Discovery Communications Inc. Earnings Fall as TV Ad Sales Decline

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Investors weren't expecting much good news in pay-TV specialist Discovery Communications' (DISCK) third-quarter results. The broadcast industry is shrinking as subscribers shift their consumption to on-demand, internet-based entertainment. As expected, the media giant's growth slowed this quarter, and its profits fell as Discovery ramped up spending to prepare itself for a more digital-focused future.

Here's a look at how the numbers compared to the prior-year period.

Data source: Discovery's financial filings. YOY = year over year.

What happened with Discovery Communications this quarter?

After two straight quarters of improving sales growth, revenue gains fell to zero as the core U.S. business slowed and the international segment shrank.

Here are the key highlights of the quarter:

• U.S. network revenue rose by 2%, marking a slowdown from the prior quarter's 7% bounce. Distribution fees that Discovery charges to pay-TV operators for the right to carry its networks rose by 7%, but advertising revenue took a turn for the worse. Ad revenue declined by 3%, compared to the prior quarter's 5% increase.
• Adjusted earnings from the U.S. business still ticked up by 3%, and profitability improved to 58% of sales from 57% last year.
• The international segment endured 3% lower revenue and a 16% decline in adjusted earnings. Most of the division's drop can be tied to currency exchange issues brought on by a stronger U.S. dollar, but Discovery also struggled with lower ratings in areas like Northern Europe.
• Earnings took a hit from a one-time impairment charge that powered a 21% decline in net income. Adjusted profits, which exclude that writedown, fell by 3%.
• Management continued to allocate cash toward stock buybacks, spending $253 million this quarter to retire 10 million of its shares at an average price of $24.47.

What management had to say

CEO David Zaslav said that management wasn't surprised by the weakening U.S. advertising industry. "We faced challenging but expected headwinds this quarter," he said while commenting on the overall results. Discovery said that the lower ratings it booked this quarter were on par with executives' forecast, and they were partially offset by higher pricing.

Discovery took the opportunity to increase investments in its digital platforms while spending heavily on exclusive content. "We have continued to strengthen and maximize our traditional pay-TV offering with robust new programming while aggressively exploiting new opportunities to leverage our content across numerous digital platforms around the world," Zaslav said.

Looking forward

Executives' long-term plan predicts that the U.S. market will produce healthy profits over the next few years even as cord-cutting pushes the subscriber base, and thus ratings, lower. Investors saw evidence to back up that optimistic reading this quarter: Profitability improved despite falling ad sales.

There are two key questions going forward. First, just how steadily will the U.S. broadcast market shrink? This quarter's falling ad revenue suggests it might be a sharper decline than executives originally thought.

Second, just how well can Zaslav and his team execute on bringing new distribution platforms up to speed so the company can extract maximum value from its content portfolio? It's clear that earnings from the traditional broadcast business alone won't be enough to keep results steadily moving higher while those new profit channels develop. That's why the company is hedging its bets this year by cutting expenses to bring its cost structure down.