Updated: Discovery Reports Higher Q2 Earnings

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Discovery Communications reported higher second-quarter earnings but said domestic revenue growth is slowing.

Net income rose 15% to $293 million, or 76 cents a share, from $254 million, or 62 cents a share, a year ago. Revenues rose 7% to $1.1 billion.

In the first quarter, Discovery's earnings took a hit from its joint venture with Oprah Winfrey, OWN: The Oprah Winfrey Network, which incurred costs from writing off programming and cutting staff. But those losses dropped in the second quarter, and the company said OWN remained on pace to be profitable in the second half of 2007.

"It's now performing even better than we thought it would," Discovery CEO David Zaslav said during the company's earning conference call with analysts. "We feel very good about it and we're looking forward to OWN being profitable next year."

Discovery senior executive vice president and CFO Andrew Warren said that OWN's losses would rise in the third and fourth quarter as the network spends more on content and marketing.

At Discovery's U.S. networks, adjusted operating income rose 8% to $426 million in the second quarter. Revenues were up 6% to $700 million. In the first quarter, revenues rose 16%, including a 13% gain in advertising revenues.

In the second quarter, ad revenue rose 7% to $387 million. Discovery said ad revenue growth was the result of higher pricing and sellouts. Distribution revenue rose 8% to $387 million.

Warren said that ad revenue growth was impacted by softer ratings on some of Discovery's big networks and that third quarter ad growth will be in the mid-single digits-even though there were no signs that the ad market was softening.

"Looking ahead, the third quarter does present some hurdles with the Olympics and limited premier hours on Discovery until after 'Shark Week' in August," said Zaslav.

"But with a strong upfront under our belts, scatter market remains relatively healthy and a balanced portfolio of existing and emerging brands, we remain confident that we can deliver sustained advertising growth moving forward," said Zaslav, who added that "we feel very good about fourth quarter and I think you can expect to see some strong numbers on the advertising side assuming that the market stays as is."

In the upfront market for next TV season, Discovery scored mid to high single-digit price increase and had the highest dollar volume in its history while selling about 55% of its ad inventory, Zaslav said.

"We were on the high-end of the market in terms of the upfront and we were very strategic," Zaslav said. "Given the success of many of our younger networks, a priority for [Discovery ad sales president] Joe Abruzzese's sales team during the upfront process was to generate higher volumes across these channels and we certainly achieved that with advertisers recognizing the value and opportunity brands such as ID and Destination America provide."

ID is also becoming a growth engine internationally. "Earlier this month, we rebranded Liv, our fully distributed entertainment channel, in 38 countries throughout Latin America to ID, after seeing the success of crime and investigation genre across our existing platforms," Zaslav said. "We are already seeing a larger audience on that channel. ID is now in over 100 countries globally and we think this can be another growth driver for our international business over the next several years."

Adjusted operating income was up 2% to $176 million at Discovery's international networks. Revenues were up 10% to $405 million.

Excluding the impact of currency fluctuations, Discovery said its revenues were up 10% and adjusted earnings rose 11%.

Discovery's operating income will be only in the low-single digits during the third quarter, because of the impact of its Netflix agreement a year ago, and negative impact from foreign currencies, Warren said. OIBDA growth will go back to the double digits in the fourth quarter he said.

Discovery left its full-year guidance unchanged. It expects total revenue to be between $4.55 billion and $4.65 billion and net income to be between $1 billion and $1.1 billion.

While second-quarter revenues were lower than most analysts forecast, earnings were above expectations.

Anthony DiClemente, analyst at Barclays Capital, said that Discovery's earnings and commentary indicated that while ad growth appears to be decelerated moderately, "we need not fear a larger, shark-sized bite."

In the U.S., analyst Michael Nathanson of Nomura Securities noted that "lower marketing expenses helped offset higher programming, but we question how sustainable this is going forward in light of the weaker ratings at the company's flagship networks." He also pointed out that this is the first time since the first quarter of 2011 that Discovery has not raised its full-year guidance.

But Todd Juenger of Sanford C. Bernstein Research, said that "our thesis for the stock is based on affiliate fee and advertising growth, domestic and internationally, and reliable cost structure. All of these items continue to deliver at or above our [high] expectations."

Discovery said it repurchased 8.5 million of its own shares during the quarter for $404 million.

"Given we have not yet found sufficient investment opportunities with attractive financial returns, we've accelerated utilizing the cash on balance sheet, as well as the cash generated from operations to repurchase shares," Warren said.

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