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NEWS CORP - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) This document contains statements that constitute "forward-looking statements" within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and Section 27A of the Securities Act of 1933, as amended. The words "expect," "estimate," "anticipate," "predict," "believe" and similar expressions and variations thereof are intended to identify forward-looking statements. These statements appear in a number of places in this document and include statements regarding the intent, belief or current expectations of News Corporation, its directors or its officers with respect to, among other things, trends affecting News Corporation's financial condition or results of operations. The readers of this document are cautioned that any forward-looking statements are not guarantees of future performance and involve risks and uncertainties. More information regarding these risks, uncertainties and other factors is set forth under the heading Part II "Other Information," Item 1A "Risk Factors" in this report. News Corporation does not ordinarily make projections of its future operating results and undertakes no obligation (and expressly disclaims any obligation) to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law. Readers should carefully review this document and the other documents filed by News Corporation with the Securities and Exchange Commission ("SEC"). This section should be read together with the unaudited consolidated financial statements of News Corporation and related notes set forth elsewhere herein and News Corporation's Annual Report on Form 10-K for the fiscal year ended June 30, 2012 as filed with the SEC on August 14, 2012 and as amended on October 1, 2012 (the "2012 Form 10-K"). INTRODUCTION Management's discussion and analysis of financial condition and results of operations is intended to help provide an understanding of News Corporation and its subsidiaries' (together, "News Corporation" or the "Company") financial condition, changes in financial condition and results of operations. This discussion is organized as follows: • Overview of the Company's Business-This section provides a general description of the Company's businesses, as well as developments that have occurred to date during fiscal 2013 that the Company believes are important in understanding its results of operations and financial condition or to disclose known trends. • Results of Operations-This section provides an analysis of the Company's results of operations for the three months ended September 30, 2012 and 2011. This analysis is presented on both a consolidated and a segment basis. In addition, a brief description is provided of significant transactions and events that have an impact on the comparability of the results being analyzed. • Liquidity and Capital Resources-This section provides an analysis of the Company's cash flows for the three months ended September 30, 2012 and 2011. Included in the discussion of outstanding debt is a discussion of the amount of financial capacity available to fund the Company's future commitments and obligations, as well as a discussion of other financing arrangements. OVERVIEW OF THE COMPANY'S BUSINESS The Company is a diversified global media company, which manages and reports its businesses in the following six segments: • Cable Network Programming, which principally consists of the production and licensing of programming distributed through cable television systems and direct broadcast satellite operators primarily in the United States, Latin America, Europe and Asia. • Filmed Entertainment, which principally consists of the production and acquisition of live-action and animated motion pictures for distribution and licensing in all formats in all entertainment media worldwide, and the production and licensing of television programming worldwide. • Television, which principally consists of the broadcasting of network programming in the United States and the operation of 27 full power broadcast television stations, including 9 duopolies, in the United States (of these stations, 17 are affiliated with the FOX Broadcasting Company ("FOX") and 10 are affiliated with Master Distribution Service, Inc. ("MyNetworkTV")). • Direct Broadcast Satellite Television, which consists of the distribution of basic and premium programming services via satellite and broadband directly to subscribers in Italy. 39 -------------------------------------------------------------------------------- Table of Contents • Publishing, which principally consists of the Company's newspapers and information services, book publishing and integrated marketing services businesses. The newspapers and information services business principally consists of the publication of national newspapers in the United Kingdom, the publication of approximately 140 newspapers in Australia, the publication of a metropolitan newspaper and a national newspaper (with international editions) in the United States and the provision of information services. The book publishing business consists of the publication of English language books throughout the world and the integrated marketing services business consists of the publication of free-standing inserts and the provision of in-store marketing products and services in the United States and Canada. • Other, which principally consists of the Company's digital media properties and Amplify, the Company's education technology businesses. Television and Cable Network Programming The Company's television operations primarily consist of FOX, MyNetworkTV and the 27 television stations owned by the Company. The television operations derive revenues primarily from the sale of advertising and to a lesser extent retransmission consent revenue. Adverse changes in general market conditions for advertising may affect revenues. The U.S. television broadcast environment is highly competitive and the primary methods of competition are the development and acquisition of popular programming. Program success is measured by ratings, which are an indication of market acceptance, with the top rated programs commanding the highest advertising prices. FOX is a broadcast network and MyNetworkTV is a programming distribution service, airing original and off-network programming. FOX and MyNetworkTV compete with broadcast networks, such as ABC, CBS, NBC and The CW Television Network, independent television stations, cable and Direct Broadcast Satellite Television program services, as well as other media, including DVDs, Blu-rays, video games, print and the Internet for audiences, programming and, in the case of FOX, advertising revenues. In addition, FOX and MyNetworkTV compete with the other broadcast networks and other programming distribution services to secure affiliations with independently owned television stations in markets across the United States. ABC, NBC and CBS each broadcasts a significantly greater number of hours of programming than FOX and, accordingly, may be able to designate or change time periods in which programming is to be broadcast with greater flexibility than FOX. In addition, future technological developments may affect competition within the television marketplace. Retransmission consent rules provide a mechanism for the television stations owned by the Company to seek and obtain payment from multi-channel video programming distributors who carry broadcasters' signals. Retransmission consent revenue consists of per subscriber-based compensatory fees paid to the Company from cable and satellite distribution systems for FOX and MyNetworkTV as well as a portion of the retransmission consent revenue the affiliates generate for their retransmission of FOX. The television stations owned and operated by the Company compete for programming, audiences and advertising revenues with other television stations and cable networks in their respective coverage areas and, in some cases, with respect to programming, with other station groups, and in the case of advertising revenues, with other local and national media. The competitive position of the television stations owned by the Company is largely influenced by the quality and strength of FOX and MyNetworkTV programming, and, in particular, the prime-time viewership of the respective network. The Company's U.S. cable network operations primarily consist of the Fox News Channel ("FOX News"), FX Networks, LLC ("FX"), Regional Sports Networks ("RSNs"), the National Geographic Channels, SPEED and the Big Ten Network. The Company's international cable networks consist of the Fox International Channels ("FIC") and STAR. FIC produces and distributes entertainment, factual, sports, and movie channels through distribution channels in Europe, Africa, Asia and Latin America using several brands, including Fox, Fox Crime, Fox Life and National Geographic Channel. STAR's owned and affiliated channels are distributed in the following countries and regions: India; Greater China; Indonesia; the rest of South East Asia; Pakistan; the Middle East and Africa; the United Kingdom and Europe; and North America. Generally, the Company's cable networks, which target various demographics, derive a majority of their revenues from monthly affiliate fees received from cable television systems and direct broadcast satellite operators based on the number of their subscribers. Affiliate fee revenues are net of the amortization of cable distribution investments (capitalized fees paid to multi-channel video programming distributors to typically facilitate the carriage of a cable network). The Company defers the cable distribution investments and amortizes the amounts on a straight-line basis over the contract period. Cable television and direct broadcast satellite are currently the predominant means of distribution of the Company's program services in the United States. Internationally, distribution technology varies region by region. 40 -------------------------------------------------------------------------------- Table of Contents The Company's cable networks compete for carriage on cable television systems, direct broadcast satellite systems and other distribution systems with other program services. A primary focus of competition is for distribution of the Company's cable network channels that are not already distributed by particular cable television or direct broadcast satellite systems. For such program services, distributors make decisions on the use of bandwidth based on various considerations, including amounts paid by programmers for launches, subscription fees payable by distributors and appeal to the distributors' subscribers. The most significant operating expenses of the Television segment and the Cable Network Programming segment are the acquisition and production expenses related to programming and the expenses related to operating the technical facilities of the broadcaster or cable network. Other expenses include promotional expenses related to improving the market visibility and awareness of the broadcaster or cable network and its programming. Additional expenses include sales commissions paid to the in-house advertising sales force, as well as salaries, employee benefits, rent and other routine overhead expenses. The Company has several multi-year sports rights agreements, including contracts with the National Football League ("NFL") through fiscal 2022, contracts with the National Association of Stock Car Auto Racing ("NASCAR") for certain races and exclusive rights for certain ancillary content through calendar year 2022, a contract with Major League Baseball ("MLB") through calendar year 2021 and other sports rights contracts. These contracts provide the Company with the broadcast rights to certain U.S. national sporting events during their respective terms. The costs of these sports contracts are charged to expense based on the ratio of each period's operating profit to estimated total operating profit for the remaining term of the contract. The profitability of these long-term U.S. national sports contracts is based on the Company's best estimates at September 30, 2012 of attributable revenues and costs; such estimates may change in the future and such changes may be significant. Should revenues decline from estimates applied at September 30, 2012, additional amortization of rights may be recorded. Should revenues improve as compared to estimated revenues, the Company may have an improved operating profit related to the contract, which may be recognized over the remaining contract term. While the Company seeks to ensure compliance with federal indecency laws and related Federal Communications Commission ("FCC") regulations, the definition of "indecency" is subject to interpretation and there can be no assurance that the Company will not broadcast programming that is ultimately determined by the FCC to violate the prohibition against indecency. Such programming could subject the Company to regulatory review or investigation, fines, adverse publicity or other sanctions, including the loss of station licenses. Filmed Entertainment The Filmed Entertainment segment derives revenue from the production and distribution of live-action and animated motion pictures and television series. In general, motion pictures produced or acquired for distribution by the Company are exhibited in U.S. and foreign theaters, followed by home entertainment, including sale and rental of DVDs and Blu-rays, video-on-demand and pay-per-view television, on-line and mobile distribution, premium subscription television, network television and basic cable and syndicated television exploitation. Television series initially produced for the networks and first-run syndication are generally licensed to domestic and international markets concurrently and subsequently released in seasonal DVD and Blu-ray box sets and made available via digital distribution platforms. More successful series are later syndicated in domestic markets. The length of the revenue cycle for television series will vary depending on the number of seasons a series remains in active production and, therefore, may cause fluctuations in operating results. License fees received for television exhibition (including international and U.S. premium television and basic cable television) are recorded as revenue in the period that licensed films or programs are available for such exhibition, which may cause substantial fluctuations in operating results. The revenues and operating results of the Filmed Entertainment segment are significantly affected by the timing of the Company's theatrical and home entertainment releases, the number of its original and returning television series that are aired by television networks and the number of its television series in off-network syndication. Theatrical and home entertainment release dates are determined by several factors, including timing of vacation and holiday periods and competition in the marketplace. The distribution windows for the release of motion pictures theatrically and in various home entertainment products and services (including subscription rentals, rental kiosks and Internet streaming services), have been compressing and may continue to change in the future. A further reduction in timing between theatrical and home entertainment releases could adversely affect the revenues and operating results of this segment. The Company enters into arrangements with third parties to co-produce many of its theatrical productions. These arrangements, which are referred to as co-financing arrangements, take various forms. The parties to these arrangements include studio and non-studio entities, both domestic and foreign. In several of these agreements, other parties control certain distribution rights. The Filmed Entertainment segment records the amounts received for the sale of an economic interest as a reduction of the cost of the film, as the 41 -------------------------------------------------------------------------------- Table of Contents investor assumes full risk for that portion of the film asset acquired in these transactions. The substance of these arrangements is that the third-party investors own an interest in the film and, therefore, receive a participation based on the respective third-party investor's interest in the profits or losses incurred on the film. Consistent with the requirements of Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") 926 "Entertainment-Films" ("ASC 926"), the estimate of a third-party investor's interest in profits or losses incurred on the film is determined by reference to the ratio of actual revenue earned to date in relation to total estimated ultimate revenues. Operating costs incurred by the Filmed Entertainment segment include: exploitation costs, primarily theatrical prints and advertising and home entertainment marketing and manufacturing costs; amortization of capitalized production, overhead and interest costs; and participations and talent residuals. Selling, general and administrative expenses include salaries, employee benefits, rent and other routine overhead. The Company competes with other film studios, such as Disney, Paramount, Sony, Universal, Warner Bros. and independent film producers in the production and distribution of motion pictures, DVDs and Blu-rays. As a producer and distributor of television programming, the Company competes with studios, television production groups and independent producers and syndicators, such as Disney, Sony, NBC Universal, Warner Bros. and Paramount Television, to sell programming both domestically and internationally. The Company also competes to obtain creative talent and story properties, which are essential to the success of the Company's filmed entertainment businesses. Direct Broadcast Satellite Television The Direct Broadcast Satellite Television ("DBS") segment's operations consist of SKY Italia, which provides basic and premium programming services via satellite directly to subscribers in Italy. SKY Italia derives revenues principally from subscriber fees. The Company believes that the quality and variety of programming, audio and interactive programming including personal video recorders, quality of picture including high definition channels, access to service, customer service and price are the key elements for gaining and maintaining market share. SKY Italia's competition includes companies that offer video, audio, interactive programming, telephony, data and other information and entertainment services, including broadband Internet providers, digital terrestrial transmission ("DTT") services, wireless companies and companies that are developing new media technologies. SKY Italia's most significant operating expenses are those related to the acquisition of entertainment, movie and sports programming and subscribers and the expenses related to operating the technical facilities. Operating expenses related to sports programming are generally recognized over the course of the related sport season, which may cause fluctuations in the operating results of this segment. The continued challenging economic environment in Italy has contributed to a reduction in consumer spending and has posed challenges for subscriber retention and growth. If this trend continues, it could have a material effect on the operating results of the DBS segment. Publishing The Company's Publishing segment consists of the Company's newspapers and information services, book publishing and integrated marketing services businesses and the related digital formats. Revenue is derived from the sale of advertising space, newspapers, books and subscriptions, as well as licensing. Adverse changes in general market conditions for advertising may affect revenues. Circulation and subscription revenues can be greatly affected by changes in the prices of the Company's and/or competitors' products, as well as by promotional activities. Operating expenses include costs related to paper, production, distribution, editorial, commissions and royalties. Selling, general and administrative expenses include promotional expenses, salaries, employee benefits, rent and other routine overhead. The Publishing segment's advertising volume, circulation, the price of paper and salaries and employee benefits are the key variables whose fluctuations can have a material effect on the Company's operating results and cash flow. The Company has to anticipate the level of advertising volume, circulation and paper prices in managing its businesses to maximize operating profit during expanding and contracting economic cycles. The Company continues to be exposed to risks associated with paper used for printing. Paper is a basic commodity and its price is sensitive to the balance of supply and demand. The Company's expenses are affected by the cyclical increases and decreases in the price of paper. The Publishing segment's products compete for readership and advertising with local and national competitors and also compete with other media alternatives in their respective markets. Competition for 42 -------------------------------------------------------------------------------- Table of Contents circulation and subscriptions is based on the content of the products provided, service, pricing and, from time to time, various promotions. The success of these products depends upon advertisers' judgments as to the most effective use of their advertising budgets. Competition for advertising is based upon the reach of the products, advertising rates and advertiser results. Such judgments are based on factors such as cost, availability of alternative media, distribution and quality of readership demographics. Like other newspaper publishing groups, the Company faces challenges to its traditional print business model from new media formats and shifting consumer preferences. The Company is also exposed to the impact of long-term structural movements in advertising spending as digital advertising rates are lower due to the additional supply of available advertisements, especially impacting classified advertising. These new media formats could impact the Company's performance, positively or negatively. As a multi-platform news provider, the Company recognizes the importance of maximizing revenues from new media, both in terms of paid-for content and in new advertising models, and continues to invest in its digital products. The development of technologies such as smartphones, tablets and similar devices and their related applications provides opportunities for the Company to make available its journalism to a new audience of readers, introduce new or different pricing schemes, develop its products to continue to attract advertisers and/or affect the relationship between publisher and consumer. The Company continues to develop and implement strategies to exploit its content in new media channels, including the introduction of paywalls around its newspaper websites. Other The Other segment consists primarily of: Digital Media Group The Company sells advertising, sponsorships and subscription services on the Company's various digital media properties. Significant expenses associated with the Company's digital media properties include development costs, advertising and promotional expenses, salaries, employee benefits and other routine overhead. Education Group Amplify, the Company's education technology businesses, is dedicated to improving K-12 education by creating digital products and services that empower teachers, students and parents in new ways. Amplify is focused on transforming teaching and learning by creating and scaling digital innovations in three areas: analytics and assessment, content and curriculum and distribution and delivery. Amplify focuses on educational analytics and formative assessment through Wireless Generation, Inc. ("Wireless Generation"). Significant expenses associated with the Company's education technology businesses include salaries, employee benefits and other routine overhead. Other Business Developments In July 2011, the Company announced that it would close its publication, The News of the World, after allegations of phone hacking and payments to public officials. As a result of management's approval of the shutdown of The News of the World, the Company has reorganized portions of the U.K. newspaper business and has recorded restructuring charges in fiscal 2013 and 2012 primarily for termination benefits and certain organizational restructuring at the U.K. newspapers. The Company is subject to several ongoing investigations by U.K. and U.S. regulators and governmental authorities, including investigations into whether similar conduct may have occurred at the Company's subsidiaries outside of the U.K. The Company is cooperating with these investigations. In addition, the Company has admitted liability in a number of civil cases related to the phone hacking allegations and has settled a number of cases. The Company created an independently-chaired Management & Standards Committee (the "MSC"), which operates independently from NI Group Limited ("News International") and has full authority to ensure cooperation with all relevant investigations and inquiries into The News of the World matters and all other related issues across News International. The MSC conducts its own internal investigation where appropriate. The MSC has an independent Chairman, Lord Grabiner QC, and reports directly to Gerson Zweifach, Senior Executive Vice President and Group General Counsel of the Company. Mr. Zweifach reports to the independent members of the Board of Directors (the "Board") through their representative Viet Dinh, an independent director and Chairman of the Company's Nominating and Corporate Governance Committee. The independent directors of the Board have retained independent outside counsel and are actively engaged in these matters. The MSC conducted an internal investigation of the three other titles at News International and engaged independent outside counsel to advise it on these investigations and all other matters it handles. News International has instituted governance reforms and issued certain enhanced policies to its employees. The Company has also engaged independent outside counsel to assist it in responding to U.S. governmental inquiries. 43 -------------------------------------------------------------------------------- Table of Contents In February 2012, the Company agreed to backstop €300 million (approximately $395 million) of financing measures that are being initiated by Sky Deutschland AG ("Sky Deutschland"), of which €145 million (approximately $195 million) remains as of September 30, 2012. In June 2012, the Company announced that it intends to pursue the separation of its publishing and its media and entertainment businesses into two distinct publicly traded companies. The global publishing company that would be created through the proposed transaction would consist of the Company's publishing businesses, its education division and other Australian assets. The global media and entertainment company would consist of the Company's cable and television assets, filmed entertainment, and direct satellite broadcasting businesses. Following the separation, each company would maintain two classes of common stock: Class A Common and Class B Common Voting Shares. The separation is expected to be completed in approximately one year from the date of announcement. In addition to final approval from the Board and stockholder approval, the completion of the separation will be subject to receipt of regulatory approvals, opinions from tax counsel and favorable rulings from certain tax jurisdictions regarding the tax-free nature of the transaction to the Company and to its stockholders, further due diligence as appropriate, and the filing and effectiveness of appropriate filings with the SEC. In July 2012, the Company acquired Thomas Nelson, Inc. ("Thomas Nelson"), one of the leading Christian book publishers in the United States, for approximately $200 million in cash. In July 2012, the Company sold its 49% investment in NDS Group Limited ("NDS") to Cisco Systems Inc. for approximately $1.9 billion in total consideration. In August 2012, the Company entered into an agreement to acquire a 51% equity interest in Eredivisie Media & Marketing CV ("EMM"). EMM is a media company based in the Netherlands which holds the Dutch Premier League soccer rights and operates several channels in the Netherlands. EMM is owned by the 18 Dutch Premier League soccer clubs and the global TV production company Endemol. The acquisition is subject to regulatory clearances and other customary closing conditions. In September 2012, the Company agreed to acquire Consolidated Media Holdings Ltd. ("CMH"), a media investment company that operates in Australia, for approximately $2 billion. CMH has a 25% interest in FOXTEL and a 50% interest in FOX Sports Australia, a producer of Australia's leading sports channels. The acquisition will double the Company's stakes in FOX Sports Australia and FOXTEL to 100% and 50%, respectively. The transaction was approved by CMH shareholders in October 2012 and by the Federal Court of Australia in November 2012, and is expected to close on November 19, 2012. In November 2012, the Company acquired the remaining 50% interest in ESPN STAR Sports ("ESS") it did not already own for approximately $335 million in cash. ESS is the leading sports broadcaster in Asia and the Company now, through its wholly owned subsidiaries, owns 100% of ESS. Accordingly, the results of ESS will be included in the Company's consolidated results of operations in November 2012. 44 -------------------------------------------------------------------------------- Table of Contents RESULTS OF OPERATIONS Results of Operations-For the three months ended September 30, 2012 versus the three months ended September 30, 2011 The following table sets forth the Company's operating results for the three months ended September 30, 2012 as compared to the three months ended September 30, 2011. For the three months ended September 30, 2012 2011 % Change (in millions, except %) Revenues $ 8,136 $ 7,959 2 % Operating expenses (4,848 ) (4,753 ) 2 % Selling, general and administrative (1,610 ) (1,527 ) 5 % Depreciation and amortization (300 ) (294 ) 2 % Impairment and restructuring charges (152 ) (91 ) 67 % Equity earnings of affiliates 190 121 57 % Interest expense, net (267 ) (258 ) 3 % Interest income 31 36 (14 )% Other, net 1,375 (130 ) * * Income before income tax expense 2,555 1,063 * * Income tax expense (259 ) (277 ) (6 )% Net income 2,296 786 * * Less: Net income attributable to noncontrolling interests (63 ) (48 ) 31 % Net income attributable to News Corporation stockholders $ 2,233 $ 738 * * ** not meaningful Overview-The Company's revenues increased 2% for the three months ended September 30, 2012 as compared to the corresponding period of fiscal 2012, primarily due to higher net affiliate and advertising revenues at the Cable Network Programming segment, partially offset by decreased revenues at the DBS segment resulting from unfavorable foreign exchange fluctuations. Operating expenses increased 2% for the three months ended September 30, 2012 as compared to the corresponding period of fiscal 2012, primarily due to higher sports programming costs at the Cable Network Programming, Television and DBS segments, and the inclusion of operating expenses resulting from the consolidation of Fox Pan American Sports LLC ("FPAS") and the acquisition of Thomas Nelson. These increases were partially offset by decreased operating expenses at the Filmed Entertainment segment resulting from lower production amortization costs. Selling, general and administrative expenses increased 5% for the three months ended September 30, 2012 as compared to the corresponding period of fiscal 2012, primarily due to $67 million of legal and professional fees related to The News of the World investigations and litigation and costs for related civil settlements and the inclusion of expenses resulting from the consolidation of FPAS. Depreciation and amortization increased 2% for the three months ended September 30, 2012 as compared to the corresponding period of fiscal 2012, primarily due to additional amortization from the consolidation of FPAS at the Cable Networking Programming segment. These increases were partially offset by favorable foreign exchange fluctuations. Impairment and restructuring charges-At the end of fiscal 2012, the Company identified certain businesses as held for sale. During the three months ended September 30, 2012, the Company recorded a $35 million non-cash impairment charge related to its assets held for sale to reduce the carrying value of these assets to estimated fair value less cost to sell. During the three months ended September 30, 2012, the Company recorded restructuring charges of $117 million, of which $112 million related to the newspaper businesses. The restructuring charges primarily relate to the reorganization of the Australian 45 -------------------------------------------------------------------------------- Table of Contents newspaper businesses which was announced at the end of fiscal 2012 and the continued reorganization of the U.K. newspaper business. The restructuring charges recorded in the first quarter of fiscal 2013 are primarily for termination benefits in Australia and contract termination payments in the U.K. During the three months ended September 30, 2011, the Company recorded approximately $91 million of restructuring charges, of which $88 million related to the newspaper businesses. The Company commenced the reorganization of portions of the newspaper business and recorded a restructuring charge primarily for termination benefits as a result of the shutdown of The News of the World and certain organizational restructurings at other newspapers. Equity earnings of affiliates-Equity earnings of affiliates increased $69 million for the three months ended September 30, 2012 as compared to the corresponding period of fiscal 2012, primarily due to a $75 million gain on the sale of a portion of the Company's British Sky Broadcasting Group plc investment in accordance with its share repurchase program and improved results from Sky Deutschland, partially offset by the sale of the Company's investment in NDS in July 2012. For the three months ended September 30, 2012 2011 % Change (in millions, except %) DBS equity affiliates $ 213 $ 123 73 % Cable channel equity affiliates 4 - * * Other equity affiliates (27 ) (2 ) * * Total Equity earnings of affiliates $ 190 $ 121 57 % ** not meaningful Interest expense, net-Interest expense, net increased $9 million for the three months ended September 30, 2012 as compared to the corresponding period of fiscal 2012, primarily due to higher public debt due to the issuance of $1.0 billion of 3.00% Senior Notes due 2022. Other, net- For the three months ended September 30, 2012 2011 (in millions) Gain on sale of investment in NDS(a) $ 1,446 $ - Change in fair value of Sky Deutschland convertible securities(a) 7 (82 ) BSkyB termination fee(a) - (63 ) Other (78 ) 15 Total Other, net $ 1,375 $ (130 ) (a) See Note 6-Investments to the accompanying unaudited consolidated financial statements. Income tax expense-The Company's effective income tax rate for the three months ended September 30, 2012 was lower than the statutory rate of 35%, primarily due to the utilization of foreign tax credits in connection with the NDS sale and permanent differences. The effective income tax rate for the three months ended September 30, 2011 was 26% which was lower than the statutory rate of 35%, primarily due to the sale of interests in subsidiaries and permanent differences. Net income-Net income increased for the three months ended September 30, 2012 as compared to the corresponding period of fiscal 2012, primarily due to the gain on the sale of the Company's investment in NDS. 46 -------------------------------------------------------------------------------- Table of Contents Net income attributable to noncontrolling interests-Net income attributable to noncontrolling interests increased for the three months ended September 30, 2012 as compared to the corresponding period of fiscal 2012, primarily due to the issuances of additional noncontrolling interests at the Company's cable businesses. Segment Analysis The following table sets forth the Company's revenues and segment operating income (loss) for the three months ended September 30, 2012 as compared to the three months ended September 30, 2011. For the three months ended September 30, 2012 2011 % Change (in millions, except %) Revenues: Cable Network Programming $ 2,449 $ 2,120 16 % Filmed Entertainment 1,745 1,778 (2 )% Television 959 923 4 % Direct Broadcast Satellite Television 817 922 (11 )% Publishing 2,018 2,069 (2 )% Other 148 147 1 % Total revenues $ 8,136 $ 7,959 2 % Segment operating income (loss): Cable Network Programming $ 953 $ 775 23 % Filmed Entertainment 400 347 15 % Television 156 133 17 % Direct Broadcast Satellite Television 23 119 (81 )% Publishing 57 110 (48 )% Other (211 ) (99 ) * * Total segment operating income $ 1,378 $ 1,385 (1 )% ** not meaningful Management believes that total segment operating income is an appropriate measure for evaluating the operating performance of the Company's business segments because it is the primary measure used by the Company's chief operating decision maker to evaluate the performance and allocate resources within the Company's businesses. Total segment operating income provides management, investors and equity analysts a measure to analyze operating performance of each of the Company's business segments and its enterprise value against historical data and competitors' data, although historical results may not be indicative of future results (as operating performance is highly contingent on many factors, including customer tastes and preferences). The following table reconciles total segment operating income to income before income tax expense. For the three months ended September 30, 2012 2011 (in millions) Total segment operating income $ 1,378 $ 1,385 Impairment and restructuring charges (152 ) (91 ) Equity earnings of affiliates 190 121 Interest expense, net (267 ) (258 ) Interest income 31 36 Other, net 1,375 (130 ) Income before income tax expense $ 2,555 $ 1,063 47 -------------------------------------------------------------------------------- Table of Contents Cable Network Programming (30% and 27% of the Company's consolidated revenues in the first three months of fiscal 2013 and 2012, respectively) For the three months ended September 30, 2012, revenues at the Cable Network Programming segment increased $329 million, or 16%, as compared to the corresponding period of fiscal 2012, primarily due to higher net affiliate and advertising revenues, partially offset by unfavorable foreign exchange fluctuations, primarily at FIC and STAR. The strengthening of the U.S dollar against the local currencies resulted in a revenue decrease of approximately $67 million for the three months ended September 30, 2012, as compared to the corresponding period of fiscal 2012. Domestic net affiliate revenues increased 16% for the three months ended September 30, 2012, primarily due to higher average rates per subscriber at the RSNs, FOX News and FX. For the three months ended September 30, 2012, domestic advertising revenues increased 8% primarily due to higher pricing at FOX News and FX and higher MLB advertising revenues. Also contributing to the increase in domestic affiliate and advertising revenues was the launch of Fox Sports San Diego. For the three months ended September 30, 2012, international net affiliate revenues increased 25%, primarily due to higher subscribers at FIC and the consolidation of FPAS partially offset by foreign exchange fluctuations. International advertising revenues improved on a local currency basis, but decreased 1% for the three months ended September 30, 2012. The decrease in international advertising revenues was primarily due to foreign exchange fluctuations and was partially offset by higher advertising revenues in Latin America due to the consolidation of FPAS. For the three months ended September 30, 2012, operating income at the Cable Network Programming segment increased $178 million, or 23%, as compared to the corresponding period of fiscal 2012, primarily due to the revenue increases noted above, partially offset by a $151 million increase in expenses, primarily due to higher sports programming costs and the consolidation of FPAS. Contributing to the sports programming increase were new contracts to broadcast cricket matches at Star India, mixed martial arts matches and additional U.S college football games. Also contributing to the increase was the launch of Fox Sports San Diego and other MLB contractual rights increases. The strengthening of the U.S. dollar against local currencies resulted in an operating income decrease of approximately $30 million for the three months ended September 30, 2012, as compared to the corresponding period of fiscal 2012. Filmed Entertainment (21% and 22% of the Company's consolidated revenues in the first three months of fiscal 2013 and 2012, respectively) For the three months ended September 30, 2012, revenues at the Filmed Entertainment segment decreased $33 million, or 2%, as compared to the corresponding period of fiscal 2012, primarily due to lower home entertainment revenues at Fox Filmed Entertainment and lower licensing revenues from Avatar. The three months ended September 30, 2011, included the home entertainment releases of Rio and X-Men: First Class with no comparable titles in the corresponding period of fiscal 2013. These revenue decreases were partially offset by increased worldwide theatrical revenues resulting from the success of Ice Age: Continental Drift in the three months ended September 30, 2012, compared to the corresponding fiscal 2012 period which included the worldwide theatrical release of Rise of the Planet of the Apes. These revenue decreases were also partially offset by increased digital distribution revenue related to the timing of content availability to Netflix. For the three months ended September 30, 2012, operating income at the Filmed Entertainment segment increased $53 million, or 15%, as compared to the corresponding period of fiscal 2012, primarily due to lower production amortization costs partially offset by the revenue decreases noted above. Television (12% of the Company's consolidated revenues in the first three months of fiscal 2013 and 2012) For the three months ended September 30, 2012, revenues at the Television segment increased $36 million, or 4%, as compared to the corresponding period of fiscal 2012, primarily due to higher retransmission consent revenues and higher political advertising revenues at the Company's television stations due to the 2012 Presidential election. These revenue increases were partially offset by lower advertising revenues at FOX primarily due to lower primetime ratings, the absence of the Emmy® Awards, which was broadcast on FOX in fiscal 2012 and the impact of the broadcast of the Summer Olympics on a different network. For the three months ended September 30, 2012, operating income at the Television segment increased $23 million, or 17%, as compared to the corresponding period of fiscal 2012, primarily due to the revenue increases noted above, partially offset by an increase in sports programming and production costs principally related to the launch of Saturday night college football broadcasts. 48 -------------------------------------------------------------------------------- Table of Contents Direct Broadcast Satellite Television (10% and 11% of the Company's consolidated revenues in the first three months of fiscal 2013 and 2012, respectively) For the three months ended September 30, 2012, SKY Italia's revenues decreased $105 million, or 11%, as compared to the corresponding period of fiscal 2012. For the three months ended September 30, 2012, revenues, on a local currency basis, were relatively consistent with the corresponding period of fiscal 2012 as higher subscription revenues were offset by lower activation fees and pay per view revenue. SKY Italia had a net decrease of approximately 40,000 subscribers during the first quarter of fiscal 2013, which decreased SKY Italia's total subscriber base to 4.9 million at September 30, 2012, reflecting the continued challenging economic environment in Italy. The total churn for three months ended September 30, 2012 was approximately 169,000 subscribers on an average subscriber base of 4.9 million, as compared to churn of approximately 157,000 subscribers on an average subscriber base of 5.0 million in the corresponding period of fiscal 2012. Subscriber churn for the period represents the number of SKY Italia subscribers whose service was disconnected during the period. During the three months ended September 30, 2012, the strengthening of the U.S. dollar against the Euro resulted in a revenue decrease of approximately $107 million as compared to the corresponding period of fiscal 2012. Average revenue per subscriber ("ARPU") of approximately €41 in the three months ended September 30, 2012 increased from approximately €40 reported in the corresponding period of fiscal 2012, primarily due to a price increase. SKY Italia calculates ARPU by dividing total subscriber-related revenues for the period by the average subscribers for the period and dividing that amount by the number of months in the period. Subscriber-related revenues are comprised of total subscription revenue, pay-per-view revenue and equipment rental revenue for the period. Average subscribers are calculated for the respective periods by adding the beginning and ending subscribers for the period and dividing by two. Subscriber acquisition costs per subscriber ("SAC") of approximately €415 in the three months ended September 30, 2012 increased from the corresponding period of fiscal 2012, primarily due to higher marketing costs on a per subscriber basis, although total marketing expense was flat as compared to the corresponding prior period. SAC is calculated by dividing total subscriber acquisition costs for a period by the number of gross SKY Italia subscribers added during the period. Subscriber acquisition costs include the cost of the commissions paid to retailers and other distributors, the cost of equipment sold directly by SKY Italia to subscribers and the costs related to installation and acquisition advertising net of any upfront activation fee. SKY Italia excludes the value of equipment capitalized under SKY Italia's equipment lease program, as well as payments and the value of returned equipment related to disconnected lease program subscribers from subscriber acquisition costs. For the three months ended September 30, 2012, SKY Italia's operating income decreased $96 million, or 81%, as compared to the corresponding period of fiscal 2012. On a local currency basis, expenses were higher by 12% primarily due to an increase in sports programming costs resulting from the inclusion of $70 million in rights cost associated with the broadcast of the Summer Olympics. During the three months ended September 30, 2012, the strengthening of the U.S. dollar against the Euro did not have a material impact on operating income. Publishing (25% and 26% of the Company's consolidated revenues in the first three months of fiscal 2013 and 2012, respectively) For the three months ended September 30, 2012, revenues at the Publishing segment decreased $51 million, or 2%, as compared to the corresponding period of fiscal 2012, primarily due to lower advertising revenues. The revenue decreases were partially offset by the inclusion of revenues from Thomas Nelson which was acquired in fiscal 2013 and increased revenues at the U.K. newspapers primarily due to the launch of the Sunday edition of The Sun in February 2012 and third party printing contracts. The strengthening of the U.S. dollar against local currencies resulted in a revenue decrease of approximately $17 million for the three months ended September 30, 2012 as compared to the corresponding period of fiscal 2012. For the three months ended September 30, 2012, operating income at the Publishing segment decreased $53 million, or 48%, as compared to the corresponding period of fiscal 2012, primarily due to the revenue decreases noted above and the inclusion of expenses at Thomas Nelson. Other (2% of the Company's consolidated revenues in the first three months of fiscal 2013 and 2012) For the three months ended September 30, 2012, revenues at the Other segment increased approximately $1 million, or 1%, as compared to the corresponding period of fiscal 2012, primarily due to higher online advertising revenues at REA Group, the Company's Australian online real estate advertising service, and higher revenues at the Company's education business, partially offset by the absence of revenues from News Outdoor Russia which was sold in July 2011. 49 -------------------------------------------------------------------------------- Table of Contents For the three months ended September 30, 2012, operating results at the Other segment decreased $112 million, as compared to the corresponding period of fiscal 2012, primarily due to the impact of legal and professional fees related to The News of the World investigations and litigation and costs for related civil settlements, higher stock based compensation expense and increased operating losses of $15 million at the Company's education business, reflecting higher product development costs. LIQUIDITY AND CAPITAL RESOURCES Current Financial Condition The Company's principal source of liquidity is internally generated funds. The Company also has a five-year unused $2 billion revolving credit facility, which expires in May 2017, and has access to various film co-production alternatives to supplement its cash flows. In addition, the Company has access to the worldwide capital markets, subject to market conditions. As of September 30, 2012, the Company was in compliance with all of the covenants under the revolving credit facility, and it does not anticipate any violation of such covenants. The Company's internally generated funds are highly dependent upon the state of the advertising markets and public acceptance of its film and television products. The principal uses of cash that affect the Company's liquidity position include the following: investments in the production and distribution of new feature films and television programs; the acquisition of and payments under programming rights for entertainment and sports programming; paper purchases; operational expenditures including employee costs; capital expenditures; interest expenses; income tax payments; investments in associated entities; dividends; acquisitions; debt repayments; and stock repurchases. The capitalization of the global publishing company that would be created through the proposed separation of the Company's publishing and media and entertainment businesses into two distinct publicly traded companies may affect the Company's liquidity position. In addition to the acquisitions, sales and possible acquisitions disclosed elsewhere, the Company has evaluated, and expects to continue to evaluate, possible acquisitions and dispositions of certain businesses. Such transactions may be material and may involve cash, the Company's securities or the assumption of additional indebtedness. Sources and Uses of Cash Net cash provided by operating activities for the three months ended September 30, 2012 and 2011 was as follows (in millions): For the three months ended September 30, 2012 2011 Net cash provided by operating activities $ 710 $ 424 The increase in net cash provided by operating activities during the three months ended September 30, 2012 as compared to the corresponding period of fiscal 2012 primarily reflects lower sports rights payments at the DBS segment, higher advertising receipts at the Television segment and lower income taxes paid. These increases were partially offset by lower advertising receipts at the Publishing segment. Net cash provided by (used in) investing activities for the three months ended September 30, 2012 and 2011 was as follows (in millions): For the three months ended September 30, 2012 2011 Net cash provided by (used in) investing activities $ 1,461 $ (93 ) The change in net cash provided by investing activities during the three months ended September 30, 2012 as compared to the corresponding period of fiscal 2012 was primarily due to the net cash proceeds received from the sale of NDS. Net cash provided by (used in) financing activities for the three months ended September 30, 2012 and 2011 was as follows (in millions): For the three months ended September 30, 2012 2011 Net cash provided by (used in) financing activities $ 179 $ (1,315 ) 50 -------------------------------------------------------------------------------- Table of Contents The change in net cash provided by financing activities during the three months ended September 30, 2012 as compared to the corresponding period of fiscal 2012 was primarily due to the issuance of $1.0 billion of 3.00% Senior Notes due 2022 and lower share repurchases during the three months ended September 30, 2012 as compared to the corresponding period of fiscal 2012. The Company currently has approximately $4.5 billion remaining of the $10 billion stock repurchase program. The Company may repurchase the remaining amount under the stock repurchase program in fiscal 2013 and expects to fund this through a combination of cash generated by operations and cash on hand. Debt Instruments The following table summarizes borrowings and repayment of borrowings for the three months ended September 30, 2012 and 2011. For the three months ended September 30, 2012 2011 (in millions) Borrowings: Notes due September 2022(a) 988 - Total borrowings $ 988 $ - Repayment of borrowings: Bank loans(a) - (32 ) Total repayment of borrowings $ - $ (32 ) (a) See Note 9-Borrowings to the accompanying unaudited consolidated financial statements for further discussion. Ratings of the Public Debt The table below summarizes the Company's credit ratings as of September 30, 2012. Rating Agency Senior Debt Outlook Moody's Baa1 Stable S&P BBB+ CreditWatch/Negative Revolving Credit Agreement In May 2012, NAI entered into a credit agreement (the "Credit Agreement"), among NAI as Borrower, the Company as Parent Guarantor, the lenders named therein, the initial issuing banks named therein, JPMorgan Chase Bank, N.A. ("JPMorgan Chase") and Citibank, N.A. as Co-Administrative Agents, JPMorgan Chase as Designated Agent and Bank of America, N.A. as Syndication Agent. The Credit Agreement provides a $2 billion unsecured revolving credit facility with a sub-limit of $400 million (or its equivalent in Euros) available for the issuance of letters of credit and a maturity date of May 2017. Under the Credit Agreement, the Company may request an increase in the amount of the credit facility up to a maximum amount of $2.5 billion and the Company may request that the maturity date be extended for up to two additional one-year periods. Borrowings are issuable in U.S. dollars only, while letters of credit are issuable in U.S. dollars or Euros. The significant terms of the agreement include the requirement that the Company maintain specific leverage ratios and limitations on secured indebtedness. Fees under the Credit Agreement will be based on the Company's long-term senior unsecured non-credit enhanced debt ratings. Given the current debt ratings, NAI pays a facility fee of 0.125% and an initial drawn cost of LIBOR plus 1.125%. Commitments The Company has commitments under certain firm contractual arrangements ("firm commitments") to make future payments. These firm commitments secure the future rights to various assets and services to be used in the normal course of operations. The total firm commitments and future debt payments as of September 30, 2012 and June 30, 2012 were $68,726 million and $63,644 million, respectively. The increase from June 30, 2012 was primarily due to the renewal of rights to telecast certain MLB regular season and post season games through the 2021 MLB season and the issuance of 3.00% Senior Notes due 2022. 51 -------------------------------------------------------------------------------- Table of Contents In October 2012, the Company signed an eight-year contract with NASCAR for the renewal of rights to telecast the Daytona 500 and the first third of the Sprint Cup Series through 2022. Guarantees The Company's guarantees as of September 30, 2012 have not changed significantly from disclosures included in the 2012 Form 10-K. In October 2012, the Company and the other joint-venture partners guaranteed the debt of an equity associate. The Company's maximum obligation under this guarantee is approximately $115 million. Contingencies Other than as disclosed in the notes to the accompanying unaudited consolidated financial statements, the Company is party to several other purchase and sale arrangements which become exercisable over the next ten years by the Company or the counter-party to the agreement. None of these arrangements that become or are exercisable in the next twelve months are material. Purchase arrangements that are exercisable by the counter-party to the agreement, and that are outside the sole control of the Company, are accounted for in accordance with ASC 480-10-S99-3A, "Distinguishing Liabilities from Equity." Accordingly, the fair values of such purchase arrangements are classified in redeemable noncontrolling interests. As disclosed in the notes to the accompanying unaudited consolidated financial statements, U.K. and U.S. regulators and governmental authorities are conducting investigations after allegations of phone hacking and inappropriate payments to public officials at our former publication, The News of the World, and other related matters, including investigations into whether similar conduct may have occurred at the Company's subsidiaries outside of the U.K. The Company is cooperating with these investigations. It is possible that these proceedings could damage our reputation and might impair our ability to conduct our business. The Company is not able to predict the ultimate outcome or cost associated with these investigations. Violations of law may result in civil, administrative or criminal fines or penalties. The Company has admitted liability in a number of civil cases related to the phone hacking allegations and has settled a number of cases. At September 30, 2012, the Company has provided for its best estimate of the liability for the claims that have been filed. The Company has announced a process under which parties can pursue claims against the Company, and management believes that it is probable that additional claims will be filed. It is not possible to estimate the liability for such additional claims given the information that is currently available to the Company. If more claims are filed and additional information becomes available, the Company will update the liability provision for such matters. Any fees, expenses, fines, penalties, judgments or settlements which might be incurred by the Company in connection with the various proceedings could affect the Company's results of operations and financial condition. The Company's operations are subject to tax in various domestic and international jurisdictions and as a matter of course, the Company is regularly audited by federal, state and foreign tax authorities. The Company believes it has appropriately accrued for the expected outcome of all pending tax matters and does not currently anticipate that the ultimate resolution of pending tax matters will have a material adverse effect on its consolidated financial condition, future results of operations or liquidity. Intangible Assets The Company has a significant amount of intangible assets, including goodwill, FCC licenses, and other copyright products and trademarks. Intangible assets acquired in business combinations are recorded at their estimated fair value at the date of acquisition. Goodwill is recorded as the difference between the cost of acquiring an entity and the estimated fair values assigned to its tangible and identifiable intangible net assets and is assigned to one or more reporting units for purposes of testing for impairment. The judgments made in determining the estimated fair value assigned to each class of intangible assets acquired, their reporting unit, as well as their useful lives can significantly impact net income. The Company accounts for its business acquisitions under the purchase method of accounting. The total cost of acquisitions is allocated to the underlying net assets, based on their respective estimated fair values. The excess of the purchase price over the estimated fair values of the tangible net assets acquired is recorded as intangibles. Amounts recorded as goodwill are assigned to one or more reporting units. Determining the fair value of assets acquired and liabilities assumed requires management's judgment and 52 -------------------------------------------------------------------------------- Table of Contents often involves the use of significant estimates and assumptions, including assumptions with respect to future cash inflows and outflows, discount rates, asset lives and market multiples, among other items. Identifying reporting units and assigning goodwill to them requires judgment involving the aggregation of business units with similar economic characteristics and the identification of existing business units that benefit from the acquired goodwill. The Company allocates goodwill to disposed businesses using the relative fair value method. Carrying values of goodwill and intangible assets with indefinite lives are reviewed at least annually for possible impairment in accordance with ASC 350, "Intangibles-Goodwill and Other." The Company's impairment review is based on, among other methods, a discounted cash flow approach that requires significant management judgments. The Company uses its judgment in assessing whether assets may have become impaired between annual valuations. Indicators such as unexpected adverse economic factors, unanticipated technological change or competitive activities, loss of key personnel and acts by governments and courts, may signal that an asset has become impaired. The Company uses direct valuation methods to value identifiable intangibles for purchase accounting and impairment testing. The direct valuation method used for FCC licenses requires, among other inputs, the use of published industry data that are based on subjective judgments about future advertising revenues in the markets where the Company owns television stations. This method also involves the use of management's judgment in estimating an appropriate discount rate reflecting the risk of a market participant in the U.S. broadcast industry. The resulting fair values for FCC licenses are sensitive to these long-term assumptions and any variations to such assumptions could result in an impairment to existing carrying values in future periods and such impairment could be material. The Company's goodwill impairment reviews are determined using a two-step process. The first step of the process is to compare the fair value of a reporting unit with its carrying amount, including goodwill. In performing the first step, the Company determines the fair value of a reporting unit by primarily using a discounted cash flow analysis and market-based valuation approach methodologies. Determining fair value requires the exercise of significant judgments, including judgments about appropriate discount rates, long-term growth rates, relevant comparable company earnings multiples and the amount and timing of expected future cash flows. The cash flows employed in the analyses are based on the Company's estimated outlook and various growth rates have been assumed for years beyond the long-term business plan period. Discount rate assumptions are based on an assessment of the risk inherent in the future cash flows of the respective reporting units. In assessing the reasonableness of its determined fair values, the Company evaluates its results against other value indicators, such as comparable public company trading values. If the fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is not impaired and the second step of the impairment review is not necessary. If the carrying amount of a reporting unit exceeds its fair value, the second step of the goodwill impairment review is required to be performed to estimate the implied fair value of the reporting unit's goodwill. The implied fair value of goodwill is determined in the same manner as the amount of goodwill recognized in a business combination. That is, the estimated fair value of the reporting unit is allocated to all of the assets and liabilities of that unit (including any unrecognized intangible assets) as if the reporting unit had been acquired in a business combination and the estimated fair value of the reporting unit was the purchase price paid. The implied fair value of the reporting unit's goodwill is compared with the carrying amount of that goodwill. If the carrying amount of the reporting unit's goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess. As a result of the fiscal 2012 annual impairment review performed, the Company recorded non-cash impairment charges of approximately $2.8 billion ($2.4 billion, net of tax) during the fiscal year ended June 30, 2012. The charges consisted of a write-down of goodwill of $1.5 billion and a write-down of indefinite-lived intangible assets of $1.3 billion. The Publishing and Other segments have reporting units with goodwill that continue to be at risk for future impairment. Goodwill was $2.2 billion as of September 30, 2012 at these reporting units where goodwill is at risk for future impairment. The Company will continue to monitor its goodwill and intangible assets for possible future impairment. Recent Accounting Pronouncements See Note 1-Basis of Presentation to the accompanying unaudited consolidated financial statements for discussion of recent accounting pronouncements. 53 -------------------------------------------------------------------------------- Table of Contents |