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Viacom 10-K 2009 Documents found in this filing:
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
FORM 10-K
For the fiscal year ended December 31, 2008 OR
For the transition period from to Commission File Number 001-32686 VIACOM INC. (Exact name of registrant as specified in its charter)
1515 Broadway New York, NY 10036 (212) 258-6000 (Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)
Securities Registered Pursuant to Section 12(b) of the Act:
Securities Registered Pursuant to Section 12(g) of the Act: None (Title Of Class) Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No ¨ Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x As of the close of business on June 30, 2008, the last business day of the registrant’s most recently completed second fiscal quarter, there were 57,362,613 shares of the registrant’s Class A common stock, par value $0.001 per share, and 565,353,499 shares of its Class B common stock, par value $0.001 per share, outstanding. The aggregate market value of Class A common stock held by non-affiliates as of June 30, 2008 was approximately $322.4 million (based upon the closing price of $30.61 per share as reported by the New York Stock Exchange on June 30, 2008). The aggregate market value of Class B common stock held by non-affiliates as of June 30, 2008 was approximately $16.5 billion (based upon the closing price of $30.54 per share as reported by the New York Stock Exchange on June 30, 2008). As of January 31, 2009, 57,362,086 shares of our Class A common stock and 548,945,967 shares of our Class B common stock were outstanding. DOCUMENTS INCORPORATED BY REFERENCE Portions of Viacom Inc.’s Notice of 2009 Annual Meeting of Stockholders and Proxy Statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended (the “Proxy Statement”) (Portion of Item 5) (Part III).
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Table of ContentsPART I Item 1. Business. Viacom is a leading global entertainment content company. We engage audiences on television, motion picture, Internet, mobile and video game platforms through many of the world’s best known entertainment brands. We manage our operations through two reporting segments: Media Networks and Filmed Entertainment. References in this document to “Viacom,” “Company,” “we,” “us” and “our” mean Viacom Inc. and our consolidated subsidiaries through which our various businesses are conducted, unless the context requires otherwise. Media Networks Our Media Networks segment provides entertainment content for consumers in key demographics attractive to advertisers, distributors and retailers. We create and acquire programming and other content for distribution to our audiences how and where they want to view and interact with it: on television, the Internet, mobile devices, video games and a variety of consumer products. MTV Networks reaches over 578 million households worldwide via its approximately 165 channels and multiplatform properties, which include MTV: Music Television® , MTV2®, mtvU®, MTV Tr3s®, VH1®, VH1 Classic™, CMT®: Country Music Television™, Logo®, Nickelodeon®, Nick at Nite®, Noggin®, The N®, Nicktoons®, Neopets® , COMEDY CENTRAL® , Spike TV® and TV Land™, among others. MTV Networks also has a growing video game business that includes the successful Rock Band® franchise and casual gaming websites such as Addictinggames.com and Shockwave.com. BET Networks is a leading provider of entertainment, music, news and public affairs television programming targeted to the African-American audience and can be seen in the United States, Canada, the Caribbean, the United Kingdom and sub-Saharan Africa. Filmed Entertainment The Filmed Entertainment segment produces, finances and distributes motion pictures and other entertainment content under the Paramount Pictures®, Paramount Vantage™, Paramount Classics™, MTV Films® and Nickelodeon Movies™ brands. The Filmed Entertainment segment will also continue to release a number of pictures under the DreamWorks™ brand. Paramount Pictures has been a leading producer and distributor of motion pictures since 1912 and has a library consisting of approximately 3,500 motion pictures and a small number of television programs. It also acquires films for distribution and has distribution relationships with DreamWorks Animation and Marvel. Paramount also distributes motion pictures and other entertainment content on DVD, television, digital and other platforms in the United States and internationally, and is expanding its presence in the games business. Our Media Networks segment derives revenues principally from advertising sales, affiliate fees and ancillary revenues. Revenues from the Filmed Entertainment segment are generated primarily from the theatrical release and/or distribution of motion pictures, sale of home entertainment products such as DVDs, and licensing motion pictures and other content to pay and basic cable television, broadcast television, syndicated television and digital media outlets. Revenues from the Media Networks segment accounted for 60%, 60% and 64% of our revenues for 2008, 2007 and 2006, respectively, and revenues from the Filmed Entertainment segment accounted for 41%, 41% and 37% of our revenues for those periods, respectively, with elimination of intercompany revenues being (1)%, (1)% and (1)%, respectively. We generated approximately 71% of our total revenues in 2008 from domestic operations, 73% in 2007 and 76% in 2006, with 29%, 27% and 24%, respectively, generated internationally. In 2008, our total international revenues were $4.254 billion, of which 64% was generated in Europe.
Table of Contents2008 Restructuring To better align our organization and cost structure with current economic conditions, we undertook a strategic review of our businesses in the fourth quarter of 2008 which resulted in a reduction in our workforce by 890 positions and write-downs of certain programming and other assets. These actions resulted in aggregate pre-tax restructuring and other charges of $454 million, of which approximately $80 million relates to severance actions and the remainder relates primarily to the write-down of programming and other assets. See Note 15 to the Consolidated Financial Statements for additional information. Corporate Information We were organized as a Delaware corporation in 2005 and our principal offices are located at 1515 Broadway, New York, New York 10036. Our telephone number is (212) 258-6000 and our website is www.viacom.com. Information on our website is not intended to be incorporated into this annual report. Business Strategy We produce and distribute television programming, motion pictures and other entertainment content under some of the world’s best known entertainment brands, many of which are household names worldwide. Our focus is on our audience, providing them the entertainment they want to experience, how and when they want to experience it. Key elements of our strategy include:
In connection with these efforts, we are committed to fostering a creative and diverse culture, which will enable us to continue to develop unique and cutting-edge content for our audiences and maintain our position as a market leader. MEDIA NETWORKS Our media networks, MTV Networks and BET Networks, operate their program services, websites and other digital media services in the United States and abroad. Our Media Networks segment generates revenues principally from three sources: (i) the sale of advertising time on our program services and digital properties, (ii) the receipt of affiliate fees from cable television operators, direct-to-home satellite operators, mobile networks and other content distributors and (iii) ancillary revenues, which include the creation and publishing of video games and other interactive products, home entertainment sales of our programming, the licensing of our content to third parties and the licensing of our brands and properties for consumer products. In 2008, advertising revenues, affiliate fees and ancillary revenues were approximately 54%, 30% and 16%, respectively, of total revenues for the Media Networks segment.
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Table of ContentsAdvertising Revenues The advertising revenues generated by each program service depend on the number of households subscribing to the service, household and viewership demographics and ratings as determined by third party research companies such as The Nielsen Company (US), LLC (“Nielsen”). Our media networks properties target key audiences considered particularly attractive to advertisers. For example, MTV targets teen and young adult demographics, Nickelodeon targets kids and their families and BET programming targets African-American audiences. The advertising industry modified the way it measures ratings in 2008 by moving to commercial ratings, which measure audience size for a commercial. Commercial ratings are measured on a “C3” basis, which counts the number of viewers that watch the commercial live or via playback during the three days following the live broadcast. In 2008, the majority of our guaranteed deals were sold on the C3 metric. We regularly evaluate the structure, content and volume of our advertising spots, and throughout 2008 took measures that resulted in improved audience retention. In 2008, domestic and global economic conditions worsened significantly, which had a rapid, negative effect on the advertising market, weakening the businesses of partners who purchase advertising on our networks and reducing their spending on advertising generally. Current economic conditions have adversely affected our advertising revenues and such effect could continue or worsen. Our advertising revenues may also fluctuate due to the ratings of our channels (including the timing and success of new programs) and seasonal variations, typically being highest in the fourth quarter. Some of our program services experienced ratings declines in 2008, which, coupled with economic conditions, caused our domestic advertising revenue to decline. Ratings challenges could reduce the amount of advertising revenue we receive and negatively affect our results of operations, and our expenses may increase moderately as we invest in new programming. Our digital revenue is derived from a combination of advertising and sponsorships. Our Media Networks segment operates approximately 400 digital media properties around the world, including websites, WAP sites, broadband services and virtual worlds, and during the fourth quarter of 2008, we collectively averaged approximately 89 million unique visitors per month. Our on-air programming drives traffic to our digital properties and vice versa, allowing convergent, or cross-platform, advertising sales. MTV Networks also syndicates ad-supported long-form and short-form video content to select online destinations which creates additional opportunities for audiences to interact with our content online, ultimately driving viewership back to our core channels and digital properties. Our Flux platform, which allows users to connect, share and interact with content and other users across a network of websites, expands user experiences and creates a seamless connection between our sites, as well as content and communities from all over the Internet. Affiliate Fees Revenues from affiliate fees are negotiated with individual cable and satellite television operators, mobile and online networks and other distributors, generally resulting in multi-year carriage agreements with set rate increases that provide us with a reasonably stable source of affiliate fee revenue. The amount of the fee we receive is determined in part by the number of subscribers to and success of the programming offered by our program services. We engage in negotiations with our cable and satellite affiliate partners on a rolling basis. We are exploring ways to build stronger and more expansive multi-media partnerships with the various distributors of our content that maximize the value of our content for us, our audience and our affiliate partners, such as increased and customized content offerings for video-on-demand and Internet distribution with our cable and satellite partners. We also receive e-commerce revenues from our digital operations.
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Table of ContentsAncillary Revenues Our ancillary revenues are principally derived from the creation and publishing of video games and other interactive products, sales of home entertainment products such as DVDs, content licensing and licensing for consumer products. In connection with our 2006 acquisition of Harmonix Music Systems, Inc. (“Harmonix”), we expanded our operations to include the creation, marketing and publishing of video games and other interactive products. Following our launch of Rock Band in 2007, we released Rock Band 2 on the Xbox 360®, PlayStation®2 and PLAYSTATION®3 platforms and both Rock Band and Rock Band 2 on the Nintendo Wii platform in 2008. We also expanded into international markets such as Italy, Sweden and Spain. The Rock Band series of games allows players to experience music in a new way, by playing as part of a virtual band using drum, bass/lead guitar and microphone peripherals. Rock Band gamers can download songs spanning all genres of rock, which provides another source of ancillary revenue for us. Electronic Arts co-manufactures, co-markets and distributes Rock Band for us in exchange for certain fees. We also continue to receive royalties from third party sales of certain related games and products, including Guitar Hero, which is published by Activision, and are exploring additional digital applications for our games. Revenues from our video game business are dependent on consumer acceptance of our games and related offerings and may fluctuate. We distribute our programming in the home entertainment market through the sale and rental of DVDs, video-on-demand, download-to-own and download-to-rent services. We also license our television programs and the concepts and/or formats of such programs to third parties for licensing fees and royalties. For example, TV Land’s new reality series She’s Got The Look has been licensed in over 65 countries worldwide. We also have a worldwide consumer products licensing business, which licenses popular characters from our programs, such as those featured in SpongeBob SquarePants, The Backyardigans, Dora the Explorer, Neopets and South Park, in connection with merchandising, video games and publishing worldwide. We generally are paid a royalty based upon a percentage of the licensee’s wholesale revenues, with an advance and/or guarantee against future expected royalties. Licensing revenue may vary from period to period depending on the popularity of the program available for license in a particular period and the popularity of licensed products among consumers. Strategic Relationships Our Media Networks properties have forged a number of strategic relationships with other leading companies:
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Media Networks Properties MTV Networks is principally comprised of four groups based on target audience, similarity of programming and other factors: the Music and Logo Group, the Kids and Family Group, the Entertainment Group and International. BET Networks’ businesses include BET, BET International and BET.com, among other properties. Information about our key media networks properties is discussed below. Unless otherwise indicated, the domestic television household numbers are according to Nielsen, the Internet user data is according to comScore Media Metrix (U.S. data only unless otherwise indicated) and the video stream data is based on internal tracking. International reach statistics are derived from internal data coupled with external sources when available. Music and Logo Group The Music and Logo Group includes our music-oriented program services and digital properties, which generally provide youth-oriented programming targeting the 18-24 and 18-34 demographics, the Harmonix and MTV Games video game operations, and Logo, our channel for the lesbian, gay, bisexual and transgender audience. Some of our key brands in this group include:
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Other key properties of the Music and Logo Group include MTV Films, MTV’s motion picture brand, under which Paramount released Stop-Loss and How She Move in 2008; and Palladia, a music-centric high definition television channel (formerly MHD).
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Table of ContentsKids and Family Group The Kids and Family Group provides high-quality entertainment and educational programs, websites and broadband services targeted to kids ages 2-17 and their families. Some of our key properties in this group include:
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Other Kids and Family Group properties include Nick Jr. Video and The Click, which are the broadband services of Nick Jr. and The N, respectively; Nickelodeon Movies, Nickelodeon’s motion picture brand, under which Paramount released The Spiderwick Chronicles in 2008 and Hotel for Dogs in January 2009; and the website ParentsConnect.com, which provides information and discussion boards for parents on local events for kids, health and development, activities and resources, among other things. In addition, Nickelodeon licenses its brands for hotels, cruises, live tours and other recreational outlets.
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Table of ContentsEntertainment Group The Entertainment Group produces and distributes programming and online content and games that generally target adult and male audiences. Some of our key properties in this group include:
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Other Entertainment Group properties include Atom.com, a broadband service for original short films and online video clips; AddictingClips.com, which houses entertaining original and user-generated video clips; and GameTrailers.com, which produces broadcast quality video content for video games. MTV Networks International Worldwide, MTV Networks’ operations reached over 660 million households in 162 countries via its program services and branded program blocks as of December 31, 2008. MTV Networks International owns and operates, participates in as a joint venturer, and/or licenses to third parties to operate over 120 program services, including extensions of our multimedia brands MTV, VH1, Nickelodeon and COMEDY CENTRAL, and program services created specifically for international and/or non-English speaking audiences such as TMF (The Music Factory), Paramount Comedy, Game One, The Box and VIVA, among others. MTVN International also operates or licenses its brands for more than 130 online properties internationally. Most of the MTVN International program services are regionally customized for the particular viewers through the inclusion of local music, programming and on-air personalities, and use of the local language. MTV Networks’ operations in Europe, Latin America and Asia represent its largest international presence. We strategically pursue the development, licensing and acquisition of program services in international markets and engage in the syndication and distribution of consumer products. Our Viacom 18 joint venture in India includes television, film and digital media content across numerous brands as well as consumer products. In July 2008, it launched Colors, a new Hindi-language general entertainment channel, and is expected to launch additional niche channels and digital content in the future. We continue to focus on efficiently expanding our international presence by ensuring that we have the appropriate forms of ownership interests in our properties worldwide. This involves concentrating our resources in the regions and on the demographics that offer the greatest growth opportunity for our brands, such as Germany, India and the United Kingdom, and entering into licensing arrangements in other regions that can be best exploited by our partners. In Europe, we launched MTVNHD, a 24-hour English language high definition
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Table of Contentsservice dedicated to music and kids. MTVNHD is now available in 11 European countries and has expanded to Mexico, with plans for further expansion in Latin America. In the Middle East, we launched Nickelodeon Arabia through an existing long-term licensing arrangement between MTVN International and TECOM Investments’ media unit, Arab Media Group. We also expanded our Eastern European presence, increased our ownership interest in Nickelodeon Australia, and plan to continue to expand our brands in various regions, including launch of COMEDYCENTRAL channels in Sweden and New Zealand in 2009. BET Networks BET Networks owns and operates program services, including its flagship BET® channel and the BET Digital Networks—BETJ™ , BET Gospel® and BET Hip Hop®.
Other BET Networks properties include its broadband website, BET on Blast, which features music videos, news, interviews, third party licensed content and other content from BET’s cable networks; and BET Mobile, which provides ringtones, games, social networking and other content for cellular phones and digital services such as video-on-demand and digital downloading.
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Table of ContentsMedia Networks Competition MTV Networks and BET Networks compete for advertising revenue with other cable and broadcast television networks, online and mobile outlets, radio programming and print media. MTV Networks generally competes with other widely distributed cable networks such as TBS, TNT, Discovery, ESPN, SciFi, FX, Lifetime and USA Network, the broadcast television networks and digital properties such as MySpace, YouTube and Hulu. Each programming service also competes for audience share with competitors’ programming services that target the same audience. For example, Nickelodeon and its related properties compete for younger viewers with several of The Walt Disney Company’s properties and with Time Warner’s Cartoon Network. Similarly, BET Networks competes with African-American oriented shows on cable and broadcast networks including TV One and online properties such as Blackplanet.com and AOL Blackvoices. We also compete with other cable networks for affiliate fees derived from distribution agreements with cable television operators, satellite operators and other distributors. Our networks also compete with other content creators for actors, writers, producers and other creative talent and for new show ideas and the acquisition of popular programming. MTV Networks also releases several video game titles on both console and PC platforms that compete with titles released by major video game publishers such as Activision and Electronic Arts. FILMED ENTERTAINMENT The Filmed Entertainment segment produces, finances and distributes motion pictures under the Paramount Pictures, Paramount Vantage, Paramount Classics, MTV Films and Nickelodeon Movies brands. In addition, the Filmed Entertainment segment will continue to release a number of pictures under the DreamWorks brand. Paramount also acquires films for distribution, has distribution and fulfillment services agreements with DreamWorks Animation SKG, Inc. and has distribution agreements with MVL Productions LLC (“Marvel”) and DW Funding LLC, the owner of the DreamWorks live-action film library. In general, motion pictures produced, acquired and/or distributed by the Filmed Entertainment segment are exhibited theatrically in the U.S. and internationally, followed by their release on DVDs, video-on-demand, pay and basic cable television, broadcast television and syndicated television (the “distribution windows”), digital media outlets, and, in some cases, other exhibitors such as airlines and hotels. Our Filmed Entertainment segment generates revenues worldwide principally from: (i) the theatrical release of motion pictures, (ii) home entertainment, which includes sales of DVDs and other products relating to the motion pictures we release theatrically and certain other programming, including content we distribute on behalf of third parties such as CBS Corporation and (iii) license fees paid worldwide by third parties for exhibition rights on various media. The Filmed Entertainment segment also generates ancillary revenues from providing production services to third parties, primarily at Paramount’s studio lot, consumer products licensing, game distribution and distribution of its content on digital platforms. In 2008, theatrical revenues, home entertainment revenues, license fees and ancillary revenues were approximately 29%, 45%, 22% and 4%, respectively, of total revenues for the Filmed Entertainment segment. In choosing films to produce, we aim to create a carefully balanced film slate that represents a variety of genres, styles and levels of investment—with the goal of creating entertainment for both niche audiences and worldwide appeal. In October 2008, Paramount announced that it would rationalize its film slate in order to compete more effectively. Beginning in 2009, we expect that the Filmed Entertainment segment will release up to 20 films per year domestically, including approximately 16 films produced or acquired by Paramount or DW Studios L.L.C. (formerly DreamWorks L.L.C.) and two to four films produced by DreamWorks Animation and Marvel. Paramount is also focused on continuing to improve market position and profitability through the development of franchise films, the expansion of film acquisition and production operations internationally, and the diversification of revenue streams, such as making library product available online to own or rent.
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Table of ContentsEach motion picture is a separate and distinct product with its profitability dependent upon many factors, among which public response and cost are of fundamental importance. The theatrical success of a motion picture is a significant factor in determining the revenues it is likely to generate in home entertainment sales and licensing fees during the various other distribution windows. Revenues from motion picture theatrical releases tend to be cyclical with increases during the summer months, around holidays and in the fourth quarter. Competition from other motion pictures released around the same time and/or for audience leisure time generally may affect revenues, particularly in an economic recession. The costs associated with producing, marketing and distributing a motion picture can be significant, and can also cause our results to vary depending on the timing of a motion picture’s release. For example, marketing costs are generally incurred before and throughout the theatrical release of a film and, to a lesser extent, other exhibition windows, and are expensed as incurred. Therefore, we typically incur losses with respect to a particular film prior to and during the film’s theatrical exhibition, and profitability may not be realized until well after a film’s theatrical release, if at all. Therefore, the results of the Filmed Entertainment segment can be volatile as films work their way through the various distribution windows. Historically, we have entered into film financing arrangements under which third parties participate in the financing of the production costs of a film or slate of films typically in exchange for a partial copyright interest. We also have agreements with third parties, including other studios, to co-finance certain of our motion pictures. Paramount’s home entertainment group is responsible for the worldwide sales, marketing and distribution of DVDs for films distributed by Paramount and other Viacom brands, as well as content we distribute on behalf of third parties, including CBS Corporation. Paramount’s made-for-home entertainment production group, Paramount Famous Productions, develops and produces feature length prequels, sequels and remakes based on the Paramount library. It plans to develop two to three made-for-DVD movies per year, and its first DVD release, Without a Paddle: Nature’s Calling, was in January 2009. Films produced and/or distributed by Paramount or DW Studios are licensed to pay and basic cable television, broadcast television and syndication worldwide. Paramount also licenses its brands for consumer products, themed restaurants, live stage plays, film clip licensing and theme parks. Revenues are typically derived from royalties based on the licensee’s revenues, with an advance and/or guarantee against future expected royalties, and may vary based on the popularity of the brand or licensed product with consumers. Paramount also distributes films and other content to consumers through digital platforms. This includes offering certain motion picture titles for sale and rent through third party online destinations, as well as offering motion picture images, ring tones and games for sale through Paramount’s direct mobile movie site, wap.paramount.mlogic3g.com. Paramount is expanding its presence in the games business with its 2008 acquisition of Screenlife, LLC, maker of the movie trivia game “Scene It” and other DVD games.
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Table of ContentsMotion Picture Production and Distribution
Domestic and International Distribution In domestic markets, Paramount performs its own marketing and distribution services for theatrical and home entertainment releases. In the domestic pay television distribution window, Paramount’s feature films initially theatrically released in the United States on or after January 1, 1998 have been exhibited by Showtime Networks, which is owned by CBS Corporation, for certain windows. This agreement applies to films theatrically released
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Table of Contentsthrough December 2007. Beginning in the fall of 2009, qualifying Paramount, Paramount Vantage or Paramount Classics titles released theatrically on or after January 1, 2008, as well as titles theatrically released by MGM, United Artists and Lionsgate on or after January 1, 2009, and various other library product and television series, will be exhibited on epix, a new premium pay television channel and video-on-demand service to be launched by our joint venture with Metro-Goldwyn-Mayer Studios Inc. (“MGM Studios”) and Lionsgate. Certain DreamWorks (including DW Studios) and DreamWorks Animation films are subject to a similar output arrangement under an agreement between DW Studios and Home Box Office (HBO). Paramount also distributes films domestically in the other distribution windows such as DVD, video-on-demand, basic cable and broadcast television and on various digital platforms, such as iTunes and Xbox Live. In international markets, through 2006, Paramount, through its international affiliates, generally distributed its motion pictures for theatrical release through United International Pictures (“UIP”), a company that we and an affiliate of Universal Studios, Inc. (“Universal”) own jointly. In January 2007, Paramount and Universal began theatrical self-distribution in 15 key countries that were separated from UIP’s distribution business, with each party taking over the UIP operating entity in designated countries. Paramount and Universal each had the option to continue a transitional distribution arrangement with the other party in those countries and the parties have negotiated an extension of certain of these arrangements. Paramount set up its own distribution operations in Japan and Spain in 2008, as well as in Germany in January 2009. In five territories Paramount will continue to distribute through Universal, and in two additional territories, Paramount will handle distribution of Universal’s motion pictures. The UIP joint venture continues to operate in certain other territories. These self-distribution activities represent a significant expansion of Paramount’s international presence, and it intends to continue to expand internationally through increased direct distribution and acquisition of local content. Key Agreements In connection with the acquisition of DreamWorks in January 2006, Paramount, DreamWorks and certain of their international affiliates entered into a seven-year agreement with DreamWorks Animation for certain exclusive distribution rights to, and home video fulfillment services for, the animated films produced by DreamWorks Animation, for which Paramount receives certain fees. The output term of the agreement expires on the later of the delivery of 13 qualified animated motion pictures and December 31, 2012, subject to earlier termination under certain limited circumstances. Also in connection with the acquisition of DreamWorks, we acquired a live-action film library consisting of 59 films released through September 16, 2005. In May 2006, we sold a controlling interest in DW Funding, the owner of the DreamWorks live-action film library. Paramount and its international affiliates retained the exclusive distribution rights to the live-action film library for a five-year period, which is renewable under certain circumstances, for which Paramount receives distribution fees. We retained a minority equity interest in DW Funding and have certain rights and obligations to reacquire the library at the end of the five-year term. In September 2008, Paramount and Marvel extended their distribution agreement under which Paramount distributed Marvel’s Iron Man in 2008. Under the agreement, Paramount will distribute Marvel’s next four to six self-produced feature films on a worldwide basis, including theatrical distribution in most foreign territories previously serviced by Marvel through local distribution entities, in exchange for distribution fees. In October 2008, Viacom, Paramount, DW Studios and the DreamWorks principals Steven Spielberg, David Geffen and Stacey Snider reached an agreement for the departure of those individuals from DW Studios. Pursuant to the agreement, the DreamWorks principals’ new company acquired certain projects in development, which Paramount has the option to co-finance and co-distribute. Our subsidiary, DW Studios, retained all other projects and retains the rights to motion pictures released prior to the departure of the DreamWorks principals, other than the live-action film library owned by DW Funding. Mr. Spielberg will continue to produce the Transformers franchise for Paramount, as well as collaborate on certain other DW Studios and Paramount films.
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Table of ContentsFilmed Entertainment Competition Our Filmed Entertainment segment competes for audiences for its motion pictures and other entertainment content with the other major studios such as Disney, Fox, Sony Pictures, Universal and Warner Bros., as well as independent film producers. Our competitive position primarily depends on the number and quality of the films produced, their distribution and marketing success, and public response. We also compete to obtain creative talent, including actors, directors and writers, and scripts for motion pictures, all of which are essential to our success. Our motion picture brands also compete with these studios and other producers of entertainment content for distribution of their products through the various distribution windows and on digital platforms. SOCIAL RESPONSIBILITY Viacom’s social responsibility commitment leverages the power of its brands and the strength of its audience relationships to encourage action on a variety of pro-social issues that are important to our employees, audiences, partners and shareholders alike. Our social responsibility efforts are spearheaded by our Corporate Responsibility Council, which seeks to provide company-wide guidance and support to the variety of pro-social causes supported by our brands and individual program services. Our businesses fuel social change through our foundations and individual campaigns, such as:
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We also believe it is important to promote socially responsible business practices both within Viacom and by our business partners. Our Global Business Practices Statement (formerly Business Conduct Statement) and Supplier Compliance Policy are posted in the “corporate governance” section of our website www.viacom.com. We also require that certain partners, such as licensees in our consumer products business, agree to a Code of Conduct as a condition to our doing business with them. More information about our social responsibility initiatives is available at www.viacom.com “corporate responsibility.” REGULATION Our businesses are subject to and affected by regulations of U.S. federal, state and local governmental authorities, and our international operations are subject to laws and regulations of local countries and pan-national bodies such as the European Union. The laws, rules, regulations, policies and procedures affecting these businesses are constantly subject to change. The descriptions which follow are summaries and should be read in conjunction with the texts of the relevant statutes, rules and regulations. The descriptions do not purport to describe all present and proposed statutes, rules and regulations affecting our businesses. Intellectual Property We are fundamentally a content company, and the protection of our brands and entertainment content, and the laws affecting our intellectual property, are of significant importance to us. See the section entitled “Intellectual Property” below for more information on our brands. Copyright Law and Content In the United States, under current law, the copyright term for authored works is the life of the author plus 70 years. For works-made-for-hire, the copyright term is the shorter of 95 years from first publication or 120 years from creation. Piracy Unauthorized reproduction, distribution or display of copyrighted material over the Internet or through other methods of distribution, such as through devices, software or websites that allow the reproduction, viewing, sharing and/or downloading of entertainment content by either ignoring or interfering with the content’s security features and copyrighted status, interferes with the market for copyrighted works and disrupts our ability to exploit our content. In addition, piracy of motion pictures through unauthorized distribution on DVDs and other platforms continues to present challenges for our industry. The extent of copyright protection and the use of technological protections, such as encryption, are controversial. Modifications to existing laws that weaken these protections could have an adverse effect on our ability to license and sell our programming. We are actively engaged in enforcement and other activities to protect our intellectual property, including monitoring notable online destinations that distribute our content, and participating in various industry-wide enforcement initiatives, education and public relations programs and legislative activity on a worldwide basis. One promising area of enforcement activity is to work with network operators, such as Internet service providers, to take action against users who distribute our content without authorization.
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Table of ContentsIn October 2008, the Prioritizing Resources and Organization for Intellectual Property Act of 2007 (the “PRO-IP Act”) was signed into law in the United States. The PRO-IP Act increases both civil and criminal penalties for counterfeiting and piracy of intellectual property associated with works of music and film, among other things; provides enhanced resources to law enforcement agencies for enforcing intellectual property rights; criminalizes the exportation of counterfeited goods; and creates an “Intellectual Property Enforcement Representative,” a cabinet-level position appointed by the Senate responsible for issuing enforcement policy to, and coordinating the efforts of, U.S. departments and agencies and coordinating the preparation of a plan to reduce counterfeit and infringing goods in the domestic and international supply chain. We strongly support this law and believe it will aid our efforts to appropriately protect our content. While many legal protections exist to combat piracy, laws domestically and internationally continue to evolve and it is likely that we will continue to expend substantial resources to appropriately protect our content. The repeal or weakening of laws intended to combat piracy and protect intellectual property could make it more difficult for us to adequately protect our intellectual property, negatively impacting its value and further increasing the costs of enforcing our rights. Media Networks Music Royalties MTV Networks and BET Networks currently obtain content for their cable networks, websites and other properties from record labels, music publishers, independent producers and artists. We have entered into global music video licensing agreements with the major record companies and major music publishers and into global or regional license agreements with certain independent record companies. MTV Networks and BET Networks also obtain certain rights to some of their content, such as performance rights of song composers and rights to non-interactive digital transmission of recordings, pursuant to licenses from performing rights organizations such as ASCAP and BMI and through statutory compulsory licenses established by the Digital Millennium Copyright Act, as amended. The performing rights royalties payable to ASCAP and BMI are either negotiated or set by statutory Rate Courts. Royalties for the compulsory licenses are established periodically by Copyright Arbitration Royalty Panels. Programming Distribution Some policymakers maintain that cable television operators should be required by law to offer programming to subscribers on a network-by-network, or “à la carte,” basis or provide specific program tiers such as those providing only family appropriate programming. In 2004, the FCC’s Media Bureau released a report which concluded that à la carte regulation would tend to decrease programming diversity and would not be in consumers’ best interests; however, it released a subsequent report in 2006 that found that à la carte regulation might benefit some consumers. The issue has been a key item of interest for certain members of the FCC and it is uncertain whether it will remain an area of focus. The FCC is also currently reviewing whether companies that own multiple cable networks should be required to enter into affiliation agreements with cable television operators and other distributors on an “unbundled” or network-by-network basis and forego tiering and distribution requirements, including those contained in our existing affiliation agreements. The requirement to unbundle our program services, or a prohibition on tiering and subscriber guarantees, could reduce distribution of certain of our program services, perhaps significantly. It could also lead to reduced viewership on some or all of our networks and increased marketing expenses, negatively affecting our revenues from advertising and affiliate fees and our results of operations. Children’s Programming Federal legislation and FCC rules limit the amount and content of commercial matter that may be shown on cable channels during programming designed for children 12 years of age and younger. Recently, some U.S. policymakers have sought limitations on food and beverage advertising during such programming. In November 2006, the UK Office of Communications (OFCOM) restricted television ads for foods and drinks high in fat, salt and sugar in and around children’s programming (children aged four to nine); an expansion of the definition of
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Table of Contents“children” to include persons aged four to fifteen, which affects our non-children oriented channels; application to all OFCOM-licensed channels regardless of the country in which their target audience is located; and bans on celebrity and licensed character ads for certain products targeted at primary school children. Implementation of the measures commenced in March 2007 and, for dedicated children’s channels whose ability to replace lost revenues from food and drink advertisers is harder to achieve, was phased-in until January 1, 2009, when full implementation was required. OFCOM is actively monitoring the impact of the restrictions. Various other laws and regulations intended to protect the interests of children are applicable to our businesses, including measures designed to protect the privacy of minors online. Indecency Some policymakers support the extension of indecency rules applicable to over-the-air television broadcasters to cover cable and satellite programming. If such an extension occurred and was not found to be unconstitutional, our content could be subject to additional regulation. The Supreme Court has included on its docket for 2009 several indecency-related matters which may affect the law in this area. Program Access Under the Communications Act of 1934, vertically integrated cable programmers are generally prohibited from offering different prices, terms or conditions to competing multichannel video programming distributors unless the differential is justified by certain permissible factors set forth in the FCC’s regulations. The FCC’s “program access” rules also limit the ability of a vertically integrated cable programmer to enter into exclusive distribution arrangements with cable television operators. A cable programmer is considered to be vertically integrated if it owns or is owned by a cable television operator in whole or in part under the FCC’s program access attribution rules. Cable television operators for this purpose may include telephone companies that provide video programming directly to subscribers. Our wholly owned program services are not currently subject to the program access rules. Our flexibility to negotiate the most favorable terms available for our content and our ability to offer cable television operators exclusive programming could be adversely affected if we were to become subject to the program access rules. INTELLECTUAL PROPERTY We create, own and distribute intellectual property worldwide. It is our practice to protect our motion pictures, programs, content, brands, characters, video games, publications and other original and acquired works, and ancillary goods and services. The following brands, logos, trade names, trademarks and related trademark families are among those strongly identified with the product lines they represent and are significant assets of ours: Viacom®, MTV Networks®, MTV: Music Television®, VH1®, CMT®: Country Music Television™, MTV Games™, Rock Band®, Harmonix®, Logo®, Nickelodeon®, Nick at Nite®, Nick Jr.®, Noggin®, Neopets®, COMEDY CENTRAL®, Spike TV®, TV Land™, MTVN International™, TMF™, VIVA™, BET Networks™, BET®, BETJ™, BET.com®, BET Mobile®, Paramount Pictures®, Paramount Vantage™, Paramount Classics™ and other domestic and international program services and digital properties. As a result, domestic and foreign laws and enforcement efforts protecting intellectual property rights are important to us, and we actively enforce our intellectual property rights against infringements. EMPLOYEES AND LABOR MATTERS At December 31, 2008, we employed approximately 11,500 full-time and part-time employees worldwide. We also had approximately 500 freelance employees on our payroll as of December 31, 2008, and use many other freelance and temporary employees in the ordinary course of our business. We engage the services of writers, directors, actors and other employees who are subject to collective bargaining agreements. In 2008, we reached new three-year agreements with the Writers Guild of America, the American Federation of Television and Radio Employees (AFTRA), the International Alliance of Theatrical and Stage Employees (IATSE) and the Directors Guild of America. The collective bargaining agreement with the Screen
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Table of ContentsActors Guild expired on June 30, 2008 and a new agreement has not yet been reached. A strike or labor dispute with the Screen Actors Guild could shut down production of feature films and television programs. Although we have taken steps to minimize the impact of a labor dispute and accelerated production of certain films and programs, an extended dispute could disrupt our operations and reduce our revenues, and we may not be able to negotiate favorable terms for a renewal. FINANCIAL INFORMATION ABOUT SEGMENTS AND FOREIGN AND DOMESTIC OPERATIONS Financial and other information by reporting segment and geographic area for the three years ended December 31, 2008 is set forth in Note 20 to our consolidated financial statements. AVAILABLE INFORMATION We file annual, quarterly and current reports, proxy and information statements, and other information with the Securities and Exchange Commission (the “SEC”). Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments to such reports filed with or furnished to the SEC pursuant to the Securities Exchange Act of 1934, as amended, will be available free of charge on our website at www.viacom.com (under “investor relations”) as soon as reasonably practicable after the reports are filed with the SEC. These documents are also available on the SEC’s website at www.sec.gov. On July 1, 2008, we submitted to the New York Stock Exchange (“NYSE”) the Annual CEO Certification required by Section 303A.12(a) of the New York Stock Exchange Listed Company Manual. We have also filed with this annual report as Exhibits 31.1 and 31.2 the certifications required under Section 302 of the Sarbanes-Oxley Act of 2002. CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS This annual report on Form 10-K, including “Item 7. Management’s Discussion and Analysis of Results of Operations and Financial Condition,” contains both historical and forward-looking statements. All statements that are not statements of historical fact are, or may be deemed to be, forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements are not based on historical facts, but rather reflect our current expectations concerning future results and events. Forward-looking statements generally can be identified by the use of statements that include phrases such as “believe,” “expect,” “anticipate,” “intend,” “plan,” “foresee,” “likely,” “will” or other similar words or phrases. Similarly, statements that describe our objectives, plans or goals are or may be forward-looking statements. These forward-looking statements involve known and unknown risks, uncertainties and other factors that are difficult to predict and which may cause our actual results, performance or achievements to be different from any future results, performance and achievements expressed or implied by these statements. These risks, uncertainties and other factors are discussed in “Item 1A. Risk Factors” below. Other risks, or updates to the risks discussed below, may be described from time to time in our news releases and other filings made under the securities laws, including our reports on Form 10-Q and Form 8-K. There may be additional risks, uncertainties and factors that we do not currently view as material or that are not necessarily known. The forward-looking statements included in this document are made only as of the date of this document and, under Section 27A of the Securities Act and Section 21E of the Exchange Act, we do not have any obligation to publicly update any forward-looking statements to reflect subsequent events or circumstances.
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Table of ContentsItem 1A. Risk Factors. A wide range of risks may affect our business and financial results, now and in the future. We consider the risks described below to be the most significant. There may be other currently unknown or unpredictable economic, business, competitive, regulatory or other factors that could have material adverse effects on our future results. Risks Related to our Business Global Economic Conditions May Continue to Have an Adverse Effect on Our Businesses There was a rapid softening of the economy and tightening of the financial markets in the second half of 2008, and the outlook for the economy in 2009 is uncertain. This slowing of the economy has increased unemployment and reduced the financial capacity of consumers, thereby slowing consumer spending on the products we sell and license and weakening the businesses of partners who purchase advertising on our networks and their spending on advertising generally. In addition, we depend on the financial markets for access to capital, as do our business partners such as cable and satellite operators, retailers, theater operators, games publishers and others. Limited or expensive access to capital could make it more difficult for these partners to do business with us, or to do business generally, which could adversely affect our businesses. Current conditions in the credit and equity markets, if they persist, could also increase our financing costs and limit our financial flexibility. The continuation, or worsening, of domestic and global economic conditions could continue to adversely affect our businesses and results of operations. Our Success is Dependent upon Audience Acceptance of our Programming, Motion Pictures, Games and Other Entertainment Content, which is Difficult to Predict The production and distribution of programming, motion pictures, games and other entertainment content are inherently risky businesses because the revenues we derive from various sources depend primarily on our content’s acceptance by the public, which is difficult to predict. Audience tastes change frequently and it is a challenge to anticipate what offerings will be successful at a certain point in time. The success of our programming, motion pictures, games and other content also depends upon the quality and acceptance of competing entertainment content, including other offerings available or released into the marketplace at or near the same time. Other factors, including the availability of alternative forms of entertainment and leisure time activities, general economic conditions, piracy, digital and on-demand distribution, and growing competition for consumer discretionary spending, the level of which may decrease as a result of the global economic crisis, may also affect the audience for our content. In our Media Networks business, our advertising revenues typically are a product of audience size and pricing, which reflect market conditions. In 2008, some of our program services experienced declines in audience size. Those trends could continue at those or other networks and reduce the amount of advertising revenue we receive, which could negatively affect our results of operations. In addition, the advertising industry modified the way it measures ratings in 2008 by moving to commercial ratings, which measure audience size for a commercial. Commercial ratings are measured on a “C3” basis, which counts the number of viewers that watch the commercial live or via playback during the three days following the live broadcast. In 2008, the majority of our guaranteed advertising deals were sold on the C3 metric. This is a different way of measuring viewership, and failure to attract audiences to the commercials that air during our programs may negatively impact our advertising revenue. Our advertising revenues may also fluctuate due to the ratings of our channels (including the timing and success of new programs), and are typically highest in the fourth quarter. Low audience ratings could also negatively affect the affiliate fees we receive and/or limit a network’s distribution potential. In addition, our expenses may increase moderately as we invest in new programming, and there is no guarantee that the new programming will be successful or generate sufficient revenue to recoup the expenditure.
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Table of ContentsIn our Filmed Entertainment business, the theatrical performance of a motion picture affects not only the theatrical revenues we receive but also those from other distribution channels, such as DVD and Blu-ray sales, television licenses and sales of licensed consumer products. A poor theatrical performance may also negatively affect our negotiating strength with theater chains, distributors and retailers, resulting in lower revenues and less desirable product promotion. The accounting for the expenses we incur in connection with our programming and motion pictures requires that we make judgments about the potential success and useful life of the program or motion picture. If our estimates prove to be incorrect, we may be forced to accelerate our recognition of the expense and/or write-down the value of the asset. For example, we estimate the ultimate revenues of a motion picture before it is released based on a number of factors. Upon a film’s initial domestic theatrical release and performance, we update our estimate of ultimate revenues based on actual results. If it is not received favorably, we may reduce our estimate of ultimate revenues, thereby accelerating the amortization of capitalized film costs. Similarly, if we determine it is no longer advantageous for us to air a program on our networks, we would accelerate our amortization of the program. Consequently, public acceptance of our programming, motion pictures, games and other entertainment content is core to our business and has the ability to affect all of our revenue streams and the timing of certain expenses. A reduction in the popularity of our content could have a significant, adverse effect on our results of operations. We Must Respond to and Capitalize on Rapid Changes in Consumer Behavior Resulting from New Technologies and Distribution Platforms in Order to Remain Competitive and Exploit New Opportunities Technology in the online and mobile arenas continues to evolve rapidly. We must adapt to changing consumer behavior driven by technological advances such as the direct connection of television to the Internet, high definition (Blu-ray) packaged media, video-on-demand, increased mobility of content and a desire for more short form, user-generated and interactive content. Changing consumer behavior may impact our traditional distribution methods, for example, by reducing viewership of our programming, the demand for DVD product or pay television subscriptions and/or the desire to see motion pictures in theaters. The domestic DVD market has softened recently, particularly in the second half of 2008. This trend may continue in 2009, and continued declines may adversely affect our home entertainment revenues and profitability. In addition, consumers are increasingly viewing content from the Internet on their televisions and on handheld or portable devices, and watching it on a time-delayed basis. We must continue to adapt our content to these viewership habits. Technologies which enable users to fast-forward or skip advertisements may affect the attractiveness of our offerings to advertisers and could therefore adversely affect our revenues. If we cannot adapt to the changing lifestyles and preferences of our target audiences and capitalize on technological advances with favorable business models, there could be a negative effect on our business. Increased Costs for Programming, Motion Pictures and Other Content May Adversely Affect Our Profits In our Media Networks segment, we have historically produced a significant amount of original programming and intend to continue to invest in this area. We also acquire programming, such as motion pictures and television series, from other television production companies and studios and pay a license fee in connection with the acquired rights. Our investments in original and acquired programming are significant, and may not be recouped when the program is broadcast or distributed, therefore leading to decreased profitability or potential write-downs. The Filmed Entertainment segment’s core business involves the production, marketing and distribution of motion pictures, the costs of which have been increasing. In particular, the “tentpole” motion pictures that we release generally have higher costs than the other films released during the year. A “tentpole” film’s underperformance theatrically can significantly affect our revenues and profitability, and negatively affect the revenues we receive from other distribution platforms.
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Table of ContentsAn increase in content acquisition costs could also affect our profits. For example, we license music and music videos for exhibition on our cable networks, websites and other content outlets from record companies in exchange for cash or advertising time or for promotional consideration. We have entered into global music video licensing agreements with the major record companies and major music publishers and into global or regional license agreements with certain independent record companies. We also license various other music rights from record companies, music publishers, performing rights societies and others. There can be no assurance that we will be able to obtain license renewals or additional license agreements from these sources, or that favorable terms will be available. Our Revenues, Expenses and Operating Results May Vary Based on the Timing, Mix, Number and Availability of Our Motion Pictures and Seasonal Factors Our revenues and operating results fluctuate due to the timing, mix, number and availability of our theatrical motion picture and home entertainment releases, as well as license periods for our content. For example, results may increase or decrease during a particular period due to differences in the number of films released compared to the corresponding period in the prior year. Our operating results also fluctuate due to the timing of the recognition of production and marketing expenses, which are typically largely incurred prior to the release of motion pictures and home entertainment product, with the recognition of related revenues in later periods. In addition, the success of our individual mix of titles may vary period over period, causing our operating results to fluctuate. Our business also has experienced and is expected to continue to experience some seasonality due to, among other things, seasonal advertising patterns and seasonal influences on audiences’ viewing habits and attendance. Typically, our revenue from advertising increases in the fourth quarter due to the holiday season, among other factors, and revenue from motion pictures increases in the summer, around holidays and in the fourth quarter. The effects of these variances make it difficult to estimate future operating results based on the results of any specific quarter. Piracy of Our Entertainment Content, Including Digital Piracy and Other Unauthorized Exhibitions of Our Content, May Decrease Revenue Received from Our Programming and Motion Pictures and Adversely Affect Our Business and Profitability The success of our business depends in part on our ability to maintain the intellectual property rights to our entertainment content. We are fundamentally a content company and piracy of our brands, motion pictures and DVDs, programming, digital content and other intellectual property has the potential to significantly affect us and the value of our content. Piracy is particularly prevalent in many parts of the world that lack effective enforcement of copyright and technical protective measures similar to existing law in the United States. Piracy is also a challenge domestically, and the interpretation of copyright laws as applied to our content remains in flux. Piracy and other unauthorized uses of content are made easier by technological advances allowing the conversion of motion pictures, programming and other content into digital formats, which facilitates the creation, transmission and sharing of high quality unauthorized copies. Unauthorized reproduction, distribution or display of our content over the Internet or through other methods of distribution, such as through devices, software or websites that allow the reproduction, viewing, sharing and/or downloading of entertainment content by either ignoring or interfering with the content’s security features and copyrighted status is a threat to our ability to protect our creative works and to recoup or profit from the expense incurred to create such works. Unauthorized use of our entertainment content may have an adverse effect on our business because it reduces the revenue that we potentially could receive from the legitimate sale and distribution of our content. We are actively engaged in enforcement and other activities to protect our intellectual property, and it is likely that we will continue to expend substantial resources in connection with these efforts. These efforts to prevent the unauthorized use of our content may affect our profitability, and may not be successful in reducing piracy.
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Table of ContentsThe Loss of Affiliation Agreements, or Renewal on Less Favorable Terms, Could Cause Our Revenues to Decline in Any Given Period or in Specific Markets We are dependent upon our affiliation agreements with cable television operators, satellite operators, mobile networks and other distributors for the distribution of our program services. We have agreements in place with the major distributors, some of which expire over the next several years and we expect to renegotiate on a rolling basis. There can be no assurance that these affiliation agreements will be renewed in the future on terms, including pricing, acceptable to us. The loss of a significant number of these arrangements or the loss of carriage on the most widely available programming tiers could reduce the distribution of our program services and decrease the potential audience for our programs, which would adversely affect our advertising and affiliate fee revenues. In addition, further consolidation among cable and satellite operators and increased vertical integration of such distributors into the cable or broadcast television businesses could adversely affect our ability to negotiate favorable terms for distribution of our program services. Furthermore, we recently announced the creation of epix, our joint venture with MGM Studios and Lionsgate to release our motion pictures in the pay television distribution window. If epix is not successful in securing affiliate relationships and subscribers, our revenues from this distribution window could be negatively affected, and we may not be able to secure pay television distribution for our motion pictures on favorable terms with another distributor. Our Video Game Business Has a Short Operating History and is Subject to Additional Risks In connection with our 2006 acquisition of Harmonix, we significantly expanded our involvement in video and online games, including Rock Band. The video game industry experienced softness in 2008 which we saw reflected in our sales of these games. Our games are distributed on several platforms, and for each platform, there are a variety of controllers and packages available. Greater than anticipated returns, increases in manufacturing or distribution costs, and/or mismatches between forecasted and actual sales will have an adverse effect on the profitability of this business and affect our results of operations. Further, the video game business is generally subject to the risk of intellectual property litigation, in particular patent litigation, and there are three patent cases pending against us related to console video games. Although we believe we will prevail in these litigations, litigation is expensive and the outcome of litigation is inherently uncertain. The failure to resolve litigation on satisfactory terms could result in higher costs or the inability to sell one or more products. The Loss of Key Talent Could Disrupt Our Business and Adversely Affect Our Revenues Our business depends upon the continued efforts, abilities and expertise of our corporate and divisional executive teams and entertainment personalities. We employ or contract with several entertainment personalities with loyal audiences and also produce motion pictures with highly regarded directors, actors and other talent. These individuals are important to achieving audience endorsement of our programs, motion pictures and other content. There can be no assurance that these individuals will remain with us or will retain their current appeal. If we fail to retain these individuals or if our entertainment personalities lose their current appeal, our revenues could be adversely affected. The Failure or Destruction of Satellites and Facilities that We Depend Upon to Distribute Our Programming Could Adversely Affect Our Business and Results of Operations We use satellite systems to transmit our program services to cable television operators and other distributors worldwide. The distribution facilities include uplinks, communications satellites and downlinks. Notwithstanding back-up and redundant systems, transmissions may be disrupted as a result of local disasters that impair on-ground uplinks or downlinks, or as a result of an impairment of a satellite. Currently, there are a limited number of communications satellites available for the transmission of programming. If a disruption occurs, we may not be able to secure alternate distribution facilities in a timely manner. Failure to do so could have a material adverse effect on our business and results of operations.
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Table of ContentsOur Obligations Related to Guarantees and Litigation Could Adversely Impact Our Financial Condition We have both recorded and potential liabilities and costs related to discontinued operations and former businesses, including, among other things, potential liabilities to landlords if Blockbuster Inc. should default on certain store leases or if Famous Players Inc. should default on certain theater leases. Blockbuster’s stock price has recently declined considerably and its senior debt is rated CCC by S&P and Caa2 by Moody’s. In addition, in connection with the sale of the DreamWorks live-action film library to DW Funding in 2006, we retained a 49% minority equity interest in DW Funding and guarantee certain debt of DW Funding. We are subject to a put option at the then current fair market value of DW Funding, commencing nine months prior to the fifth anniversary of the sale. We also have a corresponding call option exercisable at fair market value. To the extent the current fair value at the option closing date is insufficient to repay certain indebtedness, including any unpaid interest, of DW Funding guaranteed by us, we would be required to pay the difference. In addition, in connection with our joint ventures, we have made certain investments and have future funding obligations, which may not be recouped until well after our initial investment, if at all. We are also involved in pending and threatened litigation from time to time, the outcome of which is inherently uncertain and difficult to predict. We cannot assure you that our reserves and/or letters of credit are sufficient to cover these liabilities in their entirety or any one of these liabilities when it becomes due or at what point any of these or new liabilities may affect us. Therefore, there can be no assurance that these liabilities will not have an adverse effect on our financial condition. Risks Related to our Industry Changes in Advertising Markets Generally Could Cause Our Revenues and Operating Results to Decline Significantly in Any Given Period or in Specific Markets We derive substantial revenues from the sale of advertising on a variety of platforms, and a decline in advertising expenditures could significantly adversely affect our revenues and operating results in any given period. Declines can be caused by the economic prospects of specific advertisers or industries, or the economy in general, causing advertisers to alter their spending priorities based on these or other factors. Recent domestic and global economic conditions have caused a weakness in advertising expenditures by companies in many sectors of the economy. Changes in the advertising industry, such as the introduction of commercial ratings in 2008, can also affect our advertising revenues. In addition, advertising revenues may be affected by increasing competition for the leisure time of audiences, including shifts in spending toward online and mobile outlets and away from more traditional media, or toward new ways of purchasing advertising, such as through advertising exchanges. For example, we and other cable network owners may provide advertising inventory on our networks to cable television operators, satellite operators and other intermediaries who resell that inventory in competition with us. In addition, political, social or technological change may result in a reduction of various sectors’ advertising expenditures. For example, Federal legislators and regulators could impose additional limitations on advertising to children in an effort to combat childhood obesity and unhealthy eating or for other reasons, or impose limitations on product placement and other program sponsorship arrangements. Any reduction in advertising expenditures could have an adverse effect on our revenues and results of operations. Our Businesses Operate in Highly Competitive Industries Participants in the cable networks, motion picture, digital and video game industries depend on consumer acceptance of content, appeal to advertisers and solid distribution relationships. Competition for viewers, advertising and distribution is intense and comes from broadcast television, cable networks, online and mobile properties, movie studios and independent film producers and distributors, local, regional and national newspapers, video gaming sites and other media that compete for audiences, and from pirated content. In
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Table of Contentsparticular, a portion of the advertising on websites and mobile outlets is derived from traditional cable network advertisers. In addition, our competitors include market participants with interests in multiple media businesses which are often vertically integrated. Our ability to compete successfully depends on a number of factors, including our ability to provide high quality and popular entertainment content, adapt to new technologies and distribution platforms and achieve widespread distribution. Distribution capacity may become increasingly limited as broadcasters transition to digital formats, especially if “must carry” regulations are extended to channels beyond the broadcaster’s primary channel. More television options increase competition for viewers, and competitors targeting programming to narrowly defined audiences may gain an advantage over us for television advertising and affiliate revenues. There can be no assurance that we will be able to compete successfully in the future against existing or potential competitors, or that competition will not have a material adverse effect on our business, financial condition or results of operations. Requirements that Cable Television Operators Offer Programming on an à la Carte or Tiered Basis May Decrease the Distribution of Program Services and Affect Our Results of Operations Certain policymakers maintain that cable television operators should be required to offer programming to subscribers on a network-by-network, or à la carte, basis or to provide programming tiers designed specifically for certain audiences, such as family tiers. In response, certain cable television operators and other distributors have introduced tiers to their customers that may or may not include some or all of our networks. The FCC is also reviewing whether companies that own cable networks should be required to enter into affiliation agreements with cable television operators and other distributors on an “unbundled” or network-by-network basis. A purported industry class action litigation has been filed alleging damages and seeking relief related to claimed impermissible bundling of networks by cable and satellite operators, the Company and other programmers. The unbundling or tiering of our program services by cable television operators or other distributors, including a decision not to include some or all of our networks in a tier, or a requirement that we enter into affiliation agreements on a network-by-network basis, could reduce distribution of certain of our program services, perhaps significantly. It could also lead to reduced viewership on some or all of our networks and increased marketing expenses, negatively affecting our revenues from advertising and affiliate fees and our results of operations. Changes in U.S. or Foreign Communications Laws, Laws Affecting Intellectual Property Rights or Other Regulations May Have an Adverse Effect on Our Business The multichannel video programming and distribution industries in the United States are highly regulated by U.S. federal laws and regulations issued and administered by various federal agencies, including the FCC. Our program services and online properties are subject to a variety of laws and regulations, including those relating to issues such as content regulation, user privacy and data protection and consumer protection, among others. For example, various laws and regulations are intended to protect the interests of children, including limits on the amount and content of commercial material that may be shown, restrictions on children’s advertising and measures designed to protect the privacy of minors. In addition, the U.S. Congress and the FCC currently have under consideration, and may in the future adopt, new laws, regulations and policies regarding a wide variety of matters that could, directly or indirectly, affect the operations and ownership of our U.S. media properties. For example, some policymakers support the extension of indecency rules applicable to over-the-air broadcasters to cover cable and satellite programming. Other domestic and international regulators, including OFCOM in the United Kingdom, support additional limitations on food and beverage advertising to children. Our business could be affected, potentially materially, by any such new laws, regulations and policies. We could incur substantial costs to comply with new laws and regulations or substantial penalties or other liabilities if we fail to comply. We could also be required to change or limit certain of our business practices. In addition, the repeal or weakening of laws intended to combat piracy and protect intellectual property could make it more difficult for us to adequately protect our intellectual property, negatively impacting its value and
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Table of Contentsincreasing the costs of enforcing our rights. Similarly, changes in regulations imposed by governments in other jurisdictions in which we, or entities in which we have an interest, operate could adversely affect our business, results of operations and ability to expand these operations beyond their current scope. We Could Be Adversely Affected by Strikes and Other Union Activity We and our suppliers engage the services of writers, directors, actors and other talent, trade employees and others who are subject to collective bargaining agreements. The Screen Actors Guild collective bargaining agreement which covers actors who perform in our motion pictures and television programs expired on June 30, 2008, and a new agreement has not yet been reached. We are currently working under the terms and conditions of the expired agreement, and the Screen Actor’s Guild continues to have the option of seeking a strike authorization from its members. Such a labor dispute may disrupt our operations and reduce our revenues, and we may not be able to negotiate favorable terms for a renewal, which could increase our costs. Political and Economic Risks Associated with Our Businesses Could Harm Our Financial Condition Our businesses operate and have customers worldwide, and we are focused on expanding our international operations in key markets, some of which are emerging markets. Inherent risks of doing business in international markets include, among other risks, changes in the economic environment, export restrictions, currency exchange controls and/or fluctuations, tariffs or other trade barriers, longer payment cycles and, in some markets, increased risk of political instability. In particular, foreign currency fluctuations against the U.S. Dollar affect our results both positively and negatively which may cause results to fluctuate. Furthermore, some foreign markets where we operate may be even more adversely affected by current economic conditions than the United States. We also may incur substantial expense as a result of changes in the existing economic or political environment in the regions where we do business, including the imposition of new restrictions. Acts of terrorism or other hostilities, or other future financial, political, economic or other uncertainties, could lead to a reduction in revenue or loss of investment, which could adversely affect our business, financial condition or results of operations. Risks Related to Our Controlling Stockholder and Conflicts of Interest Sales of Additional Shares of Common Stock by National Amusements Could Adversely Affect the Stock Price National Amusements (“NAI”), through its beneficial ownership of our Class A common stock, has voting control of Viacom. NAI disclosed in October 2008 that it sold approximately $233 million in the aggregate of shares of Viacom and CBS Corporation non-voting common stock in connection with requirements under its credit facilities. NAI also announced that it was in constructive negotiations with its lenders regarding such facilities and outstanding notes. Although NAI stated in October that it did not intend to sell any additional shares, there can be no assurance that NAI at some future time will not sell additional shares of our stock, which could adversely affect our share price. Through Its Voting Control of Viacom, NAI is in a Position to Control Actions that Require Stockholder Approval Sumner M. Redstone, the controlling stockholder, Chairman and Chief Executive Officer of NAI, serves as our Executive Chairman and Founder, and Shari Redstone, the President and a director of NAI, serves as the non-executive Vice Chair of our Board of Directors. In addition, Philippe Dauman, our President and Chief Executive Officer, is a director of NAI, and George Abrams, one of our directors, is a director of NAI. Mr. Dauman has presently recused himself from activity as an NAI board member. In addition, NAI’s board of directors has created a special committee that does not include Mr. Redstone or Mr. Dauman in order to consider issues that may be perceived to create a conflict between their responsibilities to Viacom and to NAI. Similarly, our Board of Directors has acted by independent directors when appropriate to address such issues.
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Table of ContentsNevertheless, NAI is in a position to control the outcome of corporate actions that require stockholder approval, including the election of directors and transactions involving a change in control. The interests of NAI may not be the same as yours, and you will be unable to affect the outcome of our corporate actions for so long as NAI retains voting control. You will be reliant on our independent directors to represent your interests. Certain Members of Management, Directors and Stockholders May Face Actual or Potential Conflicts of Interest Both Viacom and CBS Corporation are controlled by NAI. Mr. Redstone, the controlling stockholder, Chairman and Chief Executive Officer of NAI, serves as our Executive Chairman and Founder and the Executive Chairman and Founder of CBS Corporation. Ms. Redstone, the President and a director of NAI, serves as non-executive Vice Chair of the Board of Directors of both Viacom and CBS Corporation. Mr. Dauman and Mr. Abrams are directors of NAI, and Frederic Salerno, one of our directors, is also a director of CBS Corporation. The NAI ownership structure and the common directors could create, or appear to create, potential conflicts of interest when the management, directors and controlling stockholder of the commonly controlled entities face decisions that could have different implications for each of us. For example, potential conflicts of interest could arise in connection with the resolution of any dispute between Viacom and CBS Corporation regarding the terms of the agreements governing the separation and the relationship between Viacom and CBS Corporation thereafter. Potential conflicts of interest, or the appearance thereof, could also arise when we and CBS Corporation enter into any commercial arrangements with each other in the future, despite review by our directors not affiliated with CBS Corporation. Our certificate of incorporation and the CBS Corporation certificate of incorporation both contain provisions related to corporate opportunities that may be of interest to us and to CBS Corporation. Our certificate of incorporation provides that in the event that a director, officer or controlling stockholder of ours who is also a director, officer or controlling stockholder of CBS Corporation acquires knowledge of a potential corporate opportunity for both Viacom and CBS Corporation, such director, officer or controlling stockholder may present such opportunity to us or CBS Corporation or both, as such director, officer or controlling stockholder deems appropriate in his or her sole discretion, and that by doing so such person will have satisfied his or her fiduciary duties to us and our stockholders. In addition, our certificate of incorporation provides that we renounce any interest in any such opportunity presented to CBS Corporation and, similarly, the CBS Corporation certificate of incorporation provides that CBS Corporation renounce any interest in any such opportunity presented to us. These provisions create the possibility that a corporate opportunity of one company may be used for the benefit of the other company. Our Business and Other Businesses Which Are Controlled By Sumner Redstone, Including CBS Corporation, Are and Will Continue to Be Attributable to Each Other for Certain Regulatory Purposes Which May Limit Business Opportunities or Impose Additional Costs So long as we and CBS Corporation are under common control, each company’s businesses, as well as the businesses of any other commonly controlled company, such as National Amusements, Inc. (“NAI”) and NAIRI, Inc., which are also controlled by Mr. Redstone, may be attributable to the other companies for purposes of U.S. and non-U.S. antitrust rules and regulations, certain rules and regulations of the FCC, and certain rules regarding political campaign contributions in the United States, among others. The businesses of each company may continue to be attributable to the other companies for FCC purposes even after the companies cease to be commonly controlled, if the companies share common officers, directors, or attributable stockholders. As a result, the businesses and conduct of any of these other companies may have the effect of limiting the activities or strategic business alternatives available to us or impose additional costs.
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Table of ContentsThe Separation Agreement Between CBS Corporation and Us Prohibits Us from Engaging in Certain Types of Businesses Under the terms of the Separation Agreement, we generally agreed that we will not own or acquire certain interests in specified types of media companies if such ownership would cause CBS Corporation to be in violation of U.S. federal laws limiting the ownership of broadcast licenses or if it would limit CBS Corporation’s ability under these laws to acquire television or radio stations or television networks. Additionally, we may not make acquisitions, enter into agreements or accept or agree to any condition that purports to bind CBS Corporation or subjects CBS Corporation to restrictions it is not otherwise subject to by legal order without CBS Corporation’s consent. We and CBS Corporation have agreed that prior to the earliest of (1) the fourth anniversary of the separation (December 31, 2009), (2) the date on which none of Mr. Redstone, NAI, NAIRI or any of their successors, assigns or transferees are deemed to have interests in both CBS Corporation and Viacom that are attributable under applicable U.S. federal laws and (3) the date on which the other company ceases to own the video programming vendors that it owns as of the separation, neither of us will own or acquire an interest in a cable television operator if such ownership would subject the other company to U.S. federal laws regulating contractual relationships between video programming vendors and video programming distributors that the other company is not then subject to. These restrictions could limit the strategic business alternatives available to us. We Rely on CBS Corporation’s Performance under Various Agreements In connection with the separation, we entered into various agreements, including the Separation Agreement, Tax Matters Agreement, and certain related party arrangements pursuant to which we provide services and products to CBS Corporation after the separation. The Separation Agreement sets forth the distribution of assets, liabilities, rights and obligations between us and CBS Corporation pursuant to the separation, and includes indemnification obligations for such liabilities and obligations. In addition, pursuant to the Tax Matters Agreement, certain income tax liabilities and related responsibilities are allocated between, and indemnification obligations have been assumed by, each of us and CBS Corporation. Each company will rely on the other company to satisfy its performance and payment obligations under these agreements. Certain of the liabilities to be assumed or indemnified by us or CBS Corporation under these agreements are legal or contractual liabilities of the other company. If CBS Corporation were to breach or be unable to satisfy its material obligations under these agreements, including a failure to satisfy its indemnification obligations, we could suffer operational difficulties or significant losses. Item 1B. Unresolved Staff Comments. Not applicable. Item 2. Properties. In addition to the properties described below, we own and lease office, studio, production and warehouse space, broadcast, antenna and satellite transmission facilities throughout the United States and around the world for our businesses. We consider our properties adequate for our present needs. Viacom
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Table of ContentsMTV Networks
BET Networks
Paramount
Litigation is inherently uncertain and always difficult to predict. However, based on our understanding and evaluation of the relevant facts and circumstances, we believe that the legal matters described below and other litigation to which we are a party are not likely, in the aggregate, to have a material adverse effect on our results of operations, financial position or cash flows. In March 2007, we filed a complaint in the United States District Court for the Southern District of New York against Google Inc. (“Google”) and its wholly-owned subsidiary YouTube, alleging that Google and YouTube violated and continue to violate the Company’s copyrights. We are seeking both damages and injunctive relief, and the lawsuit is currently in discovery. In September 2007, Brantley, et al. v. NBC Universal, Inc., et al., was filed in the United States District Court for the Central District of California against us and several other program content providers on behalf of a purported nationwide class of cable and satellite subscribers. The plaintiffs also sued several major cable and satellite program distributors. Plaintiffs allege that separate contracts between the program providers and the cable and
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Table of Contentssatellite operator defendants providing for the sale of programming in specific tiers each unreasonably restrain trade in a variety of markets in violation of the Sherman Act. In March 2008, the court granted the defendants’ motion to dismiss the plaintiffs’ First Amended Complaint. The plaintiffs subsequently filed a Second Amended Complaint seeking, among other things, treble monetary damages in an unspecified amount and an injunction to compel the offering of channels on an “à la carte” basis. In September 2008, the defendants’ motion to dismiss the Second Amended Complaint was denied and the lawsuit is now in discovery. We believe the plaintiffs’ position in this litigation is without merit and intend to continue to vigorously defend this lawsuit. Concluded Litigation Former Viacom and NAI, and certain of their respective present and former officers and directors, were defendants in a state law action in the Court of Chancery of Delaware relating to the 2004 split-off of Blockbuster from Former Viacom pursuant to an exchange offer. The plaintiff’s complaint in the Delaware action was dismissed in February 2008 and its appeal was argued before the Supreme Court of Delaware, which affirmed the dismissal in January 2009. Two other lawsuits arising from the same facts as the Delaware action were dismissed in 2007 and 2008. Item 4. Submission of Matters to a Vote of Security Holders. Not applicable.
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Table of ContentsOUR EXECUTIVE OFFICERS The following table sets forth the name, age and position of each person who serves as a Viacom executive officer.
Information about each person who serves as an executive officer of our company is set forth below.
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Table of ContentsPART II Item 5. Market for Viacom Inc.’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. Our voting Class A common stock and non-voting Class B common stock are listed and traded on the New York Stock Exchange under the symbols “VIA” and “VIA.B”, respectively. Our common stock began trading on the NYSE on January 3, 2006 at an opening price of $40.00 for our Class A common stock and $41.12 for our Class B common stock. The table below shows, for the periods indicated, the high and low daily close prices per share of our Class A and Class B common stock as reported in Thomson Financial markets services.
We do not currently anticipate paying dividends on our Class A common stock or Class B common stock. The declaration and payment of dividends to holders of our common stock will be at the discretion of our Board of Directors and will depend upon many factors, including our financial condition, earnings, legal requirements and other factors that our Board of Directors deems relevant. As of January 31, 2009, there were 2,045 record holders of our Class A common stock and 32,141 record holders of our Class B common stock. Performance Graph The following graph compares the cumulative total stockholder return on our Class A common stock and our Class B common stock with the cumulative total return of the companies listed in the Standard & Poor’s 500 Stock Index and a peer group of companies comprised of Time Warner Inc., The Walt Disney Company, News Corporation, The E.W. Scripps Company, Discovery Holding Company and CBS Corporation.
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Table of ContentsThe performance graph assumes $100 invested on January 1, 2006 in each of our Class A common stock, Class B common stock, the S&P 500 Index and the stock of our peer group companies, including reinvestment of dividends, for each calendar quarter through the calendar year ended December 31, 2008. Total Cumulative Stockholder Return for the Semi-Annual Periods Ended December 31, 2008, 2007 and 2006
Share Repurchases From June 23, 2007 to December 31, 2008, we repurchased shares of our Class B common stock under a $4.0 billion stock repurchase program which we announced on May 30, 2007. From January 2006 until June 22, 2007, we repurchased shares under a $3.0 billion stock repurchase program. In connection with the programs, we entered into an agreement with National Amusements Inc. (“NAI”) and NAIRI Inc. (the “NAIRI Agreement”) pursuant to which we agreed to buy from NAI and NAIRI, and they agreed to sell to us, a number of shares of our Class B common stock each month such that the ownership percentage of our Class A common stock and Class B common stock (considered as a single class) held by NAI and/or NAIRI would not increase as a result of our purchase of shares under the program. The NAIRI Agreement was terminated in October 2008. Since December 31, 2008, we have not purchased any shares under our stock repurchase program, but may resume purchases in the future based on a variety of factors.
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Table of ContentsThe following table provides information about our purchases of equity securities under our $4.0 billion stock repurchase program and the NAIRI Agreement during the quarter ended December 31, 2008:
Equity Compensation Plan Information Information required by this item is contained in the Proxy Statement for our 2009 Annual Meeting of Stockholders under the heading “Equity Compensation Plan Information,” which information is incorporated herein by reference. Item 6. Selected Financial Data. The selected Consolidated Statement of Earnings data for the three years ended December 31, 2008 and the Consolidated Balance Sheet data at December 31, 2008 and 2007 should be read in conjunction with the audited financial statements and “Management’s Discussion and Analysis of Results of Operations and Financial Condition” (“MD&A”) and other financial information presented elsewhere in this annual report. 2008 results are affected by $454 million of restructuring and other charges taken in the fourth quarter of 2008, as explained more fully in the MD&A in the section entitled “Factors Affecting Comparability”. The selected Consolidated Statement of Earnings data for the years ended December 31, 2005 and 2004 and the Consolidated Balance Sheet data at December 31, 2006, 2005 and 2004 have been derived from audited financial statements not included herein. CONSOLIDATED STATEMENT OF EARNINGS DATA (in millions, except earnings per share amounts)
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Table of ContentsCONSOLIDATED BALANCE SHEET DATA (in millions)
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Table of ContentsItem 7. Management’s Discussion and Analysis of Results of Operations and Financial Condition. Management’s discussion and analysis of results of operations and financial condition is provided as a supplement to and should be read in conjunction with the consolidated financial statements and related notes to enhance the understanding of our results of operations, financial condition and cash flows. References in this document to “Viacom,” “Company,” “we,” “us” and “our” mean Viacom Inc. and our consolidated subsidiaries through which our various businesses are conducted, unless the context requires otherwise. Certain amounts have been reclassified to conform to the 2008 presentation. Significant components of the management’s discussion and analysis of results of operations and financial condition section include:
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Table of ContentsManagement’s Discussion and Analysis of Results of Operations and Financial Condition (continued)
OVERVIEW Summary We are a leading global entertainment content company. We engage audiences on television, motion picture, Internet, mobile and video game platforms through many of the world’s best known entertainment brands, including MTV: Music Television®, MTV2®, mtvU®, MTV Tr3s®, VH1®, VH1 Classic™, CMT®: Country Music Television™, Logo®, Rock Band®, Nickelodeon®, Nick at Nite®, Noggin®, The N®, Nicktoons®, Neopets® , COMEDY CENTRAL®, Spike TV® and TV Land™, BET®, Paramount Pictures®, Paramount Vantage™, Paramount Classics™, MTV Films® and Nickelodeon Movies™. We manage our operations through two reporting segments: Media Networks and Filmed Entertainment. Media Networks Our Media Networks segment provides entertainment content for consumers in key demographics attractive to advertisers, distributors and retailers. We create and acquire programming and other content for distribution to our audiences how and where they want to view and interact with it: on television, the Internet, mobile devices, video games and a variety of consumer products. Our leading Media Networks properties reach over 578 million households worldwide via our multiplatform properties, operating in 162 countries and territories. We have approximately 165 channels, more than 400 digital media properties and a global consumer licensing business. MTV Networks (“MTVN”) also has a growing video game business that includes the successful Rock Band® franchise and casual gaming websites such as Addictinggames.com and Shockwave.com. Our Media Networks segment operates its program services, websites and other digital media services in the United States and abroad and generates revenues principally from three sources: (i) the sale of advertising time on our program services and digital properties, (ii) the receipt of affiliate fees from cable television operators, direct-to-home satellite operators, mobile networks and other content distributors and (iii) ancillary revenues, which include the creation and publishing of video games and other interactive products, home entertainment sales of our programming, the licensing of our content to third parties and the licensing of our brands and properties for consumer products. Our Media Networks properties target key audiences considered particularly attractive to advertisers. The advertising industry modified the way it measures ratings in 2008 by moving to commercial ratings, which measure audience size for a commercial. Commercial ratings are measured on a “C3” basis, which counts the number of viewers that watch the commercial live or via playback during the three days following the live broadcast. In 2008, the majority of our guaranteed deals were sold on the C3 metric. We regularly evaluate the structure, content and volume of our advertising spots, and throughout 2008 took measures that resulted in improved audience retention. In 2008, domestic and global economic conditions worsened significantly, which had a rapid, negative effect on the advertising market, weakening the businesses of partners who purchase advertising on our networks and reducing their spending on advertising generally. Current economic conditions have adversely affected our advertising revenues and such effect could continue or worsen. Our advertising revenues may also fluctuate due to the ratings of our channels (including the timing and success of new programs) and seasonal variations, typically being highest in the fourth quarter. Some of our program services experienced ratings declines in 2008, which, coupled with economic conditions, caused our domestic advertising revenue to decline. Ratings challenges could reduce the amount of advertising revenue we receive and negatively affect our results of operations, and our expenses may increase moderately as we invest in new programming.
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Table of ContentsManagement’s Discussion and Analysis of Results of Operations and Financial Condition (continued)
Revenues from affiliate fees are negotiated with individual cable and satellite television operators, mobile and online networks and other distributors, generally resulting in multi-year carriage agreements with set rate increases that provide us with a reasonably stable source of affiliate fee revenues. The amount of the fee we receive is determined in part by the number of subscribers to and success of the programming offered by our program services. We engage in negotiations with our cable and satellite affiliate partners on a rolling basis. Our ancillary revenues are principally derived from the creation and publishing of video games, such as from sales of the Rock Band franchise, Guitar Hero royalties and other interactive products, sales of home entertainment products such as DVDs, content licensing and licensing for consumer products, including licensing of popular characters from our programs such as those featured in SpongeBob SquarePants, The Backyardigans, Dora the Explorer, Neopets and South Park in connection with merchandising, video games and publishing worldwide. Media Networks segment revenue growth depends on the continued increase of advertising revenues and affiliate fees through our efforts to expand and enhance our brands worldwide with hit programming, new channels and other forms of entertainment and, in part, by the increased availability of our content on various distribution platforms. We continue to invest organically and through select acquisitions and investments in digital media and other assets that are attractive to our consumers and we seek to increase our revenues by expanding our audiences and strengthening our relationships with our advertising, cable, satellite, mobile and online partners to serve those audiences. Growth also depends on the continued success and expansion of our Rock Band franchise and other games that we develop, as well as continued demand for our brands in the home entertainment, television licensing and consumer products marketplaces. Media Networks segment expenses consist of operating expenses, selling, general and administrative (“SG&A”) expenses and depreciation and amortization. Operating expenses comprise costs related to original and acquired programming, including programming amortization, expenses associated with the manufacturing and distribution of video games and home entertainment products, and consumer products licensing and participation fees. SG&A expenses consist primarily of employee compensation, marketing, research and professional service fees and facility and occupancy costs. Depreciation and amortization expenses reflect depreciation of fixed assets, including transponders financed under capital leases, and amortization of finite-lived intangible assets. Filmed Entertainment The Filmed Entertainment segment produces, finances and distributes motion pictures under the Paramount Pictures, Paramount Vantage, Paramount Classics, MTV Films, and Nickelodeon Movies brands. In addition, we will continue to release a number of pictures under the DreamWorks brand. We also acquire films for distribution and have distribution relationships with DreamWorks Animation SKG, Inc., MVL Productions LLC (“Marvel”), and DW Funding LLC, the owner of the DreamWorks live-action film library. In general, motion pictures produced, acquired and/or distributed by the Filmed Entertainment segment are exhibited theatrically in the U.S. and internationally, followed by their release on DVDs, video-on-demand, pay and basic cable television, broadcast television and syndicated television (the “distribution windows”), digital media outlets, and, in some cases, other exhibitors such as airlines and hotels. Paramount has an extensive library consisting of approximately 1,100 motion picture titles produced by Paramount and acquired rights to approximately 2,400 additional motion pictures and a small number of television programs. In 2008, the Filmed Entertainment segment theatrically released in domestic and/or international markets Indiana Jones and the Kingdom of the Crystal Skull, The Curious Case of Benjamin Button, Tropic Thunder, Eagle Eye, Cloverfield, The Spiderwick Chronicles and Revolutionary Road, among others. Paramount also distributed Marvel’s Iron Man and DreamWorks Animation’s Kung Fu Panda and Madagascar: Escape 2 Africa.
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Table of ContentsManagement’s Discussion and Analysis of Results of Operations and Financial Condition (continued)
In connection with the acquisition of DreamWorks in January 2006, we acquired a live-action film library (the “live-action library”) consisting of 59 films released through September 16, 2005. In May 2006, we sold a controlling interest in DW Funding and entered into an agreement for the exclusive distribution rights to the library for a five-year period, renewable under certain circumstances, for which Paramount receives distribution fees. We retained a minority interest in DW Funding and have certain rights and obligations to reacquire the library at the end of the five-year term. Paramount also has distribution agreements with third parties, including a seven-year agreement with DreamWorks Animation for certain exclusive distribution rights to and home video fulfillment services for the animated feature films produced by DreamWorks Animation (the “DWA agreements”), for which Paramount receives certain fees. The output term of the agreement expires on the later of the delivery of 13 qualified animated motion pictures and December 31, 2012, subject to earlier termination under certain limited circumstances. In October 2008, Viacom, Paramount, DW Studios L.L.C. (formerly, DreamWorks L.L.C.) and the DreamWorks principals Steven Spielberg, David Geffen and Stacey Snider reached an agreement for the departure of those individuals from DW Studios. Pursuant to the agreement, the DreamWorks principals’ new company acquired certain projects in development, which Paramount has the option to co-finance and co-distribute. Our subsidiary, DW Studios, retained all other projects and retains the rights to motion pictures released prior to the departure of the DreamWorks principals, other than the live-action library owned by DW Funding. In September 2008, Paramount and Marvel extended their distribution agreement under which Paramount distributed Marvel’s Iron Man in 2008. Under the agreement, Paramount will distribute Marvel’s next four to six self-produced feature films on a worldwide basis, including theatrical distribution in most foreign territories previously serviced by Marvel through local distribution entities, in exchange for distribution fees. Our Filmed Entertainment segment generates revenues worldwide principally from: (i) the theatrical release of motion pictures, (ii) home entertainment, which includes sales of DVDs and other products relating to the motion pictures we release theatrically and certain other programming, including products we distribute on behalf of third parties such as CBS Corporation and (iii) license fees paid worldwide by third parties for exhibition rights on various media. Revenues from motion picture theatrical releases tend to be cyclical with increases during the summer months, around holidays and in the fourth quarter. The theatrical success of a motion picture is a significant factor in determining the revenues it is likely to generate in home entertainment sales and licensing fees during the various other distribution windows. Paramount’s home entertainment group is responsible for the worldwide sales, marketing and distribution of DVDs for films distributed by Paramount and other Viacom brands, as well as content we distribute on behalf of third parties, including CBS Corporation. The domestic DVD market has softened recently, particularly in the second half of 2008. This trend may continue in 2009, and continued declines may adversely affect our home entertainment revenues and profitability. The Filmed Entertainment segment also generates ancillary revenues from providing production services to third parties, primarily at Paramount’s studio lot, consumer products licensing, game distribution and distribution of content on digital platforms. In choosing films to produce, we aim to create a carefully balanced film slate that represents a variety of genres, styles, and levels of investment—with the goal of creating entertainment for both niche audiences and worldwide appeal. In October 2008, Paramount announced that it would rationalize its film slate in order to compete more effectively. Beginning in 2009, we expect that the Filmed Entertainment segment will release up to 20 films per year domestically including approximately 16 films produced or acquired by Paramount or DW Studios and two to four films produced by DreamWorks Animation and Marvel. Paramount is also focused on continuing to improve market position and profitability through the development of franchise films, the expansion of film acquisition and production operations internationally, and the diversification of revenue streams, such as making library product available online to own or rent.
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Table of ContentsManagement’s Discussion and Analysis of Results of Operations and Financial Condition (continued)
Filmed Entertainment segment expenses consist of operating expenses, SG&A and depreciation and amortization. Operating expenses principally include the amortization of production costs of our released feature films (including participations accrued under our third-party distribution arrangements), print and advertising expenses and other distribution costs. SG&A expenses include employee compensation, facility and occupancy costs, professional service fees and other overhead costs. Depreciation and amortization expense includes depreciation of fixed assets and amortization of acquired intangibles. We incur marketing costs before and throughout the theatrical release of a film and, to a lesser extent, other exhibition windows. Such costs are incurred to generate public interest in our films and are expensed as incurred; therefore, we typically incur losses with respect to a particular film prior to and during the film’s theatrical exhibition and profitability may not be realized until well after a film’s theatrical release, if at all. Therefore, the results of the Filmed Entertainment segment can be volatile as films work their way through the various distribution windows. Historically, we have entered into film financing arrangements under which third parties participate in the financing of the production costs of a film or slate of films typically in exchange for a partial copyright interest. We also have agreements with third parties, including other studios, to co-finance certain of our motion pictures. Competition All of our businesses operate in highly competitive industries. Our Media Networks businesses generally compete with other widely distributed cable networks, the broadcast television networks and digital properties for advertising revenue, audience share and, in the case of cable networks, affiliate fees. Our Filmed Entertainment businesses generally compete for audiences with other major motion picture studios such as Disney, Fox, Sony Pictures, Universal and Warner Bros., as well as independent film producers. Competition from these sources, other entertainment offerings and/or for audience leisure time generally may affect revenues, particularly in an economic recession. The Separation from CBS Corporation On December 31, 2005, we became a stand-alone public company in connection with our separation from the former Viacom Inc. (“Former Viacom”), which is now known as CBS Corporation. In accordance with the terms of the Separation Agreement, as more fully described below, in December 2005 we paid a preliminary special dividend to Former Viacom of $5.400 billion. In 2006 and 2007, we made further payments of $206 million and $170 million, respectively, to CBS Corporation in final resolution of the adjustments. RESULTS OF OPERATIONS Factors Affecting Comparability The consolidated financial statements as of and for the years ended December 31, 2008, 2007 and 2006 reflect our results of operations, financial position and cash flows reported in accordance with U.S. generally accepted accounting principles. Results for the aforementioned periods, as further discussed below, have been affected by certain items which affect comparability between periods. Restructuring and Other Charges To better align our organization and cost structure with current economic conditions, we undertook a strategic review of our businesses in the fourth quarter of 2008 which resulted in an aggregate of $454 million of restructuring and other charges. In addition to broad adverse economic conditions, the fourth quarter strategic review considered the emergence of sustained softness in the advertising market and ratings issues at certain channels in the Media Networks segment, and the Filmed Entertainment segment’s decision to reduce its future film slate. As a result of these initiatives we expect to save approximately $200 million in 2009.
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Table of ContentsManagement’s Discussion and Analysis of Results of Operations and Financial Condition (continued)
The December 2008 restructuring plan included workforce reductions of 890 positions across our domestic and international operations and resulted in an associated restructuring charge of $103 million. The charge includes $80 million for severance, principally consisting of one-time benefits for terminated employees, and $23 million related to lease termination costs. The plan was substantially completed in 2008 and is expected to involve cash payments of approximately $92 million, a majority of which is expected to be paid in the first half of 2009. In conjunction with the strategic review, we also assessed the effectiveness of our programming and motion pictures not yet released. As a result of the assessment, the Media Networks segment recorded a charge of $286 million principally related to management’s decision to cease use of certain acquired and original programming which was no longer achieving desired audience levels and/or branding objectives. The charge reflects the acceleration of amortization of such programming into the fourth quarter consistent with the decision to discontinue airing of the respective programs subsequent to the fourth quarter of 2008. The Filmed Entertainment segment recorded a charge of $19 million primarily related to pre-release write downs related to certain completed but not yet released films produced under the Paramount Vantage label. As a result of the restructuring, management changed its release strategy for these films, resulting in future revenue estimates falling below their cost. In addition to the above, $32 million of impairment charges were taken related primarily to finite-lived broadcast licenses in the Media Networks segment. One of the licenses was abandoned due to a change in strategy of distribution in a foreign territory and others became impaired due to a sustained deterioration in the advertising markets that supported the broadcast licenses. The Filmed Entertainment segment also incurred $14 million of charges principally related to the abandonment of certain film development rights. The following table presents the components of the 2008 restructuring and other charges by segment:
The components of the 2008 restructuring and other charges are included in the Consolidated Statement of Earnings as follows:
In addition, we recorded $77 million and $98 million of restructuring charges in 2007 and 2006, respectively. See Note 15 to our Consolidated Financial Statements for additional information regarding these actions.
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Discontinued Operations In 2008, discontinued operations, net of tax, principally reflects settlement adjustments to businesses previously sold. Discontinued operations in 2007 primarily reflects the $192 million gain on the sale of Famous Music in July 2007 and its net operating results prior to the sale. 2008 vs. 2007 Our summary consolidated results of operations are presented below for the years ended December 31, 2008 and 2007. Consolidated Results of Operations
Revenues Revenues for the year ended December 31, 2008 increased $1.202 billion, or 9%, to $14.625 billion. The increase in revenues is primarily driven by a $518 million increase in feature film revenues due to the mix of films released in the current year, as well as revenues recognized in connection with third-party distribution arrangements, a $381 million increase in ancillary revenues related to a full year of sales of the Rock Band video game series and a $281 million increase in affiliate revenues due to rate and subscriber increases. Advertising revenue growth, particularly domestically, was affected by softness in the overall advertising market as well as ratings challenges at certain of our channels.
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The following table presents our revenues by component:
NM = not meaningful
We generated 29% of our total consolidated revenues from international markets in 2008 as compared to 27% in 2007. Our principal international businesses are in Europe, of which the United Kingdom and Germany together accounted for approximately 48% and 49% of total European revenues for the years ended December 31, 2008 and 2007, respectively. The following table presents our revenues by geographic area in both total dollar values and as a percentage of total revenues:
Expenses and Operating Income Operating Expenses In 2008, operating expenses increased $1.356 billion, or 18%, to $8.787 billion. Production and programming expenditures increased $880 million, or 20%, to $5.385 billion, including $319 million, or 7 percentage points, related to the restructuring and other charges. The remaining $561 million increase was principally driven by higher participation costs, principally related to Marvel’s Iron Man and our new home entertainment distribution arrangement with CBS Corporation, feature film amortization due to the mix of film releases, and higher costs related to acquired and original programming. Distribution and other costs increased $476 million, or 16%, to $3.402 billion, principally due to higher costs associated with Rock Band and increased expenses related to our third-party distribution arrangements. For films we distribute on behalf of Marvel, DreamWorks Animation and DW Funding, we expense print and advertising costs as incurred and typically recover such costs following the theatrical release. We also record gross revenue and expenses as principal in these arrangements and in our home entertainment distribution arrangement with CBS Corporation.
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Selling, General and Administrative Expenses Selling, general and administrative expenses (“SG&A”) increased $247 million, or 9%, to $2.910 billion in 2008, which includes $94 million related to the restructuring and other charges. SG&A for the year ended December 31, 2007 includes $77 million of restructuring costs in the Media Networks segment for international and domestic operations. The net impact of these charges was a $17 million increase in SG&A, or 1 percentage point on reported growth. The remaining increase of $230 million was primarily related to higher employee compensation expense, marketing costs, technology costs and research and professional services. Depreciation and Amortization Depreciation and amortization expense increased $12 million, or 3%, in 2008, including $41 million related to the restructuring and other charges. These charges and increased depreciation due to higher capital expenditures were partially offset by lower intangible asset amortization in the Media Networks segment resulting from certain subscriber agreements that were fully amortized in 2007. Operating Income Operating income decreased $413 million, or 14%, to $2.523 billion in 2008. In the current year, we recorded $454 million related to the restructuring and other charges. Media Networks recorded $77 million of restructuring costs in 2007. The net impact of these charges was a $377 million, or 13-percentage point impact on reported operating income. The remaining $36 million decrease reflects modest decreases at the Media Networks and Filmed Entertainment segments and a $15 million, or 7%, increase in corporate expenses, including increased litigation-related costs and $3 million related to the restructuring and other charges. Interest Expense, Net Interest expense, net includes costs related to our debt, capital lease and other obligations. In 2008, interest expense, net increased $18 million from 2007 due to higher average debt outstanding partially offset by a lower average interest rate on our mix of obligations, which was driven by lower rates on our variable rate debt. Gain on Sale of Equity Investment In 2007, we sold MTV Networks’ investment in Russia for $191 million and recognized a pre-tax gain on the sale of $151 million. Equity in (Losses) Earnings of Investee Companies Equity in losses of investee companies was $74 million in 2008. The equity losses are primarily due to our share of the losses associated with our investments in Rhapsody America, which was acquired in the third quarter of 2007, and a digital satellite T.V. distributor in the Middle East. In 2009, we expect equity losses to increase primarily related to our investment in Viacom 18. Other Items, Net Other items, net reflects expenses of $112 million in 2008, compared with $43 million in 2007. The $69 million increase in expenses is principally due to an increase of $92 million in net foreign exchange losses in the current year due to the strengthening of the U.S. Dollar partially offset by $21 million of lower costs associated with our receivables securitization programs resulting from lower interest rates and a $9 million decrease in non-cash investment impairment charges in the current year. Provision for Income Taxes In 2008, the provision for income tax was $605 million. The effective income tax rate was 32.6%, as compared to 36.0% in 2007. The reduction in the effective tax rate in 2008 is principally due to discrete tax benefits of $55 million, partially offset by incremental taxes on our restructuring and other charges, for a net 2.8 percentage- point impact, recognized in 2008, compared with net discrete tax benefits of $15 million, or 0.6 percentage
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points, in 2007. The discrete tax benefits in both years were principally due to reserve releases resulting from effectively settled audits. The reduction in the effective tax rate in 2008 was also favorably impacted by income tax benefits associated with a greater mix of earnings in international markets where tax rates are lower than the U.S. statutory tax rate. Minority Interest, Net of Tax Minority interest expense, net of tax, which represents ownership held by third parties of certain consolidated entities, was $17 million and $21 million for 2008 and 2007, respectively. Net Earnings from Continuing Operations Net earnings from continuing operations decreased $397 million, or 24%, principally due to the 14% decrease in operating income, combined with the absence of the $151 million pre-tax gain on the 2007 sale of MTV Networks’ investment in Russia, the $74 million increase in equity losses from investee companies, and the $69 million increase in other expenses driven by the $92 million increase in net foreign exchange losses, partially offset by the reduction in the effective tax rate. Discontinued Operations, Net of Tax In 2008, discontinued operations, net of tax, principally reflects settlement adjustments to businesses previously sold. Discontinued operations in 2007 primarily reflects the $192 million gain on the sale of Famous Music in July 2007 and its net operating results prior to the sale. Net Earnings Net earnings decreased $587 million, or 32%, principally due to the $397 million decrease in net earnings from continuing operations and the absence of the $192 million gain on the 2007 sale of Famous Music. Segment Results of Operations Operating income is used as the measurement of segment profit performance. Transactions between reportable segments are accounted for as third-party arrangements for the purposes of presenting reporting segment results of operations. Typical intersegment transactions include the purchase of advertising by the Filmed Entertainment segment on Media Networks’ properties and the purchase of Filmed Entertainment’s feature films exhibition rights by Media Networks. The elimination of such intercompany transactions in the consolidated results of operations is included within eliminations in the table below. Certain 2007 amounts have been reclassified to conform to the 2008 presentation. Media Networks
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Revenues Worldwide revenues increased $655 million, or 8%, in 2008 to $8.756 billion, primarily due to sales of the Rock Band video game series and rate and subscriber increases in affiliate fees. Domestic revenues increased to $7.292 billion in 2008 from $6.852 billion in 2007, an increase of $440 million, or 6%. International revenues increased to $1.464 billion in 2008 from $1.249 billion in 2007, an increase of $215 million, or 17%. Advertising In 2008, worldwide advertising revenues increased $32 million, or 1%, to $4.722 billion. Domestic advertising revenue decreased $3 million, essentially flat year-over-year. During 2008, we experienced softness in the overall advertising market, particularly in the second half of the year, as well as ratings challenges at certain channels. International advertising revenues increased $35 million, or 6%, reflecting growth across Europe. Foreign exchange and the contribution of our India operations to a joint venture negatively impacted reported international growth by 1-percentage point and 3-percentage points, respectively. In light of the uncertainties surrounding the current downturn in global economic conditions, we anticipate that such economic conditions may continue to put pressure on advertising growth rates domestically and internationally. Affiliate Fees Worldwide affiliate fees increased $281 million, or 12%, to $2.620 billion in 2008. Domestic affiliate growth increased 12% principally due to rate and subscriber increases across core channels, an increase in subscribers for digital channels and increased mobile affiliate revenues. International affiliate fees increased 11% principally driven by new contracts and subscriber growth across Europe and Latin America, partially offset by rate and subscriber decreases in the UK. Ancillary Worldwide ancillary revenues increased $342 million, or 32%, to $1.414 billion in 2008. Domestic ancillary revenues were up 26%, primarily driven by a full year of sales of Rock Band, including the domestic release of Rock Band 2, partially offset by revenue declines from home entertainment, consumer products and Guitar Hero royalties. International ancillary revenues increased 50% principally due to international sales of Rock Band and television licensing fees. Expenses and Operating Income Media Networks segment expenses increased $974 million, or 19%, to $6.027 billion in 2008. Included in 2008 expenses is $389 million related to the restructuring and other charges as further described above. Expenses in 2007 included restructuring charges of $77 million. The net impact of restructuring and other charges is a $312 million increase in expenses, or 6 percentage points. The remaining increase of $662 million was primarily due to Rock Band’s higher manufacturing costs, software amortization, marketing costs, royalty costs and participations, as well as amortization of programming costs and higher employee compensation expense. Operating Expenses Operating expenses increased $813 million, or 29%, to $3.576 billion in 2008. Production and programming costs increased $453 million, or 21%, primarily related to acquired and original programming amortization. 2008 production and programming costs included $286 million, or 13 percentage points, attributable to the restructuring and other charges. The remaining $167 million, or 8 percentage points, reflects increased programming investment, principally in acquired programming. Distribution and other expenses increased $360 million, principally for manufacturing costs, software amortization, and royalty and participations costs related to Rock Band, including costs associated with the launch of Rock Band 2.
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Selling, General and Administrative Expenses SG&A increased $163 million, or 8%, to $2.177 billion in 2008, including $65 million of costs related to the restructuring and other charges. 2007 included $77 million of restructuring costs. The net impact of these charges was a $12 million favorable variance, which was more than offset by higher marketing costs, employee compensation expense, technology costs and research and professional services. Depreciation and Amortization Depreciation and amortization decreased $2 million in 2008. 2008 includes $38 million related to the restructuring and other charges, which was more than offset by the lower amortization of intangible assets, as certain subscriber agreements were fully amortized in 2007, and lower capital lease depreciation expense resulting from transponder lease expirations. Operating Income Operating income decreased $319 million, or 10%, to $2.729 billion in 2008, principally due to the net $312 million impact of restructuring and other charges. The remaining $7 million decrease reflects operating income from strong affiliate fee growth which was more than offset by the impact of the advertising revenue softness and losses associated with Rock Band. Filmed Entertainment
Revenues Worldwide revenues increased $557 million, or 10%, to $6.033 billion in 2008. The increase is primarily due to growth in theatrical revenues reflecting the mix of our current year film slate and in home entertainment third-party distribution revenues, including our new CBS distribution agreement. Domestic revenues increased to $3.242 billion in 2008 from $3.045 billion in 2007, an increase of $197 million, or 6%. International revenues increased to $2.791 billion in 2008 from $2.431 billion in 2007, an increase of $360 million, or 15%. Theatrical Worldwide theatrical revenues increased $248 million, or 17%, to $1.714 billion for the year ended December 31, 2008. Domestic theatrical revenues increased $66 million primarily due to the mix of films released in the current year, including Indiana Jones and the Kingdom of the Crystal Skull, Marvel’s Iron Man, and DreamWorks Animation’s Kung Fu Panda and Madagascar 2: Escape to Africa, compared with DreamWorks Animation’s Shrek the Third and
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Bee Movie and our release of Transformers in the prior year. Iron Man was the first Marvel film that we distributed. International theatrical revenues increased $182 million also driven primarily by the mix of films released in the current year compared to the prior period. The table below lists theatrical releases by title, by year, and sorted by release date, for the years ended December 31, 2008 and 2007.
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Home Entertainment Worldwide home entertainment revenues increased $231 million, or 9%, to $2.724 billion in 2008. Domestic home entertainment revenues increased $164 million due to higher third-party distribution revenues, including our new CBS distribution agreement for which we record gross revenues and expenses as principal in the arrangement, and the release of Iron Man, for which there was no comparable title in the prior year. These increases were partially offset by a decrease in revenues from other titles relative to the prior year. Other titles released in 2008 included Kung Fu Panda and Indiana Jones and the Kingdom of the Crystal Skull, compared with Transformers and Shrek the Third released in 2007. International home entertainment revenues increased $67 million, also driven primarily by the increase in third-party distribution revenues, including from the release of Iron Man, partially offset by a decrease in revenues from other titles relative to the prior year. The domestic DVD market has softened recently, particularly in the second half of 2008. This trend may continue in 2009, which may adversely affect our home entertainment revenues and profitability. Television License Fees Worldwide television license fees increased $39 million, or 3%, to $1.333 billion in 2008. The increase was primarily due to an increase in international markets driven by pay television and syndicated television partially offset by decreases in domestic pay and broadcast television due to the mix of available titles. Ancillary Ancillary revenues for the year ended December 31, 2008 increased $39 million principally driven by higher digital revenues and licensing and merchandising revenues, primarily in connection with Transformers. Expenses and Operating Income Filmed Entertainment segment expenses increased $634 million, or 12%, to $6.007 billion for the year ended December 31, 2008. The increase in expenses primarily reflects higher feature film participation costs, principally due to Iron Man, film amortization due to the mix of film releases, print and advertising expenses related to our third-party distribution arrangements, and the impact of the restructuring and other charges as further described above. Operating Expenses Year-over-year operating expenses are impacted by the mix of film releases during a particular year. Operating expenses increased $551 million, or 11%, to $5.377 billion in 2008 including $33 million, or 1 percentage point, related to the restructuring and other charges. The remaining increase is attributable to a $409 million, or 17%, increase in feature film costs, principally participations related to Iron Man and film amortization, as well as a $109 million, or 4%, increase in distribution and other costs, principally related to third-party distribution arrangements. Selling, General and Administrative Expenses SG&A increased $74 million, or 17%, to $522 million in 2008 including $29 million, or 6 percentage points, of severance and other costs related to the restructuring and other charges. The remaining increase is principally due to higher employee compensation. Depreciation and Amortization Expense Depreciation and amortization increased by $9 million in 2008 due to additional capital expenditures. Operating Income Operating income decreased $77 million, or 75%, to $26 million in 2008. This decline was driven by $62 million related to the restructuring and other charges and decreased home entertainment catalog performance.
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2007 vs. 2006 Our summary consolidated results of operations are presented below for the years ended December 31, 2007 and 2006. Consolidated Results of Operations
NM = not meaningful Revenues Revenues in 2007 increased $2.062 billion, or 18%, to $13.423 billion. Media Networks segment revenues increased $860 million, or 12%, to $8.101 billion. Net acquisitions (defined as acquisitions net of dispositions) in our Media Networks segment contributed net incremental revenues of $92 million. A detailed description of the 2006 and 2007 transactions included in net acquisitions is contained in the Media Networks segment section. Filmed Entertainment segment revenues increased $1.202 billion, or 28%, to $5.476 billion, including $101 million in incremental revenues for the month of January 2007 from the acquisition of DreamWorks, which closed on January 31, 2006.
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The following tables present our revenues by component in both total dollar values and as a percentage of total revenues:
We generated 27% of our total consolidated revenues from international markets in 2007 as compared to 24% in 2006. International net acquisitions by the Media Networks segment contributed $5 million and $77 million of incremental revenue during 2007 and 2006, respectively, principally in Europe. Our principal international businesses are in Europe, of which the United Kingdom and Germany accounted for approximately 49% and 54% of total European revenues in 2007 and 2006, respectively.
Expenses and Operating Income Operating Expenses In 2007, operating expenses increased $1.468 billion, or 25%, to $7.431 billion. Production and programming expenditures increased $609 million, or 16%, to $4.505 billion principally driven by increased film amortization in our Filmed Entertainment segment. The increase in feature film amortization was primarily attributable to the release of Shrek the Third and Transformers and the number and timing of other theatrical releases. Programming costs, the largest operating expense of our Media Networks segment, also increased, primarily as a result of continued investment in original and acquired programming. Distribution and other expenses increased $859 million, or 42%, to $2.926 billion, primarily due to higher print and advertising expenditures in our Filmed Entertainment segment reflecting the increased number of theatrical and home entertainment releases during the year, including Shrek the Third and Transformers, and timing of those releases. In addition, a full year of operating activity from DreamWorks and the related distribution activities for DreamWorks Animation and DW Funding added to distribution expenses for the period. Increased distribution expenses in our Media Networks segment reflect costs associated with the release of Rock Band and increased home entertainment distribution costs.
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Selling, General and Administrative Expenses SG&A expenses were up $397 million, or 18%, to $2.663 billion in 2007 primarily due to higher employee compensation expense, including cash and equity-based incentive compensation, the full year impact of net acquisitions, the impact of foreign exchange, increased legal fees and bad debt expenses, and costs associated with new business initiatives. Incremental restructuring charges of $62 million related to restructuring actions at MTVN were substantially offset by the impact of the $73 million net compensation charge taken in 2006 in connection with executive management changes. Depreciation and Amortization Depreciation and amortization expense increased $28 million, or 8%, in 2007 principally as a result of an increase in depreciation on current-year fixed asset additions. Additionally, we experienced an increase in intangible asset amortization expense resulting from a full year of amortization on 2006 acquisitions, particularly DreamWorks by the Filmed Entertainment segment. Operating Income Operating income increased $169 million, or 6%, in 2007 to $2.936 billion. Media Networks operating income increased 5% or $144 million with the 12% increase in revenues partially offset by a 17% growth in expenses, principally compensation-related costs, including restructuring charges of $77 million in 2007 versus $15 million in 2006, programming costs and costs associated with Rock Band. Filmed Entertainment operating income decreased by $29 million, or 22%, principally due to higher distribution-related costs, principally print and advertising, and higher feature film amortization related to a greater number of film releases during the year, as well as costs associated with new business initiatives. The increase in Filmed Entertainment expenses was partially offset by increased revenues on certain 2007 releases, in particular Transformers and Shrek the Third, and revenues from prior year releases. Corporate expenses declined $50 million largely due to the net compensation charge of $73 million recorded in 2006, partially offset by increased equity compensation and legal expenses. Interest Expense, Net In 2007, interest expense, net increased $22 million from the prior year due to an increase in interest rates reflecting the impact of the fixed-rate debt issuances during 2006 and 2007, which more than offset the decrease in average debt outstanding. The decrease in average debt outstanding resulted principally from the use of cash flow provided by operations and proceeds received from dispositions during 2007 of $555 million to repay indebtedness. Gain on Sale of Equity Investment In 2007, we sold MTV Networks’ investment in Russia for $191 million and recognized a pre-tax gain on the sale of $151 million. Equity in Earnings of Investee Companies Equity in earnings of investee companies decreased by $10 million in 2007. In the third quarter of 2007, we began recognizing our share of the losses from Rhapsody America. Other Items, Net Other items, net in 2007 reflected net expenses of $43 million principally arising from losses on securitization programs, as well as a $36 million impairment charge related to a minority investment accounted for under the cost method, partially offset by foreign exchange gains.
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Provision for Income Taxes For 2007, we recorded income tax expense of $929 million on pre-tax earnings of $2.580 billion resulting in an effective tax rate of 36.0% compared to 31.9% in 2006. The increase in our effective tax rate was principally due to $15 million, or 0.6 percentage points of discrete tax benefits recognized in 2007 versus $142 million, or 6.1 percentage points, in 2006. The discrete tax benefits in both years were principally the result of audit settlements. Excluding the impact of the discrete tax benefits, the reduction in the effective tax rate was principally due to incremental tax benefits associated with qualified production activities and a higher mix of international profits in markets where income is taxed at rates lower than the U.S. statutory rate and lower state taxes. Minority Interest, Net of Tax Minority interest expense, net of tax, was $21 million and $14 million in 2007 and 2006, respectively. The increase in expense was primarily attributable to the consolidation of Nick UK and MTV Japan, as well as normal operating increases. Net Earnings from Continuing Operations Net earnings from continuing operations increased $63 million, or 4%, principally due to the 6% increase in operating income and the $151 million pre-tax gain on the sale of MTV Networks’ investment in Russia, partially offset by the increase in the effective tax rate. Discontinued Operations, Net of Tax Earnings from discontinued operations in 2007 principally reflect the gain recorded in connection with the sale of Famous Music. In 2006, discontinued operations include the release of tax reserves resulting from audit settlements related to discontinued businesses, including Blockbuster Inc., which was split off from Former Viacom in 2004. Net Earnings Net earnings increased $246 million, or 15%, principally due to the $63 million increase in net earnings from continuing operations and the gain on the sale of Famous Music. Segment Results of Operations Media Networks
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During 2007, we invested $15 million in acquisitions, none of which had a significant impact on 2007 operating results. We made several acquisitions during 2006 that contributed to segment revenues and operating income in 2007, including Harmonix Music Systems, Inc. (“Harmonix”), the developer of Guitar Hero and Rock Band and other music gaming titles, in October 2006, and Atom Entertainment, Inc., which owned a portfolio of online destinations for casual games, short films and animation, in September 2006. Additional acquisitions completed during 2006 included Quizilla, LLC, Y2M: Youth Media & Marketing, Xfire, Inc. and Caballero Television. During 2006, we also acquired controlling interests in entities previously accounted for under the equity method of accounting. In November 2006, we completed the acquisition of the remaining 50% interest in MTV Poland. In September 2006, we acquired the remaining 63.8% interest in MTV Japan. In August 2006, we acquired the remaining 58% interest of BET Interactive, the owner of BET.com. In June 2006, we acquired an additional 10% interest in Nick UK. Previously, Nick UK was a fifty-fifty joint venture with BSkyB. The results of these entities have been consolidated since the closing date of the transactions (the “international consolidations”). Further, in the fourth quarter of 2006 we disposed of an international production operation. The transactions discussed above (the “net acquisitions”) impact the comparability of our results over the periods presented and contributed $92 million of net revenue growth in 2007. Therefore, the impact of net acquisitions is referenced throughout the discussion. Net acquisition impact represents amounts included in reported results for which the acquired or disposed entity was not also consolidated in the comparable period. Revenues Worldwide revenues increased $860 million, or 12%, in 2007 to $8.101 billion, led by an 8% increase in advertising revenues. Affiliate fees and ancillary revenues were up 14% and 27%, respectively. Domestic revenues increased to $6.852 billion in 2007 from $6.183 billion in 2006, an increase of $669 million, or 11%. International revenues increased to $1.249 billion in 2007 from $1.058 billion in 2006, an increase of $191 million, or 18%. Net acquisitions, as further discussed above, contributed $92 million to revenue growth. Advertising Worldwide advertising revenues were up 8% to $4.690 billion in 2007. Net acquisitions contributed 1 percentage point of reported growth. Domestic advertising revenues increased 6% versus 2006 driven by Spike TV, VH1, MTV, COMEDY CENTRAL and digital properties. International advertising revenues increased 23% primarily due to the full year impact of the 2006 acquisitions of controlling interests in Nick UK, MTV Japan and MTV Poland. In addition, international revenues benefited from strong European performance, driven by monetization of ratings strength, and foreign currency benefits, which contributed 9 percentage points of international growth, partially offset by declines in Southeast Asia due to the licensing of certain previously owned and operated channels. Affiliate Fees Worldwide affiliate fees increased 14% to $2.339 billion in 2007. The full year impact of international consolidations contributed 2 percentage points of total reported growth. Domestic affiliate fees grew 11% principally as a result of higher rates. International affiliate fees increased 30% driven principally by the consolidation of Nick UK, MTV Japan and MTV Poland, foreign exchange benefits of 8 percentage points, new channel launches and subscriber growth in certain European markets.
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Ancillary Worldwide ancillary revenues increased 27% in 2007 to $1.072 billion. Domestic ancillary revenues for the year were up 42% driven by sales of the Rock Band video game released in the fourth quarter of 2007, royalties earned on video games, including the Guitar Hero series, higher digital revenues and increased television license fees. These increases were partially offset by lower home video revenues due to a lower number of video releases. In 2006, home video revenues benefited from the release of Chappelle’s Show: The Lost Episodes. International ancillary revenues decreased 4% during the year principally due to the fourth quarter 2006 disposition of an international production operation partially offset by higher consumer products licensing and the contribution of the international consolidations. Foreign exchange contributed 3 percentage points of international growth. Expenses and Operating Income Media Networks segment expenses increased $716 million, or 17%, to $5.053 billion in 2007 primarily due to increased employee compensation costs and distribution expenses associated with the fourth quarter 2007 release of Rock Band. Operating Expenses In 2007, total operating expenses increased $306 million due primarily to an increase in distribution expenses, including costs related to Rock Band, which was released in the fourth quarter of 2007 and increased production and programming costs, principally programming amortization. The increase in programming amortization reflects both acquired programming, particularly on Spike TV and Nick at Nite, and original programming, particularly on MTV. Selling, General and Administrative Expenses In 2007, SG&A increased $404 million to $2.014 billion primarily due to increased employee compensation costs, including incentive compensation, incremental restructuring charges of $62 million, the impact of foreign exchange, higher facilities costs, the full year impact of net acquisitions, increases in legal expenses and bad debt expenses and the impact of the 2006 gain resulting from the sale of distribution rights in Europe. Depreciation and Amortization Depreciation and amortization increased $6 million in 2007 principally due to the amortization of intangibles associated with 2006 acquisitions. Operating Income Operating income grew 5% to $3.048 billion in 2007 compared to the prior year due to a 12% increase in revenues partially offset by a 17% increase in expenses, including restructuring charges of $77 million in 2007 versus $15 million in 2006. Net acquisitions contributed $11 million to operating income, primarily due to the acquisition of Harmonix and the consolidation of Nick UK partially offset by the disposition of an international production operation in 2006.
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Filmed Entertainment
The acquisition of DreamWorks and the commencement of distribution of activities for DreamWorks Animation and the live-action library films on January 31, 2006 impact the comparability of our results of operations over the periods presented. The results of operations for DreamWorks have been included in the Filmed Entertainment segment beginning February 1, 2006. Worldwide revenues increased $1.202 billion, or 28%, in 2007 to $5.476 billion. The increase in 2007 is primarily due to the number and mix of releases, including the performance of Transformers and Shrek the Third, both released in 2007. The remaining increase is driven by the acquisition of DreamWorks and the related DWA agreements, contributing incremental revenues of $101 million in January 2007. In 2006, the DreamWorks acquisition contributed revenues of $1.359 billion. Domestic revenues increased to $3.045 billion in 2007 from $2.613 billion in 2006, an increase of $432 million, or 17%. International revenues increased to $2.431 billion in 2007 from $1.661 billion in 2006, an increase of $770 million, or 46%. Theatrical Worldwide theatrical revenues in 2007 increased $600 million, or 69%, to $1.466 billion. We released twenty-six films during 2007 compared to nineteen films in 2006. Domestic revenues increased $271 million primarily due to the number and mix of theatrical releases, particularly the performance of Transformers released in 2007 compared to Mission: Impossible III in 2006. Distribution of DreamWorks Animation’s Shrek the Third and Bee Movie contributed incremental revenues of $118 million compared to Over the Hedge and Flushed Away distributed in 2006. International revenues increased $329 million due principally to our release of Transformers and distribution of Shrek the Third, which contributed a combined $197 million of incremental revenues over 2006 releases Mission: Impossible III and Over the Hedge.
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The table below lists theatrical releases by title, by year, sorted by release date, for the years ended December 31, 2007 and 2006.
Home Entertainment Worldwide home entertainment revenues in 2007 increased $377 million, or 18%, to $2.493 billion. Domestic home entertainment revenues increased $66 million to $1.469 billion due primarily to higher revenues on current year releases, including Transformers and DreamWorks Animation’s Shrek the Third, as well as a year-over-year increase in titles released, partially offset by lower revenues generated from prior year releases and catalog revenues. International home entertainment revenues increased $312 million to $1.024 billion, also reflecting the performance of Transformers and Shrek the Third and higher revenues from prior year releases, including Flushed Away and World Trade Center.
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Television License Fees Worldwide television license fees in 2007 increased $172 million, or 15%, to $1.294 billion. The DreamWorks acquisition contributed $31 million of incremental revenue in January 2007. The remaining increase is primarily attributable to an increase in international syndicated license fees and networks license fees, partially offset by a decline in pay television revenues. These fluctuations were due to the timing and mix of products available. Ancillary Ancillary revenues in 2007 increased $53 million, or 31%, to $223 million primarily due to higher licensing and merchandising revenues, principally related to Transformers, and higher digital revenues. Expenses and Operating Income Filmed Entertainment segment expenses increased $1.231 billion, or 30%, to $5.373 billion for the year ended December 31, 2007 primarily due to higher print and advertising expenses as well as feature film amortization due to the number and mix of film releases. Operating Expenses In 2007, operating expenses increased $1.166 billion, or 32%, to $4.826 billion. The increase principally reflects higher distribution-related costs of $654 million primarily due to print and advertising costs, and higher feature film amortization expense of $518 million, primarily attributable to the release of Shrek the Third and Transformers, as well as the increased number of theatrical releases during the year and timing of those releases. Selling, General and Administrative Expenses SG&A increased $48 million, or 12%, to $448 million in 2007 primarily attributable to costs associated with new business initiatives. Depreciation and Amortization Expense Depreciation and amortization increased by $17 million in 2007 resulting from a full year of amortization attributable to the acquisition of DreamWorks as well as higher depreciation of fixed assets. Operating Income Operating income decreased by $29 million in 2007 principally due to higher distribution-related costs, principally print and advertising, and higher feature film amortization related to a greater number of film releases during the year, as well as costs associated with new business initiatives. The increase in expenses in 2007 was partially offset by increased revenues on certain 2007 releases, in particular Transformers and Shrek the Third, and revenues from prior year releases. LIQUIDITY AND CAPITAL RESOURCES Liquidity Sources and Uses of Cash Our primary source of liquidity is cash provided through the operations of our businesses. These cash flows from operations, together with our credit facility and access to capital markets, provide us adequate resources to fund our ongoing operations including investment in programming and film productions, capital expenditures, new projects and acquisitions. Our principal uses of cash include the creation of new content, acquisitions of third-party content, ongoing investments in our businesses and acquisitions of businesses. We also use cash for interest and tax payments and discretionary share repurchases. We manage our use of cash with a goal of maintaining total debt levels within rating agency guidelines to maintain an investment grade credit rating.
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We may access external financing from time to time depending on our cash requirements, assessments of current and anticipated market conditions and after-tax cost of capital. Our access to capital markets can be impacted by factors outside our control. Although capital markets have been adversely affected by recent problems in the worldwide financial system, we believe that our existing bank facility and investment grade credit rating will provide us with adequate access to funding given our expected cash needs. In the current capital markets, the cost of any additional borrowings is likely to be higher than our existing borrowing costs as experienced in recent periods. Any new borrowing cost would be affected by market conditions and short and long-term debt ratings assigned by independent rating agencies, which are based on our performance as measured by certain credit metrics such as interest coverage and leverage ratios. Our bank facility is subject to one principal financial covenant which requires our interest coverage, calculated as operating income before depreciation and amortization divided by interest expense (both as defined by the credit agreement), for the most recent four consecutive fiscal quarters to be at least 3.0x. As of December 31, 2008, it was approximately 7.0x. The table below summarizes our credit ratings as of December 31, 2008:
Historically we have entered into film financing arrangements that involve the sale of a partial copyright interest in a film to third-party investors. Since the investors typically have the risks and rewards of ownership proportionate to their ownership in the film, we generally record the amounts received for the sale of copyright interest as a reduction of the cost of the film and related cash flows are reflected in net cash flow from operating activities. We also have agreements with third parties, including other studios, to co-finance certain of our motion pictures. Cash Flows Cash and cash equivalents decreased by $128 million for the year ended December 31, 2008, and increased $214 million for the year ended December 31, 2007. The change in cash and cash equivalents was attributable to the following:
Operating Activities Cash provided by operations was $2.036 billion for the year ended December 31, 2008, an increase of $260 million compared with 2007. The increase is primarily due to increased receivables collections and decreased income tax payments of $85 million, partially offset by higher participation payments associated with our current year film slate and higher spending on programming.
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The Media Networks segment consistently generates a significant percentage of our cash flow from operating activities. Advertising time is generally purchased by large media buying agencies and our affiliate fees are principally earned from cable and satellite television operators. We have payment terms of generally ninety days or less and our current days sales outstanding for the Media Networks segment, calculated as net accounts receivable divided by net revenues, multiplied by 360, was 50 days for 2008, an improvement of 7 days as compared to 2007. We continue our focus on lowering our days sales outstanding. The Filmed Entertainment segment’s operational results and ability to generate cash flow from operations substantially depend on the number and timing of films in development and production, the level and timing of print and advertising costs and the public’s response to our theatrical film and home entertainment releases. Our cash flow from operations tends to fluctuate seasonally as a result of the timing of cash payments and collections, typically being highest in the fourth quarter. Cash provided by operating activities of $1.776 billion for the year ended December 31, 2007 decreased $494 million versus 2006. The net decrease was principally due to a decrease in cash flows from receivables, primarily attributable to the $500 million increase in our securitization facilities in 2006, higher investment in original and acquired programming, and an increase of $186 million in cash taxes paid, including taxes on gains of disposed operations, partially offset by increased net earnings from continuing operations. Investing Activities Cash used in investing activities was $571 million for the year ended December 31, 2008 compared with cash from investing activities of $248 million in 2007. In 2008, cash used in investing activities includes $288 million of capital expenditures, principally related to improvements to certain new and existing facilities (including approximately $100 million related to New York real estate facilities), and a net $225 million related to business combinations, which includes a $150 million earn-out payment related to our 2006 acquisition of Harmonix, and $71 million of investments in and advances to equity affiliates. In general, our segments require relatively low levels of capital expenditures in relation to our annual cash flow from operations which contributes to our ability to generate cash flow for future investment in our content and business operations, which we expect to be able to maintain over time. In 2007, cash from investing activities was $248 million and included $191 million received from the sale of MTV Networks’ investments in Russia and $352 million from the sale of Famous Music, partially offset by $237 million in capital expenditures and a net $70 million related to business combinations and investments in and advances to equity affiliates. Financing Activities Cash used in financing activities was $1.555 billion for the year ended December 31, 2008, compared with $1.831 billion in 2007. The cash utilized during this period was principally driven by $1.266 billion of share repurchases and net payments of $280 million on the outstanding balances related to our credit facility, commercial paper and other long-term debt obligations. Cash used in 2007 for financing activities was $1.831 billion, including $2.134 billion of share repurchases. During 2007, we raised fixed rate debt of $745 million through the issuance of Senior Notes and Debentures and borrowed $750 million of bank debt under our revolving credit facility. These proceeds were used to repay $1.038 billion of commercial paper. Additionally, in 2007, we paid a final amount of $170 million related to the special dividend to CBS Corporation.
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Commitments and Contingencies Our commitments not recorded on the balance sheet primarily consist of programming and talent arrangements, operating lease arrangements, purchase obligations for goods and services and future funding commitments to joint ventures. See the section entitled Off-Balance Sheet Arrangements for additional information on these obligations. In the normal course of our business, we provide and receive the benefit of indemnities that are intended to allocate certain risks associated with business transactions. Similarly, we may remain contingently liable for various obligations of a business that has been divested in the event that a third party does not live up to its obligations under an indemnification agreement. Further, we may from time to time agree to pay additional consideration to the sellers of a business depending on the performance of the business during a period following the closing. Guarantees We guarantee debt on certain of our unconsolidated investments, including principal and interest, of approximately $242 million at December 31, 2008 and have accrued a liability of $55 million in respect of such exposures. Our guarantees principally relate to our investment in DW Funding, as more fully described in Note 5 to the Consolidated Financial Statements. At December 31, 2008, our aggregate guarantee related to lease commitments of divested businesses, primarily Blockbuster Inc. (“Blockbuster”) and Famous Players, was $1.003 billion with a recorded liability of $245 million, reflecting the estimated fair value of the guarantees at their inception, including certain assumed renewals, which may or may not occur. Based on our consideration of financial information available to us, the lessees’ performance in meeting their lease obligations, the underlying economic factors impacting the lessees’ business models and where applicable, letters of credit on our behalf, we believe that our accrual is sufficient to meet any future obligations. Blockbuster has agreed to indemnify Former Viacom with respect to any amount paid under these guarantees. In the third quarter of 2008, we and Blockbuster agreed to reduce the amount of Blockbuster’s letters of credit, which secure Blockbuster’s indemnification obligations, from $150 million to $75 million. At December 31, 2008, $90 million of letters of credit were still in place. Additionally, in connection with the separation, we agreed to indemnify Former Viacom with respect to certain theater lease obligations associated with Famous Players which Former Viacom sold in 2005. Finally, we have indemnification obligations with respect to letters of credit and surety bonds primarily used as security against non-performance in the normal course of business. The outstanding letters of credit and surety bonds at December 31, 2008 were $148 million and are not recorded on the balance sheet. Contingent Consideration on Acquisitions In October 2006, we acquired Harmonix, the developer of Guitar Hero and other music gaming titles, for initial cash consideration of $175 million. The acquisition agreement provided that to the extent financial results exceeded specific contractual targets against a defined gross profit metric through 2008, former Harmonix shareholders are eligible for incremental earn-out payments with respect to the years ended December 31, 2007 and December 31, 2008. In 2008, we paid $150 million, subject to adjustment, under this earn-out agreement related to 2007 performance. The 2008 earn-out payment, payable in 2009, will depend on the final assessment of performance and is expected to be less than the 2007 earn-out payment. Legal Matters See the section entitled Other Matters.
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Capital Resources Capital Structure and Debt At December 31, 2008, total debt was $8.002 billion, a decrease of $244 million, or 3%, from $8.246 billion at December 31, 2007. The decrease in debt reflects our increased cash from operations.
Senior Notes and Debentures In October 2007, we sold $500 million aggregate principal amount of 6.125% Senior Notes due 2017 at a price equal to 99.286% of the principal amount and $250 million aggregate principal amount of 6.750% Senior Debentures due 2037 at a price equal to 99.275% of the principal amount. The total discount on the sale of these instruments was $5 million. We used the total cash proceeds, net of discount and offering expenses, of $740 million to repay amounts outstanding under our revolving credit facility and our commercial paper program. The $750 million Senior Notes due in June 2009 are classified as long-term debt as we have the intent and ability, through utilization of our $3.25 billion revolving facility due December 2010, to refinance this debt. There are no other senior notes or debentures maturing in 2009. Note Payable In 2007, we contributed a $230 million non-interest bearing note payable ($190 million discounted at a rate of 5.8% with quarterly principal payments fully amortizing in 2013) and certain assets related to MTVN’s URGE digital music service for a 49% stake in Rhapsody America LLC, a newly formed venture with RealNetworks, Inc. At December 31, 2008, the total remaining principal balance on the note was $161 million, including an unamortized discount of $25 million. Credit Facility At December 31, 2008 and 2007, we had a single $3.25 billion revolving facility due December 2010. The primary purpose of the facility is to fund short-term liquidity needs and to support commercial paper borrowings. Borrowing rates under the revolving facility are determined at the time of each borrowing and are based generally on LIBOR plus a margin based on our senior unsecured credit rating. A facility fee is paid based on the total amount of the commitments. In addition, we may borrow in certain foreign currencies up to specified limits under the revolving facility. The credit facility contains typical covenants for an investment grade company. The principal financial covenant requires our interest coverage for the most recent four consecutive fiscal quarters to be at least 3.0x, which we met at December 31, 2008. As of December 31, 2008, it was approximately 7.0x. Commercial Paper At December 31, 2008, we have no commercial paper outstanding. At December 31, 2007, the outstanding commercial paper had a weighted average interest rate of 5.95% and an average remaining life of less than 30
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days. We typically classify commercial paper as long-term debt as we have the intent and ability through utilization of our $3.25 billion revolving facility due December 2010 to refinance this facility. Our scheduled maturities of long-term debt at face value, excluding capital leases, outstanding at December 31, 2008 were as follows:
We anticipate that future debt maturities will be funded with cash and cash equivalents, cash flows from operating activities, our credit facility and future access to capital markets. There can be no assurance that we will be able to access capital markets on terms and conditions that will be acceptable to us. There are no provisions in any of our material financing agreements that would cause an acceleration of the obligation in the event of a downgrade in our debt ratings, except in the case of our Senior Notes due 2017 and Senior Debentures due 2037, which provide for possible acceleration in the event of a change in control under certain specific circumstances coupled with ratings downgrades due to the change in control. Securitization Facilities We securitize certain receivables because historically the securitization of certain assets has been a source of lower cost funding compared to our other borrowings and diversifies our obligations among different markets and investors. We have been able to realize cost efficiencies under these arrangements since the assets securing the financing are generally held by a legally separate, wholly owned, bankruptcy-remote special purpose entity (“SPE”) that provides investors with direct security in the assets. In the future, the cost of funding under these arrangements may increase due to the adverse conditions in the worldwide financial markets and there is no guarantee that our existing arrangements will be renewed at the current existing terms or level of funding. In general, we sell, on a revolving nonrecourse basis, a percentage ownership interest in certain of our accounts receivable (the “Pooled Receivables”), which are short term in nature, through SPEs to third-party conduits sponsored by financial institutions. As consideration for Pooled Receivables sold through the securitization facilities, we receive cash and retained interests. The retained interests are included in Receivables, net on the accompanying Consolidated Balance Sheets. The retained interests may become uncollectible. In addition, we are the servicer of the receivables on behalf of the SPEs, for which we are paid a fee. The servicing fee has not been material to any period presented. The terms of the revolving securitization arrangements require that the Pooled Receivables meet certain performance ratios. At December 31, 2008 and 2007, we were in compliance with the required ratios, or have obtained the necessary waivers, under the receivable securitization programs. During 2006, we increased our total capacity under the facilities by $500 million to $950 million and utilized the proceeds to pay down outstanding commercial paper. Stock Repurchase Program For the year ended December 31, 2008, 35.1 million shares were repurchased in the open market under our $4.0 billion stock repurchase program for an aggregate purchase of $1.099 billion and an additional 3.6 million shares were purchased under the NAIRI Agreement with National Amusements, Inc., which was terminated in October 2008, for an aggregate purchase price of $124 million. Since December 31, 2008, we have not purchased any shares under our stock repurchase program, but may resume purchases in the future based on a variety of factors. Off-Balance Sheet Arrangements Our off-balance sheet arrangements primarily consist of programming and talent commitments, operating lease arrangements, purchase obligations for goods and services and funding commitments to joint ventures.
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At December 31, 2008, our significant contractual obligations, including payments due by period, were as follows:
Note: Not included in the amounts above are payments which may result from our unfunded defined benefit pension and other postretirement benefits of $429 million, unrecognized tax benefits of $462 million, including interest and penalties, $235 million of funding commitments to joint ventures and interest payments to be made under our credit facility, which expires in 2010, and payments made under guarantees, if any. The amount and timing of payments with respect to these items are subject to a number of uncertainties such that we are unable to make sufficiently reliable estimations of future payments. We do expect to make contributions of approximately $100 million in 2009 to our pension plans. MARKET RISK We are exposed to market risk related to foreign currency exchange rates and interest rates. We use or expect to use derivative financial instruments to modify exposure to risks from fluctuations in foreign currency exchange rates and interest rates. In accordance with our policy, we do not use derivative instruments unless there is an underlying exposure, and we do not hold or enter into financial instruments for speculative trading purposes. Foreign Exchange Risk We conduct business in various countries outside the United States, resulting in exposure to movements in foreign exchange rates when translating from the foreign local currency to the U.S. Dollar. In 2008 we recognized a foreign exchange loss of $50 million compared to a foreign exchange gain of $42 million in 2007, for a net unfavorable variance of $92 million. The increase in foreign exchange losses in 2008 is primarily due to the strengthening of the U.S. Dollar against foreign currencies we operate in. In 2006, we incurred a foreign exchange gain of $17 million. In order to economically hedge anticipated cash flows and foreign currency balances in such currencies as the British Pound, the Australian Dollar, the Euro, the Japanese Yen, and the Canadian Dollar, foreign currency forward contracts are used. The change in fair value of the non-designated contracts is included in current period earnings as part of Other items, net. Additionally, from time to time we designate forward contracts to hedge future production costs as cash flow hedges or a hedge of the foreign currency exposure of a net investment in a foreign operation. We manage the use of foreign exchange derivatives centrally.
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At December 31, 2008, the notional value of all foreign exchange contracts was $3 million which related to the hedging of future production costs. At December 31, 2007, the notional value of all foreign exchange contracts was $127 million, of which $26 million related to the hedging of future production costs. The remaining $101 million represented economic hedges of underlying foreign currency balances and expected foreign currency net cash flows and investment hedges. Interest Rate Risk A portion of our interest expense is exposed to movements in short-term rates. Interest rate hedges may be used to modify this exposure. As of December 31, 2008 and 2007, there were no interest rate hedges outstanding. During 2007 and 2006, we entered into $350 million and $2.350 billion, respectively, notional amount of interest rate hedges to reduce the variability of cash flows attributable to changes in the benchmark interest rate of future debt issuances. We terminated these hedges during the same years resulting in net cash proceeds to us of approximately $1 million and $88 million, respectively. We have variable-rate debt that had an outstanding balance of $1.400 billion as of December 31, 2008. Based on our variable-rate obligations outstanding at December 31, 2008, a 1% increase or decrease in the level of interest rates would, respectively, increase or decrease our annual interest expense and related cash payments by approximately $14 million. Such potential increases or decreases are based on certain simplifying assumptions, including a constant level of variable-rate debt for all maturities and an immediate, across-the-board increase or decrease in the level of interest rates with no other subsequent changes for the remainder of the period. Conversely, since most of our cash balance of $792 million is invested in variable-rate interest earning assets, we would also earn more (less) interest income due to such an increase (decrease) in interest rates. Viacom has issued Senior Notes and Debentures that, at December 31, 2008, had an outstanding balance of $6.970 billion and an estimated fair value of $5.900 billion. A 1% increase or decrease in the level of interest rates would, respectively, decrease or increase the fair value of the Senior Notes and Debentures by approximately $328 million and $377 million, respectively. Credit Risk We continually monitor our positions with, and credit quality of, our customers and the financial institutions which are counterparties to our financial instrument agreements. We are exposed to credit loss in the event of nonpayment by our customers and nonperformance by the counterparties to our financial instrument agreements. However, we do not anticipate nonperformance by the counterparties to our financial instrument agreements and we believe our allowance for doubtful accounts is sufficient to cover any anticipated nonpayment by our customers. CRITICAL ACCOUNTING POLICIES AND ESTIMATES The preparation of our financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates, judgments and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. On an ongoing basis, we evaluate our estimates, which are based on historical experience and on various other assumptions that we believe are reasonable under the circumstances. The result of these evaluations forms the basis for making judgments about the carrying values of assets and liabilities and the reported amount of expenses that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions. An appreciation of our critical accounting policies, those that are considered by management to require significant judgment and use of estimates and that could have a significant impact on our financial statements, is necessary to understand our financial results. Unless otherwise noted, we applied our critical accounting policies and estimation methods consistently in all material respects and for all periods presented, and have discussed such policies with our Audit Committee.
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Film Accounting Revenue Recognition Revenue we earn in connection with the exhibition of feature films by our Filmed Entertainment segment is recognized in accordance with Statement of Position No. 00-2, Accounting by Producers or Distributors of Films (“SOP 00-2”). Our Filmed Entertainment segment principally earns revenue from the exhibition of feature film content based upon theatrical exhibition, home entertainment and various television markets (e.g., network, pay, syndication, basic cable). We recognize revenue from theatrical distribution of motion pictures upon exhibition. We recognize revenue from home entertainment product sales, net of anticipated returns, including rebates and other incentives, upon the later of delivery or the date that these products are made widely available for sale by retailers. We recognize revenue from the licensing of feature films and original programming for exhibition in television markets upon availability for airing by the licensee. We recognize revenue for video-on-demand and similar pay-per-view arrangements as the feature films are exhibited based on end-customer purchases as reported by the distributor. Original Production and Film Costs We capitalize original production, including original programming and feature film costs, on a title-specific basis, as Inventory in the Consolidated Balance Sheets. We use an individual-forecast-computation method to amortize the costs over the applicable title’s life cycle based upon the ratio of current period and total gross revenues (“ultimate revenues”) for each title. We expense print and advertising costs as they are incurred and expense manufacturing costs, such as DVD manufacturing costs, on a unit-specific basis when we recognize the related revenue. In accordance with SOP 00-2, our estimate of ultimate revenues for feature films includes revenues from all sources that will be earned within ten years from the date of a film’s initial theatrical release. For acquired film libraries, our estimate of ultimate revenues is for a period within 20 years from the date of acquisition. Prior to the release of a feature film and throughout its life, we estimate the ultimate revenues based on the historical performance of similar content, as well as incorporating factors of the content itself, including, but not limited to, the expected number of theaters and markets in which the original content will be released, the genre of the original content and the past box office performance of the lead actors and actresses. We believe the most sensitive factor affecting our estimate of ultimate revenues for feature films is domestic theatrical exhibition, as subsequent markets have historically exhibited a high correlation to domestic theatrical performance. For original programming, each program’s costs are amortized on a straight-line basis over its estimated period of use, depending on genre and historical experience, beginning with the month of initial exhibition. The estimate of ultimate revenues impacts the timing of original production cost amortization. Upon a film’s initial release we update our estimate of ultimate revenues based on expected future and actual results. If, in our judgment, we do not believe that the amount is recoverable, we may reduce our estimate of ultimate revenues, thereby accelerating the amortization of capitalized costs. In addition, we use the individual-film-forecast computation method to determine whether or not the capitalized costs are impaired. If we believe that the release of our content will not or has not been favorably received, then we would assess whether the fair value of such content is less than the unamortized portion of its capitalized costs and, if need be, recognize an impairment charge for the amount by which the unamortized capitalized costs exceed the fair value. Acquired Programming Rights The accounting for acquired program rights is addressed by the Financial Accounting Standards Board (“FASB”) in Statement No. 63, Financial Reporting by Broadcasters (“FAS 63”). Under the provisions of FAS 63, a
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licensee reports an asset and liability for the rights acquired and obligations incurred at the commencement of the licensing period when the cost of the programming is known or reasonably determinable, the program material has been accepted by the licensee and the programming is available for airing. We record the transaction using the gross liability provision. The asset is amortized to operating expenses over the greater of straight line amortization or actual number of plays over the estimated periods revenues are generated, commencing upon availability. Determining factors used in estimating the useful life of programming includes the expected number of future airings, which may differ from the contracted number of airings, the length of the license period and expected future revenues to be generated from the programming. An impairment charge may be necessary if our estimates of future cash flows of similar programming are insufficient or if programming is abandoned. Revenue Recognition Gross versus Net Revenue Recognition We earn and recognize revenues where we act as distributor on behalf of third parties. In such cases, determining whether revenue should be reported on a gross or net basis is based on management’s assessment of whether we act as the principal or agent in the transaction. To the extent we act as the principal in a transaction, we report revenues on a gross basis. In concluding on whether or not we act as principal, we follow the guidance set forth by the Emerging Issues Task Force (“EITF”) in EITF Issue No. 99-19, Reporting Revenue Gross as a Principal versus Net as an Agent (“EITF 99-19”). The determination of whether we act as a principal or an agent in a transaction involves judgment and is based on an evaluation of whether we have the substantial risks and rewards of ownership under the terms of an arrangement. Our most significant arrangements are in connection with certain exclusive distribution rights to and home video fulfillment services for the animated feature films produced by DreamWorks Animation and the distribution agreements with Marvel, DW Funding and CBS Corporation. Under the terms of these agreements, we generally are responsible for all out-of-pocket costs, primarily comprised of distribution and marketing costs. For the provision of distribution services, we generally retain a fee based upon a percentage of gross receipts and recovers expended distribution and marketing costs on a title-by-title basis prior to any participation payments to the contracting parties of the films, except as pertains to certain contractually agreed upon advance payments. As primary obligor, revenue and related distribution and marketing costs for these arrangements are presented on a gross basis in accordance with EITF 99-19. Prior to January 1, 2008, we were not primary obligor under the distribution agreement with CBS Corporation then in effect, and therefore revenues were accounted for on a net basis. Multiple Element Arrangements The accounting for multiple element arrangements related to our video game products that include hardware, software and service components, requires significant judgment. Where a video game provides limited online features at no additional cost to the consumer, we generally consider such features to be incidental to the overall product offering and an inconsequential deliverable. Accordingly, we do not defer any revenue related to products containing these limited online features. In instances where online features or additional functionality is considered a substantive deliverable in addition to the software product, we recognize revenue ratably over an estimated service period. This evaluation is performed for each software product that is released. The accounting for other multiple element arrangements, such as bundled advertising services, requires significant judgment. We consider revenue realized or realizable and earned when it has persuasive evidence of an arrangement, delivery has occurred, the sales price is fixed and determinable, and collectibility is reasonably assured. Determining whether some or all of these criteria have been met involves assumptions and judgments that can have a significant impact on the timing and amount of revenue we report.
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Sales Returns, Allowances and Uncollectible Accounts Revenue allowances are recorded to adjust amounts originally invoiced to the estimated net realizable value in accordance with revenue recognition guidance set forth in FASB Statement No. 48, Revenue Recognition When Right of Return Exists. Upon the sale of home entertainment, video game and other products to wholesalers and retailers, we record a reduction of revenue for the impact of estimated customer future returns, rebates and other incentives (“estimated returns”). In determining estimated returns, we analyze historical return activity, current economic trends and changes in customer demand and acceptance of our products. Based on this information, we reserve a percentage of each dollar of product revenue when we provide a customer with the right of return. Our estimate of future returns affects reported revenue and operating income. If we underestimate the impact of future returns in a particular period, then we may record less revenue in later periods when returns exceed the estimated amounts. If we overestimate the impact of future returns in a particular period, then we may record additional revenue in later periods when returns are less than estimated. An incremental change of 1% in our estimated sales returns for home entertainment and video game products would have a $44 million impact on our total revenue. Our sales return allowance totaled $829 million and $706 million at December 31, 2008 and 2007, respectively. We also continually evaluate accounts receivable and establish judgments as to their ultimate collectibility. Judgments and estimates involved include an analysis of specific risks on a customer-by-customer basis for larger accounts and an analysis of actual historical write-off experience in conjunction with the length of time the receivables are past due. Using this information, management reserves an amount that is estimated to be uncollectible. An incremental change of 1% in our allowance for uncollectible accounts for trade accounts receivables would have a $24 million impact on our operating results. Our allowance for uncollectible accounts totaled $99 million and $102 million at December 31, 2008 and 2007, respectively. Provision for Income Taxes On January 1, 2007, we adopted Financial Accounting Standards Board (the “FASB”) Interpretation No. 48, Accounting for Uncertainty in Income Taxes—An Interpretation of FASB Statement No. 109 (“FIN 48”). See Notes 1 and 16 to our Consolidated Financial Statements. As a global entertainment content company, we are subject to income taxes in the United States and foreign jurisdictions where we have operations. Significant judgment is required in determining our annual provision for income taxes and evaluating our income tax positions. Our tax rates are affected by many factors, including our global mix of earnings, legislation, acquisitions, dispositions, as well as the tax characteristics of our income. In determining our tax rates on a jurisdiction basis, we are required to make judgments on the need to record deferred tax assets and liabilities, including the recoverability of deferred tax assets. A valuation allowance is established if it is more likely than not that a deferred tax asset will not be realized based on our estimates of future taxable income. Additionally, in evaluating uncertain tax positions in accordance with FIN 48 we make determination of the application of complex tax rules, regulations and practices. We evaluate our uncertain tax positions quarterly based on many factors including, but not limited to, new facts, changes in tax law and information received from regulators. A change in any one of the factors could change an existing uncertain tax position, resulting in the recognition of an additional charge or tax benefit to our tax provision in the period. As such, going forward, our effective tax rate may fluctuate. Additionally, our income tax returns are routinely audited and settlements of issues raised in these audits sometimes affect our tax provisions. The resolution of audit issues and tax positions taken may take extended periods of time due to examinations by tax authorities and statutes of limitations.
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During 2008, 2007 and 2006, we effectively settled various uncertain tax positions. As a result, our 2008, 2007 and 2006 provision for income taxes includes $55 million, $15 million and $142 million of net discrete tax benefits. A 1% change in our effective rate, excluding discrete items, would result in additional tax expense of approximately $19 million in 2008. Undistributed earnings of our foreign subsidiaries are permanently reinvested outside the United States and, therefore, no U.S. taxes have been provided thereon. Fair Value Measurements The performance of fair value measurements is an integral part of the preparation of financial statements in accordance with generally accepted accounting principles. Fair value is defined as the price that would be received to sell the asset or paid to transfer the liability in an orderly transaction between market participants to sell or transfer such an asset or liability. Selection of the appropriate valuation technique, as well as determination of assumptions, risks and estimates used by market participants in pricing the asset or liability requires significant judgment. Although we believe that the inputs used in our valuation techniques are reasonable, a change in one or more of the inputs could result in an increase or decrease in the fair value of certain assets and certain liabilities. Either instance would have an impact on both our Consolidated Balance Sheet and Consolidated Statement of Earnings. Provided below are those instances where the determination of fair value could have the most significant impact on our financial condition or results of operations: Goodwill and Indefinite-Lived Intangible Assets. On an annual basis the test for goodwill impairment is performed using a two-step process, unless there is a triggering event, in which case a test would be performed sooner. The first step is to identify a potential impairment by comparing the fair value of a reporting unit with its carrying amount. For all periods presented, our reporting units are consistent with its operating segments, in all material respects. The estimates of fair value of a reporting unit are determined based on a discounted cash flow analysis. A discounted cash flow analysis requires us to make various judgmental assumptions, including assumptions about future cash flows, growth rates and discount rates. The assumptions about future cash flows and growth rates are based on the budget and long-term business plans of each operating segment. Discount rate assumptions are based on an assessment of the risk inherent in the future cash flows of the respective reporting units. If necessary, the second step of the goodwill impairment test compares the implied fair value of the reporting unit’s goodwill with the carrying amount of that goodwill. The implied fair value of goodwill is determined in the same manner as the amount of goodwill recognized in a business combination. Our indefinite lived intangibles are primarily related to trademarks and FCC licenses. The impairment test for these intangible assets consists of a comparison of the fair value of the intangible asset with its carrying value. The estimates of fair value of trademarks are determined using a discounted cash flow valuation methodology commonly referred to as the “relief from royalty” methodology. Significant assumptions inherent in the “relief from royalty” methodology employed include estimates of appropriate marketplace royalty rates and discount rates. Our impairment analysis, which is performed annually during the fourth quarter did not result in an impairment charge for goodwill or indefinite lived intangible assets in the years presented.
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Finite-Lived Intangible Assets. In determining whether finite-lived intangible assets (e.g., customer lists, film libraries) are impaired, the accounting rules do not provide for an annual impairment test. Instead, they require that a triggering event occur before testing an asset for impairment. Once a triggering event has occurred, the impairment test employed is based on whether the intent is to hold the asset for continued use or to hold the asset for sale. If the intent is to hold the asset for continued use, first a comparison of undiscounted future cash flows against the carrying value of the asset is performed. If the carrying value exceeds the undiscounted cash flows, the asset would be written down to the discounted fair value. If the intent is to hold the asset for sale, to the extent the carrying value is greater than the asset’s value, an impairment loss is recognized for the difference. Significant judgments in this area involve determining whether a triggering event has occurred, the determination of the cash flows for the assets involved and the discount rate to be applied in determining fair value. In 2008, we recorded an impairment charge of $32 million related to certain intangibles in connection with the restructuring and related activities. In 2007 and 2006, there was no impairment of finite-lived intangible assets. RECENT PRONOUNCEMENTS Refer to Note 3 to our Consolidated Financial Statements for a discussion of recently issued accounting standards. OTHER MATTERS Legal Matters Litigation is inherently uncertain and always difficult to predict. However, based on our understanding and evaluation of the relevant facts and circumstances, we believe that the legal matters described below and other litigation to which we are a party are not likely, in the aggregate, to have a material adverse effect on our results of operations, financial position or cash flows. In March 2007, we filed a complaint in the United States District Court for the Southern District of New York against Google Inc. (“Google”) and its wholly-owned subsidiary YouTube, alleging that Google and YouTube violated and continue to violate our copyrights. We are seeking both damages and injunctive relief, and the lawsuit is currently in discovery. In September 2007, Brantley, et al. v. NBC Universal, Inc., et al., was filed in the United States District Court for the Central District of California against us and several other program content providers on behalf of a purported nationwide class of cable and satellite subscribers. The plaintiffs also sued several major cable and satellite program distributors. Plaintiffs allege that separate contracts between the program providers and the cable and satellite operator defendants providing for the sale of programming in specific tiers each unreasonably restrain trade in a variety of markets in violation of the Sherman Act. In March 2008, the court granted the defendants’ motion to dismiss the plaintiffs’ First Amended Complaint. The plaintiffs subsequently filed a Second Amended Complaint seeking, among other things, treble monetary damages in an unspecified amount and an injunction to compel the offering of channels on an “à la carte” basis. In September 2008, the defendants’ motion to dismiss the Second Amended Complaint was denied. The defendants’ appeal of that ruling was also denied and the lawsuit is now in discovery. We believe the plaintiffs’ position in this litigation is without merit and intend to continue to vigorously defend this lawsuit.
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Concluded Litigation Former Viacom and NAI, and certain of their respective present and former officers and directors, were defendants in a state law action in the Court of Chancery of Delaware relating to the 2004 split-off of Blockbuster from Former Viacom pursuant to an exchange offer. The plaintiff’s complaint in the Delaware action was dismissed in February 2008 and its appeal was argued before the Supreme Court of Delaware, which affirmed the dismissal in January 2009. Two other lawsuits arising from the same facts as the Delaware action were dismissed in 2007 and 2008. Related Parties NAI, through NAIRI, Inc., is the controlling stockholder of both Viacom and CBS Corporation. NAI also held a controlling interest in Midway Games, Inc. (“Midway”) until November 28, 2008. Sumner M. Redstone, Chairman, Chief Executive Officer and controlling shareholder of NAI, is the Executive Chairman of the Board and Founder of Viacom and CBS Corporation. In addition, Shari Redstone, who is Sumner Redstone’s daughter, is the President of NAI and the Vice Chair of the Board of Viacom and CBS Corporation. Philippe Dauman, our President and Chief Executive Officer, and George Abrams, one of our directors, serve on the boards of both NAI and Viacom. Fred Salerno, one of our directors, serves on the boards of both Viacom and CBS Corporation. See the “Risk Factors” section for additional information on our relationship with NAI. NAI licenses films in the ordinary course of business for its motion picture theaters from all major studios including Paramount. During the years ended December 31, 2008, 2007 and 2006, Paramount earned revenues from NAI in connection with these licenses in the aggregate amounts of approximately $36 million, $36 million and $14 million, respectively. In connection with our stock repurchase programs, in 2008 and 2007, respectively, we purchased 3.6 million and 6.0 million shares under the NAIRI Agreement for aggregate purchase prices of $124 million and $246 million, respectively. For information on NAI’s participation in our stock repurchase program, see the section entitled Capital Resources—Stock Repurchase Program. Viacom and CBS Corporation Related Party Transactions We, in the normal course of business, are involved in transactions with CBS Corporation and its various businesses (“CBS”) that result in the recognition of revenue and expense by Viacom. Transactions with CBS, through the normal course of business, are settled in cash. Paramount distributes certain television products into the home entertainment market on behalf of CBS. Effective January 1, 2008, Viacom entered into a new distribution agreement with CBS under which revenue and expenses are recorded on a gross basis. Under the terms of the agreement, Paramount is entitled to retain a fee based on a percentage of gross receipts and is generally responsible for all out-of-pocket costs which are recoupable, together with the annual advance due to CBS, prior to any participation payments to CBS. In connection with this agreement, Paramount made initial payments of $100 million to CBS during each of the first quarters of 2008 and 2009. Paramount also leases studio space to CBS and licensed motion picture products to CBS that were released by us through December 31, 2007. Additionally, the Media Networks segment recognizes advertising revenues from CBS. The Media Networks segment purchases television programming from CBS. The cost of such purchases is initially recorded as acquired program rights inventory and amortized over the estimated period that revenues will be generated. Both of our segments also place advertisements with CBS.
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The following table summarizes the transactions with CBS as included in our consolidated financial statements:
Special Dividend to Former Viacom In accordance with the terms of the Separation Agreement, in December 2005 we paid a preliminary special dividend to Former Viacom of $5.400 billion which was subject to adjustment. In 2006 and 2007, we made further payments of $206 million and $170 million, respectively, to CBS Corporation in final resolution of the adjustments. 401(k) Plan Transactions Following the separation, some participants in the Viacom 401(k) Plan continued to be invested in CBS Corporation Class A and Class B common stock. In 2007, CBS Corporation purchased the shares of CBS Corporation Class A and Class B common stock from the Viacom 401(k) Plan for total proceeds of $30 million. Similarly, some participants in the 401(k) plans sponsored by CBS Corporation continued to be invested in Viacom Class A and Class B common stock following the separation. In 2007, we purchased the shares of Viacom Class A and Class B common stock from the CBS-sponsored 401(k) plans for an aggregate amount of $120 million. Separation Agreement with CBS Corporation In connection with the separation, each share of Former Viacom Class A common stock was converted into the right to receive 0.5 of a share of Viacom Class A common stock and 0.5 of a share of CBS Corporation Class A common stock. Similarly, each share of Former Viacom Class B common stock was converted into the right to receive 0.5 of a share of Viacom Class B common stock and 0.5 of a share of CBS Corporation Class B common stock. Holders of Viacom Class A and Class B common stock received cash in lieu of fractional shares.
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In connection with the separation, we and CBS Corporation entered into the Separation Agreement as well as certain other agreements to govern the terms of the separation and certain of the ongoing relationships between CBS Corporation and us after the separation. These agreements include a Transition Services Agreement and a Tax Matters Agreement. These related party arrangements are more fully described below. The Separation Agreement contains the key provisions required to effect the separation of Former Viacom into Viacom and CBS Corporation. The Separation Agreement identified assets transferred, liabilities assumed and contracts assigned to us by CBS Corporation and to CBS Corporation by us in the separation, and described when and how these transfers, assumptions and assignments were to occur. The Separation Agreement also sets forth certain agreements between us and CBS Corporation with respect to the period following the separation date. Former Viacom and Viacom executed the Separation Agreement in December 2005. Indemnification Obligations. Pursuant to the Separation Agreement, each company indemnified the other company and the other company’s officers, directors and employees for any losses arising out of its failure to perform or discharge any of the liabilities it assumed pursuant to the Separation Agreement, its businesses as conducted as of the date of the separation and its breaches of shared contracts. Legal Matters. In general, under the Separation Agreement, Viacom assumed the liability for, and control of, all pending and threatened legal matters related to its own business or assumed liabilities and will indemnify the other party for any liability arising out of or resulting from such assumed legal matters. Liability for, and control of, future litigation claims against Viacom for events that took place prior to, on or after the date of the separation generally will be assumed by the company operating the business to which the claim relates or, in the case of businesses which were sold or discontinued prior to the date of the separation, or for other matters agreed to be indemnified, the company which has assumed the liabilities. Viacom agreed to cooperate in defending any claims against both of Viacom and CBS Corporation for events that took place prior to, on, or after the date of the separation. Employee Matters. The Separation Agreement allocated liabilities and responsibilities relating to employee compensation and benefit plans and programs and other related matters in connection with the separation, including the treatment of certain outstanding annual and long-term incentive awards, existing deferred compensation obligations and certain retirement and welfare benefit obligations. In general, the Separation Agreement provides that, following the separation, Viacom is responsible for all employment and benefit- related obligations and liabilities related to current employees who work for Viacom immediately following the separation, Former Viacom employees who most recently worked for other businesses and operations that became part of Viacom immediately following the separation, Former Viacom employees who most recently worked for certain other businesses and operations that were sold or discontinued prior to the separation, and certain other former employees of Former Viacom as set forth in the Separation Agreement (and, in each case, their dependents and beneficiaries). Liability for benefit-related obligations and liabilities of former employees of Former Viacom who most recently worked for the Former Viacom corporate office or the Paramount Pictures corporate office (other than those who accepted a post-separation position with CBS Corporation or Viacom) and certain corporate office employees who will remain employed by CBS Corporation and provide transition services following the separation is shared equally by Viacom and CBS Corporation. Effective as of the separation, employees of Viacom, other than overlapping employees, do not participate in Former Viacom’s employee benefit plans and Viacom established its own employee benefit plans that are substantially similar to the plans sponsored by Former Viacom prior to the separation. The Separation Agreement provided for the transfer of assets and liabilities, as applicable, relating to the pre-separation participation of
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Viacom employees and certain Former Viacom employees (as set forth in the Separation Agreement) in various Former Viacom retirement, welfare, incentive compensation and employee benefit plans from such plans to the applicable new plans established by Viacom. Limitations on Certain Acquisitions. Subject to limited exceptions, the Separation Agreement provides that none of Viacom, any subsidiary of Viacom or any person that is controlled by Viacom after the separation will own or acquire an interest in a radio or television broadcast station, television broadcast network or daily newspaper, if such ownership or acquisition would (i) cause CBS Corporation, any subsidiary of CBS Corporation or any entity controlled by CBS Corporation after the date of the separation to be in violation of U.S. federal laws limiting the ownership or control of radio broadcast stations, television broadcast stations, television broadcast networks or (ii) limit in any manner at any time under such laws CBS Corporation’s ability to acquire additional interests in a radio or television broadcast station and/or television broadcast network. These restrictions will terminate when none of Mr. Redstone, NAI, NAIRI or any of their successors, assigns or transferees are deemed to have interests in both CBS Corporation and Viacom that are attributable under applicable U.S. federal laws. The Separation Agreement also provides that neither Viacom, any subsidiary of Viacom or any person controlled by Viacom nor CBS Corporation, any subsidiary of CBS Corporation or any person controlled by CBS Corporation will acquire any asset, enter into any agreement or accept or agree to any condition that purports to bind, or subjects to a legal order, the other company, its subsidiaries or any person it controls without such other party’s written consent. In addition, neither Viacom, any subsidiary of Viacom or any person controlled by Viacom nor CBS Corporation, or subsidiary of CBS Corporation or any person controlled by CBS Corporation will own or acquire an interest in a cable television operator if such ownership would subject the other company to any U.S. federal laws regulating contractual relationships between video programming vendors and video programming distributors to which it is not then subject. These restrictions will terminate for each company on the earliest of (i) the fourth anniversary of the separation, or 12/31/09, (2) the date on which none of Mr. Redstone, NAI, NAIRI or any of their successors, assigns or transferees are deemed to have interests in both CBS Corporation and Viacom that are attributable under applicable U.S. federal laws and (3) the date on which the other company ceases to own the video programming vendors that it owns as of the separation. Tax Matters Agreement with CBS Corporation The following description of the principal provisions of the Tax Matters Agreement between Former Viacom and us is qualified by reference to the text of the Tax Matters Agreement, a form of which was filed as an exhibit to this annual report. The Tax Matters Agreement sets forth Viacom’s responsibilities with respect to, among other things, liabilities for federal, state, local and foreign income taxes for periods before and including the merger, the preparation and filing of income tax returns for such periods, disputes with taxing authorities regarding income taxes for such periods and indemnification for income taxes that would become due if the merger were taxable. Viacom will generally be responsible for federal, state and local, and foreign income taxes for periods before the merger relating to Viacom’s respective businesses. Income tax liabilities relating to discontinued operations and previously disposed businesses have been allocated in accordance with the principles applicable under the Separation Agreement for liabilities relating to those operations and businesses. Other income tax liabilities, including items that do not specifically relate to either business, will be shared equally. Viacom and CBS Corporation will generally be jointly responsible for managing any dispute relating to income taxes for which both parties may be responsible. The Tax Matters Agreement also provides that, depending on the event, Viacom may have to indemnify CBS Corporation, or CBS Corporation may have to indemnify Viacom, for some or all of
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the taxes resulting from the transactions related to the merger and the distribution of Viacom common stock if the merger and distribution do not qualify as tax-free under Sections 355 and 368 of the Code. Other Related Party Transactions In the normal course of business, we are involved in related party transactions with equity investees, principally related to investments in unconsolidated variable interest entities as more fully described in Note 5 to our Consolidated Financial Statements. These related party transactions principally relate to the provision of advertising services, licensing of film and programming content and the distribution of films for which the impact on our Consolidated Financial Statements is as follows:
All other related party transactions, including with Midway, are not material in the periods presented.
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Table of ContentsItem 7A. Quantitative and Qualitative Disclosures about Market Risk. Disclosures on our market risk are included in “Management’s Discussion and Analysis of Results of Operations and Financial Condition—Market Risk.” Item 8. Financial Statements and Supplementary Data.
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Table of ContentsMANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING Management has prepared and is responsible for our consolidated financial statements and related notes. Management is also responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended. The Company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with the authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements. Internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements prepared for external purposes in accordance with generally accepted accounting principles. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risks that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies and procedures may deteriorate. Under the supervision and with the participation of management, including our personal participation, we conducted an assessment of the effectiveness of internal control over financial reporting based on the framework in Internal Control – Integrated Framework as issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management determined that as of December 31, 2008, Viacom maintained effective internal control over financial reporting. The assessment of the effectiveness of our internal control over financial reporting as of December 31, 2008 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report included herein.
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Table of ContentsREPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Stockholders of Viacom Inc. In our opinion, the consolidated financial statements listed in the index appearing under Item 8 present fairly, in all material respects, the financial position of Viacom Inc. and its subsidiaries (the “Company”) at December 31, 2008 and 2007, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2008 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the index appearing under Item 8 presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements and financial statement schedules, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control over Financial Reporting appearing under Item 8. Our responsibility is to express opinions on these financial statements, on the financial statement schedule, and on the Company’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. As discussed in Note 1 to the consolidated financial statements, during the year ended December 31, 2007, the Company changed the manner in which it accounts for uncertain tax positions. Additionally, as also discussed in Note 1, as of December 31, 2006, the Company changed the manner in which it accounts for defined benefit pension and other postretirement plans. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ PricewaterhouseCoopers LLP New York, New York February 11, 2009
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Table of ContentsCONSOLIDATED STATEMENTS OF EARNINGS
See accompanying notes to consolidated financial statements.
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Table of ContentsCONSOLIDATED BALANCE SHEETS
See accompanying notes to consolidated financial statements.
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Table of ContentsCONSOLIDATED STATEMENTS OF CASH FLOWS
See accompanying notes to consolidated financial statements.
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Table of ContentsCONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME
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