foreign currency impairment were flat compared to the prior year, with an 11% increase in cost of revenues offset by an 8% decrease in SG&A. Excluding the foreign currency impact, our international operations increased adjusted OIBDA 8%. Adjusted for the content writeoff, adjusted OIBDA grew 21% or $18 million. Our commerce, education, and other segments delivered solid results led by our education operations, which continue to grow profitably, and by our outsourced commerce operations. Corporate expenses decreased $9 million from the prior year, due primarily to lower external consulting fees. Our performance during the second quarter of 2009 met our revenue and slightly exceeded our adjusted OIBDA expectations. As we look forward to the remainder of the year, we believe consistent revenue growth will continue to be challenging, as domestic and international markets experienced an uneven economic environment without clear visibility in the development of our advertising revenue streams.

Our outlook is greatly aided by our affiliate revenues that provide us with a predictable and growing base of income. As we look at the third quarter, we anticipate domestic advertising revenues to be flat or slightly below (inaudible - technical difficulty), we expect mid-to high single digit ad growth in our international markets, excluding the impact of foreign exchange. On the expense side we anticipate low single digit savings in the second half of the year. For 2009 we are maintaining our range of $3.375 billion to $3.5 billion of revenues. Our forecast includes approximately $80 million or a 2% decrease in revenues related to a foreign exchange rate and at 30 -- and approximately $30 million related to the deconsolidation of the Discovery Kids Network. As the first half of the year demonstrates we have been able to moderate our selling, general, and administrative cost structure to enable us to continue to invest in our program, to produce high-quality content and increase our market share and ratings.

As we update our adjusted OIBDA outlook, we anticipate meeting a portion of any future potential revenue shortfalls with adjustments to our cost structure. And as a result we are raising the low end of our adjusted OIBDA guidance to $1.35 billion, while maintaining the high end at $1.4 billion. Our adjusted OIBDA guidance includes an estimated $25 million decrease due to current foreign exchange rates compared to the prior year and a $15 million decrease related to the sale of the Discovery Kids Network. Our guidance excludes the impact of further expenditures related to the Oprah Winfrey Network. We currently anticipate investing approximately $70 million to $80 million during 2009. The investment and income statement impact will be dependent on the timing of the launch, which is currently anticipated to be early 2010.

Please note that the uncertainty of our overall economic environment may alter our forecast as we move through 2009. We anticipate net income attributable to Discovery of $500 million to $600 million and capital expenditure of $50 million to $60 million. During this past quarter we significantly improved our financial position with a combination of strong operating performance, a $500 million incremental loan facility, and $300 million proceeds from the sale of the Discovery Kids transaction. As a result of these activities, we have successfully reduced our leverage to 2.5 times adjusted OIBDA and lowered our maturities through the end of 2010 by $760 million to $510 million. We will continue to selectively increase the duration of our capital structure to better match the long lives of our assets and increase our financial flexibility. We maintain a strong liquidity position with $339 million of cash on hand, $1.6 billion of undrawn domestic revolving loans, and annualized current run rate of free cash flows over $500 million.

Please note we will be making $110 million of incremental tax payments related to the gain on the sale of Kids transaction in the second half of the year. This will bring our total anticipated cash payment for 2009 to about $450 million. Before I finish up, I would like to remind everyone that it is currently Shark Week on Discovery Channel and hopefully each of you will have a chance to tune in. I will now turn the call over to David Zaslav, our CEO.

Thanks, Brad. Good morning, everyone, and thank you for joining us. You have heard us talk in the past about Discovery's strategic advantages. We are a pure play cable programming Company with a strong brand portfolio that resonates across a truly global footprint. Our business model produces significant operating leverage, as the dual revenue streams we generate from advertising and contractually growing distribution fees are complemented by a relatively fixed cost structure. These key inherent advantages were certainly important contributors to the operating performance that Discovery delivered during the second quarter. But what I would like to discuss today is how this past quarter demonstrated our ability to execute on our business plan and undertake key strategic initiatives, even in a challenging operating environment.

While we cannot control the overall economy, it is imperative that regardless of what happens with the macro environment that we continue to deliver on those parts of our business we do have greater control of, specifically, delivering quality programming and growing ratings, aggressively pursuing all profitable revenue streams, and maintaining an appropriate cost structure. During the second quarter of 2009, the Company's US network portfolio delivered strong ratings growth, including an increase of 12% in primetime among our core adults 25 to 54 demographic. The largest rating gains were achieved at Animal Planet, which followed up its first quarter with ratings growth of 30% among adults 25 to 54 in the second quarter. Animal Planet's ratings gains were led by a new hit, "River Monsters", which was the most watched series in the network's history and returning hit "Whale Wars", which grew its audience double digits in its second season.

TLC also had a very strong quarter with ratings in its key women 25 to 54 demo up 21%. TLC saw a strong performance across its schedule including "Jon & Kate Plus 8", whose season finale delivered the highest ever primetime delivery on TLC. But "Jon and Kate" were only a part of the story this past quarter. Returning series "What Not To Wear," "Say Yes To the Dress," and "American Chopper", all delivered double-digit gains. And TLC premiered two new hits, "Little People" and "Cake Boss", which already ranks among the top five shows for women in the 25 to 54 demo. Our flagship, Discovery Channel, was up 2% this past quarter among persons 25 to 54 and finished among the top five in ad-supported cable led by strong ratings for returning favorites "Myth Busters" and "Deadliest Catch". "Deadliest Catch" delivered its highest rated season ever. It was the number one nonfiction cable series across all primetime and consistently beat the broadcast nets every Tuesday night.

Discovery Channel also had success with several new shows including "Pitchmen," "Swamp Loggers," and "Inside Planet Earth". This broad-based ratings strength across our three fully distributed US networks contributed to advertising growth domestically this quarter, despite a continued weak economy. With sustained ratings strength and increased inventory, we are well positioned to garner a larger share of the available ad dollars going forward. And with approximately 40% of our revenues derived from advertising, we will certainly benefit when the market strengthens. Before moving on, let me give you a brief synopsis of what we are seeing on the domestic ad front. Q3 cancellations finished up around the same level as Q2, but scattered visibility remains limited with money in some cases being booked just days before spots go to air. As far as the up-front is concerned, we're still in the middle of our sales process.

In general, we anticipate lower absolute levels of commitments than in the prior year and we plan on selling less inventory than in years past. We believe, based on the fact that current scatter pricing is at a premium to prior-year up-front prices, holding back additional inventory is prudent as our ratings momentum combined with a balanced portfolio that reaches both men and women demographics provides us with an opportunity to grow our market share and maximize advertising revenue. Current economic headwinds are also impacting international advertising revenue, as overall TV ad spending across international markets declined year-over-year. Despite this market's softness, we did manage to deliver 3% advertising growth at our international networks in Q2, excluding foreign currency, as we grew our audience by 23% across our global platform. But the global economic downturn hurt demand and did not enable us to fully capture the viewership growth.

We are still ramping up the international ad business and anticipate accelerating advertising revenue growth as the global economy stabilizes and we can more effectively monetize our increased audience. One of our key international initiatives is developing strong channels in addition to the Discovery Channel so we can maximize the value of our distribution platform and drive ad revenue growth. A good example of what we are looking to achieve in each of our markets is the success we have had in Latin America, where we now have four channels really delivering solid ratings. Discovery Channel, Discovery Kids, the number one 24-hour preschool network in the region, Animal Planet, and the Home and Health Network. In fact we have grown audience significantly on all these channels in primetime this year, including over 60% growth at Animal Planet and Home and Health Network.

When you combine the ratings strength with the subscriber growth, we have grown our audience in Latin America by nearly 40% overall during the last six months. Internationally advertising growth is not just about executing on the ratings, but also improving our sales efforts and further increasing our distribution. On the sales front, our focus has been on building a local market-by-market sales structure and strategy. This includes nontraditional advertising opportunities such as brand integrations and sponsorships. The quality environment our content provides is a real strength as we look to expand the way advertisers can reach their consumers. Advertising will also be driven by the larger audiences that continued penetration and additional channel launches generate as we capitalize on the secular growth trends of paid TV around the world. This past quarter, paying subs expanded by 11% despite the economic slowdown with strong growth in Latin America and Eastern Europe.

We also launched several new channel offerings including Investigation Discovery in six markets and Discovery HD in five markets, solidifying our position as the leading provider of high-definition content around the world. When and where appropriate, we will continue to launch additional brands in order to strengthen our programming lineup and deliver greater reach to advertiser. We also took several steps this past quarter to further realize some of the potential of our valuable domestic distribution. We completed the sale of a 50% stake in Discovery Kids to Hasbro for over $350 million, including the anticipated present value of the tax-sharing benefits. Hasbro and Brian Goldner are terrific partners with a deep and experienced management team overseeing a wonderful set of iconic brands. Together we are working hard to ramp up the joint venture.

A few weeks ago we announced the appointment of Margaret Loesch to the position of President and CEO of our Kids Network. She brings a long track record of creating groundbreaking children's and family entertainment, including overseeing the development of such brands as "The Smurfs", "Power Rangers", and "Transformers". Her experience includes, to name a few, launching the Kids -- the Fox Kids Network, creating the US Hallmark Channel, running Marvel Productions, and she currently serves on the board of Sesame Workshop. With a history of dedication to high quality and educational programming, Margaret is an ideal choice to lead this joint venture and we look forward to working with her to build a powerful new destination for family entertainment. This past quarter we also named Henry Schleiff to President and General Manager of Investigation Discovery.

ID just delivered the best quarter of ratings in its history and Henry, who has an unparalleled track record in the investigative and forensic genre, including growing Court TV into a top cable network, is the perfect choice to elevate ID to even greater heights. Henry has helped build several valuable cable platforms throughout his career, most recently as the CEO of Crown Media, and his appointment underscores the promise we see for ID. We're excited about the potential to grow both of these already profitable channels into more robust contributors and we will continue to look for opportunities to elevate each of our emerging networks. The last area of execution I want to touch upon is our ability to thoughtfully manage our cost structure. This is always a critical area of focus for senior management, but obviously it is increasingly important today given the current pressure from the economy on the top-line.

As Brad mentioned, despite the impact of foreign currency headwinds and economic softness on our revenues, we had very strong operating leverage this past quarter, expanding our total Company margins to over 43% from 38% a year ago. We have been vocal in the past that we will continue to invest in our brands and original content, but we will not spend unwisely. Our focus will be on success-based investment to ensure we put our money to work where it has proven to generate a return. There is no better example than Animal Planet and ID, where we have turned increased investment into strong ratings growth and, as a result, we will continue to invest in these brands going forward. But as we invest in programming, we will be diligent to offset any additional spending on content with reductions to SG&A.

This past quarter we continued to lower our personnel, marketing, and other administrative costs around the world. The net result was 19% lower SG&A costs, excluding the impact of our mark-to-market share based compensation. Now more than ever, it is imperative that we have a strong handle on costs and we will continue to focus our efforts on reducing nonstrategic costs while investing in the long-term growth potential of our businesses. Discovery had a very strong first half of 2009 and, while the economic environment remains uncertain, we feel that the operating momentum we continue to demonstrate across the globe, together with the sustained operating leverage we are focused on delivering positions the Company to deliver continued strong results in the second half of the year. And with that Brad, Mark and I are happy to take your questions.

(Operator Instructions) And your first question comes from the line of Anthony DiClemente of Barclays Capital. Please proceed.

Hi, thanks so much. A few questions. First for Brad. You kept the revenue guidance the same and took up the mid-point of the range on adjusted EBITDA despite the deconsolidation of Discovery Kids. I guess the question is what was the second half '08 revenue and EBITDA contribution from Discovery Kids? And then another one for Brad. Can you just talk a little bit about the tests and the accounting treatment of how and when you take a content charge or writeoff, like maybe you can give us a little bit more detail on the content charge in your German operations. Thanks. And I have a followup for David, thanks.

Anthony, I think I prepared in my remarks the impact of the deconsolidation from the Kids transaction, which is roughly for the second half of the year is about $25 million in revenue and about $15 million in adjusted OIBDA. So those were the two deductions from the guidance.

Okay, thanks.

We did have more favorable currency than we had in our first quarter earnings call, so we did pick up roughly $15 million of adjusted OIBDA in -- in foreign -- more favorable foreign exchange rates. The two almost offset each other. So when we produced our guidance, it was -- it's a kind of a clean number, apples to apples. With regard to the content charge, you take content charges when we don't think the revenues will enable us to realize the value of the content. And so if we're underperforming in a certain market or a certain investment and we look at the revenue streams that we'll be generating in that market, we ultimately will then perform an analysis that says is this content on our books realizable. And when it's not, that's when we take the charge.

Got you. Thanks. And then a question for David. You mentioned some of your strategies on the emerging networks. You talked about ID. I think you have 11 networks now, ex- Discovery Kids and really only two of them are mature in TLC and Discovery. I was just wondering, David, if you could talk specifically about your programming strategy for some of the other much smaller networks, for example, Fit and Military, and what your strategy might be for some of those. Is it a niche strategy, is it broader, entertainment strategy, for those much smaller networks. Thanks.

Thanks, Anthony. Well, first, all of our channels, we do have 11, are profitable. And it is great real estate for us. So on -- on channels like Science and Planet Green, we think we have good brands with real strength behind it and good leadership and so we're pushing on those. With respect to Fit TV and Military, Military has a strong audience and has been growing. We're evaluating now whether is that the best brand for us going forward, is Fit TV the best brand? How do we use that real estate in the most effective way to drive long-term sustainable growth. And so I would say Fit and Military are two that we're -- we continue to look at and evaluate.

And your next question comes from the line of Doug Mitchelson of Deutsche. Please proceed.

Thanks very much. Couple of questions. One on the up-front. What does Joey typically sell on the up-front? How much can you comfortably hold back, an extra 10% or so? And I guess as part of that, does your commentary imply that you want to maintain price above the 5% to 6% declines that a lot of networks are coming out at or do you just prefer selling less at that price because you don't like that price?

Well, let me answer it generally. We're in the middle of the process and so it's far from having concluded. But last year we did a little bit more than 50%. I mentioned this year we expect that we're going to do a little bit less. And we're going to use less inventory because we -- we're going into the market with a significant amount of strength. If you look at July, in the aggregate, TLC was up over 40 -- over 40% in the female demo and across all of our channels we were up double digits. So we have some real strength and momentum across all of our channels. And the scatter market has been trading at a premium to last year's up-front. And so we're looking to hold a little bit back because we think we're well positioned to be able to monetize that going forward. In terms of pricing, because we have some real ratings strength, we feel like we have some flexibility to have -- in our discussions, but -- but we're not looking to make significant reductions.

Are you -- let us know where scatter price it is over the up-front right now, at what level?

We're still in the middle of the process, so we're not in a position to really report out on that right now.

All right. So the other question is, Brad talked about the Oprah JV still planned for early next year so you must be getting along on the programming strategy. Can you just get us up to date with where -- what kind of programming you think you're going to be doing and Oprah's involvement in terms of doing any shows herself.

I was out in California last week and spent most of last Thursday with Oprah and Christina Norman, our CEO, and the whole team. We're-- we're making a lot of progress. We have a great team out there. Christina Norman was the President and CEO of VH-1 and MTV. She's a -- she's a true pro. Oprah is fully engaged. She's the Chairman of the network and the Chief Creative Officer. We also had the leadership from oprah.com, which is doing very well on the web side. And we showed a little bit in the up-front. And over the next few months, we'll be making some more announcements that relate to the programming. But we're pretty excited about it.

All right. Great. Thanks.

And your next question comes from the line of Jessica Reif-Cohen of Banc of America Merrill Lynch. Please proceed.

Thank you. On the cost cutting, which you've done an amazing job, but these -- do you think these are permanent costs or will you see some increase as revenues start to come back?

Jessica, with regard to the costs, our Company -- this is not like it's one area of the Company. It really is a total Company effort. And so when you look at our cost structure and where the savings have come from, they've been fairly well distributed. And the US, as well as international, it's SG&A and marketing within SG&A. And so what we're trying to do is spend our money as wisely as possible. And we do anticipate a little bit of sequential increase from the first half of the year, but still below last year, and that's because we did move some marketing dollars around from the first half into the second half due to when we were going to premiere certain episodes. But for the most part, we do think that we can continue to work on our SG&A cost structures to offset the increases at least through 2009 of any -- of the amortization increases and costs of (inaudible).

It --it really bespeaks our overall strategy, which the entire Company galvanized around and that was we put content and brand strength to the left, where we were going to continue to really drive that with investment and really try and get more product -- productivity out of our investment. And then everything else that didn't relate to that we moved to the right. And we started attacking a lot of those -- that corporate overhead so that we could put more value and more resources against our brands and against the screen. And we're starting to see some of the value of that in -- in the -- in the ratings growth and brand growth that we've been able to build throughout this year.

Thanks. And --

Jessica, it's Mark. Just one thing to add to that also is we -- we have -- some of this is coming from having put in place just a different approach to running the business. A good example of that is in international where we -- we used to run our whole network operation infrastructure as really four different groups, between the US, Europe, Asia, and Latin America. Within the last year we have put that all under common management. That's the kind of thing that I think will continue to deliver cost efficiencies over the course of time as we really roll out a more, a much more centralized management approach to that function, which is a big investment area for us.

And remember that Discovery was private for almost 20 years. And so three years ago this leadership team started to work on the productivity, work on the margins, work on the cost. So where I -- we continue to identify the levers and the opportunities and we think that there's -- there's still some meaningful opportunity going forward.

So are you where you want to be in terms of using your programming globally, or is -- ?

I didn't -- where we want -- ?

Are you where you want to be in terms of using your programming globally?

Well, we still have some more sharing. Our -- our overall reach in the past -- in this -- in this last quarter was up 23% around the world. And that, we think, is a reflection of the fact that we have more of a global programming approach to Discovery, to Science, to Animal Planet, as well as a marketing and promotion approach that's more global. And we still have a fair ways to go. This helps us in getting a buy-in from the Company that our best content -- our theory is our best content for Discovery, which is about satisfying curiosity, works -- works best all around the world. The same with Science, the same with Animal Planet. But we still have a fair ways to go in terms of the amount that we can share on each of those three platforms and we're going to continue to push that.

I just have one last question. You just announced a partnership in China. I was -- can you talk a little bit about Asia and what you're doing there?

Let me just talk about our partnership with Baidu and then Mark can give you a little bit more detail on Asia specifically. They have about 60% market share in search in China and Google has about 30%. They are effectively the Google of China. We are already one of the -- probably if not the leading, one of the leading providers of content in China. But we do it through plot -- through providing blocks of programming, where our brand does not appear. So we get value, but we don't get the branding. We've been -- we have a great team on the ground in China. We have been working very hard to try and get more presence in the market. And this was a very, I think, a very innovative way for us to get our brand and give it access to the 400 million TV viewers that we're not reaching right now with our own channel. And it also speaks to the value of the Discovery brand that Baidu got behind us with us and formed this venture. So we'll see where it goes. It's a good step forward. And Mark, you could talk a little bit about Asia.

Yes, I think generally with respect to China, we know that this is a, probably a -- a long process to get into China in the way that we're in other markets with full channels. We think that the Baidu deal is a -- is a nice step forward in that regard, but we're -- we're still very cautiously optimistic about the long-term prospects for China. Otherwise in Asia, we really have seen over the last couple of years a strategy of really decentralizing a lot of editorial and sales management out of the Singapore headquarters and into the regions, which has -- has seen success in a number of the markets there. I think we see -- we see good growth in -- in India, where we have very strong local management in Australia. We've moved teams into -- we've, in essence, created a southeast Asian region in the hopes that there is -- there is good growth there. So we think we've found the right balance between the efficiencies of centralized management out of Singapore and really increased sales efforts in the markets that we think have the most potential.

The only thing I'd add on -- on the Baidu partnership is it does speak to the value of the library and the fact that it is long tail. We own most of our content and the fact that we own most of our content, it -- most of it is evergreen and it is in this universal language of curiosity, science, and about nature that it allows us to -- to move forward in a venture like this with virtually no cost and have the potential, depending on how things work out, to have significant value. So we'll be -- we'll be pushing on that and we'll keep you posted.

Good deal.

And your next question comes from the line of David Bank of RBC Capital. Please proceed.

Thanks very much. Good morning. A couple questions. The first is I think the margin performance at the domestic nets in particular exceeded what we were looking for. And -- but we also noticed a spike in the noncash comp side. And so I -- I know that your noncash compensation is driven in large part by the performance of the stock. But just a general question, was -- was any of the expense shifted from cash comp to noncash comp? And -- and, I'm sorry, the second question is the -- the writeoff on the German related programming is -- it's a bit of a red herring, kind of tough for, I think, the Street to anticipate such things. Is there -- is there any -- were there any kind of red flags that you -- you could see that sort of thing coming? And do you see any -- any more of that likely to happen over the foreseeable future? Thanks.

Yes, let me answer both those questions. With regard to shifting costs, when we grant our noncash stock, stock option SARs and DAP, the stock options expense goes straight through our adjusted OIBDA. So we do include that. The SARs and the DAPs are mark -- they're mark-to-market and so that's what goes through the long-term incentive plan. And that's what you'll see it go up and down as the share prices move. And the share prices moved roughly 50%, 60% over the course of several months. And that has -- that's what caused the charge. There was no incremental or additional shifting between buckets or anything along those lines.

Great.

With regard to Germany, we try to be, I would say, have the most appropriate accounting possible and so we're forward-looking and our German operations are kind of unique. We had a -- we have an operation called DMAX, which is really a free to air programming effort. When the revenues were not realized to what the business plan we anticipated for 2009, we re-evaluated the extent of the content investment. When -- and so when we did that analysis, that's what caused the charge. And so as we look at July, they're on plan to what we've re-forecasted and calculated the charge, but if revenues don't materialize we would always look, we would always look at our content. And so we do that in -- throughout the world. But this one was a very specific, country specific and operational specific issue that we looked at rather than, I would say, a red herring. I would differentiate those -- those kind of events.

Thanks very much, guys.

And your next question comes from the line of Rich Greenfield of Pali Capital. Please proceed.

Hi, thanks. Your US margin, just following up on David's last question, you've gone from effectively 52% in the second quarter of '07 to 59% in the second quarter of '09. And just wondering how do you think about the potential for that to move higher? I mean, when you look at your -- the cost cutting or the efficiencies that you're gaining, how much of this is headcount related? I mean, is it a war zone in terms of firing more bodies or continuing to cut down legacy bodies? And then as you think about going forward, how much more can margins go up? I mean, is this something where margins could be really be 55%-plus over time, or are you starting to really hit a wall? And I guess the way to give us a little bit more color on that is are there smaller networks in there or are your smaller, less mature networks at 30%, 40% margins now versus the 60% blend? I mean, how do you think about the spread between the successful, the big successful ones and the smaller ones, thanks.

There's a lot of questions in that question. Rich, I'll start off and David and Mark can chime in. I think consistent -- one of the big things consistent with what Mark said is we're looking -- we look at every process, what makes sense to centralize, what makes sense to decentralize and how do we get economies of scale. And so that has been going on, whether it's in our media technology production operations group, whether it's in IT, whether it's in finance, whether it's in marketing or human resources. And so when you're going through each of those areas, you're trying to see -- to make sure that you give the businesses what adds value and you try to be as efficient with the areas that may be more extraneous. We do not -- we haven't had the bulk of the savings even close in the personnel line item. That's just not -- that has not been where it's been. It's been really getting more productivity at what we have, as well as using our marketing dollars more effectively and our SG&A dollars more effectively.

And so we do think this is a very high margin business, or an incrementally high margin business, and we should be demonstrating that over a multi-year period. The real investment is, that you make in this business, is in programming not in infrastructure. There are costs of infrastructure that you do need as you expand to certain places, but we're in geographically just about everywhere we want to be. And so most of our administrative cost structure is set or being refined down, while it's really the cost of revenue that is the thing that would -- would moderate up or down depending on are we being successful in our investments. And that's how we think about it. It's really that straight forward. So the margins are only capped by how fast that revenue grows. And that's the best way I would portray that. And that's across every network in everything we do.

The only thing I would add is we do have a unique opportunity as a nonfiction leader that as we get to know our brands better and we continue to push us on quality content, that that content, because we own it, we can use it and reuse it. We can use it on different platforms, taking it from one channel to another. And we're generally not in the business of -- we don't go out and buy content, so we don't have to go out -- we don't get leveraged when those deals come up. We own most of our shows. And so it gives us -- we should have very good leverage, very good leverage to grow our margins over the next couple of years because as a nonfiction provider that owns our content, whose content has some abil -- real good ability to run and rerun and this week as an example with Shark Week. Over 85% of what you see in Shark Week is content from our library. And so we -- we put in some new stuff, but then we have a lot -- a lot in our library to choose from and we have a great week of Shark Week. And so that does give us better -- the opportunity to have much better margins.

I will say this, Rich. The difference between our large networks, our fully distributed and our emerging networks is not as great as you would think because of a lot -- the way we think about investing and programming is success based. So we should be able to garner revenues if we're going to make incremental investment. So it's -- it's not even a 1000 basis points, it's much higher than that.

Just to give you a sense of the baskets. Our content spending is on our cost structure is about 30% of our costs, 25% is people and marketing is about 10%. That's a ballpark for you.

Thanks a lot.

And your next question comes from the line of Michael Nathanson of Sanford Bernstein. Please proceed.

Thanks. I have three and I'll do one of them at a time if it's okay. First for David, you talked about the pricing on scatter versus up-front. If we could talk a bit about what was scatter versus scatter domestically in the second quarter on pricing.

Well, as I've said, scatter is up versus up front last year. And we've been able to -- to monetize that. The volume is -- is still a challenge and the visibility is a challenge. So unlike prior years, we come in every week and we look to see what happens. And at the end of a week, we can look at it and go -- and say that was a great week, but then we start all over the next week. And so overall, it's -- last year was very strong. And for this year, we're -- we're finding that the advantage we have with our ratings and our momentum is helpful and the pricing is -- is up, but -- but every week is -- is a little bit of a combat.

I was just -- I was trying to drill down scatter versus scatter, not scatter versus up-front.

Michael, what we did see between the first and second quarter was scatter got weaker in the second quarter pricing compared to what we enjoyed in the first quarter compared to the up-front.

Okay. So you won't do scatter versus scatter?

Well, which would make it in absolute dollars down from the year before the scatter prices.

Okay. And then let me -- let me go back to both you guys. One of the things that's puzzled us is historically, and we saw it again this quarter, there's a low correlation at Discovery between domestic ratings growth and domestic advertising growth. Just look back over the past two years. Why does that occur and what closes that variance over time? So some quarters you guys blow out ratings and revenues do what they do, and some quarters ratings are not strong and revenues are still relatively solid. So how do you get closer, I guess, correlation between ratings growth and -- and ad dollar growth?

Well, first, I think this market is -- is not a market where you're going to get any kind of a perfect solution or any model is going to work. This market is really -- it's week to week. A lot of it depends on the value of your team. It depends on how much -- what your ratings look like. And there are a number of advertisers that are behaving differently. So for us, right now we have -- even though we have strength across the board, we're finding that the female demo is much stronger than the male demo. And the older male demo in the 25 to 54 is even -- is stronger than the 18 to 49. So right now, one of the things that you're seeing on Discovery is that Discovery, even though it's doing well, it doesn't have, in terms of what the marketplace is providing, the same, some of the same opportunities that a -- that a female leaning channel like TLC or Animal Planet would have in order to monetize their ratings. That could change next week. It could change next month.

Part of that has to do with the fact that autos and financials are -- are much heavier into the -- into the male demo. And the fact that as broadcasters, the broadcast ratings were down, let's say, 5% to 6%, a lot of that is reach for women. And so as advertisers look to fill that gap, they've come to us and to the other cable networks. We all -- all -- in the aggregate, we have the advantage of being about a 30% discount in terms of the CPM to broadcast, which I think is still one of our biggest advantages in our growth opportunities. But to be more specific, I don't think that you could start to model a correlation between ratings gains. This quarter we were up 12%. In internationally we're up 23% and we had 3% growth. Here we were up 12%, we had 1%. It's not a perfect market and it does go to our strategy.

Our strategy was invest in can -- in brands and content, so we can get more value in our basket that we take to advertisers. And we believe that getting people to watch our channels -- when we say we're up 23% and 12%, that means we're growing market share. We're growing market share in a recessionary environment. When the market comes back, our basket is full and we can fully monetize our domestic and international audience. And at that point, we'll really have the growth. So that's really the way that we look at it. It's much harder to get people to watch your channels and that's really what we're focused on.

And, Mike, I think the correlation's better -- it's better seen in a strong market. A good example is take third quarter of 2008 where we didn't have a great performance in TLC or Discovery and so that shaved off of what would have been 9% domestic advertising growth to 5%. So what you do see is you do see the ratings impacted. It's when you can sell it out and when the CPM is appropriate as well as the sellout, those two things will -- should correlate pretty highly. It's just when -- when you don't have the demand side it's difficult to fulfill the additional inventory that you provided by having better [at rate].

Okay, thanks. And can I just have one more for Brad. I appreciate your answers. Just wondering if you drill down a bit on -- you've talked about your advertising strategies. I wondered if you looked at advertising as a percent of SG&A last year versus this year, how much of the -- the declines in SG&A were driven by these changes in your ad spend and marketing approach?

When you say advertising, our own off-air promotions?

Yes. Off air, exactly.

Our decline in total SG&A cost was split evenly between our own advertising and our own other SG&A costs. That's the easiest way to think of it, about a 50/50 split.

Okay. Thanks.

And your next question comes from the line of Michael Morris of UBS. Please proceed.

Thank you. A couple more questions on advertising. First of all internationally the guidance that you gave for the third quarter sounds like an acceleration from the second quarter. I was wondering if there is anything specific you can share? You referenced the importance of market stability to take advantage of your underlying growth internationally. But what is giving you confidence to go from the 3% to the mid-to high single digits internationally? Also, can you talk a little bit about -- just going back to this quarter, did you see some significant improvement in the UK? Is there something material there? It sounded like that was a little bit better sequentially. And then just domestically, as you look at ad sales for the three largest networks relative to those 11 emerging networks, in this environment where buyers seem to be increasingly focused on -- on savings, have you seen any difference in their appetite for the big three versus the emerging networks, or is it just consistently sold as a package and you don't really see a difference between the two? Thank you.

Well, why don't I start with the UK because that's a pretty straight-forward answer. Last year we had the impact cap issue and because our ratings were stronger last year, the impact cap gets raised. So this year we have an opportunity to sell more impressions. For those of you that aren't familiar with the UK, it's just an odd market. You get ratings in a year and then you sell them the next year. So we're seeing some of that benefit. We're also seeing some of the benefit of the fact that we had a contractual impact cap issue last year, which isn't having an impact this year. So that's the UK. Having said that, the UK remains weak. We're seeing year-over-year growth, but the UK remains a -- a very weak market. I would say meaningfully weaker than the US. It's more of a year-over-year.

And with regard to the international and having higher levels of growth than we experienced in the second quarter, it was -- it's really based on where we're attracting. The visibility levels are low. So that is one caveat. But looking at the markets that weakened, specifically like Latin America which had a -- an impact in Mexico from the swine flu and other areas, the way we see it playing out is there should be an incrementally higher level of growth based on where our pacing is today and based on feedback from our sales force. That's what makes us feel that those -- the economies that we participate in should be doing a little bit better and the --probably the low point of this year was the second quarter, which was actually a lower growth rate than what we had in the first quarter.

With regard to, I think, the sales activity you mentioned between the three largest networks and then our eight emerging networks or smaller digital networks, it really is -- it's a mixed bag. Part of it's demographically driven, too. So at Discovery, which is, as David mentioned, more heavily toward something like autos and financial has a more male demo, that has a less of a demand than something that is more skewed toward the female demographic. And that's -- the emerging networks are along those same lines also. And so I think the incremental dollar goes usually towards the larger networks, but it's the smaller ones that are in the right demo do very well, too.

There is a, I would say, a tougher sell where an impression was an impression before and now getting people into some of our smaller networks are a little bit more of a challenge. The ones that have a stronger brand, like Science, we're doing better with. But when an advertiser in this market is looking to spend $1 and they look at Discovery, which is the -- one of the top five networks in America, or TLC, that has all this momentum, and Animal Planet, it's easier to book a $1 on those networks then to book on some of our smallers.

Thank you.

Your next question comes from the line of Benjamin Swinburne of Morgan Stanley. Please proceed.

Thanks. Good morning. I'll ask an affiliate revenue question. I think, Brad, you talked about guidance in the third quarter of, I think, you said, there were sirens going on in the background so I might have gotten it wrong, I think you said mid-single digit growth in the US and you guys did 10% roughly pro forma for the first half. So maybe you could help us think about how much of that 10% growth came from unit versus price, if there is any bifurcation on the mature networks versus the digital networks, which I know are getting increased carriage from Verizon and AT&T, and sort of what's driving the deceleration. Then I have a follow-up for David.

Ben, I did not guide for affiliate revenue specifically. The only guidance we gave was total revenues, then we also then gave -- I gave Scott inventory, the domestic and international advertising markets. So -- .

Got you.

That was confusing, I apologize. We grew about 10% in the second quarter. When you adjust out the onetime item it's about the same. We grew about 11% in the first quarter and we just about -- adjust out the onetime items. Of that growth, another 2% of that growth is noncash. So you'd have less launch amortization, which goes against revenue. So by having less you have faster revenue growth. So the real cash organic affiliate growth domestically is in that 8%ish range. Of that about half is escalations in the contract. The other half is really related to volume growth, which is clearly faster on the digital networks than on the fully distributed networks, which generally run around 1%. And that's -- that's the expectation level. You'll have that pricing increase over the next several years since our contracts for the vast majority, over 95% of our contracts, are through 2012 domestically. So that escalation will continue. And the rest is really the volume that is the piece the digital networks will move and grow as digital subscribers keep growing. And -- and so that's the best way to think about that.

So you -- so essentially, we're seeing not too much growth on analog for the big three. 3% to 4% growth on -- on the pricing. The thing that gets us that helps us now is that as digital rolls out, which we're not in control of, but the -- but the cable distributors are pushing that to helper, and any time there's competition by having the phone companies in that gives -- that's helpful to us and -- and most of -- both Verizon and AT&T carry all of our channels and carry all of our channels on analog. So when they add subscribers, that's a helpful -- that's helpful to us in terms of brand and value.

Got it. Very helpful. And then David, just in the last three months we've had a lot of activity on sort of online content. I think Disney did a deal with Netflix yesterday, it was all on the TV everywhere stuff. You've had a unique position on moving content on line. Could you just update us on your thoughts both for Discovery but maybe for the broader industry, since what other folks do definitely ultimately impacts Discovery, as well?

Sure. Well we continue to be aggressive about looking at everything that's going on in the market. We -- we are aggressive about short form content. And our -- the debenture we did in China is an example of that, how stuff works, our YouTube channel. We've been able to build our uniques across our existing platforms to over 40 million. So we're -- I think we've done a good job of nourishing our viewers on line. In terms of long form, it's still a work in progress. TV everywhere is a good step forward. The idea of trying to control the -- the access to long form content. We're going to keep our eye on it. We think we have a very valuable library. And what -- what was two years ago a flood of content going out onto the web, there's a lot of rethinking of what you do with that content, how you monetize it. The key for us is to continue to grow market share. We feel very good about the fact that we're continuing to grow market share on the web. And we're going to just have to see how long form content plays out. But I think TV everywhere is a positive.

Operator, we will take one last question, please.

Thank you. And your final question comes from the line of John Janedis of Wells Fargo Securities. Please proceed.

Hi, thanks for taking my question. Could you guys talk a little bit more about programming costs. What growth is now embedded in the guidance and how many hours of original content do you assume for the third and fourth quarter at Discovery? David, I think you mentioned last year that you had 70 hours in 3Q and 120 in 4Q. Thanks.

In terms of the guidance we do assume a full programming slate for Discovery, as we do at our other networks. And so that really is 100 to 125 original premiere hours in each quarter. So I think that's pretty consistent. And in terms of our guidance when we did in 2009, it's consistent with how we began the year, which is ultimately if you excluded impairment charges or onetime items that come up, it roughly was an increase of the $40 million range or so, based on investments that were made and how they amortize into 2009. And you'd have a similar increase in 2010 just by on the math of what we spend in our programming investments, which has been consistent over the last couple of years.

Okay. Great. And just one last quick one for you guys. With the team in place at Planet Green, is that now performing in line with expectations?

We -- we have Laura Michalchyshyn join us about two months ago. She worked with me when I was on the board of Sundance a few years ago. She's very talented. She was just out at -- at TCA with us in California last week, announced 15 new shows. So I think we had a great launch. We-- it went into a little bit of a tread water mode because we took Eileen O'Neill, who was running that channel, and put her in charge of TLC That has turned out to be a great decision. She's a fantastic leader and she's been able to really turn around that channel. But we -- it was treading water. We now have a great leader and we're off to the races.

All right. Thank you.

We want to thank everyone for participating on the call.

Thanks, everyone.

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