AOL TIME WARNER INC.
Table of Contents

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

FORM 10-Q

[  x  ]    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT of 1934 for the quarterly period ended September 30, 2002 or

[      ]    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT of 1934 for the transition period from                      to           .

Commission file number 1-15062

AOL TIME WARNER INC.

(Exact name of registrant as specified in its charter)
     
Delaware   13-4099534
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
Identification Number)

75 Rockefeller Plaza
New York, New York 10019
(212) 484-8000

(Address, including zip code, and telephone number, including
area code, of registrant’s principal executive offices)

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 the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

         
    Shares Outstanding
Description of Class   as of October 31, 2002

 
Common Stock — $.01 par value
    4,298,961,007  
Series LMCN-V Common Stock — $.01 par value
    171,185,826  

 


TABLE OF CONTENTS

MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
CONSOLIDATED BALANCE SHEET
CONSOLIDATED STATEMENT OF OPERATIONS
CONSOLIDATED STATEMENT OF CASH FLOWS                      Nine Months Ended September 30,
CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY                      Nine Months Ended September 30,
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SUPPLEMENTARY INFORMATION
PART I. FINANCIAL INFORMATION
MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
CONSOLIDATED BALANCE SHEET
CONSOLIDATED STATEMENT OF OPERATIONS
CONSOLIDATED STATEMENT OF CASH FLOWS
CONSOLIDATED STATEMENT OF PARTNERSHIP CAPITAL
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
PART II. OTHER INFORMATION
EX-10.1 AMENDMENT NO. 2 TO DEFERRED COMPENSATION
EX-10.3 FORM OF RESTATED CERTIFICATE
EX-10.4 FORM OF AMENDED AND RESTATED AGREEMENT
EX-10.5 FORM OF BY-LAWS OF TWC
EX-10.6 FORM OF REGISTRATION RIGHTS AGREEMENT
EX-10.7 FORM OF REGISTRATION RIGHTS AGREEMENT
EX-10.8 FORM OF PARENT AGREEMENT
EX-10.9 FORM OF PARTNERSHIP INTEREST SALE
EX-10.10 FORM OF REIMBURSEMENT AGREEMENT
EX-10.11 FORM OF BRAND LICENSE AGREEMENT
EX-10.12 FORM OF TAX MATTERS
EX-10.13 FORM OF BRAND AND TRADE NAME LICENSE
EX-10.14 REGISTRATION RIGHTS AGREEMENT
EX-10.15 DISTRIBUTION AGREEMENT
EX-10.16 INTELLECTUAL PROPERTY AGREEMENT
EX-10.17 CONTRIBUTION AGREEMENT
EX-10.18 INTELLECTUAL PROPERTY AGREEMENT
EX-10.19 DEMAND PROMISSORY NOTE
EX-99.1 SECTION 906 CERTIFICATIONS


Table of Contents

AOL TIME WARNER INC. AND
TIME WARNER ENTERTAINMENT COMPANY, L.P.

INDEX TO FORM 10-Q

                   
      Page
     
      AOL Time        
      Warner   TWE
     
 
PART I. FINANCIAL INFORMATION
           
 
Management’s discussion and analysis of results of operations and financial condition
      1   73
 
Consolidated balance sheet at September 30, 2002 and December 31, 2001
    35   89
 
Consolidated statement of operations for the three and nine months ended September 30, 2002 and 2001
    36   90
 
Consolidated statement of cash flows for the nine months ended September 30, 2002 and 2001
    37   91
 
Consolidated statement of shareholders’ equity and partnership capital
    38   92
 
Notes to consolidated financial statements
    39   93
 
Supplementary information
    65    
 
               
PART II. OTHER INFORMATION
    107          

 


Table of Contents

AOL TIME WARNER INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION

INTRODUCTION

         Management’s discussion and analysis of results of operations and financial condition (“MD&A”) is provided as a supplement to the accompanying consolidated financial statements and footnotes to help provide an understanding of AOL Time Warner Inc.’s (“AOL Time Warner” or the “Company”) financial condition, changes in financial condition and results of operations. The MD&A is organized as follows:

  Overview. This section provides a general description of AOL Time Warner’s businesses, as well as recent developments that the Company believes are important in understanding the results of operations, as well as to anticipate future trends in those operations.
 
  Results of operations. This section provides an analysis of the Company’s results of operations for the three and nine months ended September 30, 2002 relative to the comparable periods in 2001. This analysis is presented on both a consolidated and segment basis. In addition, a brief description is provided of transactions and events that impact the comparability of the results being analyzed.
 
  Financial condition and liquidity. This section provides an analysis of the Company’s financial condition as of September 30, 2002 and cash flows for the nine months ended September 30, 2002.
 
  Caution concerning forward-looking statements and risk factors. This section discusses how certain forward-looking statements made by the Company in this report, including throughout MD&A and in the consolidated financial statements, are based on management’s current expectations about future events and are inherently susceptible to uncertainty and changes in circumstances. In addition, a description is provided of the risk factors that could adversely affect the operations, business or financial results of the Company or its business segments.

OVERVIEW

Description of Business

         AOL Time Warner is the world’s leading media and entertainment company. The Company was formed in connection with the merger of America Online, Inc. (“America Online”) and Time Warner Inc. (“Time Warner”), which was consummated on January 11, 2001 (the “Merger”). As a result of the Merger, America Online and Time Warner each became a wholly owned subsidiary of AOL Time Warner.

         AOL Time Warner classifies its business interests into six fundamental areas: AOL, consisting principally of interactive services, Web properties, Internet technologies and electronic commerce services; Cable, consisting principally of interests in cable television systems; Filmed Entertainment, consisting principally of interests in filmed entertainment and television production; Networks, consisting principally of interests in cable television and broadcast network programming; Music, consisting principally of interests in recorded music, music publishing and DVD manufacturing; and Publishing, consisting principally of interests in magazine publishing, book publishing and direct marketing.

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AOL TIME WARNER INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION — (Continued)

Use of EBITDA

         AOL Time Warner evaluates operating performance based on several factors, including its primary financial measure of operating income (loss) before noncash depreciation of tangible assets and amortization of intangible assets (“EBITDA”). AOL Time Warner considers EBITDA an important indicator of the operational strength and performance of its businesses, including the ability to provide cash flows to service debt and fund capital expenditures. In addition, EBITDA eliminates the uneven effect across all business segments of considerable amounts of noncash depreciation of tangible assets and amortization of certain intangible assets deemed to have finite useful lives that were recognized in business combinations accounted for by the purchase method. As such, the following comparative discussion of the results of operations of AOL Time Warner includes, among other measures, an analysis of changes in EBITDA. However, EBITDA should be considered in addition to, not as a substitute for, operating income (loss), net income (loss) and other measures of financial performance reported in accordance with generally accepted accounting principles. In addition, EBITDA should not be used as a substitute for the Company’s various cash flow measures (e.g., operating cash flow and free cash flow), which are discussed in detail beginning on page 27.

Recent Developments

Restatement of Prior Financial Information

         The Company is conducting an internal review of certain advertising and commerce transactions at the AOL segment under the direction of the Company’s Chief Financial Officer. In connection with this internal review, the financial results for each of the quarters ended September 30, 2000 through June 30, 2002 will be restated. The total impact of the adjustments will be to reduce the Company’s consolidated advertising and commerce revenues by $190 million over these eight quarterly periods, with corresponding reductions in EBITDA, operating income and net income for that same time period of $97 million, $83 million and $46 million, respectively. For the AOL segment, the impact of the adjustments will be to reduce advertising and commerce revenues by $168 million over these eight quarterly periods, with corresponding reductions in EBITDA and operating income for that same time period of $97 million and $83 million, respectively. The remaining impact on the Company’s consolidated advertising and commerce revenues of $22 million represents a reduction in revenues from certain transactions related to the AOL segment in which the advertising was delivered by other AOL Time Warner segments. The adjustments represent approximately 1% of the AOL segment’s total revenues for that same two-year period, approximately 3.4% of its advertising and commerce revenues, approximately 1.9% of its EBITDA and approximately 2.1% of its operating income. The largest impact of the adjustments is in the quarter ended September 30, 2000, where advertising and commerce revenues will be reduced by $66 million, both EBITDA and operating income will be reduced by $30 million and net income will be reduced by $18 million. The restatement will result in a decrease in basic earnings per share of $0.01 in both the third and fourth quarters of 2000.

         It is expected that the audited financial statements for the affected periods will be filed with the Securities and Exchange Commission (“SEC”) in the fourth quarter of 2002. Until such time, the Company’s financial statements for the affected periods, including the audited financial statements contained in the 2001 Annual Report on Form 10-K, should no longer be relied upon as a result of the announced restatement.

         The financial results presented in this report reflect the impact of the adjustments that will be made in the restatement of the Company’s financial results. For the three months ended September 30, 2001, the total impact of

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AOL TIME WARNER INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION — (Continued)

these adjustments is a reduction of both the AOL segment’s and the Company’s consolidated advertising and commerce revenues of $16 million, with corresponding reductions in EBITDA of $6 million, operating income of $2 million and consolidated net income of $1 million. For the nine months ended September 30, 2002 and 2001, the total impact is a reduction of the Company’s consolidated advertising and commerce revenues of $12 million and $72 million, respectively, with corresponding reductions in EBITDA of $14 million and $14 million, respectively, operating income of $10 million and $7 million, respectively and net income of $2 million and $4 million, respectively. For the AOL segment, for the nine months ended September 30, 2002 and 2001, the impact of these adjustments is a reduction of advertising and commerce revenues of $6 million and $57 million, respectively, with corresponding reductions in EBITDA of $14 million and $14 million, respectively, and operating income of $10 million and $7 million, respectively. The remaining impact on the Company’s consolidated advertising and commerce revenues of $6 million and $15 million for the nine months ended September 30, 2002 and 2001, respectively, represents a reduction in revenues from certain transactions related to the AOL segment in which the advertising was delivered by other AOL Time Warner segments.

         The SEC and the Department of Justice (“DOJ”) are investigating the financial reporting and disclosure practices of the Company. The Company will continue its efforts to cooperate with the investigations. The Company is unable to predict the outcome of these investigations. Refer to Note 12 and Part II, Item 1 for additional information regarding the investigations.

Investment in Time Warner Entertainment Company, L.P.

         A majority of AOL Time Warner’s interests in the Filmed Entertainment and Cable segments, and a portion of its interests in the Networks segment, are held through Time Warner Entertainment Company, L.P. (“TWE”). Prior to the change in ownership discussed below, AOL Time Warner owned general and limited partnership interests in TWE consisting of 74.49% of the pro rata priority capital (“Series A Capital”) and residual equity capital (“Residual Capital”), and 100% of the junior priority capital (“Series B Capital”). The remaining 25.51% limited partnership interests in the Series A Capital and Residual Capital of TWE were held by subsidiaries of AT&T Corp. (“AT&T”).

         During the second quarter of 2002, AT&T exercised a one-time option to increase its ownership in the Series A Capital and Residual Capital of TWE. As a result, on May 31, 2002, AT&T’s interest in the Series A Capital and Residual Capital of TWE increased by approximately 2.13% to approximately 27.64% and AOL Time Warner’s corresponding interest in the Series A Capital and Residual Capital of TWE decreased by approximately 2.13% to approximately 72.36%. In accordance with Staff Accounting Bulletin No. 51, “Accounting for Sales of Stock of a Subsidiary”, AOL Time Warner has reflected the pretax impact of the dilution of its interest in TWE of approximately $690 million as an adjustment to paid-in capital (Note 6).

         In August 2002, AOL Time Warner and AT&T announced that they had agreed to restructure TWE. As part of the restructuring, AOL Time Warner will acquire complete ownership of TWE’s content assets, including Warner Bros. and Home Box Office, as well as TWE’s interests in The WB Network, Comedy Central and Court TV. In addition, almost all of AOL Time Warner’s interests in TWE and all of its interests in cable television systems held through wholly-owned subsidiaries will be contributed to an existing subsidiary of AT&T that will become a subsidiary of AOL Time Warner and be renamed “Time Warner Cable Inc.” In connection with the restructuring, AT&T will receive $2.1 billion in cash and AOL Time Warner common stock valued at $1.5 billion at the time of the closing of the restructuring and will retain both a 17.9% economic stake in Time Warner Cable Inc.

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AOL TIME WARNER INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION — (Continued)

and a 4.7% economic stake in TWE. AT&T’s combined interests in Time Warner Cable Inc. and TWE will result in AT&T holding an approximately 21% economic interest in the business of Time Warner Cable Inc. AT&T’s 17.9% economic stake in Time Warner Cable Inc. will represent approximately a 10.7% voting interest in Time Warner Cable Inc. The Company anticipates that the restructuring will be completed in early 2003, upon the receipt of local cable franchise approvals, where required, and other required regulatory approvals. Clearance under the Hart-Scott-Rodino Antitrust Improvement Act of 1976 has been received.

         Based upon its controlling voting interest in Time Warner Cable Inc., AOL Time Warner will consolidate the results of Time Warner Cable Inc. for accounting purposes. At the closing of the restructuring, it is anticipated that Time Warner Cable Inc. will have approximately $8.1 billion in consolidated net debt and preferred equity. Subject to market conditions, AOL Time Warner plans to conduct an initial public offering of Time Warner Cable Inc. soon after the closing of the restructuring. It is anticipated that the first $2.1 billion raised in any such offering would be used to pay off Time Warner Cable Inc. debt incurred to fund the $2.1 billion cash payment to AT&T. Thereafter, AT&T will have certain priority registration rights with respect to its stake in Time Warner Cable Inc. (Note 6).

Restructuring of TWE-Advance/Newhouse Partnership and Road Runner

         As of June 30, 2002, the TWE-Advance/Newhouse Partnership (“TWE-A/N”) was owned approximately 64.8% by TWE, the managing partner, 33.3% by the Advance/Newhouse Partnership (“Advance/Newhouse”) and 1.9% indirectly by AOL Time Warner. Prior to August 1, 2002, the financial position and operating results of TWE-A/N were consolidated by AOL Time Warner and TWE, and the partnership interest owned by Advance/Newhouse was reflected in the consolidated financial statements of AOL Time Warner and TWE as minority interest. In addition, Road Runner, a high-speed cable modem Internet service provider, was owned by TWI Cable Inc. (a wholly owned subsidiary of AOL Time Warner), TWE and TWE-A/N, with AOL Time Warner owning approximately 65% on a fully attributed basis (i.e., after considering the portion attributable to the minority partners of TWE and TWE-A/N). AOL Time Warner’s interest in Road Runner was previously accounted for using the equity method of accounting prior to the restructuring because of certain approval rights held by Advance/Newhouse, a partner in TWE-A/N.

         On June 24, 2002, TWE and Advance/Newhouse agreed to restructure TWE-A/N, which, on August 1, 2002 (the “Debt Closing Date”), resulted in Advance/Newhouse assuming responsibility for the day-to-day operations of certain TWE-A/N cable systems serving approximately 2.1 million subscribers located primarily in Florida (the “Advance/Newhouse Systems”). The restructuring is anticipated to be completed by the end of 2002, upon the receipt of certain regulatory approvals. On the Debt Closing Date, Advance/Newhouse and its affiliates arranged for a new credit facility to support the Advance/Newhouse Systems and assumed and repaid approximately $780 million of TWE-A/N’s senior indebtedness. As of the Debt Closing Date, Advance/Newhouse assumed responsibility for the day-to-day operations of the Advance/Newhouse Systems. As a result, AOL Time Warner and TWE have deconsolidated the financial position and operating results of these systems. Additionally, all prior period results associated with the Advance/Newhouse Systems, including the historical minority interest allocated to Advance/Newhouse’s interest in TWE-A/N, have been reflected as a discontinued operation for all periods presented. Under the new TWE-A/N Partnership Agreement, effective as of the Debt Closing Date, Advance/Newhouse’s partnership interest tracks only the economic performance of the Advance/Newhouse Systems, including associated liabilities, while AOL Time Warner retains all of the economic interests in the other TWE-A/N assets and liabilities.

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AOL TIME WARNER INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION — (Continued)

         As part of the restructuring of TWE-A/N, on the Debt Closing Date, AOL Time Warner effectively acquired Advance/Newhouse’s interest in Road Runner, thereby increasing its ownership to approximately 82% on a fully attributed basis. As a result of the termination of Advance/Newhouse’s minority rights in Road Runner, AOL Time Warner has consolidated the financial position and results of operations of Road Runner with the financial position and results of operations of AOL Time Warner’s Cable segment. As permitted under generally accepted accounting principles, the Company has consolidated the results of Road Runner retroactive to the beginning of the year.

         In connection with the TWE-A/N restructuring, AOL Time Warner recognized a noncash pretax gain of approximately $1.4 billion. Of this gain, approximately $1.2 billion related to the difference between the carrying value and fair value of AT&T’s interest in the Advance/Newhouse Systems, with the fair value being determined by reference to the fair value of AT&T’s additional interest acquired in the remaining TWE-A/N systems. This gain is included as part of discontinued operations in the accompanying consolidated statement of operations. However, because this gain relates in large part to AT&T’s interest in TWE-A/N, it is substantially offset by minority interest expense, which is similarly included as part of discontinued operations. The remaining pretax gain of $188 million relates to the amount that the fair value of AOL Time Warner’s acquired interest in the TWE-A/N systems remaining under the control of AOL Time Warner exceeded the carrying value of AOL Time Warner’s interest in the Advance/Newhouse Systems, and primarily relates to the portion of TWE-A/N debt assumed by Advance/Newhouse in excess of its pro rata share in effective compensation for certain adverse tax consequences to the Company as a result of the restructuring. The gain is significantly less than the gain recognized by AT&T because the carrying value of AOL Time Warner’s interest in TWE-A/N, including its interest in the Advance/Newhouse Systems, was recently adjusted to fair value as part of the purchase accounting for the Merger. The $188 million pretax gain is also included as part of discontinued operations of AOL Time Warner for the three and nine month periods ended September 30, 2002. Exclusive of the gains associated with these transactions, the impact of the TWE-A/N restructuring on AOL Time Warner’s consolidated net income is substantially mitigated because the earnings of TWE-A/N attributable to Advance/Newhouse’s historical one-third interest was reflected as minority interest expense. As stated previously, this historical minority interest expense is currently classified as part of the discontinued operations for all periods presented. Additionally, there is no impact on AOL Time Warner’s consolidated net income of consolidating Road Runner since the Company had previously accounted for its interest in Road Runner under the equity method of accounting.

Sale of Columbia House

         In June 2002, AOL Time Warner and Sony Corporation of America reached a definitive agreement to each sell 85% of its 50% interest in the Columbia House Company Partnerships (“Columbia House”) to Blackstone Capital Partners III LP (“Blackstone”), an affiliate of The Blackstone Group, a private investment bank. The sale has resulted in the Company recognizing a pretax gain of approximately $59 million, which is included in other expense, net, in the accompanying consolidated statement of operations. In addition, the Company has deferred an approximate $28 million gain on the sale. The deferred gain primarily relates to the estimated fair value of the portion of the proceeds received as a note receivable, which will be deferred until such time as the realization of such note becomes more fully assured. As a result of the sale, the Company’s interest in Columbia House has been reduced to 7.5%. As part of the transaction, AOL Time Warner will continue to license music and video product to Columbia House for a five-year period (Note 4).

$10 Billion Revolving Credit Facilities

         In July 2002, AOL Time Warner, together with certain of its consolidated subsidiaries, entered into two

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AOL TIME WARNER INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION — (Continued)

new senior unsecured long-term revolving bank credit agreements with an aggregate borrowing capacity of $10 billion (the “2002 Credit Agreements”) and terminated three existing bank credit facilities with an aggregate borrowing capacity of $12.6 billion (the “Old Credit Agreements”), which were scheduled to expire during 2002. The 2002 Credit Agreements are comprised of a $6 billion five-year revolving credit facility and a $4 billion 364-day revolving credit facility, borrowings under which may be extended for a period up to two years following the initial term. The borrowers under the 2002 Credit Agreements are AOL Time Warner, TWE, TWE-A/N and AOL Time Warner Finance Ireland. Borrowings bear interest at specific rates, generally based on the credit rating for each of the borrowers, which is currently equal to LIBOR plus .625%, including facility fees of .10% and .125% on the total commitments of the 364-day and five-year facilities, respectively. In addition, the Company is required to pay an additional usage fee of .0625% if the two facilities in the aggregate have more than 33% outstanding and .125% if the facilities have more than 66% outstanding. Currently, the Company is paying the additional  .0625% usage fee. The 2002 Credit Agreements provide same-day funding, multi-currency capability and letter of credit availability. They contain maximum leverage ratio and minimum GAAP net worth covenants of 4.5 times and $50 billion, respectively, for AOL Time Warner and a maximum leverage ratio covenant of 5.0 times for each of TWE and TWE-A/N, but do not contain any credit ratings-based defaults or covenants, nor an ongoing covenant or representation specifically relating to a material adverse change in the Company’s financial condition or results of operations. Borrowings may be used for general business purposes and unused credit is available to support commercial paper borrowings (Note 9).

RESULTS OF OPERATIONS
Transactions Affecting Comparability of Results of Operations

         AOL Time Warner’s results for 2002 have been impacted by the following transactions and events that cause them not to be comparable to the results reported in 2001.

•      New Accounting Standard for Goodwill and Other Intangible Assets. During 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 142 “Goodwill and Other Intangible Assets” (“FAS 142”), which requires that, effective January 1, 2002, goodwill, including the goodwill included in the carrying value of investments accounted for using the equity method of accounting, and certain other intangible assets deemed to have an indefinite useful life, cease amortizing (Note 3).

•     Consolidation of AOL Europe, S.A. (“AOL Europe”). On January 31, 2002, AOL Time Warner acquired 80% of Bertelsmann AG’s (“Bertelsmann”) 49.5% interest in AOL Europe for $5.3 billion in cash and on July 1, 2002 acquired the remaining 20% of Bertelsmann’s interest for $1.45 billion in cash (Note 5). As a result of the purchase of Bertelsmann’s interest in AOL Europe, AOL Time Warner has a majority interest in and began consolidating AOL Europe, retroactive to the beginning of 2002.

•     Consolidation of IPC Group Limited (“IPC”). In October 2001, AOL Time Warner’s Publishing segment acquired IPC, the parent company of IPC Media, from Cinven, one of Europe’s leading private equity firms, for approximately $1.6 billion.

•     Consolidation of Road Runner. In August 2002, AOL Time Warner’s Cable segment acquired Advance/Newhouse’s 17% indirect ownership in Road Runner, increasing the Company’s fully attributed ownership to approximately 82%. As a result of the termination of Advance/Newhouse’s minority rights in Road Runner, AOL Time Warner has consolidated the financial position and results of operations of Road Runner with the financial

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AOL TIME WARNER INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION — (Continued)

position and results of operations of AOL Time Warner’s Cable segment. As permitted under generally accepted accounting principles, the Company has consolidated the results of Road Runner retroactive to the beginning of 2002.

Discontinued Operations

         As previously discussed in “Restructuring of TWE-Advance/Newhouse Partnership and Road Runner,” the Company’s results of operations have been adjusted to reflect the results of the Advance/Newhouse Systems as a discontinued operation for all periods presented. For the six months ended June 30, 2002, the net impact of the deconsolidation of these systems was a reduction of the Cable segment’s previously reported revenues, EBITDA and operating income of $715 million, $333 million and $206 million, respectively. For the three months ended September 30, 2001, the net impact of the deconsolidation of the Advance/Newhouse Systems was a reduction of the Cable segment’s reported revenues, EBITDA and operating income of $316 million, $141 million and $74 million, respectively. For the nine months ended September 30, 2001, the net impact was a reduction of the Cable segment’s reported revenues, EBITDA and operating income of $912 million, $412 million and $225 million, respectively. In addition, as of December 31, 2001, the Advance/Newhouse Systems had current assets and total assets of approximately $64 million and $2.7 billion, respectively, and current liabilities and total liabilities of approximately $210 million and $963 million, respectively, including debt assumed in the restructuring.

New Accounting Standards

         In addition to the transactions previously discussed, in the first quarter of 2002, the Company adopted new accounting guidance in several areas that require retroactive restatement of all periods presented to reflect the new accounting provisions.

Reimbursement of “Out-of-Pocket” Expenses

         In January 2002, the FASB’s Emerging Issues Task Force (“EITF”) reached a consensus on EITF Issue No. 01-14, “Income Statement Characterization of Reimbursements Received for ‘Out-of-Pocket’ Expenses Incurred” (“EITF 01-14”). EITF 01-14 requires that reimbursements received for out-of-pocket expenses be classified as revenue on the income statement and was effective for AOL Time Warner in the first quarter of 2002. The new guidance requires retroactive restatement of all periods presented to reflect the new accounting provisions. This change in revenue classification impacts AOL Time Warner’s Cable and Music segments, resulting in an increase in both revenues and costs of approximately $92 million for the third quarter of 2001 and $287 million for the first nine months of 2001.

Emerging Issues Task Force Issue No. 01-09

         In April 2001, the FASB’s EITF reached a final consensus on EITF Issue No. 00-25, “Vendor Income Statement Characterization of Consideration Paid to a Reseller of the Vendor’s Products,” which was later codified along with other similar issues, into EITF 01-09, “Accounting for Consideration Given by a Vendor to a Customer or a Reseller of the Vendor’s Products” (“EITF 01-09”). EITF 01-09 was effective for AOL Time Warner in the first quarter of 2002. EITF 01-09 clarifies the income statement classification of costs incurred by a vendor in connection with the reseller’s purchase or promotion of the vendor’s products, resulting in certain cooperative advertising and product placement costs previously classified as selling expenses to be reflected as a reduction of revenues earned from that activity. The new guidance impacts AOL Time Warner’s AOL, Music and Publishing segments. As a

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AOL TIME WARNER INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION — (Continued)

result of applying the provisions of EITF 01-09, the Company’s revenues and costs each were reduced by an equal amount of approximately $44 million in the third quarter of 2001 and $154 million for the first nine months of 2001.

Other Significant Transactions and Nonrecurring Items

         As more fully described herein and in the related footnotes to the accompanying consolidated financial statements, the comparability of AOL Time Warner’s operating results has been affected by certain significant transactions and nonrecurring items in each period.

2002 Other Significant Transactions and Nonrecurring Items

         AOL Time Warner’s operating results for the nine months ended September 30, 2002 included (i) merger and restructuring costs of $184 million ($107 million in the first quarter and $77 million in the third quarter)(Note 2), (ii) a noncash pretax charge of $1.678 billion ($581 million in the first quarter, $364 million in the second quarter and $733 million in the third quarter) to reduce the carrying value of certain investments that experienced other-than-temporary declines in market value (Note 4), (iii) an approximate $59 million gain in the second quarter on the sale of a portion of the Company’s interest in Columbia House (Note 4) and (iv) an approximate $31 million gain in the second quarter on the redemption of a portion of the Company’s interest in TiVo Inc. (“TiVo”) (Note 4).

2001 Other Significant Transactions and Nonrecurring Items

         For the nine months ended September 30, 2001, AOL Time Warner’s operating results included (i) merger-related costs of approximately $205 million ($71 million in the first quarter and $134 million in the third quarter) (Note 2) and (ii) a noncash pretax charge of approximately $816 million ($620 million in the first quarter and $196 million in the third quarter) to reduce the carrying value of certain investments that experienced other-than-temporary declines in market value and to reflect fluctuations in derivative instruments (Note 4).

         The impact of the significant transactions and nonrecurring items discussed above on the operating results for the three and nine months ended September 30, 2002 and 2001 is as follows:

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AOL TIME WARNER INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION — (Continued)

                                 
    Three Months Ended September 30,   Nine Months Ended September 30,
   
 
    2002   2001   2002   2001
   
 
 
 
    (in millions, except per share amounts)
Adjustments for significant and nonrecurring items:
                               
Merger and restructuring costs
  $ 77     $ 134     $ 184     $ 205  
Gain on sale of Columbia House
                (59 )      
Gain on redemption of TiVo
                (31 )      
Loss on writedown of investments
    733       196       1,678       816  
 
   
     
     
     
 
Pretax impact of adjustments
    810       330       1,772       1,021  
 
   
     
     
     
 
Income tax impact of adjustments
    (324 )     (132 )     (709 )     (408 )
 
   
     
     
     
 
Net income impact of adjustments
  $ 486     $ 198     $ 1,063     $ 613  
 
   
     
     
     
 
Impact on basic income (loss) per common share before discontinued operations and cumulative effect of accounting change
  $ 0.11     $ 0.04     $ 0.24     $ 0.13  
 
   
     
     
     
 
Impact on diluted income (loss) per common share before discontinued operations and cumulative effect of accounting change
  $ 0.11     $ 0.04     $ 0.24     $ 0.13  
 
   
     
     
     
 

FAS 142

         In addition, the Company adopted, effective January 1, 2002, new accounting rules for goodwill and certain intangible assets. Among the requirements of the new rules is that goodwill and certain intangible assets be assessed for impairment using fair value measurement techniques. During the first quarter of 2002, the Company completed its impairment review and recorded a $54 billion noncash pretax charge for the impairment of goodwill, substantially all of which was generated in the Merger. The charge reflects overall market declines since the Merger was announced in January 2000, is non-operational in nature and reflected as a cumulative effect of an accounting change in the accompanying consolidated financial statements (Note 3).

         The Company will perform its annual impairment review during the fourth quarter of each year, commencing in the fourth quarter of 2002. While the Company’s overall goodwill impairment analysis will not be completed until the fourth quarter, based on the current market capitalization of AOL Time Warner as implied by the Company’s stock price, lower than expected performance at the AOL segment, and current market conditions in the cable industry, management believes that it is probable that a substantial overall goodwill impairment has occurred as of September 30, 2002. At this time, management is unable to reasonably estimate the magnitude of such an impairment. The factors that will affect the magnitude of impairment include management’s revised operating plan of the AOL segment, the results of the Company’s overall current budgeting and long-term plan process, and a valuation of assets (including unrecognized intangible assets) and liabilities, all of which will be completed in the fourth quarter. Additionally, the magnitude of any impairment will take into consideration AOL Time Warner’s overall market capitalization as well as the extent to which the stock price of comparable companies in the cable industry continue to experience a sustained decline in values. Any impairment charge would be noncash in nature and, therefore, is not expected to affect the Company’s liquidity or result in the non-compliance with any debt covenants, including the covenant to maintain at least $50 billion of GAAP net worth contained in the 2002 Credit Agreements. In addition, the Company would record any such noncash charge as a component of operating income.

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AOL TIME WARNER INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION — (Continued)

Three Months Ended September 30, 2002 Compared to Three Months Ended September 30, 2001

         Revenues and EBITDA by business segment are as follows (in millions):

                                 
    Three Months Ended September 30  
   

 
    Revenues   EBITDA
   
 
    2002   2001(a)   2002   2001
   
 
 
 
            (Restated)           (Restated)
AOL
  $ 2,215     $ 2,173     $ 432     $ 736  
Cable(b)
    1,753       1,525       680       650  
Filmed Entertainment
    2,643       2,112       331       307  
Networks
    1,832       1,663       520       450  
Music
    983       962       96       87  
Publishing
    1,353       1,095       276       196  
Corporate
                (87 )     (74 )
Merger and restructuring costs
                (77 )     (134 )
Intersegment elimination(b)
    (796 )     (462 )     (79 )     (36 )
 
   
     
     
     
 
Total revenues and EBITDA
  $ 9,983     $ 9,068     $ 2,092     $ 2,182  
Depreciation and amortization
                (777 )     (2,229 )
 
   
     
     
     
 
Total revenues and operating income (loss)
  $ 9,983     $ 9,068     $ 1,315     $ (47 )
 
   
     
     
     
 


(a)   Revenues reflect the provisions of EITF 01-09 and EITF 01-14 that were adopted by the Company in the first quarter of 2002, which require retroactive restatement of 2001 to reflect the new accounting provisions. As a result, the net impact of EITF 01-09 and EITF 01-14 was to increase revenues and costs by equal amounts of approximately $48 million for the third quarter of 2001. The net increase (decrease) in revenues and costs by business segment is as follows: AOL $(7) million, Cable $59 million, Music $23 million and Publishing $(27) million.
(b)   The Cable segment’s results reflect the restructuring of TWE-A/N, which resulted in the deconsolidation of the operating results of the Advance/Newhouse Systems for all periods presented. For the three months ended September 30, 2001, the net impact of the deconsolidation of these systems was a reduction of the Cable segment’s reported revenues, EBITDA and operating income of $316 million, $141 million and $74 million, respectively. In addition, the Cable segment’s results reflect the consolidation of Road Runner’s operating results effective January 1, 2002.

Consolidated Results

         Revenues. AOL Time Warner’s revenues increased to $9.983 billion in 2002, compared to $9.068 billion in 2001. This overall increase in revenues was driven by an increase in Subscription revenues of 21% to $4.818 billion and an increase in Content and Other revenues of 8% to $3.467 billion, offset in part by a decrease in Advertising and Commerce revenues of 10% to $1.698 billion.

         As discussed more fully below, the increase in Subscription revenues was principally due to increases in the number of subscribers and in subscription rates at the AOL, Cable and Networks segments, as well as the impact of the acquisitions of AOL Europe and IPC and the consolidation of Road Runner. The increase in Content and Other revenues was principally due to increased revenue at the Filmed Entertainment segment, principally related to improved worldwide home video results, offset in part by lower results at the AOL segment, primarily related to the termination of the iPlanet alliance with Sun Microsystems, Inc. (“Sun Microsystems”) in the third quarter of 2001.

         The decline in Advertising and Commerce revenues compared to 2001 was due to lower advertising revenues (from $1.572 billion to $1.388 billion) principally related to the AOL segment, due to the continued weakness in online advertising sales and the decline in the current benefit from prior period contract sales, which are expected to continue into 2003. However, excluding the AOL segment, advertising revenues increased 9% primarily

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AOL TIME WARNER INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION — (Continued)

related to growth at both the Networks and Publishing segments, including the impact of the acquisition of IPC. Commerce revenues ($310 million in 2002 and $308 million in 2001) were essentially flat.

         Intersegment Revenues. AOL Time Warner’s intersegment revenues increased to $796 million in 2002 compared to $462 million in 2001. The increase in intersegment revenues was principally due to an increase in film product sold by the Filmed Entertainment segment to the Company’s Networks segment. In addition, intersegment advertising and commerce revenues increased to $138 million in 2002 from $97 million in 2001. Since intersegment revenues are eliminated in consolidation, they do not impact the Company’s consolidated results.

         Corporate. AOL Time Warner’s corporate EBITDA loss increased to $87 million in 2002 from $74 million in 2001. The increase in the EBITDA loss was principally due to legal and other professional fees related to the SEC and DOJ investigations into the accounting practices of the Company, which are expected to continue into 2003.

         Depreciation and Amortization. Depreciation and amortization decreased to $777 million in 2002 from $2.229 billion in 2001. This decrease was due to a decrease in amortization expense to $181 million in 2002 from $1.784 billion in 2001 due to the adoption of FAS 142, which resulted in goodwill and certain intangible assets ceasing to be amortized. The decrease was offset in part by an increase in depreciation expense to $596 million in 2002 from $445 million in 2001. The increase in depreciation expense reflects higher levels of capital spending at the Cable segment related to the roll-out of digital services over the past three years and increased capital spending on equipment that varies with the number of new subscribers and is depreciated over a shorter useful life. In addition, depreciation at the AOL segment increased primarily due to an increase in network assets acquired as well as a decrease in the useful life of certain network assets.

         Operating Income (Loss). AOL Time Warner’s operating income increased to $1.315 billion in 2002 from an operating loss of $47 million in 2001. The improvement primarily related to a decrease in amortization expense due to the adoption of FAS 142, offset in part by a decrease in EBITDA, which is discussed in detail under “Business Segment Results,” and an increase in depreciation expense.

         Interest Expense, Net. Interest expense, net, increased to $489 million in 2002, from $341 million in 2001 due principally to incremental borrowings to purchase AOL Europe and IPC, the change in the mix of debt to higher fixed rate borrowings and reduced interest income due to the automatic conversion of the Company’s investment in Hughes Electronics Corp. (“Hughes”) from interest-bearing preferred stock to common stock in June 2002.

         Other Expense, Net. Other expense, net, increased to $851 million in 2002 from $437 million in 2001. Other expense, net, in each period included pretax noncash charges to reduce the carrying value of certain investments that experienced an other-than-temporary decline in value (Note 4). In 2002, this charge was approximately $733 million, primarily related to the Company’s investments in Hughes and America Online Latin America, Inc. (“AOL Latin America”). In 2001, the Company recorded a charge of approximately $196 million. Excluding these charges, other expense, net, decreased by $123 million in 2002 compared to 2001, primarily due to a reduction of losses from equity method investees related to reduced amortization associated with the adoption of FAS 142.

         Depending upon general market conditions and the performance of individual investments in the Company’s portfolio, the Company may be required in the future to record additional noncash charges to reduce the carrying value of individual investments to their fair value for other-than-temporary declines. In addition to investments in the Company’s portfolio as of September 30, 2002, the Company is committed to provide up to an

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AOL TIME WARNER INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION — (Continued)

additional $89 million in funding to AOL Latin America prior to December 31, 2002 in exchange for senior convertible notes. Based upon the financial condition of AOL Latin America and general market conditions, the Company may be required to record an additional noncash charge related to this investment. Any such noncash charge would be unrelated to the Company’s core operations and would be recorded in other expense, net (Note 4). Excluding equity method investees, as of September 30, 2002, the fair value and carrying value of the Company’s portfolio were approximately $1.742 billion and $1.699 billion, respectively.

         Minority Interest Income (Expense). Minority interest income (expense) was $55 million of expense in 2002, compared to $12 million of minority interest income in 2001. The 2002 expense primarily reflects the impact of adopting FAS 142, which resulted in a reduction in amortization expense at the Company’s partially owned consolidated investees, thereby resulting in higher income attributable to minority partners.

         Income Tax Provision. AOL Time Warner had an income tax benefit of $25 million in 2002, compared to income tax expense of $174 million in 2001. The effective tax rate in each period differs from the 35% U.S. federal statutory rate as a result of several factors, including the Company’s pretax income relative to the amount of non-temporary differences (i.e., certain financial statement expenses that are not deductible for income tax purposes), foreign income taxed at different rates and state and local income taxes. The most significant non-temporary difference in 2002 relates to foreign losses with no tax benefit and in 2001 relates to nondeductible amortization of goodwill.

         As of September 30, 2002, the Company had net operating loss carryforwards of approximately $12.0 billion, primarily resulting from stock option exercises. These carryforwards are available to offset future U.S. Federal taxable income and are, therefore, expected to reduce Federal income taxes paid by the Company. If the net operating losses are not utilized, they expire in varying amounts, starting in 2011 through 2021.

         Net Income (Loss) and Net Income (Loss) Per Common Share. AOL Time Warner had net income of $57 million in 2002 compared to a net loss of $997 million in 2001. Basic and diluted net income per common share was $0.01 in 2002 compared to basic and diluted net loss per common share of $0.22 in 2001.

         As previously described and summarized in the table on page 9, the comparability of the Company’s operating results for 2002 and 2001 have been affected by the recognition of certain significant and nonrecurring items. These items totaled pretax losses of $810 million in 2002 and $330 million in 2001. In addition, beginning in the third quarter of 2002, the Company has reported the results of the Advance/Newhouse Systems as a discontinued operation for all periods presented. The impact of the discontinued operations was income of $112 million in 2002, primarily relating to a gain on the disposition of the Advance/Newhouse Systems compared to a loss of $10 million in 2001. Excluding the impact of the significant and nonrecurring items and the discontinued operations, the Company’s normalized net income from continuing operations was $431 million in 2002 compared to a loss of $789 million in 2001. Similarly, the normalized basic and diluted net income from continuing operations per common share was $0.10 in 2002 compared to a loss of $0.18 per share in 2001. The improvement primarily reflects reduced amortization associated with the adoption of FAS 142, offset in part by an overall decrease in AOL Time Warner’s EBITDA and increased depreciation expense, interest expense, net, and other expense, net.

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AOL TIME WARNER INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION — (Continued)

Management Evaluation

         As noted above, the acquisition of AOL Europe and IPC, the consolidation of Road Runner, as well as the implementation of FAS 142, significantly impacted the comparability of AOL Time Warner’s 2002 results. In addition, other significant transactions and nonrecurring items occurred in each year, which also impacted the comparability of the Company’s results. As such, in reviewing the performance of its businesses, management also evaluates the Company’s results assuming that the acquisitions of AOL Europe and IPC, the consolidation of Road Runner and the adoption of FAS 142 occurred as of the beginning of 2001. In addition, management evaluates results excluding the previously discussed other significant transactions and nonrecurring items. Giving effect to these items, the Company’s total revenues would have increased 6% (from $9.417 billion to $9.983 billion), EBITDA would have decreased 1% (from $2.187 billion to $2.169 billion), operating income would have declined 11% (from $1.570 billion to $1.392 billion) and income from continuing operations would have declined 27% (from $592 million to $431 million).

Business Segment Results

         AOL. Revenues increased 2% to $2.215 billion in 2002, compared to $2.173 billion in 2001. EBITDA decreased 41% to $432 million in 2002, compared to $736 million in 2001.

         Revenues benefited from a 33% increase in Subscription revenues (from $1.374 billion to $1.827 billion), which was offset in part by a 47% decrease in Advertising and Commerce revenues (from $601 million to $321 million) and a 66% decrease in Content and Other revenues (from $198 million to $67 million).

         The growth in subscription revenues was primarily related to the acquisition of AOL Europe in 2002, as well as domestic revenue growth. Domestically, subscription revenues increased 11% and were principally driven by membership growth. The number of AOL brand subscribers in the U.S. was 26.7 million at September 30, 2002 compared to 24.2 million at September 30, 2001. The average monthly subscription revenue per domestic subscriber for the quarter increased 2% to $18.34 as compared to $18.06 in the prior year quarter. This increase is due to the standard unlimited rate increase of $1.95 per month to $23.90 (effective beginning in July 2001) and a shift in the mix of members to new higher premium rate plans. These increases were offset in part by new member acquisition programs and member service and retention programs that offer incentives in the form of discounts and free months to AOL’s members.

         The majority of AOL’s domestic subscribers are on standard unlimited pricing plans. Additionally, AOL has entered into certain bundling programs with original equipment manufacturers (“OEMs”) that generally do not result in subscription revenues during introductory periods, as well as the sale of bulk subscriptions at a discounted rate to AOL’s selected strategic partners for distribution to their employees. As of September 30, 2002, of the 26.7 million domestic AOL members, approximately 82% were on standard unlimited pricing plans (including 11% under various free trial, member service and retention programs), 13% were on lower priced plans, including Bring Your Own Access (“BYOA”), bulk employee programs with strategic partners, and limited usage plans (weighted average monthly rate of approximately $11.45), and the remaining 5% were on OEM bundled plans.

         The number of AOL brand subscribers in Europe was 6.1 million at September 30, 2002 and the average monthly subscription revenue per European subscriber for the third quarter of 2002 was $15.48. This compares to AOL brand subscribers in Europe of 5.0 million at September 30, 2001 and average monthly subscription revenue per European subscriber for the third quarter of 2001 of $12.97. The average monthly subscription revenue per European subscriber in 2002 was impacted by price increases implemented earlier this year in various European countries offering the AOL service and the positive effect of changes in foreign currency exchange rates.

         The decline in Advertising and Commerce revenues resulted from a decline in advertising revenues (from $547 million to $267 million), as commerce revenues were flat. The decline in advertising revenues is principally

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AOL TIME WARNER INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION — (Continued)

due to a reduction in benefits from prior period domestic contract sales and continued weakness in online advertising sales, which is expected to extend into 2003. The advertising revenue decline was slightly offset by contributions from AOL Europe. Domestic contractual commitments received in prior periods contributed advertising revenue of $164 million in the 2002 period compared to $431 million in the comparable prior year period. Included in the amount of revenue from domestic contractual commitments received in prior periods was revenue recognized from the termination of contractual commitments, which declined to less than $1 million in the 2002 period compared to $72 million in the comparable prior year period. Also contributing to the decline in advertising is a slight decline in intercompany sales of advertising to other business segments of AOL Time Warner in 2002 compared to 2001 (from $40 million to $37 million). Of the $267 million of advertising revenue in the current quarter, approximately $89 million related to the five most significant domestic advertisers. Similarly, of the $547 million of advertising revenue in the prior year quarter, approximately $185 million related to the five most significant domestic advertisers.

         During the quarter, domestic advertising commitments for future periods declined to $648 million as of September 30, 2002 from approximately $860 million as of June 30, 2002. This compares to advertising commitments of $1.378 billion as of September 30, 2001 and $1.760 billion as of June 30, 2001. During the three months ended September 30, 2002, in addition to the $164 million recognized in revenue, remaining commitments were reduced by approximately $80 million, without any revenue being recognized, to reflect a decline in future consideration to be received related to the termination or restructuring of various contracts. Similarly, during the three months ended September 30, 2001, in addition to the $431 million recognized in revenue, remaining commitments were reduced by approximately $20 million, without any revenue being recognized, to reflect a decline in future consideration to be received related to the termination or restructuring of various contracts. Included in the $648 million of advertising commitments for future periods as of September 30, 2002 are approximately $217 million of commitments for the five largest commitments. Similarly, included in the $1.378 billion of advertising commitments for future periods as of September 30, 2001 are $442 million of commitments for the five largest commitments.

         The Company expects to complete performance on a majority of the remaining domestic advertising commitments by the end of 2003. Further declines in future consideration to be received, and revenue that would otherwise be recognized, could occur from additional terminations or restructurings of such commitments. As services under certain large longer term contracts signed in previous periods are completed, the Company expects to enter into fewer long term contracts as the Company develops its online advertising strategy, reducing its reliance on long-term arrangements, including arrangements which involve significant non-advertising components, as the market continues to migrate to more traditional short-term advertiser arrangements. The Company expects that the level of advertising commitments for future periods will decline as traditional advertiser arrangements typically involve shorter terms. The Company is uncertain whether the amount of revenue from the more traditional short-term advertising arrangements will reach the levels of current and prior advertising revenue even if the online advertising market improves. The Company also is uncertain of its ability to replace or renew advertising sales for some of its largest advertisers.

         The decrease in Content and Other revenues is primarily due to the termination of AOL’s iPlanet alliance with Sun Microsystems in the third quarter of 2001, which contributed approximately $131 million of revenue and approximately $129 million of EBITDA during the third quarter of 2001. This was offset in part by $30 million of intercompany network revenues which are derived primarily through network services provided to Road Runner, which began in November 2001.

         The decline in EBITDA is primarily due to the advertising revenue shortfall, the absence of revenues from the iPlanet alliance and an increase in domestic marketing expenses. EBITDA was also impacted by an increase in

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AOL TIME WARNER INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION — (Continued)

intercompany advertising purchased by AOL on properties of other AOL Time Warner business segments (from $64 million to $68 million), including advertising purchased on Time Warner Cable properties in support of the rollout of AOL Broadband services. In the third quarter of 2002, EBITDA losses at AOL Europe were $1 million. It is expected that fourth quarter losses at AOL Europe will increase compared to the current quarter, due to seasonal increases in marketing efforts as well as member usage and, the rate of year over year improvement will slow in 2003.

         The current year results are significantly impacted by the acquisition of AOL Europe as discussed above. Accordingly, management also evaluates the current period results assuming the operations of AOL Europe were consolidated beginning January 1, 2001. Assuming such consolidation as of January 1, 2001, AOL’s revenues would have decreased by 7% to $2.215 billion in 2002, compared to $2.378 billion in 2001. Subscription revenues would have increased by 15% to $1.827 billion in 2002, compared to $1.586 billion in 2001, Advertising and Commerce revenues would have decreased 48% to $321 million in 2002, compared to $612 million in 2001, Content and Other revenues would have decreased 63% to $67 million in 2002, as compared to $180 million in 2001, and EBITDA would have decreased 30% to $432 million in 2002, compared to $617 million in 2001.

         Cable. Revenues increased 15% to $1.753 billion in 2002 compared to $1.525 in 2001. EBITDA increased 5% to $680 million in 2002 from $650 million in 2001.

         Revenues increased due to a 16% increase in Subscription revenues (from $1.381 billion to $1.601 billion) and a 6% increase in Advertising and Commerce revenues (from $144 million to $152 million). The increase in Subscription revenues was due to higher basic cable rates, increases in high-speed data services subscribers, digital cable subscribers and basic cable subscribers, as well as the impact of the consolidation of Road Runner in 2002. In 2002, as compared to the prior year comparable period, high-speed data subscribers increased by 69% to 2.313 million, digital cable subscribers increased by 47% to 3.456 million and basic cable subscribers increased by 1.5% to 10.862 million. In addition, total customer relationships, representing the number of customers that receive at least one level of service, increased by 4% to approximately 11.2 million as of September 30, 2002 compared to approximately 10.8 million as of September 30, 2001 and revenue generating units, representing the total of all analog video, digital video, high-speed data and telephony customers, increased by 16% to approximately 16.6 million in 2002 compared to approximately 14.4 million in 2001. The Company’s subscriber amounts include subscribers at both consolidated entities and investees accounted for under the equity method of accounting. High speed data subscribers include residential subscribers, as well as commercial and bulk (e.g., apartment buildings and universities) subscribers. Due to their nature, commercial and bulk subscribers are charged at a higher amount than residential subscribers. The number of commercial and bulk high speed data subscribers is calculated by dividing commercial and high speed data revenue by the lower average rate charged to residential customers.

         The increase in Advertising and Commerce revenues was primarily related to higher intercompany sales of advertising to other business segments of AOL Time Warner (from $11 million to $31 million) offset in part by lower levels of advertising purchased by programming vendors to promote their channels, including new channel launches (from $36 million to $19 million). The Company expects fourth quarter 2002 advertising sales to programming vendors to be below fourth quarter 2001 levels and overall 2003 amounts to be lower than 2002.

         EBITDA increased principally as a result of the revenue gains, offset in part by increases in programming and other operating costs and the consolidation of Road Runner in 2002. Video programming costs increased 19%, relating to general programming rate increases across both basic and digital services, the addition of new

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AOL TIME WARNER INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION — (Continued)

programming services and higher basic and digital subscriber levels. Programming costs are expected to continue to increase as general programming rates increase and digital services continue to be rolled out. Other operating costs increased as a result of the roll out of new services and higher development spending in the Interactive Personal Video division (from $0 to $9 million).

         As noted above, the consolidation of Road Runner effective January 1, 2002 significantly impacted the comparability of the Cable segment’s 2002 results by increasing revenues and decreasing EBITDA. As such, management of the Company also evaluates the results of the Cable segment assuming that the results of Road Runner were included in both periods. Assuming that the results of Road Runner were included in both periods, total revenues would have increased 14% (from $1.543 billion to $1.753 billion), Subscription revenues would have increased 15% (from $1.398 billion to $1.601 billion) and EBITDA would have increased 11% (from $612 million to $680 million).

         Filmed Entertainment. Revenues increased 25% to $2.643 billion in 2002, compared to $2.112 billion in 2001. EBITDA increased 8% to $331 million in 2002, compared to $307 million in 2001.

         Revenues increased and EBITDA decreased at Warner Bros. while revenues and EBITDA increased at the filmed entertainment businesses of Turner Broadcasting System, Inc. (the “Turner filmed entertainment businesses”), which include New Line Cinema, Castle Rock and the former film and television libraries of Metro-Goldwyn-Mayer, Inc. and RKO pictures.

         For Warner Bros., the revenue increase was primarily related to international home video performance, including Harry Potter and the Sorcerer’s Stone and Ocean’s Eleven, syndication revenues from the initial availability of Will & Grace and revenues from the sale of cable broadcasting rights to The Drew Carey Show to the cable networks of Turner Broadcasting System, Inc. (the “Turner cable networks”). This was offset in part by the reduction in 2002 of revenues related to the sale of broadcasting rights for Friends and reduced commerce revenues related to the closure of its Studio Stores. For the Turner filmed entertainment businesses, revenues increased primarily due to the home video performance of The Lord of the Rings: The Fellowship of the Ring, revenues from the sale of Seinfeld broadcasting rights to the Turner cable networks and the domestic theatrical performance of Austin Powers in Goldmember.

         For Warner Bros., EBITDA declined against difficult comparisons, which includes the sale of broadcasting rights for Friends in 2001. In addition, the current period revenue growth was partially offset by costs associated with current period theatrical releases. For the Turner filmed entertainment businesses, EBITDA increased primarily due to the revenue increase.

         Networks. Revenues increased 10% to $1.832 billion in 2002, compared to $1.663 billion in 2001. EBITDA increased 16% to $520 million in 2002 from $450 million in 2001.

         Revenues grew primarily due to an 8% increase in Subscription revenues with growth at both the Turner cable networks and HBO, a 7% increase in Advertising and Commerce revenues (from $535 million to $574 million) with growth at both the Turner cable networks and The WB Network and a 39% increase in Content and Other revenues with strong growth at HBO. EBITDA increased at the Turner cable networks and HBO, offset in part by lower results at The WB Network.

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AOL TIME WARNER INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION — (Continued)

         For the Turner cable networks, Subscription revenues benefited from higher domestic rates and an increase in the number of domestic subscribers, led by TNT, TBS, Turner Classic Movies, CNN and Cartoon Network. Advertising and Commerce revenues increased 5% (from $430 million to $453 million) due to a slight recovery in the cable television advertising market offset in part by a slight decline in intercompany sales of advertising to other business segments of AOL Time Warner (from $30 million to $28 million). For HBO, Subscription revenues benefited from an increase in the number of subscribers and higher rates. Content and Other revenues benefited from higher home video sales of HBO’s original programming and higher licensing and syndication revenue from the broadcast comedy series, Everybody Loves Raymond. For The WB Network, the increase in Advertising and Commerce revenues (from $105 million to $121 million) was primarily driven by higher rates.

         For the Turner cable networks, the EBITDA increase was principally due to the increased revenues, partially offset by higher programming costs. For HBO, the increase in EBITDA was principally due to the increase in revenues. For The WB Network, the lower EBITDA was principally due to higher programming and marketing costs, offset in part by the increase in revenues.

         Music. Revenues increased 2% to $983 million in 2002, compared to $962 million in 2001. EBITDA increased 10% to $96 million in 2002 from $87 million in 2001.

         Revenues increased primarily due to the impact of the acquisition of Word Entertainment in January 2002, lower provisions for returns due to improved historical experience, the positive effect of changes in foreign currency exchange rates on international revenues and increases in DVD manufacturing volume, partially offset by declines in recorded music shipments related to the ongoing weakness in the worldwide music industry and lower DVD manufacturing prices. Industry-wide worldwide sales continue to be negatively impacted by the effects of piracy. In addition, downward pressure on DVD manufacturing pricing could negatively affect future manufacturing profits.

         The increase in EBITDA is due primarily to the revenue increase, the impact of various cost-saving and restructuring programs and lower marketing and bad debt expense, offset in part by higher artist and repertoire costs. As of September 30, 2002, the Music segment had year-to-date domestic album market share of 17.2% compared to 16.8% at December 31, 2001.

         Publishing. Revenues increased 24% to $1.353 billion in 2002 compared to $1.095 billion in 2001. EBITDA increased 41% to $276 million in 2002 from $196 million in 2001.

         Revenues increased due to a 34% increase in Subscription revenues (from $308 million to $414 million), 21% increase in Advertising and Commerce revenues (from $628 million to $762 million) and an 11% increase in Content and Other revenues (from $159 million to $177 million). The increases in both Subscription revenues and Advertising and Commerce revenues were due predominantly to the acquisitions of IPC in October 2001 and Synapse Group Inc. (“Synapse”) in December 2001. The growth in Advertising and Commerce revenues was offset in part by lower commerce revenues from Time Life’s direct marketing business. Advertising revenues increased 17%, predominantly due to the impact of IPC and increased intercompany sales of advertising to other business segments of AOL Time Warner (from $8 million to $34 million). In addition, advertising revenues benefited slightly from additional issues published in the current period, as well as the stabilization of the advertising market during the quarter, which benefited from soft comparisons to the prior year quarter in the aftermath of September 11th. The growth in intercompany advertising primarily relates to the sale of online advertising on the various Publishing segment websites under an intercompany arrangement, whereby the AOL segment acts as principal in the sale of such advertising to third parties and remits to the Publishing segment a share of the advertising revenues generated.

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AOL TIME WARNER INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION — (Continued)

The stabilization of the advertising market primarily benefited the non-business oriented publications, while softness continued in the advertising market for business oriented publications. The increase in Content and Other revenues is due primarily to increased sales at Time Inc. Home Entertainment, a marketer of editorial brand product extensions for some of the magazine franchises, as well as the impact of the acquisition of IPC.

         The growth in EBITDA is due primarily to the acquisitions of IPC and Synapse, as well as overall cost savings.

         As noted above, the acquisition of IPC in October 2001 significantly impacted the comparability of the Publishing segment’s 2002 results by significantly increasing both revenues and EBITDA. As such, management of the Company also evaluates the results of the Publishing segment assuming that the results of IPC were included in both periods. Assuming that the results of IPC were included in both periods, total revenues would have increased 11% (from $1.221 billion to $1.353 billion), Subscription revenues would have increased 8% (from $382 million to $414 million), Advertising and Commerce revenues would have increased 13% (from $673 million to $762 million) and EBITDA would have increased 23% (from $224 million to $276 million).

Nine Months Ended September 30, 2002 Compared to Nine Months Ended September 30, 2001

         Revenues and EBITDA by business segment are as follows (in millions):

                                 
    Nine Months Ended September 30
   
    Revenues   EBITDA
   
 
    2002   2001(a)   2002   2001
   
 
 
 
            (Restated)           (Restated)
AOL
  $ 6,772     $ 6,373     $ 1,324     $ 2,213  
Cable (b)
    5,198       4,404       2,007       1,924  
Filmed Entertainment
    7,165       6,217       840       670  
Networks
    5,575       5,190       1,371       1,343  
Music
    2,902       2,801       294       268  
Publishing
    3,830       3,179       758       580  
Corporate
                (246 )     (219 )
Merger and restructuring costs
                (184 )     (205 )
Intersegment elimination(b)
    (1,801 )     (1,313 )     (66 )     (59 )
 
   
     
     
     
 
Total revenues and EBITDA
  $ 29,641     $ 26,851     $ 6,098     $ 6,515  
Depreciation and amortization
                (2,206 )     (6,589 )
 
   
     
     
     
 
Total revenues and operating income (loss)
  $ 29,641     $ 26,851     $ 3,892     $ (74 )
 
   
     
     
     
 


(a)   Revenues reflect the provisions of EITF 01-09 and EITF 01-14 that were adopted by the Company in the first quarter of 2002, which require retroactive restatement of 2001 to reflect the new accounting provisions. As a result, the net impact of EITF 01-09 and EITF 01-14 was to increase revenues and costs by equal amounts of approximately $133 million for the first nine months of 2001. The net increase (decrease) in revenues and costs by business segment is as follows: AOL $(29) million, Cable $172 million, Music $86 million and Publishing $(96) million.
(b)   Cable’s results reflect the restructuring of TWE-A/N, which resulted in the deconsolidation of the operating results of the Advance/Newhouse Systems for all periods presented. For the six months ended June 30, 2002, the net impact of the deconsolidation of these systems was a reduction of Cable’s previously reported revenues, EBITDA and operating income of $715 million, $333 million and $206 million, respectively. For the nine months ended September 30, 2001, the net impact was a reduction of Cable’s reported revenues, EBITDA and operating income of $912 million, $412 million and $225 million, respectively. In addition, Cable’s results reflect the consolidation of Road Runner’s operating results effective January 1, 2002.

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AOL TIME WARNER INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION — (Continued)

Consolidated Results

         Revenues. AOL Time Warner’s revenues increased to $29.641 billion in 2002, compared to $26.851 billion in 2001. The overall increase in revenues was driven by an increase in Subscription revenues of 23% to $14.032 billion and an increase in Content and Other revenues of 8% to $10.091 billion, offset by a decrease in Advertising and Commerce revenues of 9% to $5.518 billion.

         As discussed more fully below, the increase in Subscription revenues was principally due to increases in the number of subscribers and in subscription rates at the AOL, Cable and Networks segments, as well as the impact of the acquisitions of AOL Europe and IPC and the consolidation of Road Runner. The increase in Content and Other revenues was principally due to increased revenue at the Filmed Entertainment segment related to improved international theatrical and worldwide home video results, offset in part by lower results at the AOL segment, primarily related to the termination of the iPlanet alliance with Sun Microsystems in the third quarter of 2001.

         The decline in Advertising and Commerce revenues was principally due to lower advertising revenues (from $5.055 billion to $4.475 billion), principally related to the AOL segment, due to continued weakness in online advertising sales and the decline in the current benefit from prior period contract sales, which are expected to continue into 2003. However, excluding the AOL segment, advertising revenues increased 7% primarily related to growth at the Networks and Publishing segments, including the impact of the acquisition of IPC. Commerce revenues ($1.043 billion in 2002 and $1.033 billion in 2001) were essentially flat.

         Intersegment Revenues. AOL Time Warner’s intersegment revenues increased to $1.801 billion in 2002 compared to $1.313 billion in 2001. The increase in intersegment revenues was principally due to increases in network services provided by the AOL segment to the Cable segment, DVD manufacturing provided by the Music segment to the Filmed Entertainment segment and film product sold by the Filmed Entertainment segment to the Company’s Networks segment. In addition, intersegment Advertising and Commerce revenues increased to $402 million in 2002 from $263 million in 2001. Since intersegment revenues are eliminated in consolidation, they do not impact the Company’s consolidated results.

         Corporate. AOL Time Warner’s corporate EBITDA loss increased to $246 million in 2002 from $219 million in 2001. The increase in EBITDA loss was principally due to legal and other professional fees related to the SEC and DOJ investigations into the financial reporting and disclosure practices of the Company, which are expected to continue into 2003, as well as certain project termination costs.

         Depreciation and Amortization. Depreciation and amortization decreased to $2.206 billion in 2002 from $6.589 billion in 2001. The decrease was due to a decrease in amortization expense to $520 million in 2002 from $5.318 billion in 2001 due to the adoption of FAS 142, which resulted in goodwill and certain intangible assets ceasing to be amortized, offset in part by the impact of additional amortization expense from the acquisitions of AOL Europe and IPC. This decrease was offset in part by an increase in depreciation expense to $1.686 billion in 2002 from $1.271 billion in 2001. The increase in depreciation expense reflects higher levels of capital spending at the Cable segment related to the roll-out of digital services over the past three years and increased capital spending on equipment that varies with the number of new subscribers and is depreciated over a shorter useful life. In addition, depreciation at the AOL segment increased primarily due to an increase in network assets acquired as well as a decrease in the useful life of certain network assets.

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AOL TIME WARNER INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION — (Continued)

         Operating Income (Loss). AOL Time Warner’s operating income increased to $3.892 billion in 2002 from an operating loss of $74 million in 2001. The improvement primarily related to a decrease in amortization expense due to the adoption of FAS 142, offset in part by a decrease in EBITDA, which is discussed in detail under “Business Segment Results,” and an increase in depreciation expense.

         Interest Expense, Net. Interest expense, net, increased to $1.306 billion in 2002, from $996 million in 2001, due principally to additional interest expense on incremental borrowings to purchase AOL Europe and IPC, offset in part by lower market interest rates in 2002.

         Other Expense, Net. Other expense, net, increased to $1.837 billion in 2002 from $1.572 billion in 2001. Other expense, net, in each period included pretax noncash charges to reduce the carrying value of certain investments that experienced an other-than-temporary decline in value. In 2002, this charge was approximately $1.678 billion, primarily related to AOL Time Warner’s investments in Hughes, Time Warner Telecom Inc., Gateway, Inc. and AOL Latin America, which was offset in part by an approximate $59 million gain on the sale of a portion of the Company’s interest in Columbia House and an approximate $31 million gain on the redemption of a portion of the Company’s interest in TiVo. In 2001, AOL Time Warner recorded a charge of approximately $870 million, which was offset in part by approximately $54 million of pretax gains related to equity derivative instruments and the sale of certain investments. Excluding these charges and the Columbia House and TiVo gains, other expense, net, decreased by $507 million in 2002 compared to 2001 primarily due to a reduction of losses from equity method investees, primarily relating to reduced amortization associated with the adoption of FAS 142, offset in part by the absence of prior year net pretax investment-related gains, including gains related to the exchange of various unconsolidated cable television systems at TWE (attributable to the minority owners of TWE).

         Depending upon general market conditions and the performance of individual investments in the Company’s portfolio, the Company may be required in the future to record additional noncash charges to reduce the carrying value of individual investments to their fair value for other-than-temporary declines. In addition to investments in the Company’s portfolio as of September 30, 2002, the Company is committed to provide up to an additional $89 million in funding to AOL Latin America prior to December 31, 2002 in exchange for senior convertible notes. Based upon the financial condition of AOL Latin America and general market conditions, the Company may be required to record an additional noncash charge related to this investment. Any such charge would be unrelated to the Company’s core operations and would be recorded in other expense, net (Note 4). Excluding equity method investees, as of September 30, 2002, the fair value and carrying value of the Company’s portfolio were approximately $1.742 billion and $1.699 billion, respectively.

         Minority Interest Income (Expense). Minority interest income (expense) was $139 million of expense in 2002, compared to $18 million of minority interest income in 2001. The 2002 expense primarily reflects the adoption of FAS 142, which resulted in a reduction of amortization expense at the Company’s partially owned consolidated investees, thereby resulting in higher income attributable to minority partners and accretion on the preferred securities of AOL Europe. The increase in minority interest expense was partially offset by the absence in 2002 of an allocation of pretax gains related to the exchange of various unconsolidated cable television systems in 2001 at TWE attributable to the minority owners of TWE.

         Income Tax Provision. AOL Time Warner had income tax expense of $279 million in 2002, compared to $450 million in 2001. The effective tax rate in each period differs from the 35% U.S. federal statutory rate as a result of several factors, including the Company’s pretax income relative to the amount of non-temporary differences (i.e., certain financial statement expenses that are not deductible for income tax purposes), foreign income taxed at

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AOL TIME WARNER INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION — (Continued)

different rates and state and local income taxes. The most significant non-temporary difference in 2002 relates to foreign losses with no tax benefit and in 2001 relates to nondeductible amortization of goodwill.

         As of September 30, 2002, the Company had net operating loss carryforwards of approximately $12.0 billion, primarily resulting from stock option exercises. These carryforwards are available to offset future U.S. Federal taxable income and are, therefore, expected to reduce Federal income taxes paid by the Company. If the net operating losses are not utilized, they expire in varying amounts, starting in 2011 through 2021.

         Net Income (Loss) and Net Income (Loss) Per Common Share. AOL Time Warner had a net loss of $53.791 billion in 2002 compared to a net loss of $3.103 billion in 2001. Basic and diluted net loss per common share was $12.09 in 2002 compared to basic and diluted net loss per common share of $0.70 in 2001.

         As previously described and summarized in the table on page 9, the comparability of the Company’s operating results for 2002 and 2001 have been affected by the recognition of certain significant and nonrecurring items. These items totaled pretax losses of $1.772 billion in 2002 and $1.021 billion in 2001. In addition, beginning in the third quarter of 2002, the Company has reported the results of the Advance/Newhouse Systems as a discontinued operation for all periods presented. The impact of the discontinued operations was income of $113 million in 2002, primarily relating to a gain on the disposition of the Advance/Newhouse Systems and a loss of $29 million in 2001. Net income in 2002 was also impacted by a charge of approximately $54.235 billion relating to the cumulative effect of an accounting change, discussed further in Notes 1 and 3. Excluding the impact of the significant and nonrecurring items, the discontinued operations, and the cumulative effect of an accounting change, the Company’s normalized net income from continuing operations was $1.394 billion in 2002 compared to a net loss of $2.461 billion in 2001. Similarly, the normalized basic and diluted net income from continuing operations per common share was $0.31 in 2002 compared to a loss of $0.56 in 2001. The improvement in normalized earnings principally resulted from reduced amortization associated with the adoption of FAS 142, offset in part by an overall decline in AOL Time Warner’s EBITDA, increased depreciation expense, net, and other expense, net.

Management Evaluation

         As noted above, the acquisition of AOL Europe and IPC, the consolidation of Road Runner, as well as the implementation of FAS 142, significantly impacted the comparability of AOL Time Warner’s 2002 results. In addition, other significant transactions and nonrecurring items occurred in each year, which also impacted the comparability of the Company’s results. As such, management also evaluates the Company’s results assuming that the acquisitions of AOL Europe and IPC, the consolidation of Road Runner and the adoption of FAS 142 occurred as of the beginning of 2001. In addition, in reviewing the performance of its businesses, management evaluates results excluding the previously discussed other significant transactions and nonrecurring items. Giving effect to these items, the Company’s total revenues would have increased 6% (from $27.896 billion to $29.641 billion), EBITDA would have increased 1% (from $6.214 billion to $6.282 billion), operating income would have declined 7% (from $4.385 billion to $4.076 billion) and income from continuing operations and before the cumulative effect of an accounting change would have declined 10% (from $1.547 billion to $1.394 billion).

Business Segment Results

         AOL. Revenues increased 6% to $6.772 billion in 2002, compared to $6.373 billion in 2001. EBITDA decreased 40% to $1.324 billion in 2002, compared to $2.213 billion in 2001.

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AOL TIME WARNER INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION — (Continued)

         Revenues benefited from a 36% increase in Subscription revenues (from $3.910 billion to $5.330 billion), which was offset in part by a 38% decrease in Advertising and Commerce revenues (from $1.965 billion to $1.228 billion) and a 57% decrease in Content and Other revenues (from $498 million to $214 million).

         The growth in subscription revenues was primarily related to the acquisition of AOL Europe in 2002, as well as domestic revenue growth. Domestically, subscription revenues increased 15% and was principally driven by membership growth and price increases. The number of AOL brand subscribers in the U.S. was 26.7 million at September 30, 2002 compared to 24.2 million at September 30, 2001. The average monthly subscription revenue per domestic subscriber for the first nine months of 2002 increased 4% to $18.19 as compared to $17.54 in the prior year comparable period. This increase is due to the standard unlimited rate increase of $1.95 per month to $23.90 (effective beginning in July 2001) and a shift in the mix of members to new higher premium rate plans. These increases were offset in part by new member acquisition programs and member service and retention programs that offer incentives in the form of discounts and free months to AOL’s members.

         The majority of AOL's domestic subscribers are on unlimited pricing plans. Additionally, AOL has entered into certain bundling programs with OEMs that generally do not result in subscription revenues during introductory periods, as well as the sale of bulk subscriptions at a discounted rate to AOL’s selected strategic partners for distribution to their employees. As of September 30, 2002, of the 26.7 million domestic AOL members, approximately 82% were on standard unlimited pricing plans (including 11% under various free trial, member service and retention programs), 13% were on lower priced plans, including BYOA, bulk employee programs with strategic partners, and limited usage plans (weighted average monthly rate of approximately $10.85), and the remaining 5% were on OEM bundled plans.

         The number of AOL brand subscribers in Europe was 6.1 million at September 30, 2002 and the average monthly subscription revenue per European subscriber for the first nine months of 2002 was $14.37. This compares to AOL brand subscribers in Europe of 5.0 million at September 30, 2001 and average monthly subscription revenue per European subscriber for the first nine months of 2002 of $12.67. The average monthly subscription revenue per European subscriber in 2002 was impacted by price increases implemented earlier this year in various European countries offering the AOL service and the positive effect of changes in foreign currency exchange rates.

         The decline in Advertising and Commerce revenues resulted from a decline in advertising revenues (from $1.761 billion to $998 million) and a 13% decrease in commerce revenues. The decline in advertising revenues is principally due to a reduction in benefits from prior period contract sales and continued weakness in online advertising sales, which are expected to extend into 2003. The advertising revenue decline was slightly offset by contributions from AOL Europe. Domestic contractual commitments received in prior periods contributed advertising revenue of $669 million in the 2002 period compared to $1.258 billion in the comparable prior year period. Included in the amount of revenue from domestic contractual commitments received in prior periods was revenue recognized from the termination of contractual commitments, which declined to $10 million in the 2002 period compared to $128 million in the comparable prior year period. The decline in advertising revenues was offset in part by an increase in the intercompany sales of advertising to other business segments of AOL Time Warner in 2002 as compared to 2001 (from $90 million to $141 million). Of the $998 million of advertising revenue in the current nine-month period, approximately $331 million related to the five most significant domestic advertisers. Similarly, of the $1.761 billion of advertising revenue in the prior year nine-month period, approximately $380 million related to the five most significant domestic advertisers.

         During the first nine months of 2002, domestic advertising commitments for future periods declined to $648 million as of September 30, 2002 from $1.450 billion as of December 31, 2001. This compares to advertising commitments

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AOL TIME WARNER INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION — (Continued)

of $1.378 billion as of September 30, 2001 and $2.598 billion as of December 31, 2000. During the first nine months of 2002, in addition to the $669 million recognized in revenue, remaining commitments were reduced by approximately $343 million, without any revenue being recognized, to reflect a decline in future consideration to be received related to the termination or restructuring of various contracts. Similarly, during the nine months ended September 30, 2001, in addition to the $1.258 billion recognized in revenue, remaining commitments were reduced by approximately $376 million, without any revenue being recognized, to reflect a decline in future consideration to be received related to the termination or restructuring of various contracts. Included in the $648 million of advertising commitments for future periods as of September 30, 2002 are approximately $217 million of commitments for the five largest commitments. Similarly, included in the $1.378 billion of advertising commitments for future periods as of September 30, 2001 are $442 million of commitments for the five largest commitments.

         The Company expects to complete performance on a majority of the remaining domestic advertising commitments by the end of 2003. Further declines in future consideration to be received, and revenue that would otherwise be recognized, could occur from additional terminations or restructurings of such commitments. As services under certain large longer term contracts signed in previous periods are completed, the Company expects to enter into fewer long term contracts as the Company develops its online advertising strategy, reducing its reliance on long-term arrangements, including arrangements which involve significant non-advertising components, as the market continues to migrate to more traditional short-term advertiser arrangements. The Company expects that the level of advertising commitments for future periods will decline as traditional advertiser arrangements typically involve shorter terms. The Company is uncertain whether the amount of revenue from the more traditional short-term advertising arrangements will reach the levels of current and prior advertising revenue even if the online advertising market improves. The Company also is uncertain of its ability to replace or renew advertising sales for some of its largest advertisers.

         The decrease in Content and Other revenues is primarily due to the termination of AOL’s iPlanet alliance with Sun Microsystems in the third quarter of 2001, which contributed approximately $305 million of revenue and approximately $249 million of EBITDA during the first nine months of 2001. This was offset in part by $82 million of intercompany network revenues which are derived primarily through network services provided to Road Runner, which began in November 2001.

         The decline in EBITDA is primarily due to the advertising revenue shortfall, the absence of revenues from the iPlanet alliance, an increase in domestic marketing expenses, as well as EBITDA losses at AOL Europe of $126 million. EBITDA was also impacted by an increase in intercompany advertising purchased by AOL on properties of other AOL Time Warner business segments (from $141 million to $216 million), including advertising purchased on Time Warner Cable properties in support of the rollout of AOL Broadband services.

         The current year results are significantly impacted by the acquisition of AOL Europe as discussed above. Accordingly, management also evaluates the current period results assuming the operations of AOL Europe were consolidated beginning January 1, 2001. Assuming such consolidation as of January 1, 2001, AOL’s revenues would have decreased by 3% to $6.772 billion in 2002, compared to $6.966 billion in 2001. Subscription revenues would have increased 18% to $5.330 billion in 2002, as compared to $4.516 billion in 2001, Advertising and Commerce revenues would have decreased 39% to $1.228 billion in 2002, as compared to $2.007 billion in 2001, content and other revenues would have decreased 52% to $214 million, as compared to $443 million in 2001, and EBITDA would have decreased 25% to $1.324 billion in 2002, compared to $1.768 billion in 2001.

         Cable. Revenues increased 18% to $5.198 billion in 2002 compared to $4.404 billion in 2001. EBITDA increased 4% to $2.007 billion in 2002 from $1.924 billion in 2001.

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AOL TIME WARNER INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION — (Continued)

         Revenues increased due to a 17% increase in Subscription revenues (from $4.050 billion to $4.722 billion) and a 34% increase in Advertising and Commerce revenues (from $354 million to $476 million). The increase in Subscription revenues was due to higher basic cable rates and increases in high-speed data services subscribers, digital cable subscribers and basic cable subscribers, as well as the impact of the consolidation of Road Runner in 2002. In 2002, as compared to the prior year comparable period, high-speed data subscribers increased by 69% to 2.313 million, digital cable subscribers increased by 47% to 3.456 million and basic cable subscribers increased by 1.5% to 10.862 million. In addition, total customer relationships, representing the number of customers that receive at least one level of service, increased by 4% to approximately 11.2 million as of September 30, 2002 compared to approximately 10.8 million as of September 30, 2001 and revenue generating units, representing the total of all analog video, digital video, high-speed data and telephony customers, increased by 16% to approximately 16.6 million in 2002 compared to approximately 14.4 million in 2001. The Company’s subscriber amounts include subscribers at both consolidated entities and investees accounted for under the equity method of accounting. High speed data subscribers include residential subscribers, as well as commercial and bulk (e.g., apartment buildings and universities) subscribers. Due to their nature, commercial and bulk subscribers are charged at a higher amount than residential subscribers. The number of commercial and bulk high speed data subscribers is calculated by dividing commercial and high speed data revenue by the lower average rate charged to residential customers.

         The increase in Advertising and Commerce revenues was primarily related to an increase in advertising purchased by programming vendors to promote their channels, including new channel launches (from $53 million to $101 million) and an increase in the intercompany sale of advertising to other business segments of AOL Time Warner (from $32 million to $89 million). The Company expects fourth quarter 2002 advertising sales to programming vendors to be below fourth quarter 2001 levels and overall 2003 amounts to be lower than 2002.

         EBITDA increased principally as a result of the revenue gains, offset in part by increases in programming and other operating costs and the consolidation of Road Runner in 2002. The increase in video programming costs of 22% relates to general programming rate increases across both basic and digital services, the addition of new programming services and higher basic and digital subscriber levels. Programming costs are expected to continue to increase as general programming rates increase and digital services continue to be rolled out. Other operating costs increased as a result of the roll out of new services, higher property taxes associated with the upgrade of cable plants and higher development spending in the Interactive Personal Video division (from $0 to $22 million).

         As noted above, the consolidation of Road Runner effective January 1, 2002 significantly impacted the comparability of the Cable segment’s 2002 results by increasing revenues and decreasing EBITDA. As such, management of the Company also evaluates the results of the Cable segment assuming that the results of Road Runner were included in both periods. Assuming that the results of Road Runner were included in both periods, total revenues would have increased 16% (from $4.472 billion to $5.198 billion), Subscription revenues would have increased 15% (from $4.115 billion to $4.722 billion) and EBITDA would have increased 12% (from $1.796 billion to $2.007 billion).

         Filmed Entertainment. Revenues increased 15% to $7.165 billion in 2002, compared to $6.217 billion in 2001. EBITDA increased 25% to $840 million in 2002, compared to $670 million in 2001.

         Revenues and EBITDA increased at both Warner Bros. and the Turner filmed entertainment businesses, which include New Line Cinema, Castle Rock and the former film and television libraries of Metro-Goldwyn-Mayer, Inc. and RKO pictures.

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AOL TIME WARNER INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION — (Continued)

         For Warner Bros., the revenue increase was primarily related to the worldwide theatrical and home video performance of Harry Potter and the Sorcerer’s Stone and Ocean’s Eleven, partially offset by reduced commerce revenues related to the closure of its Studio Stores. For the Turner filmed entertainment businesses, revenues increased primarily due to New Line Cinema’s continued theatrical and home video success of The Lord of the Rings: The Fellowship of the Ring.

         For Warner Bros., EBITDA increased principally due to the profitability of Harry Potter and the Sorcerer’s Stone. For the Turner filmed entertainment businesses, EBITDA increased primarily due to the revenue increase.

         Networks. Revenues increased 7% to $5.575 billion in 2002, compared to $5.190 billion in 2001. EBITDA increased 2% to $1.371 billion in 2002 from $1.343 billion in 2001.

         Revenues grew primarily due to an 8% increase in Subscription revenues with growth at both the Turner cable networks and HBO, a 3% increase in Advertising and Commerce revenues (from $1.803 billion to $1.850 billion) with growth at both the Turner cable networks and the WB Network and a 25% increase in Content and Other revenues with growth at HBO, offset in part a decrease at the Turner cable networks. EBITDA increased due to improved results at HBO offset in part by lower results at the Turner cable networks and The WB Network.

         For the Turner cable networks, Subscription revenues benefited from higher domestic rates and an increase in the number of domestic subscribers, led by TNT, Turner Classic Movies, TBS, CNN, and Cartoon Network. Advertising and Commerce revenues increased slightly ($1.477 billion in 2002 compared to $1.459 billion in 2001) reflecting a slight recovery in the cable television advertising market during the second and third quarters of 2002, which was offset in part by a slight decline in intercompany sales of advertising to other business segments of AOL Time Warner (from $87 million to $84 million). For HBO, Subscription revenues benefited from an increase in the number of subscribers and higher rates. Content and Other revenues benefited from higher home video sales of HBO’s original programming and higher licensing and syndication revenue from the broadcast comedy series Everybody Loves Raymond. For The WB Network, the increase in Advertising and Commerce revenues was driven by higher rates.

         For the Turner cable networks, the decrease in EBITDA was principally due to higher programming, marketing and newsgathering costs, partially offset by the increased Subscription revenues. In addition, EBITDA was negatively affected by an allowance for doubtful accounts established on receivables from Adelphia Communications, a major cable television operator (“Adelphia”). For The WB Network, the EBITDA decline was principally due to higher program license fees offset in part by higher Advertising and Commerce revenues. For HBO, the increase in EBITDA was principally due to the increase in revenues and reduced costs relating to the finalization of certain licensing agreements, offset in part by an allowance for doubtful accounts established on receivables from Adelphia and higher write-offs of development costs.

         Music. Revenues increased 4% to $2.902 billion in 2002, compared to $2.801 billion in 2001. EBITDA increased 10% to $294 million in 2002 from $268 million in 2001.

         Revenues increased primarily due to the impact of the acquisition of Word Entertainment in January 2002, lower provisions for returns due to improved historical experience and increases in DVD manufacturing volume, offset in part by declines in recorded music shipments related to the ongoing weakness in the worldwide music industry, the negative effect of changes in foreign currency exchange rates on international revenues and lower DVD

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AOL TIME WARNER INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION — (Continued)

manufacturing prices. Industry-wide worldwide music sales continue to be negatively impacted by the effects of piracy. In addition, downward pressure on DVD manufacturing pricing, could negatively affect future manufacturing profits.

         The increase in EBITDA is due primarily to the higher revenues, the impact of various cost-saving and restructuring programs and lower marketing and bad debt expense, partially offset by higher artist and repertoire costs. As of September 30, 2002, the Music segment had year-to-date domestic album market share of 17.2%, compared to 16.8% at December 31, 2001.

         Publishing. Revenues increased 20% to $3.830 billion in 2002 compared to $3.179 billion in 2001. EBITDA increased 31% to $758 million in 2002 from $580 million in 2001.

         Revenues increased due to a 35% increase in Subscription revenues (from $781 million to $1.057 billion), 15% increase in Advertising and Commerce revenues (from $1.990 billion to $2.285 billion) and a 20% increase in Content and Other revenues (from $408 million to $488 million). The increases in both Subscription revenues and Advertising and Commerce revenues were due to the acquisitions of IPC in October 2001 and Synapse in December 2001. The growth in Advertising and Commerce revenues was offset in part by lower commerce revenues from Time Life’s direct marketing business. Advertising revenues increased 9% due to the acquisition of IPC. Advertising increases at the non-business oriented publications were offset by continued softness in the advertising market for business oriented publications. The increase in Content and Other revenues is due primarily to increased sales at the AOL Time Warner Book Group due to the carryover successes of 2001 bestsellers and the success of several 2002 releases, including “The Lovely Bones”, as well as the impact of the acquisition of IPC.

         The growth in EBITDA is due predominantly to the acquisitions of IPC and Synapse and, to a lesser extent, overall cost savings and reduced costs relating to the final settlement of certain liabilities associated with the closure of American Family Enterprises during 2001, offset in part by additional reserves established on receivables from newsstand distributors.

         As noted above, the acquisition of IPC in October 2001 significantly impacted the comparability of the Publishing segment’s 2002 results by significantly increasing both revenues and EBITDA. As such, management of the Company also evaluates the results of the Publishing segment assuming that the results of IPC were included in both periods. Assuming that the results of IPC were included in both periods, total revenues would have increased 7% (from $3.563 billion to $3.830 billion), Subscription revenues would have increased 5% (from $1.006 billion to $1.057 billion), Advertising and Commerce revenues would have increased 7% (from $2.130 billion to $2.285 billion) and EBITDA would have increased 17% (from $647 million to $758 million).

FINANCIAL CONDITION AND LIQUIDITY
September 30, 2002

Current Financial Condition

         At September 30, 2002, AOL Time Warner had $28.3 billion of debt, $2.3 billion of cash and equivalents (net debt of $26.0 billion, defined as total debt less cash and cash equivalents) and $98.0 billion of shareholders’ equity, compared to $22.8 billion of debt, $719 million of cash and equivalents (net debt of $22.1 billion) and $152.0 billion of shareholders’ equity at December 31, 2001. In addition, as of September 30, 2002, AOL Europe also had approximately $792 million, including accrued dividends, of redeemable preferred securities outstanding,

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MANAGEMENT’S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION — (Continued)

which is classified as minority interest in the accompanying consolidated balance sheet. These securities are required to be redeemed by the Company in April 2003 in cash, AOL Time Warner common stock, or a combination thereof, at the discretion of the Company. Further, pursuant to a previously negotiated agreement and as previously disclosed, TWE is committed to acquiring in January 2003 an incremental 11% interest in The WB Network for $128 million in cash. The Company had approximately $8.4 billion of committed, available funding as of September 30, 2002. The Company has no scheduled debt maturities for the remainder of 2002. However, the holders of the 6.85% debentures due 2026 of Time Warner Companies, Inc., a wholly owned subsidiary of the Company, may at their option cause the Company to redeem on January 15, 2003, the $400 million principal amount outstanding of such debentures at 100% of their principal amount plus accrued and unpaid interest to the date of redemption.

         The Company’s outstanding utilization under its accounts receivable and backlog securitization facilities was approximately $1.7 billion as of September 30, 2002 and $1.6 billion as of December 31, 2001. The Company has either renewed or extended the maturity dates of certain securitization facilities with $800 million of committed capacity that were scheduled to mature during the third quarter of 2002. Total committed capacity under the Company’s accounts receivable and backlog securitization facilities as of September 30, 2002 was approximately $2.0 billion, of which, approximately $350 million is scheduled to mature in the fourth quarter of 2002.

         As discussed in more detail below, management believes that AOL Time Warner’s operating cash flow, cash and equivalents, borrowing capacity under the 2002 Credit Agreements and commercial paper programs are sufficient to fund its capital and liquidity needs for the foreseeable future.

Cash Flows

Operating Activities

         Cash provided by operations increased to $5.925 billion for the first nine months of 2002 as compared to $4.230 billion in 2001. This year over year growth in cash flow from operations compared to 2001 was driven primarily by over $1.7 billion of improvements in working capital, lower income taxes and interest payments and a decrease in payments to settle restructuring and merger-related liabilities, offset in part by a decrease in EBITDA and the consolidation of losses at AOL Europe and Road Runner. The improvements in working capital are related to reduced working capital needs in the current period compared to increased working capital needs in the prior period. Working capital needs are subject to wide fluctuations based on the timing of cash transactions related to production schedules, the acquisition of programming, collection of sales proceeds and similar items. The current period benefits are largely expected to reverse in future periods.

         During the first nine months of 2002, cash provided by operations of $5.925 billion reflected $6.098 billion of EBITDA, less $1.018 billion of net interest payments, $180 million of net income taxes paid and $565 million of payments to settle merger and restructuring liabilities. Cash flow from operations also reflects a reduction in other working capital requirements of $1.590 billion.

         During the first nine months of 2001, cash provided by operations of $4.230 billion reflected $6.515 billion of EBITDA, less $886 million of net interest payments, $263 million of net income taxes paid and $1.030 billion of payments to settle restructuring and merger-related liabilities. Cash flow from operations also reflects an increase in working capital requirements of $106 million.

Investing Activities

         Cash used by investing activities was $9.618 billion in the first nine months of 2002, compared to $1.993 billion in 2001. The year over year increase in cash used by investing activities compared to 2001 is primarily due to

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MANAGEMENT’S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION — (Continued)

the increased cash used for acquisitions and investments, principally the acquisition of Bertelsmann’s interest in AOL Europe. Also contributing to the increase is the absence in 2002 of proceeds from the sale of short-term investments that occurred in the first nine months of 2001 (primarily money market investments held by America Online at the time of the Merger).

         During the first nine months of 2002, cash used by investing activities of $9.618 billion reflected approximately $7.582 billion of cash used for acquisitions and investments, including $6.75 billion related to the acquisition of Bertelsmann’s interest in AOL Europe. In addition, cash used by investing activities in 2002 included $2.284 billion of total capital expenditures and product development costs, offset in part by $248 million of proceeds received from the sale of investments.

         During the first nine months of 2001, cash used by investing activities of $1.993 billion reflected $1.774 billion of cash used for acquisitions and investments and $2.660 billion of total capital expenditures and product development costs, offset in part by $690 million of cash acquired in the Merger and $1.751 billion of proceeds received from the sale of investments. The proceeds received from the sale of investments in 2001 was due primarily to the sale of short-term investments previously held by America Online.

Financing Activities

         Cash provided by financing activities was $5.323 billion for the first nine months of 2002 as compared to cash used by financing activities of $3.342 billion in 2001. The year over year increase in cash provided by financing activities is principally due to incremental borrowings in the current period used to finance the acquisition of Bertelsmann’s interest in AOL Europe compared to net repayments on borrowings and the repurchase of AOL Time Warner common stock in the prior period.

         During the first nine months of 2002, cash provided from financing activities of $5.323 billion resulted from approximately $5.493 billion of net incremental borrowings, primarily used to acquire Bertelsmann’s interest in AOL Europe, and $255 million of proceeds received principally from the exercise of employee stock options, offset in part by the redemption of redeemable preferred securities at AOL Europe for $255 million, the repurchase of AOL Time Warner common stock for total cash of $102 million, $11 million of dividends and partnership distributions and $35 million of principal payments on capital leases.

         During the first nine months of 2001, cash used by financing activities of $3.342 billion resulted from $1.248 billion of net payments on borrowings, the repurchase of AOL Time Warner common stock for an aggregate cost of $2.298 billion, the redemption of redeemable preferred securities of subsidiaries for $575 million and $55 million of dividends and partnership distributions, offset in part by $813 million of proceeds received principally from the exercise of employee stock options.

Free Cash Flow

         AOL Time Warner evaluates operating performance based on several measures including free cash flow, which is defined as cash provided by operations less capital expenditures and product development costs, dividend payments and partnership distributions, and principal payments on capital leases. The comparability of AOL Time Warner’s free cash flow has been affected by certain significant unusual and nonrecurring items in each period. Specifically, AOL Time Warner’s free cash flow has been impacted by the cash impact of the significant and nonrecurring items previously discussed. In addition, free cash flow has been impacted by payments made in

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MANAGEMENT’S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION — (Continued)

settling other merger and restructuring liabilities. For the first nine months of 2002, these items aggregated approximately $565 million of cash payments. For 2001, these items aggregated approximately $981 million. Excluding the effect of these nonrecurring items and discontinued operations, free cash flow increased to $3.999 billion in 2002 from $2.481 billion in 2001, primarily due to improved cash flows from the Company’s filmed entertainment businesses, reduced interest and taxes paid, lower capital expenditures and product development costs and improvements in working capital. In addition, excluding the effect of nonrecurring items and cash flow from discontinued operations, the free cash flow during the first nine months of 2002 represented 64% conversion of EBITDA to free cash flow, compared to a 37% conversion ratio in 2001. Part of the growth in free cash flow was related to the timing of various cash payments and receipts which are expected to have an offsetting impact on free cash flow generation in future quarters. As a result, the Company expects a reduction in the rate that it converts EBITDA to free cash flow in future periods. On an as reported basis, free cash flow in 2002 was $3.434 billion, compared to $1.500 billion in 2001.

TWE Cash Flow Restrictions

         The assets and cash flows of TWE are restricted by certain borrowing and partnership agreements and are unavailable to AOL Time Warner except through the payment of certain fees, reimbursements, cash distributions and loans, which are subject to limitations. Under the 2002 Credit Agreements, TWE is permitted to incur additional indebtedness to make loans, advances, distributions and other cash payments to AOL Time Warner, subject to its individual compliance with the leverage ratio covenant contained therein.

Common Stock Repurchase Program

         In January 2001, AOL Time Warner’s Board of Directors authorized a common stock repurchase program that allows AOL Time Warner to repurchase, from time to time, up to $5 billion of common stock over a two-year period. During the first nine months of 2002, the Company repurchased approximately 4 million shares at an aggregate cost of $102 million. These repurchases increased the cumulative shares purchased under this common stock repurchase program to approximately 79.4 million shares at an aggregate cost of $3.148 billion. In an effort to maintain financial flexibility, the pace of share repurchases under this program has slowed in 2002. As such, the Company does not expect that its repurchases of common stock for the remainder of the year will be significant.

$10 Billion Shelf Registration Statement

         In January 2001, AOL Time Warner filed a shelf registration statement with the SEC, which allowed AOL Time Warner to offer and sell from time to time, debt securities, preferred stock, series common stock, common stock and/or warrants to purchase debt and equity securities in amounts up to $10 billion in initial aggregate public offering prices. On April 19, 2001, AOL Time Warner issued an aggregate of $4 billion principal amount of debt securities under this shelf registration statement at various fixed interest rates and maturities of 5, 10 and 30 years. On April 8, 2002, AOL Time Warner issued the remaining $6 billion principal amount of debt securities under this shelf registration statement at various fixed interest rates and maturities of 3, 5, 10 and 30 years. The net proceeds to the Company were approximately $3.964 billion under the first issuance and approximately $5.930 billion under the second issuance, both of which were used for general corporate purposes, including, but not limited to, the repayment of outstanding commercial paper and bank debt (Note 9).

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AOL TIME WARNER INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION — (Continued)

$10 Billion Revolving Credit Facilities

         In July 2002, AOL Time Warner, together with certain of its consolidated subsidiaries, entered into two new senior unsecured long-term revolving bank credit agreements with an aggregate borrowing capacity of $10 billion (the “2002 Credit Agreements”) and terminated three existing bank credit facilities with an aggregate borrowing capacity of $12.6 billion (the “Old Credit Agreements”), which were scheduled to expire during 2002. The 2002 Credit Agreements are comprised of a $6 billion five-year revolving credit facility and a $4 billion 364-day revolving credit facility, borrowings under which may be extended for a period up to two years following the initial term. The borrowers under the 2002 Credit Agreements are AOL Time Warner, TWE, TWE-A/N and AOL Time Warner Finance Ireland. Borrowings bear interest at specific rates, generally based on the credit rating for each of the borrowers, which is currently equal to LIBOR plus .625%, including facility fees of .10% and .125% on the total commitments of the 364-day and five-year facilities, respectively. The obligations of each of AOL Time Warner and AOL Time Warner Finance Ireland are guaranteed by America Online, Time Warner, TBS and TW Companies, directly or indirectly. The obligation of AOL Time Warner Finance Ireland is guaranteed by AOL Time Warner. In addition, the Company is required to pay an additional usage fee of .0625% if the two facilities in the aggregate have more than 33% outstanding and .125% if the facilities have more than 66% outstanding. Currently, the Company is paying the additional .0625% usage fee. The 2002 Credit Agreements provide same-day funding, multi-currency capability and letter of credit availability. They contain maximum leverage ratio and minimum GAAP net worth covenants of 4.5 times and $50 billion, respectively, for AOL Time Warner and a maximum leverage ratio covenant of 5.0 times for each of TWE and TWE-A/N, but do not contain any credit ratings-based defaults or covenants, nor an ongoing covenant or representation specifically relating to a material adverse change in the Company’s financial condition or results of operations. Borrowings may be used for general business purposes and unused credit is available to support commercial paper borrowings (Note 9).

Capital Expenditures and Product Development Costs

         AOL Time Warner’s total capital expenditures and product development costs were $2.284 billion and $2.660 billion for the nine months ended September 30, 2002 and 2001, respectively. Capital expenditures and product development costs from continuing operations were $2.078 billion in 2002 compared to $2.362 billion in 2001. Capital expenditures and product development costs from continuing operations principally relate to the Company’s Cable segment, which had capital expenditures of $1.225 billion in 2002 compared to $1.328 billion in 2001. The Cable segment, over the past several years, has been engaged in a plan to upgrade the technological capability and reliability of its cable television systems and develop new services. Also contributing to capital expenditures and product development costs are product development costs incurred by the AOL segment which amounted to $169 million and $255 million for the nine months ended September 30, 2002 and 2001, respectively. The Cable segment’s capital expenditures from continuing operations are comprised of the following categories:

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MANAGEMENT’S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION — (Continued)

                                   
      Three Months Ended September 30,   Nine Months Ended September 30,
     
 
      2002   2001   2002   2001
     
 
 
 
              (millions)        
Cable Segment Capital Expenditures
                               
Customer premise equipment
  $ 198     $ 212     $ 643     $ 732  
Scaleable infrastructure
    25       17       114       53  
Line extensions
    45       39       134       108  
Upgrade/rebuild
    56       90       153       279  
Support capital
    86       42       181       156  
 
   
     
     
     
 
 
Total capital expenditures
  $ 410     $ 400     $ 1,225     $ 1,328  
 
   
     
     
     
 

         AOL Time Warner’s Cable segment generally capitalizes expenditures for tangible fixed assets having a useful life of greater than one year. Capitalized costs typically include direct material, direct labor, overhead and interest. Sales and marketing costs, as well as the costs of repairing or maintaining existing fixed assets, are expensed as incurred. Types of capitalized expenditures at the Cable segment include plant upgrades, drops (i.e., customer installations), converters and cable modems. With respect to customer premise equipment, including converters and cable modems, the Cable segment capitalizes direct installation charges only upon the initial deployment of such assets. All costs incurred in subsequent disconnects and reconnects are expensed as incurred. Depreciation on these assets is provided generally using the straight-line method over their estimated useful life. For converters and modems, such life is generally 3-5 years and for plant upgrades, such useful life is up to 16 years. As of September 30, 2002, the total net book value of capitalized labor and overhead costs associated with the installation of converters and modems was approximately $150 million. As of that same date, the net book value of all capitalized costs associated with converters and modems, including equipment costs, was approximately $1.4 billion.

         Included in the AOL segment’s product development costs are costs incurred for the production of technologically feasible computer software that generates additional functionality to its existing software products. Capitalized costs typically include direct labor and related overhead for software produced by AOL as well as the cost of software purchased from third parties. Costs incurred on a product prior to the determination that the product is technologically feasible, as well as maintenance costs of established products, are expensed as incurred. All costs in the software development process which are experimental in nature are classified as research and development and are expensed as incurred until technological feasibility has been established. Once technological feasibility has been established, such costs are capitalized until the software has completed testing and is mass-marketed. Amortization is provided on a product-by-product basis using the greater of the straight-line method or the current year revenue as a percentage of total revenue estimates for the related software product, not to exceed five years, commencing the month after the date of the product release. The total net book value related to capitalized software costs was approximately $330 million as of September 30, 2002.

Filmed Entertainment Backlog

         Backlog represents the amount of future revenue not yet recorded from cash contracts for the licensing of theatrical and television product for pay cable, basic cable, network and syndicated television exhibition. Backlog for all of AOL Time Warner’s Filmed Entertainment companies was approximately $3.3 billion at September 30, 2002, compared to approximately $3.8 billion at December 31, 2001 (including amounts relating to the licensing of film product to AOL Time Warner’s Networks segment of approximately $744 million at September 30, 2002 and approximately $1.231 billion at December 31, 2001).

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MANAGEMENT’S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION — (Continued)

CAUTION CONCERNING FORWARD-LOOKING STATEMENTS AND RISK FACTORS

         The SEC encourages companies to disclose forward-looking information so that investors can better understand a company’s future prospects and make informed investment decisions. This document contains such “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, particularly statements anticipating future growth in revenues, EBITDA and cash flow. Words such as “anticipates,” “estimates,” “expects,” “projects,” “intends,” “plans,” “believes” and words and terms of similar substance used in connection with any discussion of future operating or financial performance identify such forward-looking statements. Those forward-looking statements are based on management’s present expectations and beliefs about future events. As with any projection or forecast, they are inherently susceptible to uncertainty and changes in circumstances, and the Company is under no obligation to (and expressly disclaims any such obligation to) update or alter its forward-looking statements whether as a result of such changes, new information, future events or otherwise.

         AOL Time Warner operates in highly competitive, consumer-driven and rapidly changing Internet, media and entertainment businesses. These businesses are affected by government regulation, economic, strategic, political and social conditions, consumer response to new and existing products and services, technological developments and, particularly in view of new technologies, the continued ability to protect intellectual property rights. AOL Time Warner’s actual results could differ materially from management’s expectations because of changes in such factors. Other factors and risks could adversely affect the operations, business or financial results of AOL Time Warner or its business segments in the future and could also cause actual results to differ from those contained in the forward-looking statements, including those identified in AOL Time Warner’s other filings with the SEC and the following:

  For AOL Time Warner’s America Online businesses, the ability to implement potential changes in strategy resulting from the new management’s review of the business; the ability to develop new products and services to remain competitive; the ability to develop, adopt or have access to new technologies; the ability to successfully implement its broadband strategy; the ability to have access to distribution channels controlled by third parties; the ability to retain and grow the subscriber base; the ability to provide adequate server, network and system capacity; increased costs and business disruption resulting from the financial difficulties being experienced by a number of AOL’s network service providers, including WorldCom; the risk of unanticipated increased costs for network services; increased competition from providers of Internet services; the ability to attract more traditional advertisers to the online advertising medium; the ability to renew existing advertising or marketing commitments, including the ability to renew or replace individual large multi-period online advertising commitments with similar commitments or with shorter term advertising sales, which are generally affected more by the current unfavorable state of overall online advertising market conditions; the ability to maintain or renew large advertising arrangements (during the nine months ended September 30, 2002, the ten most significant third party advertising customers of America Online represented 43% of America Online’s aggregate domestic advertising revenues as compared to 31% for the nine months ended September 30, 2001); the ability to maintain or enter into new electronic commerce, advertising, marketing or content arrangements; the risk that the online advertising market will not improve at all or at a rate comparable to improvements in the general advertising market; the ability to maintain and grow market share in the enterprise software industry; the risks from changes in U.S. and international regulatory environments affecting interactive services; and the ability to continue to expand successfully internationally.
 
  For AOL Time Warner’s cable business, more aggressive than expected competition from new technologies and other types of video programming distributors, including DBS and DSL; increases in government regulation of

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MANAGEMENT’S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION — (Continued)

    basic cable or equipment rates or other terms of service (such as “digital must-carry,” open access or common carrier requirements); government regulation of other services, such as broadband cable modem service; increased difficulty in obtaining franchise renewals; the failure of new equipment (such as digital set-top boxes) or services (such as digital cable, high-speed online services, telephony over cable or video-on-demand) to appeal to enough consumers or to be available at prices consumers are willing to pay, to function as expected and to be delivered in a timely fashion; theft of service from interception of cable transmissions; fluctuations in spending levels by advertisers and consumers; the ability to enter into new program vendor advertising arrangements; and greater than expected increases in programming or other costs.
 
  For AOL Time Warner’s filmed entertainment businesses generally, their ability to continue to attract and select desirable talent and scripts at manageable costs; general increases in production costs; fragmentation of consumer leisure and entertainment time (and its possible negative effects on the broadcast and cable networks, which are significant customers of these businesses); continued popularity of merchandising; the potential repeal of the Sonny Bono Copyright Term Extension Act; the uncertain impact of technological developments which may facilitate piracy of the Company’s copyrighted works; and risks associated with foreign currency exchange rates. With respect to feature films, the increasing marketing costs associated with theatrical film releases in a highly competitive marketplace; with respect to television programming, a decrease in demand for television programming provided by non-affiliated producers; and with respect to home video, the ability to maintain relationships with significant customers in the rental and sell-through markets.
 
  For AOL Time Warner’s network businesses, greater than expected programming or production costs; increased news gathering costs in the event of a war; public or cable operator resistance to price increases (and the negative impact on premium programmers of increases in basic cable rates); increased regulation of distribution agreements; the sensitivity of network advertising to economic cyclicality and to new media technologies; the impact of consolidation among cable and satellite distributors; piracy of music by means of interception of cable and satellite transmissions or Internet peer-to-peer file sharing; the impact of personal video recorder “ad-stripping” functions on advertising sales; the development of new technologies that alter the role of programming networks and services; and greater than expected fragmentation of consumer viewership due to an increased number of programming services or the increased popularity of alternatives to television.
 
  For AOL Time Warner’s music business, its ability to continue to attract and select desirable talent at manageable costs; the popular demand for particular artists and albums; the timely completion of albums by major artists; its ability to continue to enforce its intellectual property rights in digital environments; piracy of music by means of Internet peer-to-peer file sharing; its ability to develop a successful business model applicable to a digital online environment; the potential repeal of Subsection (6) of California Labor Code Section 2855 regarding the maximum length of personal service contracts; the potential repeal of the Sonny Bono Copyright Term Extension Act; risks associated with foreign currency exchange rates; its ability to utilize DVD manufacturing capacity fully and to maintain current DVD manufacturing pricing; and the overall strength of global music sales.
 
  For AOL Time Warner’s print media and publishing businesses, fluctuations in spending levels by advertisers and consumers; unanticipated increases in paper, postal and distribution costs (including costs resulting from financial pressure on the U.S. Postal Service); increased costs and business disruption resulting from instability in the newsstand distribution channel; the introduction and increased popularity of alternative technologies for the provision of news and information; and the ability to continue to develop new sources of circulation.

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MANAGEMENT’S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION — (Continued)

  For AOL Time Warner generally, the risks related to the continued successful operation of the businesses of AOL Time Warner on an integrated basis and the possibility that the Company will not be able to continue to realize the benefits of the combination of these businesses; lower than expected valuations associated with the cash flows and revenues at the AOL Time Warner segments may result in the inability of the Company to realize the value of recorded intangibles and goodwill at those segments.

         In addition, the Company’s overall financial strategy, including growth in operations, maintaining its financial ratios and a strong balance sheet, could be adversely affected by increased interest rates, decreased liquidity in the capital markets (including any reduction in its ability to access either the capital markets for debt securities or bank financings), failure to meet earnings expectations, significant acquisitions or other transactions, economic slowdowns, increased expenses as a result of the SEC and DOJ investigations and the shareholder litigation pending against the Company, as well as the risk of costs associated with judgments in or settlements of such matters, and changes in the Company’s plans, strategies and intentions.

Item 4.   Controls and Procedures

         Within the 90-day period prior to the filing of this report, the Company, under the supervision and with the participation of its management, including the Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of the Company’s “disclosure controls and procedures” (as defined in Rule 13a-14(c) under the Securities Exchange Act of 1934 (the “Exchange Act”)). Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective in timely making known to them material information relating to the Company and the Company’s consolidated subsidiaries required to be disclosed in the Company’s reports filed or submitted under the Exchange Act. The Company has investments in certain unconsolidated entities. As the Company does not control or manage these entities, its disclosure controls and procedures with respect to such entities are necessarily substantially more limited than those it maintains with respect to its consolidated subsidiaries. There have been no significant changes in the Company’s internal controls or in other factors that could significantly affect the internal controls subsequent to the date the Company completed its evaluation.

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AOL TIME WARNER INC.
CONSOLIDATED BALANCE SHEET
(Unaudited)

                 
    September 30,   December 31,
    2002   2001
   
 
            (Restated)
    (millions, except
    per share amounts)
ASSETS
               
Current assets
               
Cash and equivalents
  $ 2,349     $ 719  
Receivables, less allowances of $2.163 and $1.889 billion
    4,858       6,054  
Inventories
    1,731       1,791  
Prepaid expenses and other current assets
    1,876       1,687  
 
   
     
 
Total current assets
    10,814       10,251  
 
               
Noncurrent inventories and film costs
    3,344       3,490  
Investments, including available-for-sale securities
    5,002       6,886  
Property, plant and equipment
    11,763       12,669  
Intangible assets subject to amortization
    7,162       7,289  
Intangible assets not subject to amortization
    38,300       37,708  
Goodwill
    81,688       127,420  
Other assets
    2,815       2,791  
 
   
     
 
Total assets
  $ 160,888     $ 208,504  
 
   
     
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
               
Current liabilities
               
Accounts payable
  $ 1,918     $ 2,266  
Participations payable
    1,498       1,253  
Royalties and programming costs payable
    1,635       1,515  
Deferred revenue
    1,550       1,451  
Debt due within one year
    89       48  
Other current liabilities
    6,312       6,443  
 
   
     
 
Total current liabilities
    13,002       12,976  
 
               
Long-term debt
    28,244       22,792  
Deferred income taxes
    10,975       11,231  
Deferred revenue
    1,038       1,048  
Other liabilities
    4,694       4,839  
Minority interests
    4,917       3,591  
 
               
Shareholders’ equity
               
Series LMCN-V Common Stock, $0.01 par value, 171.2 million shares outstanding in each period
    2       2  
AOL Time Warner Common Stock, $0.01 par value, 4.296 and 4.258 billion shares outstanding
    42       42  
Paid-in capital
    155,093       155,172  
Accumulated other comprehensive income (loss), net
    (90 )     49  
Retained earnings
    (57,029 )     (3,238 )
 
   
     
 
Total shareholders’ equity
    98,018       152,027  
 
   
     
 
Total liabilities and shareholders’ equity
  $ 160,888     $ 208,504  
 
   
     
 

See accompanying notes.

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AOL TIME WARNER INC.
CONSOLIDATED STATEMENT OF OPERATIONS
(Unaudited)

                                   
      Three Months Ended   Nine Months Ended
      September 30,   September 30,
     
 
      2002   2001   2002   2001
     
 
 
 
              (Restated)           (Restated)
      (millions, except per share amounts)
Revenues:
                               
 
Subscriptions
  $ 4,818     $ 3,970     $ 14,032     $ 11,448  
 
Advertising and commerce
    1,698       1,880       5,518       6,088  
 
Content and other
    3,467       3,218       10,091       9,315  
 
   
     
     
     
 
Total revenues(a)
    9,983       9,068       29,641       26,851  
 
                               
Costs of revenues(a)
    (6,111 )     (5,006 )     (17,787 )     (14,759 )
Selling, general and administrative(a)
    (2,299 )     (2,191 )     (7,258 )     (6,643 )
Amortization of goodwill and other intangible assets
    (181 )     (1,784 )     (520 )     (5,318 )
Merger and restructuring costs
    (77 )     (134 )     (184 )     (205 )
 
                               
Operating income (loss)
    1,315       (47 )     3,892       (74 )
 
                               
Interest expense, net(a)
    (489 )     (341 )     (1,306 )     (996 )
Other expense, net(a)
    (851 )     (437 )     (1,837 )     (1,572 )
Minority interest income (expense)
    (55 )     12       (139 )     18  
 
   
     
     
     
 
Income (loss) before income taxes, discontinued operations and cumulative effect of accounting change
    (80 )     (813 )     610       (2,624 )
Income tax benefit (provision)
    25       (174 )     (279 )     (450 )
 
   
     
     
     
 
Income (loss) before discontinued operations and cumulative effect of accounting change
    (55 )     (987 )     331       (3,074 )
Discontinued operations, net of tax
    112       (10 )     113       (29 )
 
   
     
     
     
 
Income (loss) before cumulative effect of accounting change
    57       (997 )     444       (3,103 )
Cumulative effect of accounting change
                (54,235 )      
 
   
     
     
     
 
Net income (loss) applicable to common shares
  $ 57     $ (997 )   $ (53,791 )   $ (3,103 )
 
   
     
     
     
 
Basic income (loss) per common share before discontinued operations and cumulative effect of accounting change
  $ (0.01 )   $ (0.22 )   $ 0.07     $ (0.69 )
Discontinued operations
    0.02             0.03       (0.01 )
Cumulative effect of accounting change
                (12.19 )      
 
   
     
     
     
 
Basic net income (loss) per common share
  $ 0.01     $ (0.22 )   $ (12.09 )   $ (0.70 )
 
   
     
     
     
 
Average basic common shares
    4,464.2       4,439.9       4,449.2       4,429.2  
 
   
     
     
     
 
Diluted income (loss) per common share before discontinued operations and cumulative effect of accounting change
  $ (0.01 )   $ (0.22 )   $ 0.07     $ (0.69 )
Discontinued operations
    0.02             0.03       (0.01 )
Cumulative effect of accounting change
                (12.19 )      
 
   
     
     
     
 
Diluted net income (loss) per common share
  $ 0.01     $ (0.22 )   $ (12.09 )   $ (0.70 )
 
   
     
     
     
 
Average diluted common shares
    4,507.0       4,583.8       4,523.1       4,593.8  
 
   
     
     
     
 

(a)     Includes the following income (expenses) resulting from transactions with related companies:
 
                        Revenues
  $ 220     $ 269     $ 693     $ 735  
                        Cost of revenues
    85       (71 )     (98 )     (248 )
                        Selling, general and administrative
    7       19       19       7  
                        Interest income (expense), net
    2       6       7       14  
                        Other income (expense), net
    (7 )     (5 )     (12 )     (15 )

See accompanying notes.

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AOL TIME WARNER INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
Nine Months Ended September 30,
(Unaudited)

                     
        2002   2001
       
 
                (Restated)
        (millions)
OPERATIONS
               
Net income (loss)(a)
  $ (53,791 )   $ (3,103 )
Adjustments for noncash and nonoperating items:
               
   
Cumulative effect of accounting change
    54,235        
   
Depreciation and amortization
    2,206       6,589  
   
Amortization of film costs
    1,810       1,671  
   
Loss on writedown of investments
    1,685       821  
   
Net gain on sale of investments
    (95 )     (33 )
   
Equity in losses of investee companies after distributions
    248       716  
Changes in operating assets and liabilities, net of acquisitions
    (638 )     (2,824 )
Adjustments for noncash and nonoperating items, and changes in operating assets and liabilities for discontinued operations
    265       393  
 
   
     
 
Cash provided by operations
    5,925       4,230  
 
   
     
 
INVESTING ACTIVITIES
               
Acquisition of Time Warner Inc. cash and equivalents
          690  
Investments and acquisitions, net of cash acquired
    (7,582 )     (1,774 )
Capital expenditures and product development costs from continuing operations
    (2,078 )     (2,362 )
Capital expenditures from discontinued operations
    (206 )     (298 )
Investment proceeds
    248       1,751  
 
   
     
 
Cash used by investing activities
    (9,618 )     (1,993 )
 
   
     
 
FINANCING ACTIVITIES
               
Borrowings
    19,133       7,948  
Debt repayments
    (13,640 )     (9,196 )
Redemption of redeemable preferred securities of subsidiaries
    (255 )     (575 )
Proceeds from exercise of stock option and dividend reimbursement plans
    255       813  
Current period repurchases of common stock
    (102 )     (2,298 )
Dividends paid and partnership distributions for discontinued operations, net
    (11 )     (51 )
Dividends paid and partnership distributions for continuing operations
          (4 )
Principal payments on capital leases
    (35 )      
Other
    (22 )     21  
 
   
     
 
Cash provided (used) by financing activities
    5,323       (3,342 )
 
   
     
 
INCREASE (DECREASE) IN CASH AND EQUIVALENTS
    1,630       (1,105 )
 
               
CASH AND EQUIVALENTS AT BEGINNING OF PERIOD
    719       2,610  
 
   
     
 
CASH AND EQUIVALENTS AT END OF PERIOD
  $ 2,349     $ 1,505  
 
   
     
 


(a)   Includes net income (loss) from discontinued operations of $113 million in 2002 and $(29) million in 2001.

See accompanying notes.

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AOL TIME WARNER INC.
CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY
Nine Months Ended September 30,
(Unaudited)

                 
    2002   2001
   
 
            (Restated)
    (millions)
BALANCE AT BEGINNING OF PERIOD
  $ 152,027     $ 6,727  
         
Issuance of common stock in connection with America Online-Time Warner merger
          146,430  
Reversal of America Online’s deferred tax valuation allowance
          4,439  
 
   
     
 
Balance at beginning of period, adjusted to give effect to the America Online-Time Warner merger
    152,027       157,596  
 
Net loss
    (53,791 )     (3,103 )
Other comprehensive loss (a)
    (139 )     (59 )
 
   
     
 
Comprehensive loss
    (53,930 )     (3,162 )
Repurchases of AOL Time Warner common stock
    (102 )     (2,359 )
Dilution of interest in Time Warner Entertainment Company, L.P. (net of $276 million income tax impact)
    (414 )      
Other, principally shares issued pursuant to stock option and benefit plans, including $119 million and $1.298 billion of tax benefit
    437       2,152  
 
   
     
 
BALANCE AT END OF PERIOD
  $ 98,018     $ 154,227  
 
   
     
 


(a)   2002 includes a $725 million pretax reduction (income tax impact of $290 million), related to the write-down of certain investments, accounted for under FAS 115, from a decline in market value determined to be other-than-temporary.

See accompanying notes.

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Table of Contents

AOL TIME WARNER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1.   DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION

Description of Business

         AOL Time Warner Inc. (“AOL Time Warner” or the “Company”) is the world’s leading media and entertainment company. The Company was formed in connection with the merger of America Online, Inc. (“America Online”) and Time Warner Inc. (“Time Warner”), which was consummated on January 11, 2001 (the “Merger”). As a result of the Merger, America Online and Time Warner each became a wholly owned subsidiary of AOL Time Warner.

         AOL Time Warner classifies its business interests into six fundamental areas: AOL, consisting principally of interactive services, Web properties, Internet technologies and electronic commerce services; Cable, consisting principally of interests in cable television systems; Filmed Entertainment, consisting principally of interests in filmed entertainment and television production; Networks, consisting principally of interests in cable television and broadcast network programming; Music, consisting principally of interests in recorded music, music publishing and DVD manufacturing; and Publishing, consisting principally of interests in magazine publishing, book publishing and direct marketing. Financial information for AOL Time Warner’s various business segments is presented in Note 11.

         Each of the business interests within AOL Time Warner – AOL, Cable, Filmed Entertainment, Networks, Music and Publishing – is important to management’s objective of increasing shareholder value through the creation, extension and distribution of recognizable brands and copyrights throughout the world. Such brands and copyrights include (1) leading worldwide Internet services, such as the AOL and Compuserve services, leading Web properties, such as Netscape, Moviefone and MapQuest, instant messaging services, such as ICQ and AOL Instant Messenger, and music properties, such as the AOL Music Channel and Winamp, (2) Time Warner Cable, currently the second largest operator of cable television systems in the U.S., (3) the unique and extensive film, television and animation libraries owned or managed by Warner Bros. and New Line Cinema, and trademarks such as the Looney Tunes characters, Batman and The Flintstones, (4) leading television networks, such as The WB Network, HBO, Cinemax, CNN, TNT, TBS Superstation and Cartoon Network, (5) copyrighted music from many of the world’s leading recording artists that is produced and distributed by a family of established record labels such as Warner Bros. Records, Atlantic Records, Elektra Entertainment and Warner Music International and (6) magazine franchises, such as Time, People and Sports Illustrated.

Investment in Time Warner Entertainment Company, L.P.

         A majority of AOL Time Warner’s interests in the Filmed Entertainment and Cable segments, and a portion of its interests in the Networks segment, are held through Time Warner Entertainment Company, L.P. (“TWE”). As of September 30, 2002, AOL Time Warner owned general and limited partnership interests in TWE consisting of 72.36% of the pro rata priority capital (“Series A Capital”) and residual equity capital (“Residual Capital”), and 100% of the junior priority capital (“Series B Capital”). The remaining 27.64% limited partnership interests in the Series A Capital and Residual Capital of TWE were held by MediaOne TWE Holdings, Inc., a subsidiary of AT&T Corp. (“AT&T”). In August 2002, AOL Time Warner and AT&T announced that they had agreed to restructure TWE (Note 6).

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AOL TIME WARNER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)

Basis of Presentation

Restatement of Prior Financial Information

         The Company is conducting an internal review of certain advertising and commerce transactions at the AOL segment under the direction of the Company’s Chief Financial Officer. In connection with this internal review, the financial results for each of the quarters ended September 30, 2000 through June 30, 2002 will be restated. The total impact of the adjustments will be to reduce the Company’s consolidated advertising and commerce revenues by $190 million over these eight quarterly periods, with corresponding reductions in EBITDA and operating income and net income for that same time period of $97 million and $83 million and $46, respectively. For the AOL segment, the impact of the adjustments will be to reduce advertising and commerce revenues by $168 million over these eight quarterly periods, with corresponding reductions in EBITDA and operating income for that same time period of $97 million and $83 million, respectively. The remaining impact on the Company’s consolidated advertising and commerce revenues of $22 million represents a reduction in revenues from certain transactions related to the AOL segment in which the advertising was delivered by other AOL Time Warner segments. The adjustments represent approximately 1% of the AOL segment’s total revenues for that same two-year period, approximately 3.4% of its advertising and commerce revenues, approximately 1.9% of its EBITDA and approximately 2.1% of its operating income. The largest impact of the adjustments is in the quarter ended September 30, 2000, where advertising and commerce revenues will be reduced by $66 million and both EBITDA and operating income will be reduced by $30 million and net income will be reduced by $18 million. The restatement will result in a decrease in basic earnings per share of $0.01 in both the third and fourth quarters of 2000.

         It is expected that the audited financial statements for the affected periods will be filed with the Securities and Exchange Commission (“SEC”) in the fourth quarter of 2002. Until such time, the Company’s financial statements for the affected periods, including the audited financial statements contained in the 2001 Annual Report on Form 10-K, should no longer be relied upon as a result of the announced restatement.

         The financial results presented in this report reflect the impact of the adjustments that will be made in the restatement of the Company’s financial results. For the three months ended September 30, 2001, the total impact of these adjustments is a reduction of both the AOL segment’s and the Company’s consolidated advertising and commerce revenues of $16 million, with a corresponding reduction in EBITDA of $6 million operating income of $2 million and consolidated net income of $1 million. For the nine months ended September 30, 2002 and 2001, the total impact is a reduction of the Company’s consolidated advertising and commerce revenues of $12 million and $72 million, respectively, with a corresponding reduction in EBITDA of $14 million and $14 million, operating income of $10 million and $7 million, respectively and net income of $2 million and $4 million, respectively. For the AOL segment, for the nine months ended September 30, 2002 and 2001, the impact of these adjustments is a reduction of advertising and commerce revenues of $6 million and $57 million, respectively, with a corresponding reduction in EBITDA of $14 million and $14 million, respectively and operating income of $10 million and $7 million, respectively. The remaining impact on advertising and commerce revenues of $6 million and $15 million for the nine months ended September 30, 2002 and 2001, respectively, represents a reduction in revenues from certain transactions related to the AOL segment in which the advertising was delivered by other AOL Time Warner segments.

         The SEC and the Department of Justice (“DOJ”) are investigating the financial reporting and disclosure practices of the Company. The Company will continue its efforts to cooperate with the investigations. The Company is unable to predict the outcome of these investigations. Refer to Note 12 and Part II, Item 1 for additional information regarding the investigations.

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AOL TIME WARNER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)

Discontinued Operations

         As discussed in Note 7, the Company’s results of operations have been adjusted to reflect the results of the Advance/Newhouse Systems as a discontinued operation for all periods presented. For the six months ended June 30, 2002, the net impact of the deconsolidation of these systems was a reduction of the Cable segment’s previously reported revenues, EBITDA and operating income of $715 million, $333 million and $206 million, respectively. For the three months ended September 30, 2001, the net impact of the deconsolidation of the Advance/Newhouse Systems was a reduction of the Cable segment’s reported revenues, EBITDA and operating income of $316 million, $141 million and $74 million, respectively. For the nine months ended September 30, 2001, the net impact was a reduction of the Cable segment’s reported revenues, EBITDA and operating income of $912 million, $412 million and $225 million, respectively. In addition, as of December 31, 2001, the Advance/Newhouse Systems had current assets and total assets of approximately $64 million and $2.7 billion, respectively, and current liabilities and total liabilities of approximately $210 million and $963 million, respectively, including debt assumed in the restructuring.

Interim Financial Statements

The accompanying consolidated financial statements are unaudited but, in the opinion of management, contain all the adjustments (consisting of those of a normal recurring nature) considered necessary to present fairly the financial position and the results of operations and cash flows for the periods presented in conformity with accounting principles generally accepted in the United States applicable to interim periods. Reference is made to the unaudited consolidated financial statements of AOL Time Warner, included in its Annual Report on Form 10-K for the year ended December 31, 2001, as amended by Amendment No. 1 thereto on Form 10-K/A filed March 26, 2002 and Amendment No. 2 thereto on Form 10-K/A filed June 28, 2002 (the “2001 Form 10-K”). However, due to the previously discussed restatement of financial information, the financial statements included in the 2001 Form 10-K should no longer be relied upon.

Revenue Classification Changes

Reimbursement of “Out-of-Pocket” Expenses

         In January 2002, the Emerging Issues Task Force (“EITF”) of the Financial Accounting Standards Board (“FASB”) reached a consensus on EITF Issue No. 01-14, “Income Statement Characterization of Reimbursements Received for ‘Out-of-Pocket’ Expenses Incurred” (“EITF 01-14”). EITF 01-14 requires that reimbursements received for out-of-pocket expenses be classified as revenue on the income statement and was effective for AOL Time Warner in the first quarter of 2002. The new guidance requires retroactive restatement of all periods presented to reflect the new accounting provisions. This change in revenue classification impacts AOL Time Warner’s Cable and Music segments, resulting in an increase in both revenues and costs of approximately $92 million in the third quarter of 2001 and an increase in both revenues and costs of approximately $287 million for the first nine months of 2001.

Emerging Issues Task Force Issue No. 01-09

         In April 2001, EITF reached a final consensus on EITF Issue No. 00-25, “Vendor Income Statement Characterization of Consideration Paid to a Reseller of the Vendor’s Products,” which was later codified along with other similar issues, into EITF Issue No. 01-09, “Accounting for Consideration Given by a Vendor to a Customer or a Reseller of the Vendor’s Products” (“EITF 01-09”). EITF 01-09 was effective for AOL Time Warner in the first quarter of 2002. EITF 01-09 clarifies the income statement classification of costs incurred by a vendor in connection with the reseller’s purchase or promotion of the vendor’s products, resulting in certain cooperative advertising and product placement costs previously

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AOL TIME WARNER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)

classified as selling expenses to be reflected as a reduction of revenues earned from that activity. The new guidance impacts AOL Time Warner’s AOL, Music and Publishing segments and requires retroactive restatement of all periods presented to reflect the new accounting provisions. As a result of applying the provisions of EITF 01-09, the Company’s revenues and costs each were reduced by an equal amount of approximately $44 million in the third quarter of 2001 and approximately $154 million for the first nine months of 2001.

Accounting for Business Combinations

         In July 2001, the FASB issued Statements of Financial Accounting Standards (“Statement”) No. 141, “Business Combinations” and No. 142, “Goodwill and Other Intangible Assets” (“FAS 142”). These standards change the accounting for business combinations by, among other things, prohibiting the prospective use of pooling-of-interests accounting and requiring companies to stop amortizing goodwill and certain intangible assets with an indefinite useful life. Instead, goodwill and intangible assets deemed to have an indefinite useful life will be subject to an annual review for impairment. The new standards generally were effective for AOL Time Warner in the first quarter of 2002 and for purchase business combinations consummated after June 30, 2001. Upon adoption of FAS 142 in the first quarter of 2002, AOL Time Warner recorded a one-time, noncash charge of approximately $54 billion to reduce the carrying value of its goodwill. Such charge is non-operational in nature and is reflected as a cumulative effect of accounting change in the accompanying consolidated statement of operations. For additional discussion on the impact of adopting FAS 142, see Note 3.

Impact of Significant Acquisitions

         AOL Time Warner’s results for 2002 have been impacted by the following acquisitions that cause them not to be comparable to the results reported in 2001.

  Consolidation of AOL Europe, S.A. (“AOL Europe”). On January 31, 2002, AOL Time Warner acquired 80% of Bertelsmann AG’s (“Bertelsmann”) 49.5% interest in AOL Europe for $5.3 billion in cash and on July 1, 2002 acquired the remaining 20% of Bertelsmann’s interest for $1.45 billion in cash (Note 5). As a result of the purchase of Bertelsmann’s interest in AOL Europe, AOL Time Warner has a majority interest in and began consolidating AOL Europe, retroactive to the beginning of 2002.
 
  Consolidation of IPC Group Limited (“IPC”). In October 2001, AOL Time Warner’s Publishing segment acquired IPC, the parent company of IPC Media, from Cinven, one of Europe’s leading private equity firms, for approximately $1.6 billion.
 
  Consolidation of Road Runner. In August 2002, AOL Time Warner’s Cable segment acquired Advance/Newhouse’s 17% indirect ownership in Road Runner, increasing the Company’s fully attributed ownership to approximately 82%. As a result of the termination of Advance/Newhouse’s minority rights in Road Runner, AOL Time Warner has consolidated the financial position and results of operations of Road Runner with the financial position and results of operations of AOL Time Warner’s Cable segment. As permitted under generally accepted accounting principles, the Company has consolidated the results of Road Runner retroactive to the beginning of the 2002.

         If the consolidation of AOL Europe, IPC and Road Runner had occurred on January 1, 2001, for the three months ended September 30, 2001, the Company’s consolidated revenues would have increased by $349 million to $9.417 billion, operating loss would have increased by $209 million to $256 million, net loss would have increased by $192 million to $1.189 billion, and net loss per share would have increased by $0.05 to $0.27. For the nine months ended September 30, 2001, revenues would have increased by $1.045 billion to $27.896 billion, operating loss would have increased by $725

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AOL TIME WARNER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)

million to $799 million, net loss would have increased by $683 million to $3.786 billion, and net loss per share would have increased by $0.15 to $0.85

Reclassifications

         Certain reclassifications have been made to the prior year’s financial information to conform to the September 30, 2002 presentation.

2. MERGER AND RESTRUCTURING COSTS

Merger Costs

         In accordance with accounting principles generally accepted in the United States, AOL Time Warner generally treats merger costs relating to business combinations accounted for using the purchase method of accounting as additional purchase price paid. However, certain merger costs do not meet the criteria for capitalization and are expensed as incurred. Certain merger costs were expensed as incurred as they either related to the operations of the acquirer, including the AOL operations with respect to the Merger, or otherwise did not qualify as a liability or cost assumed in a purchase business combination, including AOL Time Warner’s acquisition of Time Warner. Merger costs both capitalized and expensed are discussed in more detail in the following paragraphs.

Merger Costs Capitalized as a Cost of Acquisition

         In connection with the Merger, the Company has reviewed its operations and implemented several plans to restructure the operations of America Online and Time Warner (“restructuring plans”). As part of the restructuring plans, the Company accrued a restructuring liability of approximately $1.340 billion during 2001. The restructuring accruals relate to costs to exit and consolidate certain activities of Time Warner, as well as costs to terminate employees across various Time Warner business units. Such amounts were recognized as liabilities assumed in the purchase business combination and included in the allocation of the cost to acquire Time Warner. Accordingly, such amounts resulted in additional goodwill being recorded in connection with the Merger.

         Of the total restructuring accrual, approximately $880 million related to work force reductions and represented employee termination benefits and relocation costs. Employee termination costs occurred across most Time Warner business units and ranged from senior executives to line personnel. The total number of employees initially identified to be involuntarily terminated or relocated approximated 8,200. As of September 30, 2002, approximately 6,100 of the terminations and relocations had occurred. The remaining 2,100 terminations and relocations are anticipated to occur during the fourth quarter of 2002 or are no longer expected to occur. In accordance with EITF Issue No. 95-3, “Recognition of Liabilities in Connection with a Purchase Business Combination,” the accruals associated with any termination or relocation that does not occur by the end of 2002 will be reversed against goodwill established in purchase accounting. Because certain employees can defer receipt of termination benefits for up to 24 months, cash payments are continuing after the employee was terminated. Termination payments of approximately $300 million were made in 2001 ($100 million of which was in the third quarter and $235 million for the first nine months of 2001), an additional $52 million was paid in the third quarter of 2002 and approximately $220 million was paid for the first nine months of 2002. In addition, for the first nine months of 2002, there were noncash reductions in the restructuring accrual of approximately $43 million ($27 million in the third quarter), as actual termination payments were less than amounts originally estimated. As of September 30, 2002, the remaining liability of approximately $317 million was primarily classified as a current liability in the accompanying consolidated balance sheet.

         The restructuring accrual also includes approximately $460 million associated with exiting certain activities, primarily related to lease and contract termination costs. Specifically, the Company plans to consolidate certain operations

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AOL TIME WARNER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)

and has exited other under-performing operations, including the Studio Store operations of the Filmed Entertainment segment and the World Championship Wrestling operations of the Networks segment. The restructuring accrual associated with other exiting activities specifically includes incremental costs and contractual termination obligations for items such as lease termination payments and other facility exit costs incurred as a direct result of these plans, which will not have future benefits. Payments related to exiting activities were approximately $165 million in 2001 ($30 million of which was paid in the third quarter and $90 million for the first nine months of 2001), an additional $18 million was paid in the third quarter of 2002 and $84 million was paid in the first nine months of 2002. In addition, for the first nine months of 2002, there were noncash reductions in the restructuring accrual of approximately $53 million ($38 million in the third quarter), as actual termination payments were less than amounts originally estimated. As of September 30, 2002, the remaining liability of approximately $158 million was primarily classified as a current liability in the accompanying consolidated balance sheet.

         Selected information relating to the restructuring costs included in the allocation of the cost to acquire Time Warner is as follows (in millions):

                         
            Other        
    Employee Termination   Exit Costs   Total
   
 
 
Initial Accruals
  $ 880     $ 460     $ 1,340  
Cash paid – 2001
    (300 )     (165 )     (465 )
 
   
     
     
 
Restructuring liability as of December 31, 2001
    580       295       875  
Cash paid – 2002
    (220 )     (84 )     (304 )
Noncash reductions(a) – 2002
    (43 )     (53 )     (96 )
 
   
     
     
 
Restructuring liability as of September 30, 2002
  $ 317     $ 158     $ 475  
 
   
     
     
 


(a)   Noncash reductions represent adjustments to the restructuring accrual, and a corresponding reduction in goodwill, as actual costs related to employee terminations and other exit costs were less than originally estimated.

Merger Costs Expensed as Incurred

         During 2001, the restructuring plans included approximately $250 million of merger costs that were expensed as incurred and included in merger and restructuring costs in the accompanying consolidated statement of operations ($134 million of which was recognized in the third quarter and $205 million for the first nine months of 2001). Of the $250 million, approximately $201 million related to employee termination benefits and other contractual terminations at the AOL segment. The number of employees expected to be terminated at the AOL segment was 2,430. The severed employees spanned all major departments and divisions within the AOL segment, including Technology, Digital City, MapQuest, AOL Brand, Member Services, Interactive Marketing, Compuserve, Business Affairs, AIM/ICQ, Netscape, Wireless Strategy, Spinner, Acquisition Marketing, iPlanet, Tech & Systems Development, AOL Products, Interactive Properties and Netscape. In addition, approximately $37 million of merger costs related to the renegotiation of various contractual commitments in the Music segment and approximately $12 million related to other merger-related costs, primarily costs incurred in connection with the termination of AOL Time Warner’s merger discussions with AT&T regarding their broadband businesses. As of September 30, 2002, approximately $38 million of the $250 million has not been paid and is primarily classified as a current liability in the accompanying consolidated balance sheet.

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AOL TIME WARNER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)

Restructuring Costs

         For the three and nine month periods ended September 30, 2002, the Company has incurred and accrued other restructuring costs of $77 million and $184 million, respectively, related to various contractual terminations and obligations, including certain contractual employee termination benefits. As of September 30, 2002, $74 million has been paid against these accruals. The remaining $110 million is primarily classified as a current liability in the accompanying consolidated balance sheet. These costs are included in merger and restructuring costs in the accompanying consolidated statement of operations.

         Included in the restructuring charge for the three and nine month periods of 2002 was $67 million and $131 million, respectively, related to lease obligations of the AOL segment for network modems that will no longer be used because network providers are upgrading their networks to newer technology. Specifically, under certain existing agreements with network providers, AOL is leasing the modems used in providing network services. In the first and third quarters, plans were established under which network providers would upgrade and replace the AOL supplied modems. Accordingly, the Company accrued the remaining lease obligations, less estimated recoveries, for the period that these modems will no longer be in use. The remaining $10 million of restructuring costs recorded during the three month period ended September 30, 2002, relates to certain contractual employee termination benefits. A liability related to contractual employee termination benefits is recognized when it becomes probable that the employee will be entitled to the benefits and such benefits can be reasonably estimated. The $10 million is comprised of $35 million of new accruals recorded during the quarter, partially offset by the reversal of a previously recorded accrual of $25 million as a result of it no longer being probable that the related contractual employee termination benefits would be paid by the Company.

3. GOODWILL AND INTANGIBLE ASSETS

         As discussed in Note 1, in January 2002, AOL Time Warner adopted FAS 142, which requires companies to stop amortizing goodwill and certain intangible assets with an indefinite useful life. Instead, FAS 142 requires that goodwill and intangible assets deemed to have an indefinite useful life be reviewed for impairment upon adoption of FAS 142 (January 1, 2002) and annually thereafter. The Company will perform its annual impairment review during the fourth quarter of each year, commencing in the fourth quarter of 2002.

         Under FAS 142, goodwill impairment is deemed to exist if the net book value of a reporting unit exceeds its estimated fair value. The Company’s reporting units are generally consistent with the operating segments underlying the segments identified in Note 11 – Segment Information. This methodology differs from AOL Time Warner’s previous policy, as provided under accounting standards existing at that time, of using undiscounted cash flows on an enterprise-wide basis to determine if goodwill was recoverable.

         Upon adoption of FAS 142 in the first quarter of 2002, AOL Time Warner recorded a one-time, noncash charge of approximately $54 billion to reduce the carrying value of its goodwill. Such charge is nonoperational in nature and is reflected as a cumulative effect of accounting change in the accompanying consolidated statement of operations. In calculating the impairment charge, the fair value of the impaired reporting units underlying the segments were estimated using either a discounted cash flow methodology, recent comparable transactions or a combination thereof.

         The FAS 142 goodwill impairment is associated solely with goodwill resulting from the Merger. The amount of the impairment primarily reflects the decline in the Company’s stock price since the Merger was announced and valued for accounting purposes in January of 2000. Prior to performing the review for impairment, FAS 142 required that all goodwill deemed to be related to the entity as a whole be assigned to all of the Company’s reporting units, including the reporting units of the acquirer. This differs from the previous accounting rules where goodwill was assigned only to the businesses of the company acquired. As a result, a portion of the goodwill generated in the Merger has been reallocated to the AOL segment.

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AOL TIME WARNER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)

         A summary of changes in the Company’s goodwill during the first nine months of 2002, and total assets at September 30, 2002, by business segment is as follows (in millions):

                                         
    Goodwill   Total Assets
   
 
    January 1,   Acquisitions &           September 30,   September 30,
    2002(1)   Adjustments(2)   Impairments(3)   2002   2002
   
 
 
 
 
    (Restated)                                
AOL
  $ 27,729     $ 8,551     $     $ 36,280     $ 41,369  
Cable
    33,259       183       (22,976 )     10,466       48,172  
Filmed Entertainment(4)
    9,110       (107 )     (4,091 )     4,912       15,839  
Networks(5)
    33,562       (54 )     (13,077 )     20,431       31,808  
Music
    5,477       31       (4,796 )     712       7,533  
Publishing
    18,283       (137 )     (9,259 )     8,887       14,089  
Corporate
                            2,078  
 
   
     
     
     
     
 
Total
  $ 127,420     $ 8,467     $ (54,199 )   $ 81,688     $ 160,888  
 
   
     
     
     
     
 


(1)   Reflects the reallocation of goodwill to the AOL reporting unit under FAS 142.
(2)   Adjustments primarily relate to the Company’s preliminary purchase price allocation for several acquisitions. Specifically, the ultimate goodwill associated with certain acquisitions (including IPC, Business 2.0, Synapse, AOL Europe, and This Old House) continues to be adjusted as the value of the assets and liabilities (including merger liabilities) acquired are finalized.
(3)   The impairment charge does not include approximately $(36) million related to goodwill impairments associated with equity investees.
(4)   Includes impairments at Warner Bros. $(2.851 billion) and at the Turner filmed entertainment businesses $(1.240 billion).
(5)   Includes impairments at the Turner cable networks $(10.933 billion), HBO $(1.933 billion) and The WB Network $(211 million).

         While the Company’s overall goodwill impairment analysis under FAS 142 will not be completed until the fourth quarter, based on the current market capitalization of AOL Time Warner as implied by the Company’s stock price, lower than expected performance at the AOL segment, and current market conditions in the cable industry, management believes that it is probable that a substantial overall goodwill impairment has occurred as of September 30, 2002. At this time, management is unable to reasonably estimate the magnitude of such an impairment. The factors that will affect the magnitude of impairment include management’s revised operating plan for the AOL segment, the results of the Company’s overall current budgeting and long-term plan process, and a valuation of assets (including unrecognized intangible assets) and liabilities, all of which will be completed in the fourth quarter. Additionally, the magnitude of any impairment will take into consideration AOL Time Warner’s overall market capitalization as well as the extent to which the stock price of comparable companies in the cable industry continue to experience a sustained decline in values. Any impairment charge would be noncash in nature and, therefore, is not expected to affect the Company’s liquidity or result in the non-compliance with any debt covenants, including the covenant to maintain at least $50 billion of GAAP net worth contained in the 2002 Credit Agreements. In addition, the Company would record any such noncash charge as a component of operating income.

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AOL TIME WARNER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)

         As of September 30, 2002 and December 31, 2001, the Company’s intangible assets and related accumulated amortization consisted of the following (in millions):

                                                 
    As of September 30, 2002   As of December 31, 2001
   
 
            Accumulated                   Accumulated        
    Gross   Amortization   Net   Gross   Amortization   Net
   
 
 
 
 
 
Intangible assets subject to amortization:
                                               
Music catalogues and copyrights
  $ 3,194     $ (290 )   $ 2,904     $ 3,080     $ (153 )   $ 2,927  
Film library
    3,559       (342 )     3,217       3,559       (196 )     3,363  
Customer lists and other intangible assets
    1,734       (693 )     1,041       1,519       (520 )     999  
 
   
     
     
     
     
     
 
Total
  $ 8,487     $ (1,325 )   $ 7,162     $ 8,158     $ (869 )   $ 7,289  
 
   
     
     
     
     
     
 
Intangible assets not subject to amortization:
                                               
Cable television franchises
  $ 28,567     $ (1,518 )   $ 27,049     $ 28,452     $ (1,878 )   $ 26,574  
Sports franchises
    500       (20 )     480       500       (20 )     480  
Brands, trademarks and other intangible assets
    11,091       (320 )     10,771       10,974       (320 )     10,654  
 
   
     
     
     
     
     
 
Total
  $ 40,158     $ (1,858 )   $ 38,300     $ 39,926     $ (2,218 )   $ 37,708  
 
   
     
     
     
     
     
 

         The Company recorded amortization expense of $181 million during the third quarter of 2002 compared to $1.784 billion during the third quarter of 2001. The Company recorded amortization expense of $520 million for the first nine months of 2002 compared to $5.318 billion for the first nine months of 2001. Based on the current amount of intangible assets subject to amortization, the estimated amortization expense for each of the succeeding 5 years are as follows: 2003: $662 million; 2004: $645 million; 2005: $577 million; 2006: $441 million; and 2007: $373 million. As acquisitions and dispositions occur in the future and as purchase price allocations are finalized, these amounts may vary.

         During the first nine months of 2002, the Company acquired the following intangible assets (in millions):

                 
            Weighted Average
            Amortization Period
           
Music catalogues and copyrights
  $ 70     15 years
Customer lists and other intangible assets subject to amortization
    307     6 years
Cable television franchises (a)
    1,193     Indefinite
Brands, trademarks and other intangible assets not subject to amortization
    117     Indefinite
 
   
         
Total
  $ 1,687          
 
   
         


(a)   The increase in cable television franchises primarily relates to the increase in the carrying value of AT&T’s interest in the TWE-Advance/Newhouse Partnership as part of a restructuring of that partnership (Note 7).

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)

         The 2001 results do not reflect the provisions of FAS 142. Had AOL Time Warner adopted FAS 142 on January 1, 2001, the net income (loss) and basic and diluted net income (loss) per common share would have been changed to the adjusted amounts indicated below:

                         
    Three Months Ended September 30, 2001 (Restated)
   
    (millions, except per share amounts)
            Net income   Net income
    Net income   (loss) per basic   (loss) per diluted
    (loss)   common share   common share
   
 
 
As reported
  $ (997 )   $ (0.22 )   $ (0.22 )
Impact of dilutive shares on net loss
                0.01  
Add: Goodwill amortization
    1,320       0.30       0.29  
Add: Intangible amortization
    372       0.08       0.08  
Add: Equity investee goodwill amortization
    99       0.02       0.02  
Minority interest impact
    (41 )     (0.01 )     (0.01 )
Income tax impact (a)
    (176 )     (0.04 )     (0.04 )
Discontinued operations
    10              
 
   
     
     
 
Adjusted
  $ 587     $ 0.13     $ 0.13  
 
   
     
     
 


(a)   Because goodwill is nondeductible for tax purposes, the income tax impact reflects only the ceasing of intangible amortization and equity investee goodwill amortization.
                         
    Nine Months Ended September 30, 2001 (Restated)
   
    (millions, except per share amounts)
            Net income   Net income
    Net income   (loss) per basic   (loss) per diluted
    (loss)   common share   common share
   
 
 
As reported
  $ (3,103 )   $ (0.70 )   $ (0.70 )
Impact of dilutive shares on net loss
                0.03  
Add: Goodwill amortization
    3,899       0.88       0.85  
Add: Intangible amortization
    1,080       0.24       0.23  
Add: Equity investee goodwill amortization
    383       0.09       0.08  
Minority interest impact
    (120 )     (0.03 )     (0.03 )
Income tax impact (a)
    (549 )     (0.12 )     (0.12 )
Discontinued operations
    30       0.01       0.01  
 
   
     
     
 
Adjusted
  $ 1,620     $ 0.37     $ 0.35  
 
   
     
     
 


(a)   Because goodwill is nondeductible for tax purposes, the income tax impact reflects only the ceasing of intangible amortization and equity investee goodwill amortization.

4. INVESTMENTS

Investment Write-Downs

         The United States economy has experienced a broad decline in the public equity markets, particularly in technology stocks, including investments held in the Company’s portfolio. Similarly, the Company experienced significant declines in the value of certain privately held investments and restricted securities. As a result, the Company recorded noncash pretax charges to reduce the carrying value of certain investments that experienced other-than-temporary declines of approximately $733 million in the third quarter of 2002 and $1.678 billion for the nine months ended September 30, 2002, which are included in other expense, net, in the accompanying consolidated statement of operations. Included in these amounts were approximately $1 million of net losses on equity warrants for the third quarter of 2002 and $7 million of net gains on equity warrants in the first nine months of 2002. The Company recorded noncash pretax charges of $196 million for the third quarter of 2001 and $816 million for the first nine months of 2001, which are included in other expense, net, in the accompanying consolidated statement of operations. Included in these amounts were approximately $49 million of net

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AOL TIME WARNER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)

losses on equity warrants for the third quarter of 2001 and $33 million of net losses on equity warrants in the first nine months of 2001.

         Included in the noncash pretax charges for three and nine month periods ended September 30, 2002 are charges related to the writedown of AOL Time Warner’s investments in Time Warner Telecom Inc. (“Time Warner Telecom”) of $24 million for the three-month period and $796 million for the nine-month period, Gateway Inc. of $39 million for the three-month period and $140 million for the nine-month period, Hughes Electronics Corp. (“Hughes”) of $505 million for both the three and nine-month periods and America Online Latin America, Inc. (“AOL Latin America”) of $106 million for both the three and nine-month periods for declines deemed other-than temporary. Time Warner Telecom is a leading fiber facilities-based provider of metropolitan and regional optical broadband networks and services to business customers. The value of the Time Warner Telecom investment was adjusted upward in the Merger by over $2 billion to its estimated fair value. Since the date of the Merger, Time Warner Telecom’s share price has declined significantly, resulting in impairment charges of approximately $1.2 billion in the fourth quarter of 2001 and approximately $796 million for the first nine months of 2002. As of September 30, 2002, the remaining carrying value of the Company’s investment in Time Warner Telecom after equity losses, is approximately $41 million.

         As of September 30, 2002, Time Warner Telecom was owned 44% by AOL Time Warner, 14% by Advance/Newhouse Partnership and 42% by other third parties. AOL Time Warner’s interest in Time Warner Telecom is being accounted for using the equity method of accounting. For the three months ended September 30, 2002, Time Warner Telecom had revenues, operating loss and net loss of approximately $167 million, $22 million and $48 million, respectively. For the nine months ended September 30, 2002, Time Warner Telecom had revenues, operating loss and net loss of approximately $520 million, $44 million and $122 million, respectively.

         As of September 30, 2002, AOL Time Warner has total investments, excluding equity-method investments, with a carrying value of $1.699 billion for which their estimated fair value exceeded the carrying value by approximately $43 million.

Sale of Columbia House

         Prior to June 2002, the Columbia House Company Partnerships (“Columbia House”) was a 50-50 joint venture between AOL Time Warner and Sony Corporation of America (“Sony”). In June 2002, AOL Time Warner and Sony reached a definitive agreement to each sell 85% of its 50% interest in Columbia House to Blackstone Capital Partners III LP (“Blackstone”), an affiliate of The Blackstone Group, a private investment bank. Under the terms of the sale agreement, the Company received proceeds of approximately $125 million in cash and a subordinated note receivable from Columbia House Holdings, Inc., a majority owned subsidiary of Blackstone, with a face amount of approximately $35 million. The sale has resulted in the Company recognizing a pretax gain of approximately $59 million, which is included in other expense, net, in the accompanying consolidated statement of operations. In addition, the Company has deferred an approximate $28 million gain on the sale. The deferred gain primarily relates to the estimated fair value of the portion of the proceeds received as a note receivable, which will be deferred until such time as the realization of such note becomes more fully assured. As a result of the sale, the Company’s interest in Columbia House has been reduced to 7.5%. As part of the transaction, AOL Time Warner will continue to license music and video product to Columbia House for a five-year period.

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AOL TIME WARNER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)

Redemption of an Interest in TiVo

         During the second quarter of 2002, approximately 1.6 million shares of preferred stock of TiVo Inc. (“TiVo”) held by the Company were redeemed. As a part of this transaction, the Company also sold certain rights and licenses for developed technology to TiVo. In return, the Company received proceeds of approximately $44 million of cash and recognized a gain of approximately $31 million, which is included in other expense, net, in the accompanying consolidated statement of operations.

AOL Latin America

         AOL Latin America is a joint venture among AOL Time Warner, the Cisneros Group and Banco Itaú (a leading Brazilian bank) that provides online services and support principally to customers in Brazil, Mexico and Argentina. In August 2000, AOL Latin America completed an initial public offering of approximately 25 million shares of its Class A common stock, representing approximately 10% of the ownership interest in AOL Latin America at the time of the offering.

         In March 2002, AOL Time Warner announced that it would make available to AOL Latin America up to $160 million throughout 2002 to fund the operations of AOL Latin America. In exchange for this investment, AOL Time Warner would receive senior convertible notes. Each note carries a fixed interest rate of 11% per annum (payable quarterly), has a five-year maturity and is convertible into AOL Latin America convertible preferred stock, which is convertible into Class A common stock of AOL Latin America at a conversion price of $3.624 per share (20% above the market price at the time of investment). AOL Latin America has the option to redeem the notes after 18 months and the option to make interest payments in either cash or additional shares of convertible preferred stock. As of September 30, 2002, AOL Time Warner had provided AOL Latin America approximately $71 million of this committed amount.

         In addition, as of September 30, 2002, the Company held approximately 4 million shares of Class A common stock, warrants to purchase approximately 16.5 million shares of Class A common stock with an exercise price of $8 per share and approximately 121.7 million shares of Series B Redeemable Convertible Preferred Stock, which are convertible into an equal number of Class A common shares. On October 3, 2002, the Company and AOL Latin America entered into an agreement pursuant to which the Company is obligated in certain circumstances to convert a number of its Series B Redeemable Convertible Preferred Stock into shares of Class A common stock on a one-for-one basis. The purpose of the agreement and the proposed conversion is to facilitate the continued listing of AOL Latin America’s Class A common stock on the Nasdaq SmallCap Market. Assuming the conversion of all of the Company’s investments in convertible securities of AOL Latin America, including the full $160 million principal amount of notes, AOL Time Warner’s economic interest in AOL Latin America would increase to approximately 50% on a fully diluted basis. However, even if AOL Time Warner’s economic interest reached 50%, the Company would continue to account for its investment under the equity method of accounting because of certain approval rights held by a minority partner in AOL Latin America. On November 5, 2002, the Nasdaq granted AOL Latin America an exception to the market capitalization listing requirement for a period of time. Based on the closing bid price of AOL Latin America common stock on November 5, 2002, the Company was not obligated to convert any shares of its Series B Redeemable Convertible Preferred Stock.

         Based upon the fair value of the Company’s investment in AOL Latin America, the Company determined that both the senior convertible notes and the Series B Redeemable Convertible Preferred Stock had experienced other-than-temporary declines in value of $106 million in the aggregate. As previously discussed, the Company is committed to fund up to an additional $89 million prior to December 31, 2002, including approximately $9.5 million, which was funded in October 2002, in exchange for additional senior convertible notes. Depending upon the financial condition of AOL Latin America and general market conditions, the Company may be required to record an additional noncash charge to reduce the carrying value of its investment in the near future.

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AOL TIME WARNER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  —  (Continued)
(Unaudited)

5. AOL EUROPE

         AOL Europe was a joint venture between AOL Time Warner and Bertelsmann AG (“Bertelsmann”). In March 2000, America Online and Bertelsmann announced an agreement to restructure their interests in AOL Europe. This restructuring consisted of a put and call arrangement under which the Company could purchase or be required to purchase Bertelsmann’s 49.5% interest in AOL Europe for consideration ranging from $6.75 billion to $8.25 billion.

         On January 31, 2002, AOL Time Warner acquired 80% of Bertelsmann’s 49.5% interest in AOL Europe for $5.3 billion in cash as a result of Bertelsmann’s exercise of its initial put option. On July 1, 2002, AOL Time Warner acquired the remaining 20% of Bertelsmann’s interest for $1.45 billion in cash. As a result of the purchase of Bertelsmann’s interest in AOL Europe, AOL Time Warner has a majority interest in and began consolidating AOL Europe, retroactive to the beginning of 2002. Previously, the Company owned a 49.5% preferred interest in AOL Europe and accounted for its investment in AOL Europe using the equity method of accounting. At January 31, 2002, AOL Europe had $573 million of debt which was subsequently refinanced with AOL Time Warner debt carrying lower interest rates. Additionally, in February 2002, certain redeemable preferred securities previously issued by AOL Europe were redeemed for $255 million. AOL Europe’s remaining $725 million of preferred securities are required to be redeemed in April 2003 for approximately $815 million including accrued dividends, in cash, AOL Time Warner common stock, or a combination thereof, at the discretion of the Company (Note 10).

         As of January 1, 2002, AOL Europe had total assets of approximately $150 million, consisting principally of approximately $88 million in receivables and approximately $52 million in cash and equivalents. In addition, AOL Europe had approximately $2.0 billion of total liabilities, including $573 million of debt, approximately $415 million of other current liabilities and approximately $1 billion of redeemable preferred securities, including $255 million of redeemable preferred securities redeemed in February 2002. The assets and liabilities of AOL Europe are included in the AOL segment. In connection with the allocation of the price paid by AOL Time Warner to acquire the additional interest in AOL Europe, the AOL segment recognized approximately $8.4 billion of goodwill and approximately $230 million of subscriber lists, which will be amortized over a useful life of 5 years with no residual value. The allocation of the purchase price is preliminary because the Company has yet to complete its valuation process for these intangible assets.

6. INVESTMENT IN TWE

         TWE is a Delaware limited partnership that was capitalized in 1992 and currently owns and operates substantially all of the Filmed Entertainment-Warner Bros., Networks-HBO and The WB Network, and Cable businesses previously owned by subsidiaries of AOL Time Warner. As of March 31, 2002, AOL Time Warner, through its wholly owned subsidiaries, collectively owned general and limited partnership interests in TWE consisting of 74.49% of the Series A Capital and Residual Capital and 100% of the Series B Capital. The remaining 25.51% limited partnership interests in the Series A Capital and Residual Capital of TWE were held by AT&T. Certain AOL Time Warner subsidiaries are the general partners of TWE (the “General Partners”).

         During the second quarter of 2002, AT&T exercised a one-time option to increase its ownership in the Series A Capital and Residual Capital of TWE. The option allowed AT&T to obtain up to an additional 6.33% of Series A Capital and Residual Capital interests determined based on the compounded annual growth rate of TWE’s adjusted Cable EBITDA, as defined in the option agreement, over the life of the option, and whether AT&T or TWE elected to have the exercise price paid with partnership interests rather than cash. On April 19, 2002, AT&T

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AOL TIME WARNER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  —  (Continued)
(Unaudited)

delivered to TWE a notice that the option would be exercised on a cashless basis, effective May 31, 2002. As a result, on May 31, 2002, AT&T’s interest in the Series A Capital and Residual Capital of TWE increased by approximately 2.13% to approximately 27.64% and AOL Time Warner’s corresponding interest in the Series A and Residual Capital of TWE decreased by approximately 2.13% to approximately 72.36%. In accordance with Staff Accounting Bulletin No. 51, “Accounting for Sales of Stock of a Subsidiary,” AOL Time Warner has reflected the pretax impact of the dilution of its interest in TWE of approximately $690 million as an adjustment to equity. Due to the Company’s 100% ownership of the Series B Capital, AOL Time Warner’s economic interest in TWE exceeds 72.36%.

         In August 2002, AOL Time Warner and AT&T announced that they had agreed to restructure TWE. As part of the restructuring, AOL Time Warner will acquire complete ownership of TWE’s content assets, including Warner Bros. and Home Box Office, as well as TWE’s interests in The WB Network, Comedy Central and Court TV. In addition, almost all of AOL Time Warner’s interests in TWE and all of its interests in cable television systems held through wholly-owned subsidiaries, will be contributed to an existing subsidiary of AT&T that will become a subsidiary of AOL Time Warner and will be renamed “Time Warner Cable Inc.” In connection with the restructuring, AT&T will receive $2.1 billion in cash and AOL Time Warner common stock valued at $1.5 billion at the time of closing the restructuring and will retain a 17.9% economic stake in Time Warner Cable Inc. and a 4.7% economic stake in TWE. AT&T’s combined interests in Time Warner Cable Inc. and TWE will result in AT&T holding an approximately 21% economic interest in the business of Time Warner Cable Inc. AT&T’s 17.9% economic stake in Time Warner Cable Inc. will represent approximately a 10.7% voting interest in Time Warner Cable Inc. The Company anticipates that the restructuring will be completed in early 2003, upon the receipt of local cable franchise approvals, where required, and other required regulatory approvals. Clearance under the Hart-Scott -Rodino Antitrust Improvement Act of 1976 has been received.

         Based upon its controlling voting interest in Time Warner Cable Inc., AOL Time Warner will consolidate the results of Time Warner Cable Inc. for accounting purposes. At the closing of the restructuring, it is anticipated that Time Warner Cable Inc. will have approximately $8.1 billion in consolidated net debt and preferred equity. Subject to market conditions, AOL Time Warner plans to conduct an initial public offering of Time Warner Cable Inc. soon after the closing of the restructuring. It is anticipated that the first $2.1 billion raised in any such offering would be used to repay Time Warner Cable Inc.’s debt incurred to fund the $2.1 billion cash payment to AT&T. Thereafter, AT&T will have certain priority registration rights with respect to its interest in Time Warner Cable Inc.

         The TWE partnership agreement provides for special allocations of income, loss and distributions of partnership capital, including priority distributions in the event of liquidation. As a result of the Merger, a portion of the $147 billion cost to acquire Time Warner was allocated to the underlying net assets of TWE, to the extent acquired. TWE reported net income of $1.336 billion, excluding a $1.2 billion gain relating to the restructuring of the TWE-Advance/Newhouse Partnership (Note 7) and a $22 billion noncash charge related to the cumulative effect of an accounting change, for the first nine months of 2002 and a net loss of $823 million for the first nine months of 2001. Because of the priority rights over allocations of income and distributions of TWE held by the General Partners, $1.239 billion of TWE’s income for the nine months ended September 30, 2002 was allocated to AOL Time Warner and $97 million was allocated to AT&T. For 2001, $820 million of TWE’s loss for the nine months ended September 30, 2001 was allocated to AOL Time Warner and $45 million was allocated to AT&T. The allocation of a portion of TWE’s loss to AT&T in 2001 was almost entirely offset by the allocation to AT&T of pretax gains attributable to AT&T that were recognized in connection with the sale or exchange of various cable television systems at TWE.

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AOL TIME WARNER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  —  (Continued)
(Unaudited)

         The assets and cash flows of TWE are restricted by the TWE partnership and credit agreements. As such, they are unavailable for use by the partners except through the payment of certain fees, reimbursements, cash distributions and loans, which are subject to limitations.

7. RESTRUCTURING OF TWE-ADVANCE/NEWHOUSE PARTNERSHIP AND ROAD RUNNER

         As of June 30, 2002, the TWE-Advance/Newhouse Partnership (“TWE-A/N”) was owned approximately 64.8% by TWE, the managing partner, 33.3% by the Advance/Newhouse Partnership (“Advance/Newhouse”) and 1.9% indirectly by AOL Time Warner. Prior to August 1, 2002, the financial position and operating results of TWE-A/N were consolidated by AOL Time Warner and TWE, and the partnership interest owned by Advance/Newhouse was reflected in the consolidated financial statements of AOL Time Warner and TWE as minority interest. In addition, Road Runner, a high-speed cable modem Internet service provider, was owned by TWI Cable Inc. (a wholly owned subsidiary of AOL Time Warner), TWE and TWE-A/N, with AOL Time Warner owning approximately 65% on a fully attributed basis (i.e., after considering the portion attributable to the minority partners of TWE and TWE-A/N). AOL Time Warner’s interest in Road Runner was previously accounted for using the equity method of accounting prior to the restructuring because of certain approval rights held by Advance/Newhouse, a partner in TWE-A/N.

         On June 24, 2002, TWE and Advance/Newhouse agreed to restructure TWE-A/N, which, on August 1, 2002, (the “Debt Closing Date”) resulted in Advance/Newhouse assuming responsibility for the day-to-day operations of certain TWE-A/N cable systems serving approximately 2.1 million subscribers located primarily in Florida (the “Advance/Newhouse Systems”). The restructuring is anticipated to be completed by the end of 2002, upon the receipt of certain regulatory approvals. On the Debt Closing Date, Advance/Newhouse and its affiliates arranged for a new credit facility to support the Advance/Newhouse Systems assumed and repaid approximately $780 million of TWE-A/N’s senior indebtedness. As of the Debt Closing Date, Advance/Newhouse assumed responsibility for the day-to-day operations of the Advance/Newhouse Systems. As a result, AOL Time Warner and TWE have deconsolidated the financial position and operating results of these systems. Additionally, all prior period results associated with the Advance/Newhouse Systems, including the historical minority interest allocated to Advance/Newhouse’s interest in TWE-A/N, have been reflected as a discontinued operation for all periods presented. Under the new TWE-A/N Partnership Agreement, effective as of the Debt Closing Date, Advance/Newhouse’s partnership interest tracks only the economic performance of the Advance/Newhouse Systems, including associated liabilities, while AOL Time Warner retains all of the economic interests in the other TWE-A/N assets and liabilities. The net impact of the deconsolidation of these systems was a reduction of the Cable segment’s previously reported six months ended June 30, 2002, revenues, EBITDA and operating income of $715 million, $333 million and $206 million, respectively. For the three and nine months ended September 30, 2001, the net impact of the deconsolidation of these systems was a reduction of the Cable segment’s reported revenues, EBITDA and operating income of $316 million and $912 million, respectively, $141 million and $412 million, respectively and $74 million and $225 million, respectively.

         As part of the restructuring of TWE-A/N, on the Debt Closing Date, AOL Time Warner effectively acquired Advance/Newhouse’s interest in Road Runner, thereby increasing its ownership to approximately 82% on a fully attributed basis. As a result of the termination of Advance/Newhouse’s minority rights in Road Runner, AOL Time Warner has consolidated the financial position and results of operations of Road Runner with the financial position and results of operations of AOL Time Warner’s Cable segment. As permitted under generally accepted accounting principles, the Company has consolidated the results of Road Runner retroactive to the beginning of the year.

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AOL TIME WARNER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  —  (Continued)
(Unaudited)

         In connection with the TWE-A/N restructuring, AOL Time Warner recognized a noncash pretax gain of approximately $1.4 billion. Of this gain, approximately $1.2 billion related to the difference between the carrying value and fair value of AT&T’s interest in the Advance/Newhouse Systems, with the fair value being determined by reference to the fair value of AT&T’s additional interest acquired in the remaining TWE-A/N systems. This gain is included as part of discontinued operations in the accompanying consolidated statement of operations. However, because this gain relates in large part to AT&T’s interest in TWE-A/N, it is substantially offset by minority interest expense, which is similarly included as part of discontinued operations. The remaining pretax gain of $188 million relates to the amount that the fair value of AOL Time Warner’s acquired interest in the TWE-A/N systems remaining under the control of AOL Time Warner exceeded the carrying value of AOL Time Warner’s interest in the Advance/Newhouse Systems, and primarily relates to the portion of TWE-A/N debt assumed by Advance/Newhouse in excess of its pro rata share in effective compensation for certain adverse tax consequences to the Company as a result of the restructuring. The gain is significantly less than the gain recognized by AT&T because the carrying value of AOL Time Warner’s interest in TWE-A/N, including its interest in the Advance/Newhouse Systems, was recently adjusted to fair value as part of the purchase accounting for the Merger. The $188 million pretax gain is also included as part of discontinued operations of AOL Time Warner for the three and nine month periods ended September 30, 2002. Exclusive of the gains associated with these transactions, the impact of the TWE-A/N restructuring on AOL Time Warner’s consolidated net income is substantially mitigated because the earnings of TWE-A/N attributable to Advance/Newhouse’s historical one-third interest was reflected as minority interest expense. As stated previously, this historical minority interest expense is currently classified as part of the discontinued operations for all periods presented. Additionally, there is no impact on AOL Time Warner’s consolidated net income of consolidating Road Runner since the Company had previously accounted for its interest in Road Runner under the equity method of accounting.

8. INVENTORIES

         Inventories and film costs consist of:

                   
      September 30, 2002   December 31, 2001
     
 
      (millions)
Programming costs, less amortization
  $ 2,542     $ 2,536  
Magazines, books, recorded music and other merchandise
    504       553  
Film costs-Theatrical:
               
 
Released, less amortization
    719       847  
 
Completed and not released
    309       356  
 
In production
    460       381  
 
Development and pre-production
    263       290  
Film costs-Television:
               
 
Released, less amortization
    65       162  
 
Completed and not released
    175       95  
 
In production
    34       59  
 
Development and pre-production
    4       2  
 
   
     
 
Total inventories and film costs(a)
    5,075       5,281  
Less current portion of inventory(b)
    1,731       1,791  
 
   
     
 
Total noncurrent inventories and film costs
  $ 3,344     $ 3,490  
 
   
     
 


(a)   Does not include $3.217 billion and $3.363 billion of net film library costs as of September 30, 2002 and December 31, 2001, respectively, which are included in intangible assets subject to amortization on the accompanying consolidated balance sheet. See Note 3.
(b)   Current inventory as of September 30, 2002 is comprised of programming inventory for the Networks segment (approximately $1.227 billion), books from the publishing business (approximately $229 million), videocassettes, DVDs and compact discs from the filmed entertainment and music business (approximately $238 million), and general merchandise, primarily at the AOL business (approximately $37 million).

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AOL TIME WARNER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  —  (Continued)
(Unaudited)

9. LONG-TERM DEBT

         In January 2001, AOL Time Warner filed a shelf registration statement with the SEC, which allowed AOL Time Warner to offer and sell from time to time, debt securities, preferred stock, series common stock, common stock and/or warrants to purchase debt and equity securities in amounts up to $10 billion in initial aggregate public offering prices. On April 19, 2001, AOL Time Warner issued an aggregate of $4 billion principal amount of debt securities under this shelf registration statement at various fixed interest rates and maturities of 5, 10 and 30 years. On April 8, 2002, AOL Time Warner issued the remaining $6 billion principal amount of debt securities under this shelf registration statement at various fixed interest rates and maturities of 3, 5, 10 and 30 years. The net proceeds to the Company were approximately $3.964 billion under the first issuance and approximately $5.930 billion under the second issuance, both of which were used for general corporate purposes, including, but not limited to, the repayment of outstanding commercial paper and bank debt. The securities under both issuances are guaranteed on an unsecured basis by each of America Online and Time Warner. In addition, Time Warner Companies, Inc. (“TW Companies”) and Turner Broadcasting System, Inc. (“TBS”) have guaranteed, on an unsecured basis, Time Warner’s guarantee of the securities.

         In July 2002, AOL Time Warner, together with certain of its consolidated subsidiaries, entered into two new senior unsecured long-term revolving bank credit agreements with an aggregate borrowing capacity of $10 billion (the “2002 Credit Agreements”) and terminated three existing bank credit facilities with an aggregate borrowing capacity of $12.6 billion (the “Old Credit Agreements”), which were scheduled to expire during 2002. The 2002 Credit Agreements are comprised of a $6 billion five-year revolving credit facility and a $4 billion 364-day revolving credit facility, borrowings under which may be extended for a period up to two years following the initial term. The borrowers under the 2002 Credit Agreements are AOL Time Warner, TWE, TWE-A/N and AOL Time Warner Finance Ireland. The obligations of each of AOL Time Warner and AOL Time Warner Finance Ireland are guaranteed by America Online, Time Warner, TBS and TW Companies, directly or indirectly. The obligation of AOL Time Warner Finance Ireland is guaranteed by AOL Time Warner. Borrowings bear interest at specific rates, generally based on the credit rating for each of the borrowers, which is currently equal to LIBOR plus .625%, including facility fees of .10% and .125% on the total commitments of the 364-day and five-year facilities, respectively. In addition, the Company is required to pay an additional usage fee of .0625% if the two facilities in the aggregate have more than 33% outstanding and .125% if the facilities have more than 66% outstanding. Currently, the Company is paying the additional .0625% usage fee. The 2002 Credit Agreements provide same-day funding, multi-currency capability and letter of credit availability. They contain maximum leverage ratio and minimum GAAP net worth covenants of 4.5 times and $50 billion, respectively, for AOL Time Warner and a maximum leverage ratio covenant of 5.0 times for each of TWE and TWE-A/N, but do not contain any credit ratings-based defaults or covenants, nor an ongoing covenant or representation specifically relating to a material adverse change in the Company’s financial condition or results of operations. Borrowings may be used for general business purposes and unused credit is available to support commercial paper borrowings.

10. MANDATORILY REDEEMABLE PREFERRED SECURITIES

         AOL Europe has 725,000 shares of redeemable preferred securities outstanding with a liquidation preference of $725 million. Dividends are accreted at an annual rate of 6% and the total accumulated dividends as of September 30, 2002 were approximately $67 million. These securities and related dividends are classified as Minority Interest in the accompanying consolidated balance sheet. The preferred shares are required to be redeemed no later than April 1, 2003 in cash, AOL Time Warner stock or a combination thereof, at the Company’s discretion.

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AOL TIME WARNER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)

         In 1995, the Company, through TW Companies, issued approximately 23 million Company-obligated mandatorily redeemable preferred securities of a wholly owned subsidiary (“Preferred Trust Securities”) for aggregate gross proceeds of $575 million. The sole assets of the subsidiary that was the obligor on the Preferred Trust Securities were $592 million principal amount of 8 7/8% subordinated debentures of TW Companies due December 31, 2025. Cumulative cash distributions were payable on the Preferred Trust Securities at an annual rate of 8 7/8%. The Preferred Trust Securities were mandatorily redeemable for cash on December 31, 2025, and TW Companies had the right to redeem the Preferred Trust Securities, in whole or in part, on or after December 31, 2000, or in other certain circumstances.

         On February 13, 2001, TW Companies redeemed all 23 million shares of the Preferred Trust Securities. The redemption price was $25 per security, plus accrued and unpaid distributions thereon equal to $0.265 per security. The total redemption price of $581 million was funded with borrowings under the Old Credit Agreements.

11. SEGMENT INFORMATION

         AOL Time Warner classifies its business interests into six fundamental areas: AOL, consisting principally of interactive services, Web properties, Internet technologies and electronic commerce services; Cable, consisting principally of interests in cable television systems; Filmed Entertainment, consisting principally of interests in filmed entertainment and television production; Networks, consisting principally of interests in cable television and broadcast network programming; Music, consisting principally of interests in recorded music, music publishing and DVD manufacturing; and Publishing, consisting principally of interests in magazine publishing, book publishing and direct marketing.

         Information as to the operations of AOL Time Warner in different business segments is set forth below based on the nature of the products and services offered. AOL Time Warner evaluates performance based on several factors, of which the primary financial measure is operating income (loss) before noncash depreciation of tangible assets and amortization of intangible assets (“EBITDA”).

         The accounting policies of the business segments are the same as those described in the summary of significant accounting policies under Note 1 in the Company’s 2001 Form 10-K. Intersegment sales are accounted for at fair value as if the sales were with third parties.

                                   
      Three Months Ended September 30,   Nine Months Ended September 30,
     
 
      2002   2001(a)   2002   2001(a)
     
 
 
 
              (Restated)           (Restated)
                       
      (in millions)
Revenues
                               
AOL
  $ 2,215     $ 2,173     $ 6,772     $ 6,373  
Cable(b)
    1,753       1,525       5,198       4,404  
Filmed Entertainment
    2,643       2,112       7,165       6,217  
Networks
    1,832       1,663       5,575       5,190  
Music
    983       962       2,902       2,801  
Publishing
    1,353       1,095       3,830       3,179  
Intersegment elimination
    (796 )     (462 )     (1,801 )     (1,313 )
 
   
     
     
     
 
 
Total revenues
  $ 9,983     $ 9,068     $ 29,641     $ 26,851  
 
   
     
     
     
 


(a)   Revenues reflect the provisions of EITF 01-09 and EITF 01-14 that were adopted by the Company in the first quarter of 2002, which require retroactive restatement of 2001 to reflect the new accounting provisions. As a result, the net impact of EITF 01-09 and EITF 01-14 was to increase revenues and costs by equal amounts of approximately $48 million for the third quarter of 2001 and approximately $133 million for the first nine months of 2001. The net increase (decrease) in revenues and costs for the three-month period by business segment is as follows: AOL $(7) million, Cable $59 million, Music $23 million and Publishing $(27) million, and for the nine-month period is, AOL $(29) million, Cable $172 million, Music $86 million and Publishing $(96) million.
(b)   The Cable segment’s results reflect the restructuring of TWE-A/N, which resulted in the deconsolidation of the operating results of the Advance/Newhouse Systems for all periods presented. For the three and nine months ended September 30, 2001, and the six months ended June 30, 2002, the net impact of the deconsolidation of these systems was a reduction of the Cable segment’s reported revenues of $316 million, $912 million and $715 million, respectively. In addition, the Cable segment’s results reflect the consolidation of Road Runner’s operating results effective January 1, 2002.

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AOL TIME WARNER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)

Intersegment Revenues

         In the normal course of business, the AOL Time Warner segments enter into transactions with one another. The most common types of intercompany transactions include:

  The Filmed Entertainment segment generating content revenue by licensing television and theatrical programming to the Networks segment;
 
  The Networks segment generating subscription revenues by selling cable network programming to the Cable segment; and
 
  The AOL, Cable, Networks and Publishing segments generating advertising and commerce revenue by cross-promoting the products and services of all AOL Time Warner segments.
 
  The Music segment generating content revenue by manufacturing DVDs for the Filmed Entertainment segment.

         These intercompany transactions are recorded by each segment at fair value as if the transactions were with third parties and, therefore, impact segment performance. While intercompany transactions are treated like third-party transactions to determine segment performance, the revenues (and corresponding expenses recognized by the segment that is counterparty to the transaction) are eliminated in consolidation and, therefore, do not themselves impact consolidated results. Revenues recognized by AOL Time Warner’s segments on intercompany transactions are as follows:

                                   
      Three Months Ended September 30,   Nine Months Ended September 30,
     
 
      2002   2001   2002   2001
     
 
 
 
              (Restated)           (Restated)
                       
      (millions)
Intercompany Revenues
                               
AOL
  $ 68     $ 40     $ 223     $ 90  
Cable
    37       11       103       32  
Filmed Entertainment
    381       208       684       576  
Networks
    146       133       414       402  
Music
    130       62       318       187  
Publishing
    34       8       59       26  
 
   
     
     
     
 
 
Total intercompany revenues
  $ 796     $ 462     $ 1,801     $ 1,313  
 
   
     
     
     
 

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AOL TIME WARNER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)

         Included in the total intercompany revenues above are intercompany advertising and commerce revenues, as follows:

                                   
      Three Months Ended September 30,   Nine Months Ended September 30,
     
 
      2002   2001   2002   2001
     
 
 
 
          (Restated)       (Restated)
      (millions)
Intercompany Advertising and Commerce Revenues
                               
AOL
  $ 37     $ 40     $ 141     $ 90  
Cable
    31       11       89       32  
Filmed Entertainment
                       
Networks
    36       38       113       115  
Music
                       
Publishing
    34       8       59       26  
 
   
     
     
     
 
 
Total intercompany advertising and commerce revenues:
  $ 138     $ 97     $ 402     $ 263  
 
   
     
     
     
 
                                   
      Three Months Ended September 30,   Nine Months Ended September 30,
     
 
      2002   2001   2002   2001
     
 
 
 
              (Restated)           (Restated)
      (millions)
EBITDA(a)
                               
AOL
  $ 432     $ 736     $ 1,324     $ 2,213  
Cable(b)
    680       650       2,007       1,924  
Filmed Entertainment
    331       307       840       670  
Networks
    520       450       1,371       1,343  
Music
    96       87       294       268  
Publishing
    276       196       758       580  
Corporate
    (87 )     (74 )     (246 )     (219 )
Merger and restructuring costs
    (77 )     (134 )     (184 )     (205 )
Intersegment elimination
    (79 )     (36 )     (66 )     (59 )
 
   
     
     
     
 
 
Total EBITDA
  $ 2,092     $ 2,182     $ 6,098     $ 6,515  
 
   
     
     
     
 


(a)   EBITDA represents operating income (loss) before noncash depreciation of tangible assets and amortization of intangible assets. After deducting depreciation and amortization, for the three months ended September 30, AOL Time Warner’s operating income (loss) was $1.315 billion in 2002 and $(47) million in 2001. For the nine months ended September 30, AOL Time Warner’s operating income (loss) was $3.892 billion in 2002 and $(74) million in 2001.
(b)   The Cable segment’s results reflect the restructuring of TWE-A/N, which resulted in the deconsolidation of the operating results of the Advance/Newhouse Systems for all periods presented. For the three and nine months ended September 30, 2001 and six months ended June 30, 2002, the net impact of the deconsolidation of these systems was a reduction of the Cable segment’s reported EBITDA of $141 million, $412 million and $333 million, respectively. In addition, the Cable segment’s results reflect the consolidation of Road Runner’s operating results effective January 1, 2002.

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AOL TIME WARNER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)

                                   
      Three Months Ended September 30,   Nine Months Ended September 30,
     
 
      2002   2001   2002   2001
     
 
 
 
              (Restated)           (Restated)
      (millions)
Depreciation of Property, Plant and Equipment
                               
AOL
  $ 165     $ 105     $ 452     $ 304  
Cable
    307       234       876       648  
Filmed Entertainment
    19       21       57       66  
Networks
    44       40       125       118  
Music
    29       23       85       69  
Publishing
    25       16       71       49  
Corporate
    7       6       20       17  
 
   
     
     
     
 
 
Total depreciation
  $ 596     $ 445     $ 1,686     $ 1,271  
 
   
     
     
     
 
                                   
      Three Months Ended September 30,   Nine Months Ended September 30,
     
 
      2002   2001   2002   2001
     
 
 
 
              (Restated)           (Restated)
      (millions)
Amortization of Intangible Assets(a)
                               
AOL
  $ 39     $ 31     $ 121     $ 97  
Cable
    3       618       5       1,854  
Filmed Entertainment
    48       118       143       355  
Networks
    7       481       18       1,434  
Music
    45       211       133       626  
Publishing
    39       234       100       698  
Corporate
          91             254  
 
   
     
     
     
 
 
Total amortization
  $ 181     $ 1,784     $ 520     $ 5,318  
 
   
     
     
     
 


(a)   Includes amortization relating to business combinations accounted for by the purchase method, substantially all of which arose in the $147 billion acquisition of Time Warner in 2001.

         As discussed in Note 3, when FAS 142 is initially applied, all goodwill recognized on the Company’s consolidated balance sheet on that date is reviewed for impairment using the new guidance. Before performing the review for impairment, the new guidance requires that all goodwill deemed to relate to the entity as a whole be assigned to all of the Company’s reporting units (generally, the AOL Time Warner operating segments), including the reporting units of the acquirer. This differs from the previous accounting rules, which required goodwill to be assigned only to the businesses of the company acquired. As a result, a portion of the goodwill generated in the Merger was reallocated to the AOL segment resulting in a change in segment assets. Following are AOL Time Warner’s assets by business segment, reflecting the reallocation of goodwill in accordance with FAS 142, as of September 30, 2002 and December 31, 2001:

                 
    September 30,   December 31,
    2002   2001
   
 
            (Restated)
    (millions)
Assets
               
AOL
  $ 41,369     $ 34,021  
Cable
    48,172       71,265  
Filmed Entertainment
    15,839       20,646  
Networks
    31,808       44,580  
Music
    7,533       12,399  
Publishing
    14,089       23,374  
Corporate
    2,078       2,219  
 
   
     
 
Total assets
  $ 160,888     $ 208,504  
 
   
     
 

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AOL TIME WARNER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)

12.   COMMITMENTS AND CONTINGENCIES

Securities Matters

         As of November 13, 2002, twenty-seven putative class action lawsuits alleging violations of the federal securities laws are pending against the Company (the “AOL Time Warner Shareholder Litigation”). These lawsuits also name as defendants certain current and former executives of the Company and, in three instances, America Online. Twenty-two of these are pending in the United States District Court for the Southern District of New York, four are pending in the United States District Court for the Eastern District of Virginia and one in the United States District Court for the Eastern District of Texas. The complaints purport to be made on behalf of certain shareholders of the Company and allege that the Company made material misrepresentations and/or omissions of material fact in violation of Section 10(b) of the Securities Exchange Act of 1934 (the “Exchange Act”), Rule 10b-5 promulgated thereunder, and Section 20(a) of the Exchange Act. Plaintiffs claim that the Company failed to disclose America Online’s declining advertising revenues and that the Company and America Online inappropriately inflated advertising revenues in a series of transactions. Certain of the lawsuits also allege that certain of the individual defendants and other insiders at the Company improperly sold their personal holdings of AOL Time Warner stock. Certain of the lawsuits, in addition to the above allegations, allege that the Company failed to disclose that the Merger was not generating the synergies anticipated at the time of the announcement of the Merger and, further, that the Company inappropriately delayed writing down more than $50 billion of goodwill. The lawsuits seek an unspecified amount in compensatory damages. On August 29, 2002, the Company filed a motion with the Judicial Panel on Multi-district Litigation to transfer all federal lawsuits within the AOL Time Warner Shareholder Litigation to the Southern District of New York for coordinated and consolidated pretrial proceedings. That motion is scheduled to be heard on November 21, 2002. In addition, all AOL Time Warner Shareholder Litigation now pending and to be filed in the Southern District of New York have been consolidated into one action for all purposes. Nine parties are seeking “lead plaintiff” status in the AOL Time Warner Shareholder Litigation. The Company intends to defend against the AOL Time Warner Shareholder Litigation vigorously. The Company is unable to predict the outcome of the cases or reasonably estimate a range of possible loss.

         On November 5, 2002, a putative class action lawsuit was filed in the United States District Court for the Southern District of New York against the Company, unnamed members of the Administrative Committee of the AOL Time Warner Savings Plan and certain current and former directors of the Company alleging violations of the Employee Retirement Income Security Act. The complaint purports to be brought on behalf of participants in the AOL Time Warner Savings Plan and alleges that the Company and other defendants breached certain fiduciary duties to such participants by failing to disclose, among other things, that the Company was experiencing declining advertising revenues and that the Company was inappropriately inflating advertising revenues through various transactions. The complaint seeks unspecified damages and unspecified equitable relief. The Company has not yet been served with the complaint in this action. The Company intends to defend against this action vigorously. The Company is unable to predict the outcome of the case or reasonably estimate a range of possible loss.

         As of November 13, 2002, eight shareholder derivative actions are pending against certain current and former directors and officers of the Company, as well as against the Company as nominal defendant. Three of the lawsuits are pending in New York State Supreme Court for the County of New York, one in the United States District Court for the Southern District of New York and four in the Court of Chancery of the State of Delaware for New Castle County. The complaints allege that defendants breached their fiduciary duties by causing the Company to issue corporate statements that did not accurately disclose that America Online had declining advertising revenues, that the Merger was not generating the synergies anticipated at the time of the announcement of the Merger and that the Company inappropriately delayed writing down more than $50 billion of goodwill, thereby exposing the Company to potential liability for alleged violations of federal securities laws. The lawsuits further allege that certain of the defendants improperly sold their personal holdings of AOL Time Warner stock. The lawsuits request that (i) all proceeds from defendants’ sales of AOL Time Warner common stock, (ii) all expenses incurred by the Company as a result of the defense of the shareholder class actions discussed above and (iii) any improper salaries or payments be returned to the Company. The Company intends to defend against these lawsuits vigorously. The Company is unable to predict the outcome of these suits or reasonably estimate a range of possible loss.

         The Securities and Exchange Commission and the Department of Justice are investigating the financial reporting and disclosure practices of the Company. The Company is continuing its efforts to cooperate in the investigations. The Company cannot predict the outcome of the

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AOL TIME WARNER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)

investigations at this time.

         Further, during the week beginning August 5, 2002, the Company learned of information regarding three transactions involving its AOL division that it reported could, upon further review, result in the Company concluding that the consideration received was recognized inappropriately as advertising and commerce revenues. The Company began an internal review of the accounting of these and other advertising and commerce transactions at the AOL division for the period of July 1, 1999 through March 31, 2002 under the direction of its Chief Financial Officer, which is ongoing. The review has included AOL’s larger advertising and commerce transactions, its multi-element transactions and other transactions in which there was a significant degree of accounting judgment exercised. The review has encompassed an examination of the original transaction documents, interviews with key personnel responsible for negotiating or accounting for the transactions and the review of other relevant materials. As a result of this review, the Company announced on October 23, 2002 that it had concluded it would adjust the accounting for the three transactions discussed above, as well as certain other transactions involving the AOL division, and that it would restate the Company’s financial results for each of the quarters ended September 30, 2000 through June 30, 2002. See Note 1, “Description of Business and Basis of Presentation – Basis of Presentation – Restatement of Prior Financial Information” for a discussion of the impact of the restatement on the financial results of the Company.

Other Matters

         On January 22, 2002, Netscape, a wholly-owned subsidiary of America Online, sued Microsoft Corporation (“Microsoft”) in the United States District Court for the District of Columbia for antitrust violations under Sections 1 and 2 of the Sherman Act, as well as for other common law violations. Among other things, the complaint alleges that Microsoft’s actions to maintain its monopoly in the market for Intel-compatible personal computer operating systems worldwide injured Netscape, consumers and competition in violation of Section 2 of the Sherman Act and continues to do so. The complaint also alleges that Microsoft’s actions constitute illegal monopolization and attempted monopolization of a worldwide market for Web browsers and that Microsoft has engaged in illegal practices by tying its Web browser, Internet Explorer, to Microsoft’s operating system in various ways. The complaint seeks damages for the injuries inflicted upon Netscape, including treble damages and attorneys’ fees, as well as injunctive relief to remedy the anti-competitive behavior alleged. On March 29, 2002, Microsoft filed its answer to the complaint denying all claims and allegations. On June 17, 2002, the Judicial Panel on Multi-District Litigation transferred the case to the United States District Court for the District of Maryland for all pretrial proceedings. Due to the preliminary status of the matter, it is not possible for the Company at this time to provide a view on its probable outcome or to provide a reasonable estimate as to the amount that might be recovered through this action.

         America Online has been named as defendant in several putative class action lawsuits brought by consumers and Internet service providers (“ISP”), alleging certain injuries to have been caused by installation of AOL versions 5.0 and 6.0 software. The parties have entered into settlement agreements covering the consumer and ISP AOL version 5.0 installation claims on terms that are not material to the Company’s financial condition or results of operations. On August 21, 2002, the Court approved the settlement of the consumer claims related to AOL version 5.0. The settlement of the ISP claims related to AOL version 5.0 remains subject to final Court approval. In one of the AOL version 6.0 cases, AOL’s motion to dismiss was granted and the plaintiff’s appeal of that decision remains pending. The Company believes that these cases are without merit and intends to defend them vigorously. The Company is unable, however, to predict the outcome of these cases, or reasonably estimate a range of possible loss given their current status.

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AOL TIME WARNER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)

         The Department of Labor has closed its investigation into the applicability of the Fair Labor Standards Act (“FLSA”) to America Online’s Community Leader program without taking any action against the Company. However, putative classes of former and current Community Leader volunteers have brought lawsuits in several states against America Online alleging violations of the FLSA and comparable state statutes on the basis that they were acting as employees rather than volunteers in serving as Community Leaders and are entitled to wages. An additional putative class action lawsuit has been filed against the Company, America Online and AOL Community, Inc. alleging violations of the Employee Retirement Income Security Act (“ERISA”) on the basis that the plaintiffs were acting as employees rather than volunteers and are entitled to pension, welfare or other employee benefits under ERISA. Although the Company does not believe that these lawsuits regarding Community Leader volunteers have any merit and intends to defend against them vigorously, the Company is unable to predict the outcome of the cases, or reasonably estimate a range of possible loss due to the preliminary nature of the matters.

         In Six Flags Over Georgia LLC et al. v. Time Warner Entertainment Company et al., following a trial in December 1998, the jury returned a verdict for plaintiffs and against defendants, including TWE, on plaintiffs’ claims for breaches of fiduciary duty. The jury awarded plaintiffs approximately $197 million in compensatory damages and $257 million in punitive damages, and interest began accruing on those amounts at the Georgia annual statutory rate of twelve percent. The Company paid the compensatory damages with accrued interest during the first quarter of 2001. Payment of the punitive damages portion of the award with accrued interest was stayed by the United States Supreme Court on March 1, 2001 pending the disposition of a certiorari petition with that Court, which was filed by TWE on June 15, 2001. On October 1, 2001, the United States Supreme Court granted TWE’s petition, vacated the decision by the Georgia Court of Appeals affirming the punitive damages award, and remanded the matter to the Georgia Court of Appeals for further consideration. The Georgia Court of Appeals affirmed and reinstated its earlier decision regarding the punitive damage award on March 29, 2002. On September 16, 2002, the Georgia Supreme Court denied TWE’s petition for a writ of certiorari seeking review of the decision of the Georgia Court of Appeals and subsequently denied TWE’s motion for reconsideration of its September 16th ruling. Plaintiffs have agreed not to pursue payment of the punitive damages award and accrued interest until the resolution of TWE’s petition for writ of certiorari to the United States Supreme Court, which TWE intends to file.

         On April 8, 2002, three former employees of certain subsidiaries of the Company filed Henry Spann et al. v. AOL Time Warner Inc. et al., a purported class action, in the United States District Court for the Central District of California. Plaintiffs have named as defendants, among others, the Company, Time Warner Entertainment Company, L.P., Warner-Elektra-Atlantic Corporation, WEA Manufacturing Inc., Warner Bros. Records Inc., Atlantic Recording Corporation, various pension plans sponsored by the companies and the administrative committees of those plans. Plaintiffs allege that defendants miscalculated the proper amount of pension benefits owed to them and other class members as required under the plans in violation of ERISA. The lawsuit has been transferred to the United States District Court for the Southern District of New York. The Company believes the lawsuit has no merit and intends to defend against it vigorously. Due to its preliminary status, the Company is unable to predict the outcome of the case or reasonably estimate a range of possible loss.

         The Company is subject to a number of state and federal class action lawsuits, as well as an action brought by a number of state Attorneys General alleging unlawful horizontal and vertical agreements to fix the prices of compact discs by the major record companies. The parties to the federal action commenced by the Attorneys General have entered into a settlement agreement on terms that will not have a material impact on the Company’s financial statements or results of operations. The settlement has been preliminarily approved by the Court, but is subject to its final approval. In the remaining lawsuits, the Company has entered into memoranda of understanding to settle these actions on terms that will not have a material impact on the Company’s financial statements or results of operations. The settlement of these remaining actions is also subject to Court approval.

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AOL TIME WARNER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)

         America Online, Inc. is involved in arbitration proceedings, Homestore.com, Inc. v. America Online, Inc., in the District of Columbia. Homestore.com, Inc. (“Homestore”) alleges that America Online breached an April 2000 distribution agreement with Homestore (the “Distribution Agreement”) by (i) failing to deliver to Homestore the required number of impressions (user visits to America Online pages including Homestore promotions); (ii) failing to provide 18 required promotions to Homestore; (iii) failing to use good faith efforts to meet the target number of Unique AOL Visitors (as defined in the Distribution Agreement); and (iv) violating the premier, prominence and exclusivity provisions of the Distribution Agreement. Homestore seeks a declaration of material breach by America Online, compensatory damages, termination of the Distribution Agreement and a declaration that the section of the Distribution Agreement allowing America Online to draw on a $90 million letter of credit and receive other payments from Homestore in the event of termination is an unenforceable penalty provision. The arbitration panel held a hearing on the merits in July 2002 and a decision from the panel is pending. The Company is unable to predict the outcome of the panel’s decision or reasonably estimate a range of possible loss.

         The costs and other effects of pending or future litigation, governmental investigations, legal and administrative cases and proceedings (whether civil or criminal), settlements, judgments and investigations, claims and changes in those matters (including those matters described above), and developments or assertions by or against the Company relating to intellectual property rights and intellectual property licenses, could have a material adverse effect on the Company’s business, financial condition and operating results.

13.   ADDITIONAL FINANCIAL INFORMATION

Cash Flows

         Additional financial information with respect to cash (payments) and receipts are as follows:

                 
    Nine Months Ended September 30,
   
    2002   2001
   
 
    (millions)
Cash payments made for interest
  $ (1,101 )   $ (1,042 )
Interest income received
    83       156  
 
   
     
 
Cash interest expense, net
  $ (1,018 )   $ (886 )
 
   
     
 
Cash payments made for income taxes
  $ (229 )   $ (304 )
Income tax refunds received
    49       41  
 
   
     
 
Cash taxes, net
  $ (180 )   $ (263 )
 
   
     
 

Interest Expense, Net

         Interest expense, net, consists of:

                                   
      Three Months Ended September 30,   Nine Months Ended September 30,
     
 
      2002   2001   2002   2001
     
 
 
 
      (millions)
Interest Income
  $ 18     $ 43     $ 96     $ 156  
Interest Expense
    (507 )     (384 )     (1,402 )     (1,152 )
 
   
     
     
     
 
 
Total interest expense, net
  $ (489 )   $ (341 )   $ (1,306 )   $ (996 )
 
   
     
     
     
 

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AOL TIME WARNER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)

Other Expense, Net

         Other expense, net, consists of:

                                   
      Three Months Ended September 30,   Nine Months Ended September 30,
     
 
      2002   2001   2002   2001
     
 
 
 
      (millions)
Net investment losses(a)
  $ (733 )   $ (196 )   $ (1,583 )   $ (841 )
Losses on equity investees
    (100 )     (222 )     (215 )     (707 )
Gains related to the exchange of unconsolidated cable television systems at TWE
                      39  
Losses on asset securitization programs
    (15 )     (20 )     (37 )     (56 )
Miscellaneous
    (3 )     1       (2 )     (7 )
 
   
     
     
     
 
 
Total other expense, net
  $ (851 )   $ (437 )   $ (1,837 )   $ (1,572 )
 
   
     
     
     
 


(a)   Includes a noncash pretax charge to reduce the carrying value of certain investments for other-than-temporary declines in value of approximately $733 million and $1.678 billion for the three and nine months ended September 30, 2002, respectively and approximately $196 million and $816 million for the three and nine months ended September 30, 2001 (Note 4).

Other Current Liabilities

         Other current liabilities consist of:

                   
      September 30,   December 31,
      2002   2001
     
 
      (millions)
Accrued expenses
  $ 5,429     $ 5,474  
Accrued compensation
    761       904  
Accrued income taxes
    122       65  
 
   
     
 
 
Total other current liabilities
  $ 6,312     $ 6,443  
 
   
     
 

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AOL TIME WARNER INC.
SUPPLEMENTARY INFORMATION
CONDENSED CONSOLIDATING FINANCIAL STATEMENTS
(Unaudited)

         America Online, Inc. (“America Online”), Time Warner Inc. (“Time Warner”), Time Warner Companies, Inc. (“TW Companies”) and Turner Broadcasting System, Inc. (“TBS” and, together with America Online, Time Warner and TW Companies, the “Guarantor Subsidiaries”) are wholly owned subsidiaries of AOL Time Warner Inc. (“AOL Time Warner”). AOL Time Warner, America Online, Time Warner, TW Companies and TBS have fully and unconditionally, jointly and severally, and directly or indirectly, guaranteed all of the outstanding publicly traded indebtedness of each other. Set forth below are condensed consolidating financial statements of AOL Time Warner, including each of the Guarantor Subsidiaries, presented for the information of each company’s public debtholders. The following condensed consolidating financial statements present the results of operations, financial position and cash flows of (i) America Online, Time Warner, TW Companies and TBS (in each case, reflecting investments in its consolidated subsidiaries under the equity method of accounting), (ii) the direct and indirect non-guarantor subsidiaries of AOL Time Warner and (iii) the eliminations necessary to arrive at the information for AOL Time Warner on a consolidated basis. There are no restrictions on the Company’s ability to obtain funds from any of its wholly owned subsidiaries through dividends, loans or advances. These condensed consolidating financial statements should be read in conjunction with the accompanying consolidated financial statements of AOL Time Warner.

Consolidating Statement of Operations
For The Three Months Ended September 30, 2002

                                                                 
    AOL                                   Non-           AOL Time
    Time   America   Time   TW           Guarantor           Warner
    Warner   Online   Warner   Companies   TBS   Subsidiaries   Eliminations   Consolidated
   
 
 
 
 
 
 
 
    (millions)
Revenues
  $     $ 1,744     $     $     $ 206     $ 8,169     $ (136 )   $ 9,983  
 
   
     
     
     
     
     
     
     
 
Cost of revenues
          (1,057 )                 (116 )     (5,074 )     136       (6,111 )
Selling, general and administrative
    (10 )     (459 )     (10 )     (4 )     (31 )     (1,785 )           (2,299 )
Amortization of goodwill and other intangible assets
          (3 )                       (178 )           (181 )
Merger-related costs
    (10 )     (65 )                       (2 )           (77 )
 
   
     
     
     
     
     
     
     
 
Operating income (loss)
    (20 )     160       (10 )     (4 )     59       1,130             1,315  
Equity in pretax income (loss) of consolidated subsidiaries
    188       (37 )     762       681       230             (1,824 )      
Interest (expense) income, net
    (183 )     (22 )     (16 )     (98 )     (32 )     (138 )           (489 )
Other expense, net
    (65 )     (637 )     (1 )     (6 )     (3 )     (94 )     (45 )     (851 )
Minority interest expense
                                  (55 )           (55 )
 
   
     
     
     
     
     
     
     
 
Income before income taxes
    (80 )     (536 )     735       573       254       843       (1,869 )     (80 )
Income tax provision
    25       201       (287 )     (223 )     (101 )     (332 )     742       25  
 
   
     
     
     
     
     
     
     
 
Income before discontinued operations and cumulative effect of accounting changes
    (55 )     (335 )     448       350       153       511       (1,127 )     (55 )
 
   
     
     
     
     
     
     
     
 
Discontinued operations
    112             112       112             112       (336 )     112  
Cumulative effect of accounting change
                                               
 
   
     
     
     
     
     
     
     
 
Net income
  $ 57     $ (335 )   $ 560     $ 462     $ 153     $ 623     $ (1,463 )   $ 57  
 
   
     
     
     
     
     
     
     
 

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AOL TIME WARNER INC.
SUPPLEMENTARY INFORMATION
CONDENSED CONSOLIDATING FINANCIAL STATEMENTS — (Continued)
(Unaudited)

Consolidating Statement of Operations
For The Three Months Ended September 30, 2001
(Restated)

                                                                 
    AOL                                   Non-           AOL Time
    Time   America   Time   TW           Guarantor           Warner
    Warner   Online   Warner   Companies   TBS   Subsidiaries   Eliminations   Consolidated
   
 
 
 
 
 
 
 
    (millions)
Revenues
  $     $ 1,725     $     $     $ 184     $ 7,246     $ (87 )   $ 9,068  
 
   
     
     
     
     
     
     
     
 
Cost of revenues
          (910 )                 (82 )     (4,101 )     87       (5,006 )
Selling, general and administrative
    (6 )     (422 )     (8 )     (4 )     (33 )     (1,718 )           (2,191 )
Amortization of goodwill and other intangible assets
    (86 )     (3 )                 (74 )     (1,621 )           (1,784 )
Merger-related costs
    (4 )     (133 )                       3             (134 )
 
   
     
     
     
     
     
     
     
 
Operating income (loss)
    (96 )     257       (8 )     (4 )     (5 )     (191 )           (47 )
Equity in pretax income (loss) of consolidated subsidiaries
    (641 )     194       (914 )     (584 )     (115 )           2,060        
Interest income (expense), net
    (74 )     18       (4 )     (88 )     (35 )     (158 )           (341 )
Other expense, net
    (2 )     (170 )     (14 )     (11 )     (6 )     (204 )     (30 )     (437 )
Minority interest expense
                                  12             12  
 
   
     
     
     
     
     
     
     
 
Income (loss) before income taxes
    (813 )     299       (940 )     (687 )     (161 )     (541 )     2,030       (813 )
Income tax provision
    (174 )     (100 )     (141 )     (127 )     (81 )     (301 )     750       (174 )
 
   
     
     
     
     
     
     
     
 
Net income (loss) before discontinued operations
    (987 )     199       (1,081 )     (814 )     (242 )     (842 )     2,780       (987 )
Discontinued operations, net of tax
    (10 )           (10 )     (10 )           (10 )     30       (10 )
 
   
     
     
     
     
     
     
     
 
Net income (loss)
  $ (997 )   $ 199     $ (1,091 )   $ (824 )   $ (242 )   $ (852 )   $ 2,810     $ (997 )
 
   
     
     
     
     
     
     
     
 

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AOL TIME WARNER INC.
SUPPLEMENTARY INFORMATION
CONDENSED CONSOLIDATING FINANCIAL STATEMENTS — (Continued)
(Unaudited)

Consolidating Statement of Operations
For The Nine Months Ended September 30, 2002

                                                                 
    AOL                                   Non-           AOL Time
    Time   America   Time   TW           Guarantor           Warner
    Warner   Online   Warner   Companies   TBS   Subsidiaries   Eliminations   Consolidated
   
 
 
 
 
 
 
 
    (millions)
Revenues
  $     $ 5,347     $     $     $ 637     $ 23,864     $ (207 )   $ 29,641  
 
   
     
     
     
     
     
     
     
 
Cost of revenues
          (3,088 )                 (346 )     (14,560 )     207       (17,787 )
Selling, general and administrative
    (27 )     (1,402 )     (27 )     (12 )     (102 )     (5,688 )           (7,258 )
Amortization of goodwill and other intangible assets
          (10 )                       (510 )           (520 )
Merger-related costs
    (38 )     (137 )                       (9 )           (184 )
 
   
     
     
     
     
     
     
     
 
Operating income (loss)
    (65 )     710       (27 )     (12 )     189       3,097             3,892  
Equity in pretax income (loss) of consolidated subsidiaries
    1,150       (213 )     1,586       1,461       577             (4,561 )      
Interest (expense) income, net
    (425 )     (12 )     (69 )     (296 )     (91 )     (413 )           (1,306 )
Other expense, net
    (50 )     (783 )     (6 )     (114 )     (5 )     (753 )     (126 )     (1,837 )
Minority interest expense
                                  (139 )           (139 )
 
   
     
     
     
     
     
     
     
 
Income before income taxes
    610       (298 )     1,484       1,039       670       1,792       (4,687 )     610  
Income tax provision
    (279 )     61       (570 )     (398 )     (261 )     (694 )     1,862       (279 )
 
   
     
     
     
     
     
     
     
 
Income before discontinued operations and cumulative effect of accounting changes
    331       (237 )     914       641       409       1,098       (2,825 )     331  
 
   
     
     
     
     
     
     
     
 
Discontinued operations
    113             113       113             113       (339 )     113  
Cumulative effect of accounting change
    (54,235 )           (54,235 )     (42,062 )     (12,173 )     (52,048 )     160,518       (54,235 )
 
   
     
     
     
     
     
     
     
 
Net income
  $ (53,791 )   $ (237 )   $ (53,208 )   $ (41,308 )   $ (11,764 )   $ (50,837 )   $ 157,354     $ (53,791 )
 
   
     
     
     
     
     
     
     
 

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Table of Contents

AOL TIME WARNER INC.
SUPPLEMENTARY INFORMATION
CONDENSED CONSOLIDATING FINANCIAL STATEMENTS — (Continued)
(Unaudited)

Consolidating Statement of Operations
For The Nine Months Ended September 30, 2001
(Restated)

                                                                 
            America                                                
            Online                                                
    AOL   (predecessor                           Non-           AOL Time
    Time   to AOL   Time   TW           Guarantor           Warner
    Warner   Time Warner)   Warner   Companies   TBS   Subsidiaries   Eliminations   Consolidated
   
 
 
 
 
 
 
 
    (millions)
Revenues
  $     $ 4,901     $     $     $ 604     $ 21,497     $ (151 )   $ 26,851  
 
   
     
     
     
     
     
     
     
 
Cost of revenues
          (2,534 )                 (257 )     (12,119 )     151       (14,759 )
Selling, general and administrative
    (23 )     (1,154 )     (24 )     (11 )     (111 )     (5,320 )           (6,643 )
Amortization of goodwill and other intangible assets
    (253 )     (10 )                 (223 )     (4,832 )           (5,318 )
Merger-related costs
    (4 )     (200 )                       (1 )           (205 )
 
   
     
     
     
     
     
     
     
 
Operating income (loss)
    (280 )     1,003       (24 )     (11 )     13       (775 )           (74 )
Equity in pretax income (loss) of consolidated subsidiaries
    (2,212 )     550       (2,963 )     (1,933 )     (414 )           6,972        
Interest income (expense), net
    (130 )     74       (28 )     (310 )     (121 )     (481 )           (996 )
Other expense, net
    (2 )     (783 )     (41 )     (44 )     (14 )     (602 )     (86 )     (1,572 )
Minority interest expense
                                  18             18  
 
   
     
     
     
     
     
     
     
 
Income (loss) before income taxes
    (2,624 )     844       (3,056 )     (2,298 )     (536 )     (1,840 )     6,886       (2,624 )
Income tax provision
    (450 )     (312 )     (302 )     (269 )     (207 )     (789 )     1,879       (450 )
 
   
     
     
     
     
     
     
     
 
Net income (loss) before discontinued operations
    (3,074 )     532       (3,358 )     (2,567 )     (743 )     (2,629 )     8,765       (3,074 )
Discontinued operations, net of tax
    (29 )           (29 )     (29 )           (29 )     87       (29 )
 
   
     
     
     
     
     
     
     
 
Net income (loss)
  $ (3,103 )   $ 532     $ (3,387 )   $ (2,596 )   $ (743 )   $ (2,658 )   $ 8,852     $ (3,103 )
 
   
     
     
     
     
     
     
     
 

68


Table of Contents

AOL TIME WARNER INC.
SUPPLEMENTARY INFORMATION
CONDENSED CONSOLIDATING FINANCIAL STATEMENTS — (Continued)
(Unaudited)

Consolidating Balance Sheet
September 30, 2002

                                                                 
    AOL                                   Non-           AOL Time
    Time   America   Time   TW           Guarantor           Warner
    Warner   Online   Warner   Companies   TBS   Subsidiaries   Eliminations   Consolidated
   
 
 
 
 
 
 
 
    (millions)
ASSETS
                                                               
Current assets
                                                               
Cash and equivalents
  $ 974     $ 6     $     $ 1,672     $ 62     $ 1,241     $ (1,606 )   $ 2,349  
Receivables, net
    28       330       7       9       136       4,348             4,858  
Inventories
                            203       1,528             1,731  
Prepaid expenses and other current assets
    21       162                   9       1,684             1,876  
 
   
     
     
     
     
     
     
     
 
Total current assets
    1,023       498       7       1,681       410       8,801       (1,606 )     10,814  
Noncurrent inventories and film costs
                            459       2,885             3,344  
Investments in amounts due to and from consolidated subsidiaries
    110,662       14,889       89,385       70,945       18,003             (303,884 )      
Investments, including available-for-sale securities
    26       1,697       237       5       93       3,927       (983 )     5,002  
Property, plant and equipment
    63       1,105       7             69       10,519             11,763  
Intangible assets subject to amortization
                                  7,162             7,162  
Intangible assets not subject to amortization
                            641       37,659             38,300  
Goodwill and other intangible assets
    9,825       22,006               (19 )     2,805       47,071             81,688  
Other assets
    984       470       1       47       89       2,080       (856 )     2,815  
 
   
     
     
     
     
     
     
     
 
Total assets
  $ 122,583     $ 40,665     $ 89,637     $ 72,659     $ 22,569     $ 120,104     $ (307,329 )   $ 160,888  
 
   
     
     
     
     
     
     
     
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
                                                               
Current liabilities
                                                               
Accounts payable
  $ 11     $ 22     $ 1     $     $ 14     $ 1,870     $     $ 1,918  
Participations payable
                                  1,498             1,498  
Royalties and programming costs payable
                            16       1,619             1,635  
Deferred revenue
          726                   2       822             1,550  
Debt due within one year
                                  89             89  
Other current liabilities
    564       1,126       51       80       159       4,375       (43 )     6,312  
 
   
     
     
     
     
     
     
     
 
Total current liabilities
    575       1,874       52       80       191       10,273       (43 )     13,002  
Long-term debt
    13,751       1,601       1,470       6,016       788       7,081       (2,463 )     28,244  
Debt due to (from) affiliates
    (856 )                       1,647       1,015       (1,806 )      
Deferred income taxes
    10,975       (3,296 )     14,271       12,247       2,105       14,352       (39,679 )     10,975  
Deferred revenue
          29                         1,009             1,038  
Other liabilities
    120       20       389             363       3,802             4,694  
Minority interests
                                  4,917             4,917  
Shareholders’ equity
                                                               
Due (to) from AOL Time Warner and subsidiaries
          5,977       8,607       3,114       (2,113 )     (12,988 )     (2,597 )      
Other shareholders’ equity
    98,018       34,460       64,848       51,202       19,588       90,643       (260,741 )     98,018  
 
   
     
     
     
     
     
     
     
 
Total shareholders’ equity
    98,018       40,437       73,455       54,316       17,475       77,655       (263,338 )     98,018  
 
   
     
     
     
     
     
     
     
 
Total liabilities and shareholders’ equity
  $ 122,583     $ 40,665     $ 89,637     $ 72,659     $ 22,569     $ 120,104     $ (307,329 )   $ 160,888  
 
   
     
     
     
     
     
     
     
 

69


Table of Contents

AOL TIME WARNER INC.
SUPPLEMENTARY INFORMATION
CONDENSED CONSOLIDATING FINANCIAL STATEMENTS — (Continued)
(Unaudited)

Consolidating Balance Sheet
December 31, 2001
(Restated)

                                                                 
    AOL                                   Non-           AOL Time
    Time   America   Time   TW           Guarantor           Warner
    Warner   Online   Warner   Companies   TBS   Subsidiaries   Eliminations   Consolidated
   
 
 
 
 
 
 
 
    (millions)
ASSETS
                                                               
Current assets
                                                               
Cash and equivalents
  $ (10 )   $ 41     $     $ 1,837     $ 86     $ 499     $ (1,734 )   $ 719  
Receivables, net
    36       555       19       10       114       5,320             6,054  
Inventories
                            170       1,621             1,791  
Prepaid expenses and other current assets
    15       254                   6       1,412             1,687  
 
   
     
     
     
     
     
     
     
 
Total current assets
    41       850       19       1,847       376       8,852       (1,734 )     10,251  
Noncurrent inventories and film costs
                            267       3,211       12       3,490  
Investments in amounts due to and from consolidated subsidiaries
    159,387       2,635       174,094       135,182       34,071             (505,369 )      
Investments, including available-for-sale securities
          2,667       268       96       94       4,654       (893 )     6,886  
Property, plant and equipment
    47       1,022       7             83       11,510             12,669  
Intangible assets subject to amortization
                                  7,289             7,289  
Intangible assets not subject to amortization
                            641       37,067             37,708  
Goodwill and other intangible assets
    9,759       134                   6,720       110,807             127,420  
Other assets
    97       380       69       47       83       2,115             2,791  
 
   
     
     
     
     
     
     
     
 
Total assets
  $ 169,331     $ 7,688     $ 174,457     $ 137,172     $ 42,335     $ 185,505     $ (507,984 )   $ 208,504  
 
   
     
     
     
     
     
     
     
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
                                                               
Current liabilities
                                                               
Accounts payable
  $ 18     $ 82     $ 1     $     $ 16     $ 2,149     $     $ 2,266  
Participations payable
                                  1,253             1,253  
Royalties and programming costs payable
                                  1,515             1,515  
Deferred revenue
          739                   1       711             1,451  
Debt due within one year
                                  48             48  
Other current liabilities
    248       1,074       34       154       167       4,806       (40 )     6,443  
 
   
     
     
     
     
     
     
     
 
Total current liabilities
    266       1,895       35       154       184       10,482       (40 )     12,976  
Long-term debt
    5,697       1,488       2,066       6,040       791       8,445       (1,735 )     22,792  
Debt due to affiliates
                            1,647       158       (1,805 )      
Deferred income taxes
    11,231       (4,106 )     15,366       13,285       2,162       15,446       (42,153 )     11,231  
Deferred revenue
          64                         984             1,048  
Other liabilities
    110       30       376             198       4,125             4,839  
Minority interests
                                  3,591             3,591  
Shareholders’ equity
                                                               
Due (to) from AOL Time Warner and subsidiaries
          907       10,685       4,928       (1,620 )     (12,756 )     (2,144 )      
Other shareholders’ equity
    152,027       7,410       145,929       112,765       38,973       155,030       (460,107 )     152,027  
 
   
     
     
     
     
     
     
     
 
Total shareholders’ equity
    152,027       8,317       156,614       117,693       37,353       142,274       (462,251 )     152,027  
 
   
     
     
     
     
     
     
     
 
Total liabilities and shareholders’ equity
  $ 169,331     $ 7,688     $ 174,457     $ 137,172     $ 42,335     $ 185,505     $ (507,984 )   $