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LIBERTY MEDIA CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) Certain statements in this Quarterly Report on Form 10-Q constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including statements regarding our business, product and marketing strategies; new service offerings; revenue growth and subscriber trends at QVC, Inc. and Starz, LLC; the recoverability of our goodwill and other long-lived assets; counterparty performance under our derivative arrangements; our projected sources and uses of cash; the estimated value of our derivative instruments; our ability to complete the proposed split-off of the businesses, assets and liabilities attributed to our Liberty Capital and Liberty Starz tracking stock groups; and the anticipated non-material impact of certain contingent liabilities related to legal and tax proceedings and other matters arising in the ordinary course of business. Where, in any forward-looking statement, we express an expectation or belief as to future results or events, such expectation or belief is expressed in good faith and believed to have a reasonable basis, but there can be no assurance that the expectation or belief will result or be achieved or accomplished. The following include some but not all of the factors that could cause actual results or events to differ materially from those anticipated: º • º customer demand for our products and services and our ability to adapt to changes in demand; º • º competitor responses to our products and services, and the products and services of the entities in which we have interests; º • º uncertainties inherent in the development and integration of new business lines and business strategies; º • º uncertainties associated with product and service development and market acceptance, including the development and provision of programming for new television and telecommunications technologies; º • º our future financial performance, including availability, terms and deployment of capital; º • º our ability to successfully integrate and recognize anticipated efficiencies and benefits from the businesses we acquire; º • º the ability of suppliers and vendors to deliver products, equipment, software and services; º • º the outcome of any pending or threatened litigation; º • º availability of qualified personnel; º • º changes in, or failure or inability to comply with, government regulations, including, without limitation, regulations of the Federal Communications Commission, and adverse outcomes from regulatory proceedings; º • º changes in the nature of key strategic relationships with partners, vendors and joint venturers; º • º general economic and business conditions and industry trends including the current economic downturn; º • º consumer spending levels, including the availability and amount of individual consumer debt; º • º disruption in the production of theatrical films or television programs due to strikes by unions representing writers, directors or actors; º • º continued consolidation of the broadband distribution and movie studio industries; º • º changes in distribution and viewing of television programming, including the expanded deployment of personal video recorders, video on demand and IP television and their impact on home shopping networks; I-34 -------------------------------------------------------------------------------- º • º increased digital TV penetration and the impact on channel positioning of our networks; º • º rapid technological changes; º • º capital spending for the acquisition and/or development of telecommunications networks and services; º • º the regulatory and competitive environment of the industries in which we, and the entities in which we have interests, operate; º • º threatened terrorist attacks and ongoing military action in the Middle East and other parts of the world; and º • º fluctuations in foreign currency exchange rates and political unrest in international markets. For additional risk factors, please see Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2010. These forward-looking statements and such risks, uncertainties and other factors speak only as of the date of this Quarterly Report, and we expressly disclaim any obligation or undertaking to disseminate any updates or revisions to any forward-looking statement contained herein, to reflect any change in our expectations with regard thereto, or any other change in events, conditions or circumstances on which any such statement is based. The following discussion and analysis provides information concerning our results of operations and financial condition. This discussion should be read in conjunction with our accompanying condensed consolidated financial statements and the notes thereto and our Annual Report on Form 10-K for the year ended December 31, 2010. Overview We own controlling and non-controlling interests in a broad range of video and on-line commerce, media, communications and entertainment companies. Our more significant operating subsidiaries, which are also our principal reportable segments, are QVC and Starz. QVC markets and sells a wide variety of consumer products in the United States and several foreign countries, primarily by means of its televised shopping programs and via the Internet through its domestic and international websites. Starz provides premium networks distributed by cable operators, direct-to-home satellite providers, telephone companies and other distributors in the United States and develops, produces and acquires entertainment content and distributes such content to consumers in a wide variety of formats in the United States and throughout the world. Our "Corporate and Other" category includes our other consolidated subsidiaries and corporate expenses. Our other consolidated subsidiaries include Provide Commerce, Inc., Backcountry.com, Inc., Bodybuilding.com, LLC, Celebrate Interactive Holdings, Inc., Atlanta National League Baseball Club, Inc. and TruePosition, Inc. Provide operates an e-commerce marketplace of websites for perishable goods, including flowers, fruits and desserts, as well as upscale personalized gifts. Backcountry operates websites offering outdoor and backcountry sports gear and clothing. Bodybuilding manages websites related to sports nutrition, body building and fitness. Celebrate operates websites that offer costumes, accessories, décor and party supplies. ANLBC owns the Atlanta Braves, a major league baseball club, as well as certain of the Atlanta Braves' minor league clubs. TruePosition provides equipment and technology that deliver location-based services to wireless users. In addition to the foregoing businesses, we hold ownership interests in Expedia, Inc., SIRIUS XM and Live Nation which we account for as equity method investments; and we continue to maintain investments and related financial instruments in public companies such as Time Warner, Time Warner Cable and Sprint Nextel Corporation, which are accounted for at their respective fair market values and are included in corporate and other. I-35 -------------------------------------------------------------------------------- Tracking Stocks Tracking stock is a type of common stock that the issuing company intends to reflect or "track" the economic performance of a particular business or "group," rather than the economic performance of the company as a whole. Liberty has three tracking stocks-Liberty Interactive common stock, Liberty Starz common stock and Liberty Capital common stock, which are intended to track and reflect the economic performance of the Interactive Group, Starz Group and Capital Group, respectively. While the Interactive Group, the Starz Group and the Capital Group have separate collections of businesses, assets and liabilities attributed to them, no group is a separate legal entity and therefore cannot own assets, issue securities or enter into legally binding agreements. Holders of tracking stocks have no direct claim to the group's stock or assets and are not represented by separate boards of directors. Instead, holders of tracking stock are stockholders of the parent corporation, with a single board of directors and subject to all of the risks and liabilities of the parent corporation. On February 9, 2011, Liberty's Board of Directors approved the change in attribution of (i) approximately $1.138 billion principal amount of Liberty Media LLC's 3.125% Exchangeable Senior Debentures due 2023 (the "TWX Exchangeable Notes"), (ii) 21,785,130 shares of Time Warner Inc. common stock, 5,468,254 shares of Time Warner Cable Inc. common stock and 1,980,425 shares of AOL, Inc. common stock, which collectively represent the basket of securities into which the TWX Exchangeable Notes are exchangeable (the "Basket Securities") and (iii) $263.8 million in cash from the Capital Group to the Interactive Group, effective immediately (the "TWX Reattribution"). The TWX Reattribution had no effect on the assets and liabilities attributed to the Starz Group, nor did it effect any change to the obligor of the TWX Exchangeable Notes, which remains Liberty Media LLC. Liberty has made changes in the attribution of certain assets, liabilities and businesses between the Groups in prior periods, as discussed in previous financial statements filed with the Securities and Exchange Commission and in the Notes to Condensed Financial Statements included in this Quarterly Report on Form 10-Q. Liberty has reflected these reattributions prospectively in the unaudited attributed financial information. These changes in attribution had no effect on the balance sheet and results of operations of Liberty on consolidated basis. See Exhibit 99.1 to this Quarterly Report on Form 10-Q for unaudited attributed financial information for our tracking stock groups. During the second quarter of 2010, Liberty announced that its board of directors has authorized its management to proceed with a plan to separate the Capital and Starz tracking stock groups from the Interactive tracking stock group. The proposed split-off will be effected by the redemption of all the outstanding shares of Liberty Capital tracking stock and Liberty Starz tracking stock in exchange for shares in a wholly-owned subsidiary of Liberty ("Liberty CapStarz"). Liberty CapStarz will hold all the assets and be subject to all the liabilities attributed to the Liberty Capital and Liberty Starz tracking stock groups. The common stock of Liberty CapStarz will be divided into two tracking stock groups, one tracking assets that are currently attributed to the Liberty Capital group ("Liberty CapStarz Splitco Capital") and the other tracking assets that are currently attributed to the Liberty Starz group ("Liberty CapStarz Splitco Starz"). In the redemption, holders of Liberty Capital tracking stock will receive shares of Liberty CapStarz Capital tracking stock and holders of Liberty Starz tracking stock will receive shares of Liberty CapStarz Starz tracking stock. After the redemption, Liberty CapStarz and Liberty will be separate public companies. The proposed split-off is intended to be tax-free to stockholders of Liberty and its completion will be subject to various conditions including the continued validity of an IRS private letter ruling that was issued to Liberty in connection with the proposed split-off, the opinions of tax counsel and required I-36 -------------------------------------------------------------------------------- governmental approvals. On May 23, 2011, the proposed Split-Off was approved by the requisite vote of Liberty stockholders. In August 2010, Liberty filed suit in the Delaware Court of Chancery against the trustee under the indenture governing the public indebtedness issued by the Company's subsidiary, Liberty Media LLC. The lawsuit was filed in response to allegations made by a law firm purporting to represent a holder with a large position in this public indebtedness. The lawsuit seeks a declaratory judgment by the court that the proposed split-off will not constitute a disposition of "all or substantially all" of the assets of Liberty Media LLC, as those terms are used in the indenture, as well as related injunctive relief. During the second quarter of 2011, Liberty received a favorable ruling in its case against the trustee which was subsequently appealed. Resolution of the subject matter of this lawsuit, through a final non-appealable judgment, is a condition to Liberty completing the proposed split-off. Subject to the satisfaction of the conditions described above, Liberty intends to complete the proposed split-off in the third quarter of 2011. The term "Interactive Group" does not represent a separate legal entity, rather it represents those businesses, assets and liabilities which Liberty has attributed to that group. The assets and businesses Liberty has attributed to the Interactive Group are those engaged in video and on-line commerce, and include its subsidiaries QVC, Provide, Backcountry, Bodybuilding and Celebrate and its noncontrolling interest in Expedia, Inc. ("Expedia"), HSN, Inc. ("HSN"), Interval Leisure Group, Inc. ("Interval") and Tree.com, Inc. ("Lending Tree"). In addition, Liberty has attributed $4,201 million principal amount (as of June 30, 2011) of its public debt to the Interactive Group. The Interactive Group will also include such other businesses, assets and liabilities that Liberty's board of directors may in the future determine to attribute to the Interactive Group, including such other businesses and assets as Liberty may acquire for the Interactive Group. Similarly, the term "Starz Group" does not represent a separate legal entity, rather it represents those businesses, assets and liabilities which Liberty has attributed to that group. The Starz Group focuses primarily on video programming and development, acquisition and distribution of content and is comprised primarily of Starz, LLC ("Starz") and $1,035 million (as of June 30, 2011) of cash, including subsidiary cash. The Starz Group will also include such other businesses, assets and liabilities that Liberty's board of directors may in the future determine to attribute to the Starz Group, including such other businesses as Liberty may acquire for the Starz Group. The term "Capital Group" also does not represent a separate legal entity, rather it represents all of Liberty's businesses, assets and liabilities other than those which have been attributed to the Interactive Group or the Starz Group. The assets and businesses attributed to the Capital Group include Liberty's subsidiaries: Atlanta National League Baseball Club, Inc. ("ANLBC") and TruePosition, Inc. ("TruePosition"); and its interests in Sirius XM Radio Inc. ("SIRIUS XM"), Live Nation Entertainment, Inc. ("Live Nation"), Time Warner Inc., Time Warner Cable Inc. and Sprint Nextel Corporation. In addition, Liberty has attributed $1,067 million of cash, including subsidiary cash, and $750 million principal amount (as of June 30, 2011) of its exchangeable senior debentures and other parent debt to the Capital Group. The Capital Group will also include such other businesses, assets and liabilities that Liberty's board of directors may in the future determine to attribute to the Capital Group, including such other businesses and assets as Liberty may acquire for the Capital Group. I-37 -------------------------------------------------------------------------------- Results of Operations-Consolidated General. We provide in the tables below information regarding our Consolidated Operating Results and Other Income and Expense, as well as information regarding the contribution to those items from our reportable segments categorized by tracking stock group. The "corporate and other" category for each tracking stock group consists of those assets or businesses which do not qualify as a separate reportable segment. For a more detailed discussion and analysis of the financial results of the principal reporting segments of each tracking stock group, see "Results of Operations-Tracking Stock Groups" below. As discussed more fully in Management's Discussion and Analysis for the Starz Group the Starz Media Reattribution impacted the presentation for the Starz Group and Capital Group due to the change in attribution of the legacy Starz Media businesses to the Starz Group as of September 30, 2010. The results for Starz Media remain in the Capital Group for the six months ended June 30, 2010, during the period those businesses were attributed to that group, and are included in the Starz Group for the six months June 30, 2011 in the results of Starz, LLC (the combined entity). I-38 -------------------------------------------------------------------------------- Consolidated Operating Results Three months Six months ended ended June 30, June 30, 2011 2010 2011 2010 amounts in millions Revenue Interactive Group QVC $ 1,898 1,758 3,733 3,515 Corporate and other 347 295 671 563 2,245 2,053 4,404 4,078 Starz Group Starz, LLC 403 308 794 613 Corporate and other - 3 1 5 403 311 795 618 Capital Group Starz Media - 84 - 228 Corporate and other 135 116 716 138 135 200 716 366 Consolidated Liberty $ 2,783 2,564 5,915 5,062 Adjusted OIBDA Interactive Group QVC $ 418 403 781 769 Corporate and other 32 25 47 40 450 428 828 809 Starz Group Starz, LLC 118 107 249 213 Corporate and other (1 ) (4 ) (6 ) (7 ) 117 103 243 206 Capital Group Starz Media - (54 ) - (61 ) Corporate and other 7 (5 ) 365 (41 ) 7 (59 ) 365 (102 ) Consolidated Liberty $ 574 472 1,436 913 Operating Income (Loss) Interactive Group QVC $ 281 270 506 502 Corporate and other 7 4 (5 ) (10 ) 288 274 501 492 Starz Group Starz, LLC 112 102 236 201 Corporate and other (4 ) (6 ) (12 ) (13 ) 108 96 224 188 Capital Group Starz Media - (55 ) - (64 ) Corporate and other (14 ) (28 ) 329 (89 ) (14 ) (83 ) 329 (153 ) Consolidated Liberty $ 382 287 1,054 527 I-39 -------------------------------------------------------------------------------- Revenue. Our consolidated revenue increased 8.5% and 16.9% for the three and six month periods ended June 30, 2011, respectively, as compared to the corresponding prior year period. The three months increase was primarily due to increased revenue at QVC ($140 million) and the E-commerce companies ($52 million). The six month increase is due primarily to increases for Liberty Capital Group's corporate and other ($578 million), due to a one time recognition of previously deferred revenues at TruePosition, and increased revenue at QVC ($218 million). See Management's Discussion and Analysis for each of our tracking stock groups below for a more complete discussion of the results of operations of certain of our subsidiaries. Adjusted OIBDA. We define Adjusted OIBDA as revenue less cost of sales, operating expenses and selling, general and administrative ("SG&A") expenses (excluding stock compensation). Our chief operating decision maker and management team use this measure of performance in conjunction with other measures to evaluate our businesses and make decisions about allocating resources among our businesses. We believe this is an important indicator of the operational strength and performance of our businesses, including each business's ability to service debt and fund capital expenditures. In addition, this measure allows us to view operating results, perform analytical comparisons and benchmarking between businesses and identify strategies to improve performance. This measure of performance excludes such costs as depreciation and amortization, stock-based compensation, separately reported litigation settlements and restructuring and impairment charges that are included in the measurement of operating income pursuant to GAAP. Accordingly, Adjusted OIBDA should be considered in addition to, but not as a substitute for, operating income, net income, cash flow provided by operating activities and other measures of financial performance prepared in accordance with GAAP. See note 13 to the accompanying condensed consolidated financial statements for a reconciliation of Adjusted OIBDA to Earnings (loss) from continuing operations before income taxes. Consolidated Adjusted OIBDA increased $102 million and $523 million for the three and six months ended June 30, 2011, respectively, as compared to the corresponding prior year periods. The three month increase was primarily driven by the improved results from the legacy Starz Media businesses which contributed $54 million in Adjusted OIBDA losses in the prior year period and Adjusted OIBDA income of $6 million in the current year three month period. The six month increase is due to an increase at Liberty Capital Group's corporate and other ($406 million), due to a one time recognition of previously deferred revenues at TruePosition, and the increased results for Starz, LLC. See Management's Discussion and Analysis for each of our tracking stock groups below for a more complete discussion of the results of operations of certain of our subsidiaries. Stock-based compensation. Stock-based compensation includes compensation related to (1) options and stock appreciation rights ("SARs") for shares of our common stock that are granted to certain of our officers and employees, (2) phantom stock appreciation rights ("PSARs") granted to officers and employees of certain of our subsidiaries pursuant to private equity plans and (3) amortization of restricted stock grants. We recorded $51 million and $60 million of stock compensation expense for the six months ended June 30, 2011 and 2010, respectively. The decrease in stock compensation expense in 2011 relates primarily to our liability classified awards due to a less significant increase in our stock prices in the current period as compared to the prior period offset slightly by additional grants in the current year which increased amortization of stock compensation. As of June 30, 2011, the total unrecognized compensation cost related to unvested Liberty equity awards was approximately $200 million. Such amount will be recognized in our consolidated statements of operations over a weighted average period of approximately 2.8 years. Operating income. Our consolidated operating income increased $95 million and $527 million for the three and six months ended June 30, 2011, respectively, as compared to the corresponding prior year period. The three month increase was primarily driven by the improved results from the legacy I-40 -------------------------------------------------------------------------------- Starz Media businesses which contributed $55 million in operating losses in the prior year period and contributed approximately $4 million in operating income in the current year three month period. The six month increase is primarily the result of increases for the Liberty Capital Group ($418 million) and the improved results for combined Starz, LLC. Other Income and Expense Components of Other Income (Expense) are presented in the table below. Three months Six months ended ended June 30, June 30, 2011 2010 2011 2010 amounts in millions Interest expense Interactive Group $ (107 ) (163 ) (217 ) (310 ) Starz Group (2 ) (1 ) (3 ) (1 ) Capital Group (1 ) (10 ) (7 ) (33 ) Consolidated Liberty $ (110 ) (174 ) (227 ) (344 ) Share of earnings (losses) of affiliates Interactive Group $ 37 36 57 59 Starz Group - - - - Capital Group (22 ) 3 (50 ) (11 ) Consolidated Liberty $ 15 39 7 48 Realized and unrealized gains (losses) on financial instruments, net Interactive Group $ 89 7 10 32 Starz Group - - 1 (1 ) Capital Group 54 (88 ) 175 55 Consolidated Liberty $ 143 (81 ) 186 86 Gains (losses) on dispositions, net Interactive Group $ - - - 364 Starz Group - - (2 ) - Capital Group - 25 - 24 Consolidated Liberty $ - 25 (2 ) 388 Other, net Interactive Group $ 3 (21 ) 21 (43 ) Starz Group 2 - 2 - Capital Group 24 23 49 43 Consolidated Liberty $ 29 2 72 - Interest expense. Consolidated interest expense decreased $64 million and $117 million for the three and six months ended June 30, 2011, respectively, as compared to the corresponding prior year period. The overall decreases in interest expense related to a lower average debt balance throughout the quarter and year, as compared to the corresponding prior year periods. Additionally, the interest expense by tracking stock groups has shifted to the Interactive Group as a result of the reattributions, previously described. I-41 -------------------------------------------------------------------------------- Share of earnings (losses) of affiliates. The following table presents our share of earnings (losses) of affiliates: Three months Six months ended ended June 30, June 30, 2011 2010 2011 2010 amounts in millions Interactive Group Expedia $ 35 28 48 42 Other 2 8 9 17 Capital Group Sirius (1 ) 8 (8 ) - Live Nation (22 ) - (45 ) - Other 1 (5 ) 3 (11 ) $ 15 39 7 48 During June 2011, Liberty acquired an additional 5.5 million shares of Live Nation which increased our ownership percentage above 20% of the outstanding voting shares. Due to the presumption that an entity with an ownership percentage greater than 20% has significant influence and no other factors would rebut that presumption, the Company is accounting for the investment as an equity method affiliate. The Company has elected to record its share of earnings (loss) for Live Nation on a three-month lag due to timeliness considerations. Increases in ownership which result in a change to the equity method of accounting generally require retroactive recognition of an investment's share of earnings (loss) in prior periods. Due to the relative insignificance of our share of losses for Live Nation in previous periods, both quantitatively and qualitatively, the Company has recorded such amounts in the current year. Approximately $12 million of the losses recorded for the six months ended June 30, 2011 relate to the prior year. Realized and unrealized gains (losses) on financial instruments. Realized and unrealized gains (losses) on financial instruments are comprised of changes in the fair value of the following: Three months Six months ended ended June 30, June 30, 2011 2010 2011 2010 amounts in millions Non-strategic Securities $ 138 (179 ) 429 30 Exchangeable senior debentures 22 86 (165 ) 16 Equity collars(1) - (4 ) - (2 ) Borrowed shares(1) (23 ) 64 (118 ) 61 Other derivatives 6 (48 ) 40 (19 ) $ 143 (81 ) 186 86 -------------------------------------------------------------------------------- º (1) º Changes in fair value are due primarily to changes in the market prices of the underlying marketable securities. Gains (losses) on dispositions. Gains on dispositions in 2010 include a $178 million gain related to the Ticketmaster and Live Nation merger, a gain related to the sale of our GSI commerce shares of $132 million and a gain of $53 million related to the disposition of IAC shares. I-42 -------------------------------------------------------------------------------- Income taxes. Our effective tax rate for the six months ended June 30, 2011 is 39% which is greater than the U.S. federal income tax rate of 35% primarily due to the impact of state taxes. Additionally, the net direct tax impacts of $110 million arising from the sale of a 25% noncontrolling interest in a consolidated subsidiary was recorded as a reduction to equity in accordance with relevant accounting guidance for noncontrolling interests. The tax attributes relating to the remaining 75% of equity of this consolidated subsidiary have not been reflected in our deferred taxes. Net earnings. We had net earnings of $668 million and $440 million for the six months ended June 30, 2011 and 2010, respectively. The change in net earnings was the result of the above-described fluctuations in our revenue, expenses and other gains and losses. Material Changes in Financial Condition While the Interactive Group, the Starz Group and the Capital Group are not separate legal entities and the assets and liabilities attributed to each group remain assets and liabilities of our consolidated company, we manage the liquidity and financial resources of each group separately. Keeping in mind that assets of one group may be used to satisfy liabilities of one of the other groups, the following discussion assumes, consistent with management expectations, that future liquidity needs of each group will be funded by the financial resources attributed to each respective group. As of June 30, 2011 substantially all of our cash and cash equivalents are invested in U.S. Treasury securities, other government securities or government guaranteed funds, AAA rated money market funds and other highly rated financial and corporate debt instruments. The following are potential sources of liquidity for each group to the extent the identified asset or transaction has been attributed to such group: available cash balances, cash generated by the operating activities of our privately-owned subsidiaries (to the extent such cash exceeds the working capital needs of the subsidiaries and is not otherwise restricted), proceeds from asset sales, monetization of our public investment portfolio (including derivatives), debt and equity issuances, and dividend and interest receipts. Standard & Poor's Ratings Services and Moody's Investors Services put our corporate ratings on credit watch with developing implications and possible downgrade, respectively, following the Company's announcement of the proposed split-off in June of 2010. During the second quarter of 2011 Standard & Poor's Ratings Services placed our corporate rating on credit watch positive with a likely upgrade to BB with a stable outlook upon the completion of the proposed split-off. In the event we need to obtain external debt financing, these ratings could hurt our ability to obtain financing and could increase the cost of any financing we are able to obtain. Consolidated Liberty. As of June 30, 2011 Liberty had a cash balance of $3,414 million along with additional sources of liquidity of $372 million in short term marketable securities and $2,516 million of unpledged Non-strategic AFS securities. To the extent the Company recognizes any taxable gains from the sale of assets, including in the settlement of derivative instruments, we may incur tax expense and be required to make tax payments, thereby reducing any cash proceeds. Further, our operating businesses have provided, on average, more than $1 billion in annual operating cash flow over the prior three years and we do not anticipate any significant reductions in that amount in future years, with the exception of the impacts to operating cash flow from the proposed split-off. The projected uses of Liberty cash are the costs to service outstanding debt, continued capital improvement spending and the potential buyback of common stock under the approved share buyback programs. We also may be required to make net payments of income tax liabilities to settle items under discussion with tax authorities. Additionally, we may make investments in existing or new businesses. In May 2011, we made a proposal to acquire a 70% equity ownership interest in Barnes & Noble Inc. for $17 per share in cash. The proposal is subject to various conditions, including satisfactory financing and I-43 -------------------------------------------------------------------------------- the participation of founding chairman Leonard Riggio, both in terms of his continuing equity ownership and his continuing role in management. If this transaction is consummated, we expect that our cash contribution toward the purchase price, depending on the amount of financing that can be obtained, will be in the range of $500 million. Interactive Group. During the six months ended June 30, 2011, the Interactive Group's primary uses of cash were $393 million of debt repayments and $103 million of capital expenditures. These uses of cash were funded primarily with $264 million of cash reattributed from the Capital Group from the TWX Reattribution, $192 million in borrowings and $348 million of cash provided by operating activities, which is net of $138 million of intercompany tax payments to the Capital Group. The projected uses of Interactive Group cash for the remainder of 2011 include approximately $190 million for interest payments on QVC and parent debt attributed to the Interactive Group, $250 million for capital expenditures, additional tax payments to the Capital Group and potential payments to settle outstanding put options on Liberty Interactive Group common stock. In addition, we may make repurchases of Liberty Interactive common stock and additional investments in existing or new businesses and attribute such investments to the Interactive Group. We expect that the Interactive Group will fund its 2011 cash needs with cash on hand and cash provided by operating activities. At June 30, 2011, the Interactive Group's sources of liquidity include $1,312 million in cash and $1,258 of unpledged Non-strategic AFS securities. In addition, at June 30, 2011, unused capacity under the QVC Bank Credit Facilities aggregated $1,389 million. QVC was in compliance with its debt covenants as of June 30, 2011. Starz Group. During the six months ended June 30, 2011, the Starz Group's primary uses of cash were $77 million related to investments in original programming and other entertainment content and $57 million for payments on outstanding debt. The uses of cash were funded by cash on hand and cash from operations. As of June 30, 2011, the Starz Group had a cash balance of $1,035 million. The projected uses of Starz Group cash in 2011 include continued investment in original programming and other entertainment content. In addition, we may make additional repurchases of Liberty Starz common stock and additional investments in existing or new businesses and attribute such investments to the Starz Group. We expect that we will be able to use a combination of cash on hand and cash from operations to fund Starz Group cash needs in 2011. Capital Group. During the six months ended June 30, 2011, the Capital Group's primary uses of cash were $264 million of cash reattributed to the Interactive Group related to the TWX Reattribution, purchases of $134 million in short term marketable securities and $96 million for repurchases of Liberty Capital common stock. The uses of cash were funded by cash on hand and cash from operations. The projected uses of Capital Group cash for the remainder of 2011 are not expected to be significant. We note the attributed outstanding debt of $750 million is due in March of 2012. Restricted cash of $638 million (at June 30, 2011) and a basket of AFS debt securities are available to satisfy that obligation at maturity. We also may be required to make net payments of income tax liabilities to settle items under discussion with tax authorities. We may make additional repurchases of Liberty Capital common stock and additional investments in existing or new businesses. In May 2011, we made a proposal to acquire a 70% equity ownership interest in Barnes & Noble Inc. for $17 per share in cash. The proposal is subject to various conditions, including satisfactory financing and the participation of founding chairman Leonard Riggio, both in terms of his continuing equity ownership and his continuing role in management. If this transaction is consummated, we expect that our cash contribution toward the purchase price, depending on the amount of financing that can be obtained, will be in the range of $500 million. I-44 -------------------------------------------------------------------------------- We expect that the Capital Group's investing and financing activities will be funded with a combination of cash on hand, net tax payments from the Interactive Group and the Starz Group and dispositions of non-strategic assets. At June 30, 2011, the Capital Group's sources of liquidity include $1,067 million in cash, $192 million in short term marketable securities and $1,194 million of unpledged non-strategic AFS securities. To the extent the Capital Group recognizes any taxable gains from the sale of assets, including in the settlement of derivative instruments, we may incur current tax expense and be required to make tax payments, thereby reducing any cash proceeds attributable to the Capital Group. Results of Operations-Tracking Stock Groups Interactive Group The Interactive Group consists of our subsidiaries QVC, Provide, Backcountry, Bodybuilding and Celebrate, our interests in Expedia, HSN, Interval, Lending Tree and $4,201 million principal amount (as of June 30, 2011) of our publicly-traded debt. The following discussion and analysis provides information concerning the results of operations of the Interactive Group. This discussion should be read in conjunction with (1) our condensed consolidated financial statements and notes thereto included elsewhere in this Quarterly Report on Form 10-Q and (2) the Unaudited Attributed Financial Information for Tracking Stock Groups filed as Exhibit 99.1 to this Quarterly Report on Form 10-Q. Results of Operations Three months Six months ended ended June 30, June 30, 2011 2010 2011 2010 amounts in millions Revenue QVC $ 1,898 1,758 3,733 3,515 E-commerce businesses 347 295 671 563 Corporate and other - - - - $ 2,245 2,053 4,404 4,078 Adjusted OIBDA QVC $ 418 403 781 769 E-commerce businesses 36 28 65 46 Corporate and other (4 ) (3 ) (18 ) (6 ) $ 450 428 828 809 Operating Income (Loss) QVC $ 281 270 506 502 E-commerce businesses 19 8 27 12 Corporate and other (12 ) (4 ) (32 ) (22 ) $ 288 274 501 492 Operating Results by Business QVC. QVC is a retailer of a wide range of consumer products, which are marketed and sold primarily by merchandise-focused televised shopping programs and via the Internet. In the United States, QVC's live programming is distributed via its nationally televised shopping program 24 hours a I-45 -------------------------------------------------------------------------------- day, 364 days a year ("QVC-US"). Internationally, QVC's program services are based in the United Kingdom ("QVC-UK"), Germany ("QVC-Germany"), Japan ("QVC-Japan") and Italy ("QVC-Italy"). QVC-UK distributes its program 24 hours a day with 17 hours of live programming and QVC-Germany and QVC-Japan each distribute live programming 24 hours a day. QVC-Italy launched on October 1, 2010 and is distributing programming live for 17 hours a day on satellite and public television and an additional 7 hours a day of recorded programming on satellite television. QVC's operating results are as follows: Three months Six months ended ended June 30, June 30, 2011 2010 2011 2010 amounts in millions Net revenue $ 1,898 1,758 3,733 3,515 Cost of sales (1,183 ) (1,105 ) (2,363 ) (2,230 ) Gross profit 715 653 1,370 1,285 Operating expenses (183 ) (166 ) (358 ) (331 ) SG&A expenses (excluding stock-based compensation (114 ) (84 ) (231 ) (185 ) Adjusted OIBDA 418 403 781 769 Stock-based compensation-SG&A (6 ) (4 ) (10 ) (9 ) Depreciation and amortization (131 ) (129 ) (265 ) (258 ) Operating income $ 281 270 506 502 Net revenue is generated in the following geographical areas: Three months Six months ended ended June 30, June 30, 2011 2010 2011 2010 amounts in millions QVC-US $ 1,232 1,193 2,424 2,349 QVC-UK 154 135 292 262 QVC-Germany 237 196 505 436 QVC-Japan 269 234 502 468 QVC-Italy 6 - 10 - $ 1,898 1,758 3,733 3,515 QVC's consolidated net revenue increased 8.0% and 6.2% during the three and six months ended June 30, 2011, respectively, as compared to the prior year period. The three month increase in net revenue is comprised of $80 million due to a 4.1% increase in the average sales price per unit ("ASP"), $72 million due to favorable foreign currency rates in all international markets and $17 million due to a 0.9% increase in units sold from 39.1 million to 39.4 million. These increases were partially offset by a $29 million increase in estimated product returns. Returns as a percent of gross product revenue increased to 19.7% from 19.1%. The six month increase in net revenue is comprised of $158 million due to a 4.1% increase in ASP, $94 million due to favorable foreign currency rates in all international markets and $24 million due to a 0.6% increase in units sold from 76.2 million to 76.7 million. These increases were partially offset by a $50 million increase in product returns and an $8 million decrease in net shipping and handling revenue. Returns as a percent of gross product revenue increased to 19.6% from 19.2%. I-46 -------------------------------------------------------------------------------- During the three and six months ended June 30, 2011 and 2010, the changes in revenue and expenses were impacted by changes in the exchange rates for the UK pound sterling, the euro and the Japanese yen. In the event the U.S. dollar strengthens against these foreign currencies in the future, QVC's revenue and operating cash flow will be negatively impacted. The percentage increase (decrease) in revenue for each of QVC's geographic areas in U.S. dollars and in local currency is as follows: Percentage increase (decrease) in net revenue Three months Six months ended ended June 30, June 30, 2011 2011 U.S. dollars Local currency U.S. dollars Local currency QVC-US 3.3 % 3.3 % 3.2 % 3.2 % QVC-UK 14.1 % 3.9 % 11.5 % 4.6 % QVC-Germany 20.9 % 7.4 % 15.8 % 10.2 % QVC-Japan 15.0 % 1.5 % 7.3 % (3.8 )% On March 11, 2011 there was a significant earthquake in Japan. As a result, QVC-Japan was off-air for 12 days and experienced an interruption of its business. The facilities suffered moderate damage. QVC-Japan returned on-air and resumed operations on March 23, 2011. The earthquake and related events have impacted the three and six month periods ended June 30, 2011, however QVC-Japan experienced a steady recovery of sales in May and June 2011 as compared to the prior year periods. QVC-US growth in net revenue for the three month period ended June 30, 2011 is due primarily to an increase in ASP partially offset by a decrease in units sold, a decrease in shipping and handling revenue and an increase in returns associated with the sales increase. For the three months ended June 30, 2011, QVC-US shipped sales increased due to growth in sales of accessories, apparel and home décor. For the six months ended June 30, 2011, QVC-US shipped sales increased due to growth in sales of accessories, apparel, electronics, kitchen and home décor. Jewelry sales declined in both periods. The decrease in shipping and handling is due to increased use of free shipping and handling promotions which are most often subsidized by the vendors or included in the margin. For the three month period, return rates increased slightly from 18.4% to 18.5% but for the six month period, declined from 18.5% to 18.3%. QVC-UK's growth for the three and six months ended June 30, 2011 is the result of increased sales in the apparel product category. QVC-Germany experienced growth in all product categories, with the exception of electronics and beauty in both periods. QVC-Germany's sales growth was somewhat offset by a higher return rate in both periods. For the three months ended June 30, 2011, QVC-Japan experienced growth in apparel. QVC-Italy's sales consisted of primarily home and beauty products. The QVC service is already received by substantially all of the cable television and direct broadcast satellite homes in the U.S., the UK and Germany. In addition, in Japan, analog customers are expected to be converted to a digital environment beginning in July 2011, with that conversion to be completed by 2015. We believe that it is likely that such analog switch-off will have a negative impact on the overall number of subscribers viewing the program. QVC is currently evaluating the possible impact on QVC-Japan's results as well as opportunities to acquire subscribers via other distribution channels that will aid in mitigating the impact of the conversion. QVC's future sales growth will primarily depend on expansions into new countries, sales growth from its e-commerce and mobile platforms, additions of new customers from homes already receiving the QVC service and growth in sales to existing customers. QVC's future sales may also be affected by (i) the willingness of cable and satellite distributors to continue carrying QVC's programming service, (ii) QVC's ability to maintain favorable channel positioning, which may become more difficult as distributors convert analog customers to I-47 -------------------------------------------------------------------------------- digital, (iii) changes in television viewing habits because of personal video recorders, video-on-demand and IP television and (iv) general economic conditions. QVC's gross profit percentage increased from 37.1% to 37.7% and from 36.6% to 36.7% during the three and six months ended June 30, 2011. For the three months ended June 30, 2011 the increase is due primarily to higher initial product margins in the home and jewelry areas and to a lesser extent, accessories. This favorability was partially offset by higher inventory obsolescence provisions. Freight expenses contributed favorably to both the three and six months ended June 30, 2011 in part due to less units shipped and additional vendor subsidies. QVC's operating expenses are principally comprised of commissions, order processing and customer service expenses, credit card processing fees, telecommunications expense and production costs. Operating expenses increased 10.2% and 8.2% for the three and six month periods ended June 30, 2011, as compared to the prior year period. Included in these increases is growth of $4 million and $8 million for the three and six months ended June 30, 2011, respectively related to QVC-Italy operations. Other increases include an increase in commissions expense due to sales growth, an increase in production personnel expenses and an increase in credit card fees due to sales growth as well as an increase in rates. QVC's SG&A expenses include personnel, information technology, provision for doubtful accounts, credit card income and marketing and advertising expenses. Such expenses increased as a percent of net revenue from 4.8% to 6.0% for the three months ended June 30, 2011 and from 5.3% to 6.2% for the six months ended June 30, 2011. Included in QVC's SG&A results are $9 million and $3 million of costs for three months ended June 30, 2011 and 2010, respectively, and $15 million and $6 million of costs for the six months ended June 30, 2011 and 2010, respectively, related to the launch of the QVC-Italy service. QVC-Italy incurred an adjusted OIBDA loss for the three months ended June 30, 2011 and 2010 of $13 million and $5 million, respectively, and $23 million and $9 million for the six months ended June 30, 2011 and 2010, respectively. Net credit card operations income decreased $6 million and $12 million for the three months ended and the six months ended June 30, 2011, compared to the prior year period. Effective August 2, 2010, upon the expiration of the existing contract, QVC entered into a new agreement with GE Money Bank, which provides revolving credit directly to QVC customers solely for the purchase of merchandise from QVC. Under the new agreement QVC receives a portion of the economics from the credit card program according to percentages that vary with the performance of the portfolio. The new agreement, which will expire in August 2015, is substantially different than the expired agreement between the parties. QVC's operating income (and adjusted OIBDA) will be negatively impacted due to the terms of the new agreement. However, QVC has used the $501 million of cash proceeds from the recovery of its noninterest bearing cash deposit maintained at GE Money Bank in connection with the prior arrangement to retire a portion of its outstanding bank facility in 2010. QVC's net credit card income would have been $9 million and $19 million more favorable for the three months and six months ended June 30, 2011, respectively, based on the terms of the expired contract compared to the new contract. Excluding the impacts of QVC-Italy, foreign currency exchange and net credit card operations, QVC's SG&A expense increased $13 million or 12.7% for the three months ended June 30, 2011 and $18 million or 8.2% for the six months ended June 30, 2011. The increase was the result of increased spending in a variety of categories including personnel, outside services, franchise taxes, online marketing and public relations events. E-commerce businesses. Our e-commerce businesses are comprised primarily of Provide, Backcountry, Bodybuilding and Celebrate. Revenue for the e-commerce businesses is seasonal due to I-48 -------------------------------------------------------------------------------- certain holidays, which drive a significant portion of the e-commerce businesses' revenue. The third quarter is generally lower, as compared to the other three quarters, due to fewer holidays. Revenue increased $52 million and $108 million for the three and six months ended June 30, 2011, as compared to the corresponding prior year periods. Each of our respective e-commerce businesses reported an increase in revenue for the three and six months ended June 30, 2011 as compared to the corresponding prior year periods. Such increases are the result of acquisitions and deconsolidations, increased marketing efforts and increased conversion due to site optimization and broader inventory offerings. Adjusted OIBDA for the e-commerce businesses increased $8 million and $19 million for the three and six month periods in 2011 and represented 10.4% and 9.7% of revenue in 2011, respectively, as compared to 9.5% and 8.2% in 2010, respectively. Starz Group The Starz Group is primarily comprised of our subsidiary Starz and $1,035 million of cash, including subsidiary cash. The following discussion and analysis provides information concerning the attributed results of operations of the Starz Group. This discussion should be read in conjunction with (1) our condensed consolidated financial statements and notes thereto included elsewhere in this Quarterly Report on Form 10-Q and (2) the Unaudited Attributed Financial Information for Tracking Stock Groups filed as Exhibit 99.1 to this Quarterly Report on Form 10-Q. Results of Operations Three months Six months ended ended June 30, June 30, 2011 2010 2011 2010 amounts in millions Revenue Starz, LLC $ 403 308 794 613 Corporate and other - 3 1 5 $ 403 311 795 618 Adjusted OIBDA Starz, LLC $ 118 107 249 213 Corporate and other (1 ) (4 ) (6 ) (7 ) $ 117 103 243 206 Operating Income (Loss) Starz, LLC $ 112 102 236 201 Corporate and other (4 ) (6 ) (12 ) (13 ) $ 108 96 224 188 Starz, LLC. Starz provides premium networks distributed by cable operators, direct-to-home satellite providers, telephone companies and other distributors in the United States and develops, produces and acquires entertainment content and distributes such content to consumers in the United States and throughout the world. Additionally, as of September 30, 2010, Starz includes the remaining operations of Starz Media. Starz is managed based on the following lines of business: Starz Channels (legacy Starz Entertainment business, excluding ancillary revenue and expenses related to original programming) and Home Video, Television, Digital Media and Animation (legacy Starz Media businesses). We believe, with the decisions that have been made surrounding the legacy Starz Media businesses, the prospective results of Starz will be largely driven by the results of Starz Channels. I-49 -------------------------------------------------------------------------------- A large portion of Starz's revenue is derived from the delivery of movies and original programming content to consumers through the Starz Channels' distribution partners. Some of Starz's affiliation agreements with its distribution partners provide for payments to Starz based on the number of subscribers that receive the Starz Channels' services ("consignment agreements"). Starz also has fixed-rate affiliation agreements with certain of its distribution partners. Pursuant to these agreements, the distribution partners pay an agreed-upon rate regardless of the number of subscribers. The agreed-upon rate may be increased annually to the extent the contract provides for an increase. The affiliation agreements expire in 2011 through 2018. During the quarter ended June 30, 2011, approximately 54% of the Starz Channels' revenue was generated by its three largest customers, Comcast, DIRECTV and Dish Network, each of which individually generated 10% or more of the Starz Channels' revenue for such period. Starz's operating results are as follows: Three months Six months ended ended June 30, June 30, 2011 2010 2011 2010 amounts in millions Revenue $ 403 383 794 829 Operating expenses (233 ) (270 ) (428 ) (506 ) SG&A expenses (52 ) (65 ) (117 ) (175 ) Adjusted OIBDA 118 48 249 148 Stock-based compensation (2 ) 1 (3 ) (3 ) Depreciation and amortization (4 ) (6 ) (10 ) (11 ) Operating income $ 112 43 236 134 As discussed above, the results for Starz for the three and six months ended June 30, 2011 include the legacy Starz Entertainment business operations and the legacy Starz Media business operations, due to the Starz Media Reattribution (effective as of September 30, 2010). For discussion purposes, the historical results for the Starz Media legacy businesses have been combined with the historical results of the Starz Entertainment legacy businesses, including the impacts of intercompany eliminations, for the three and six months ended June 30, 2010. Starz's revenue increased $20 million and decreased $35 million for the three and six months ended June 30, 2011, respectively, as compared to the corresponding prior year periods. Revenue for the three months increased as a result of an $8 million increase due to higher effective rate for the Starz Channels' services, $6 million due to growth in the average number of subscriptions and $3 million in additional ancillary revenue related to international television distribution rights and home video for Starz original content. The remaining increase was primarily attributable to the home video performance of "The Kings Speech" distributed for the Weinstein Company in the current period which was partially offset by no theatrical releases of films in 2011. The decrease in revenue for the six months ended June 30, 2011 as compared to the prior year was primarily attributable to no theatrical films released in 2011 as compared to two in 2010 and a decrease in the number of theatrical films released on home video. The overall decrease was partially offset by revenue growth resulting from a $10 million increase due to higher effective rate for the Starz Channels' services, $14 million due to growth in the average number of subscriptions and $14 million in additional ancillary revenue related to international television distribution rights and home video for Starz original content. Starz, Encore, and the Encore thematic multiplex channels ("EMP") are the primary drivers of Starz's revenue. Starz average subscriptions increased 9.7% and 9.0% for the three and six months ended June 30, 2011 compared to the corresponding period of 2010 and EMP average subscriptions increased 4.7% and 5.6% for the three and six months ended June 30, 2011 compared to the I-50 -------------------------------------------------------------------------------- corresponding period of 2010. The impact on revenue due to subscription increases is affected by the relative percentages of increases under consignment agreements and fixed-rate agreements. In this regard, as of June 30, 2011 subscriptions under fixed-rate agreements were 28.5 million while subscriptions under consignment agreements were 23.4 million. As of June 30, 2010, subscriptions under fixed-rate affiliation agreements were 26.6 million while subscriptions under consignment agreements were 22.7 million. Operating expenses decreased by $37 million and $78 million for the three and six months ended June 30, 2011 as compared to the corresponding prior year periods. Approximately $48 million and $91 million of such decrease, respectively, was the result of lower production and acquisition costs, lower home video costs and no theatrical releases in the current period. These operating expense decreases were partially offset by increases, related to the Starz Channels, of 4.7% and 1.7% for the three and six months ended June 30, 2011 as compared to the corresponding prior year periods. Programming expenses are Starz's primary operating expense and totaled approximately $164 million and $312 million for the three and six months ended June 30, 2011 and $156 million and $307 million for the three and six months ended June 30, 2010. We expect that programming costs related to original programming will continue to increase in the future as Starz continues to invest in original content. Starz's SG&A expenses decreased by $13 million and $58 million for the three and six months ended June 30, 2011 as compared to the corresponding prior year periods. The primary driver in decreased SG&A expenses as compared to the prior year periods was the decisions made regarding the theatrical film business. This decrease was partially offset by increased advertising expenses related to original programming content and increased personnel costs. Starz's Adjusted OIBDA increased $70 million and $101 million for the three and six months ended June 30, 2011 as compared to the corresponding prior year periods. The increase in Adjusted OIBDA was a combination of improved results by the Starz Channels business and the decisions made regarding the Theatrical film business in the prior year. As discussed above, the elimination of theatrical film releases and fewer theatrical home video releases resulted in less revenue which was more than offset by no spending in the current period on marketing and advertising associated with the theatrical exhibition of such productions, lower production and acquisition costs and lower home video costs. Capital Group The Capital Group is comprised of our subsidiaries, assets and liabilities not attributed to the Interactive Group or the Starz Group, including controlling interests in ANLBC and TruePosition as well as minority investments in SiriusXM, Live Nation, Time Warner Inc., Time Warner Cable Inc., Sprint and other public and private companies. In addition, we have attributed $1,067 million of cash, including subsidiary cash, and $750 million principal amount (as of June 30, 2011) of our parent debt to the Capital Group. The following discussion and analysis provides information concerning the attributed results of operations of the Capital Group. This discussion should be read in conjunction with (1) our condensed consolidated financial statements and notes thereto included elsewhere in this Quarterly Report on I-51 -------------------------------------------------------------------------------- |