TIME WARNER INC.
Table of Contents



UNITED STATES

SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549


Form 10-K


ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2004

Commission file number 001-15062


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 No.)
One Time Warner Center
New York, NY 10019-8016
(Address of Principal Executive Offices)

(212) 484-8000

(Registrant’s Telephone Number, Including Area Code)


Securities registered pursuant to Section 12(b) of the Act:

     
Title of each class Name of each exchange on which registered


Common Stock, $.01 par value
  New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act:

None

     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, and (2) has been subject to such filing requirements for the past 90 days. Yes þ         No o

     Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

     Indicate by check mark if the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes þ

     As of the close of business on February 28, 2005, there were 4,499,568,010 shares of the registrant’s Common Stock and 96,315,431 shares of the registrant’s Series LMCN-V Common Stock outstanding. The aggregate market value of the registrant’s voting and non-voting common equity securities held by non-affiliates of the registrant (based upon the closing price of such shares on the New York Stock Exchange on June 30, 2004) was approximately $79.80 billion.

Documents Incorporated by Reference:

     
Description of document Part of the Form 10-K


Portions of the definitive Proxy Statement to be
used in connection with the registrant’s 2005
Annual Meeting of Stockholders
  Part III (Item 10 through Item 14)
(Portions of Items 10 and 12 are not incorporated by reference and are provided herein; portions of Item 11 are not incorporated by reference and are provided in the registrant’s definitive Proxy Statement)




TABLE OF CONTENTS

PART I
Item 1. Business.
Item 2. Properties.
Item 3. Legal Proceedings.
Item 4. Submission of Matters to a Vote of Security Holders.
PART II
Item 5. Market For Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Item 6. Selected Financial Data.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
Item 8. Financial Statements and Supplementary Data.
Item 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure.
Item 9A. Controls and Procedures.
Item 9B. Other Information.
PART III
Items 10, 11, 12, 13 and 14. Directors and Executive Officers of the Registrant; Executive Compensation; Security Ownership of Certain Beneficial Owners and Management; Certain Relationships and Related Transactions; Principal Accounting Fees and Services.
PART IV
Item 15. Exhibits and Financial Statements Schedules
SIGNATURES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
EXHIBIT INDEX
EX-10.27 NON-EMPLOYEE DIRECTORS' DEFERRED COMPENSATION PLAN
EX-10.39 EMPLOYMENT AGREEMENT
EX-10.58 AMENDMENT NO. 1 TO THE TOLLING AND OPTIONAL REDEMPTION AGREEMENT
EX-21 SUBSIDIARIES OF THE REGISTRANT
EX-23 CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS.
EX-31.1 CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER
EX-31.2 CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER
EX-32 CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER AND PRINCIPAL FINANCIAL OFFICER


Table of Contents

PART I

 
Item 1. Business.

      Time Warner Inc. (the “Company” or “Time Warner”) is a leading media and entertainment company. The Company was formed in connection with the merger of America Online, Inc. (“America Online”) and Time Warner Inc., now known as Historic TW Inc. (“Historic TW”), which was consummated on January 11, 2001 (the “Merger” or the “America Online-Historic TW Merger”). The Company classifies its businesses into the following fundamental areas:

  •  America Online, consisting principally of interactive services;
 
  •  Cable, consisting principally of interests in cable systems providing video, high-speed data and Digital Phone services;
 
  •  Filmed Entertainment, consisting principally of feature film, television and home video production and distribution;
 
  •  Networks, consisting principally of cable television and broadcast networks; and
 
  •  Publishing, consisting principally of magazine and book publishing.

      At February 1, 2005, the Company had a total of approximately 84,900 active employees.

      For convenience, the terms the “Company,” “Time Warner” and the “Registrant” are used in this report to refer to both the parent company and collectively to the parent company and the subsidiaries through which its various businesses are conducted, unless the context otherwise requires.

 
SEC and DOJ Investigations

      On December 15, 2004, the Company announced that it and its subsidiary America Online reached a definitive agreement with the Department of Justice (“DOJ”) that resolves the DOJ’s investigation of the Company. The Company also announced that it has proposed a settlement to the staff of the Securities and Exchange Commission (“SEC”) that the staff has agreed to recommend to the SEC Commissioners. For further information, see “Legal Proceedings — Update on Status of Government Investigations” herein.

 
Sale of Warner Music

      In conjunction with the Company’s debt reduction program announced in January 2003, on March 1, 2004 the Company completed the sale of its recorded music and music publishing business to a private investor group. For further information with respect to this and other sales and dispositions by the Company during 2004, see “Management’s Discussion and Analysis of Results of Operations and Financial Condition — Other Recent Developments,” in the financial pages herein.

 
Caution Concerning Forward-Looking Statements

      This Annual Report on Form 10-K includes certain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are based on management’s current expectations and are subject to uncertainty and changes in circumstances. Actual results may vary materially from the expectations contained herein due to changes in economic, business, competitive, technological and/or regulatory factors. More detailed information about those factors is set forth in “Management’s Discussion and Analysis of Results of Operations and Financial Condition,” in the financial pages herein. Time Warner is under no obligation to (and expressly disclaims any obligation to) update or alter its forward-looking statements, whether as a result of new information, subsequent events or otherwise.

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Available Information and Website

      The Company’s annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments to such reports filed with or furnished to the SEC pursuant to Sections 13(a) or 15(d) of the Securities Exchange Act are available free of charge on the Company’s website at www.timewarner.com as soon as reasonably practicable after such reports are electronically filed with the SEC.

AMERICA ONLINE

      America Online, Inc., a wholly owned subsidiary of the Company based in Dulles, Virginia, is a leader in interactive services.

      During the fourth quarter of 2004, America Online reorganized its operations into four business units — Access, Audience, Digital Services and International — to streamline management and more closely align these business units to the consumers that America Online serves. The Access business concentrates on attracting and retaining subscribers (also referred to as members) across America Online’s domestic Internet service provider (“ISP”) businesses, which include the AOL service, the CompuServe service and the Netscape Internet service. The Audience business develops America Online’s audience on the Internet by offering a variety of interactive content and services and earns revenue from that audience through various forms of online advertising as well as online commerce. Brands include America Online’s network of portals and Websites, including AOL.com, AOL Instant Messenger, ICQ, Moviefone and MapQuest. The Digital Services business works to develop next-generation digital services, including MusicNet@AOL and AOL Call Alert, for the dial-up, high-speed and mobile Internet audience that appeal to AOL members and Internet users generally. AOL Europe, the principal component of the International business, has subscribers in France, Germany and the U.K. and offers local language content and online communities.

Access

AOL Service

      The core AOL service, a subscription-based service with over 22.2 million members in the U.S. and 28.5 million members in the U.S. and Europe, combined, at December 31, 2004, provides members with access to the Internet and a global, interactive community offering a wide variety of content, features and tools. The AOL service provides safety and security features and tools, specialized content, online communities, customization and control features, commerce and search opportunities.

      Subscribers to the AOL service are charged based on the level of service selected. The primary price plans for U.S. members are a $23.90 per month plan that provides unlimited dial-up telephone access to the Internet and use of the AOL service and a $14.95 per month plan that typically offers unlimited use of the AOL service through an Internet connection not provided by America Online, as well as a limited number of hours of dial-up telephone access to the Internet and the AOL service. Members also may select from other pricing plans with lower rates, including limited usage plans and plans that allow members to pay for multiple months of the AOL service in advance at a reduced rate. AOL members may cancel their membership at any time in accordance with the terms of service. America Online employs a wide range of marketing campaigns and promotions to attract new members, and continues to test new price plans and payment methods. America Online utilizes a number of incentives and retention programs to encourage members to continue as members, as well as to bring back former members.

      America Online recognizes that consumers wish to have the flexibility of connecting to the AOL service and the Internet via different connection methods, whether high-speed or telephone dial-up, and from different types of equipment, such as a desktop computer, handheld device or cellular telephone, and continues to develop new marketing strategies to address this desire for flexibility. For example, in January 2005 America Online announced an agreement with Time Warner Cable to develop and market a special edition of the AOL service in combination with high-speed connectivity and a limited number of hours

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of dial-up telephone access. America Online and Time Warner Cable will work together to migrate existing AOL service and Road Runner subscribers and prospects to the new offering as their lead broadband product, and Time Warner Cable will share a portion of the subscriber revenues with America Online. Members connecting to the AOL service through a high-speed connection such as cable or digital subscriber lines (DSL) have access to expanded multimedia content, including streaming music, CD-quality radio and other audio, full-motion video and streaming news clips.

Other Internet Service Providers

      The CompuServe and Netscape Internet services target value-oriented Internet service consumers in the U.S. Subscriber fees are charged to members based on the level of service selected. America Online also operates the Wal-Mart Connect dial-up service offered by Wal-Mart Stores, Inc.

Audience

      America Online offers a variety of interactive content and services which together form an online network of America Online portals and Websites on the Internet. The America Online network includes Websites, content and services that are AOL-branded, such as AOL.com, AOL Instant Messenger, and Moviefone, and other sites and services that are owned and operated by America Online, such as MapQuest, ICQ and Netscape.com, the Netscape portal. The America Online network also includes Websites that are owned or operated by third parties or affiliated companies, such as the Time Inc. Websites, for which America Online sells advertising and earns advertising revenue. America Online’s audience includes AOL members as well as Internet users visiting America Online’s network. The mission of the Audience business is to increase the activity and maintain or expand the audience of unique visitors to the America Online network which, in turn, drives AOL’s advertising revenues. America Online is planning to launch a new version of the AOL.com Website as a portal, making expanded features and content available to the entire Internet community, in mid-2005.

      America Online earns revenue by offering advertisers a range of online marketing and promotional opportunities on its network. Online advertising arrangements generally take the form of payments by advertisers on either a fixed-fee basis or on a pay-for-performance basis, where the advertiser pays based on the “click” or customer transaction resulting from the advertisement. In its network, America Online offers its advertisers banner advertising, search and other performance-based advertising, as well as a variety of customized programs, including premier placement, rich media advertising, sponsorship of content offerings for designated time periods, local and classified advertising, and the opportunity to target groups.

      America Online also generates advertising revenue through Advertising.com. Acquired by America Online in August 2004, Advertising.com develops and sells marketing programs to advertisers, primarily on a pay-for-performance basis, using advertising inventory that Advertising.com purchases from, or obtains by entering into revenue-sharing arrangements with, interactive publishers and Websites. In addition, as part of America Online’s new arrangement with Time Warner Cable, America Online will manage and sell advertising and search inventory for Time Warner Cable’s Road Runner portal and will share with Time Warner Cable a portion of the advertising revenues it generates.

Digital Services

      America Online’s Digital Services business is responsible for creating products and services to appeal to the dial-up, high-speed and mobile Internet audience. By creating products and services that appeal to both AOL members and Internet users, Digital Services aims to extend the tenure of AOL memberships and to increase revenues earned from its audience.

      America Online offers a variety of premium and subscription services to its members, including MusicNet@AOL, an online music subscription service, AOL PassCode, which provides members a second level of AOL account protection, and voice services, including AOL by Phone, AOL Call Alert and AOL

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Voicemail. During 2005, America Online is planning to expand its offering of premium and subscription services to AOL members and Internet users.

      The Digital Services business expects to offer premium and subscription mobile services that deliver features and content to users of wireless devices, such as mobile phones, PDAs and other handheld devices. America Online also provides text entry solutions for wireless devices through its subsidiary, Tegic Communications, Inc. Tegic’s T9 Text Input software enables individuals to efficiently send e-mail and instant messages using the standard telephone keypad to enter words or sentences.

AOL Europe and Other International Operations

      AOL Europe, a division of America Online, has its principal operations in France, Germany, the U.K. and Luxembourg, which is the location from which the AOL service is supplied in Europe. AOL Europe had approximately 6.3 million members in Europe as of December 31, 2004. Due to regulation of the telecommunications industry, AOL Europe is able to offer a competitive bundled broadband access product, which includes the AOL service and high-speed Internet access, as well as a dial-up access product, to consumers in the U.K., France and Germany. In addition, the online service provided to members in each of these countries is produced in the local language and includes online communities. AOL Europe also supplies the CompuServe service in Europe, targeting professional business-oriented consumers. The AOL service is also offered through a joint venture in Canada.

      America Online Latin America, Inc. (“AOLA”), a consolidated joint venture and publicly traded company, operates services in Brazil, Mexico and Argentina, and serves members of the AOL-branded service in Puerto Rico.

Technologies

      America Online employs a multiple vendor strategy in designing, structuring and operating the network services utilized in its interactive online services. AOLnet, a transfer control protocol/Internet protocol (TCP/IP) network of third-party network service providers, is used for the AOL service, the Netscape service, certain versions of the CompuServe service in North America, and other subscriber services in addition to being used by outside parties. America Online expects it will continue to review its network services arrangements in order to align its network capacity with market conditions, provide members of its online services with higher speed access and manage data network costs.

      America Online enters into multi-year data communications agreements to support AOLnet. In connection with those agreements, America Online may commit to purchase certain minimum levels of data communications services or to pay a fixed cost for the network services.

      America Online also utilizes the AOL Transit Data Network (“ATDN”), the domestic and international network that connects AOL, CompuServe 2000 and Time Warner Cable high-speed data customers to the Internet. The ATDN functions as the conduit between all of Time Warner’s content and the Internet, linking together facilities on four continents, with its greatest capacity in the U.S. and Europe. The ATDN Internet backbone is built from high-end routers and high-bandwidth circuits purchased under long-term agreements from third party carriers.

      Improving and maintaining AOLnet and ATDN requires a substantial investment in telecommunications equipment. In addition to making cash purchases of telecommunications equipment, America Online also finances purchases of this equipment by entering into capital leases.

Marketing

      To support its goals of attracting and retaining members, growing the audience to its America Online network, and developing and differentiating its family of brands, America Online markets its brands, products and services through a broad array of programs and media, including broadcast television and radio advertising

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campaigns, direct mail, telemarketing, magazine inserts (including magazines published by the Company’s publishing segment) and print advertisements, retail distribution, bundling agreements, Web advertising and alternate media. Other marketing strategies include online and offline cross-promotion and co-branding with a wide variety of partners. Additionally, through multi-year bundling agreements, the interactive online services and products are installed on several different brands of personal computers made by personal computer manufacturers and are available to consumers by clicking on an icon during the computer’s initial setup process or are available on the desktop. America Online also utilizes targeted or limited online and offline promotions, marketing programs and pricing plans designed to appeal to particular groups of potential users of its interactive online services and to distinguish and develop its different brands, products and services.

Competition

      America Online’s Access business competes for subscription revenues with multiple companies providing dial-up Internet service, including EarthLink and discount ISPs such as NetZero. America Online also competes with companies that provide Internet access via broadband technologies, such as cable companies and telephone companies. America Online also competes more broadly for subscription revenues and members’ time with cable, information, entertainment and media companies.

      America Online’s Audience business competes for advertising, search and commerce revenues with a wide range of companies, including ISPs, Web-based portals, and individual Websites providing content, commerce, search, community and similar features as well as media companies. Competitors for audience include Yahoo, MSN and Google.

      America Online faces challenges in gaining access to high-speed networks for distribution of the AOL service or other America Online services both from network providers and from competition from other interactive services providers. America Online also competes with other interactive services providers to secure relationships with providers of personal communications devices. America Online’s Digital Services business also faces competition from a diverse group of providers in developing and offering premium and subscription services. Although this is an emerging area, these services may include educational services, safety and security services, mobile messaging, online games, digital rights management and entertainment services.

      AOL Europe operates in a competitive environment involving ISPs as well as telecommunications companies and cable providers. Its main competitors are British Telecom and Wanadoo in the U.K., Wanadoo and Free in France and T-Online and Freenet in Germany.

CABLE

      The Company’s Cable business, consisting of Time Warner Cable Inc. and its subsidiaries (“Time Warner Cable” or “TWC Inc.”), is the second largest operator of cable systems in the U.S. in terms of subscribers served. As of December 31, 2004, Time Warner Cable managed cable systems serving nearly 10.9 million basic cable subscribers, of which approximately 9.3 million were in cable systems owned by consolidated entities. All of TWC Inc.’s cable business is conducted under the Time Warner Cable brand name.

      The Company holds an effective aggregate 79% interest in Time Warner Cable. Comcast Corporation (“Comcast”) holds the remaining interest in Time Warner Cable. See “Description of Certain Provisions of Agreements related to Time Warner Cable” herein for additional information with respect to the Company’s and Comcast’s ownership in Time Warner Cable.

      The Company has determined that it would like to expand its cable business through acquisitions if it is able to do so on terms it considers appropriate. In furtherance of that interest, Time Warner Cable has submitted a joint bid, along with Comcast, to acquire the assets of Adelphia Communications Corporation (“Adelphia”) in connection with the auction process initiated by Adelphia. It is unknown at this time whether the bid will be successful and, if so, on what terms.

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Systems Operations

      Time Warner Cable offers three product lines: video programming, high-speed data and its newest service, Digital Phone, an Internet protocol-based voice service. As of December 31, 2004, cable systems owned or managed by Time Warner Cable passed approximately 19 million homes, provided basic video service to nearly 10.9 million subscribers, over 4.8 million of whom also subscribe to Time Warner Cable digital video service, and provided high-speed data services to 4.1 million residential subscribers and commercial accounts. By year-end 2004, Time Warner Cable had launched Digital Phone service in all 31 of its regional operating divisions.

      Time Warner Cable operates large, clustered and technologically upgraded cable systems in 27 states. As of December 31, 2004, over 75% of its subscribers were in 19 geographic clusters, each serving more than 300,000 subscribers, and nearly all of its cable systems were capable of carrying two-way broadband services and had been upgraded to 750MHz or higher. Approximately 89% of Time Warner Cable’s subscribers are located in eight states and all but two of its 31 regional operating divisions are focused on discrete geographic areas.

      Time Warner Cable is an industry leader in developing and rolling-out innovative new products and services, including on demand services, IP-based telephony, high-definition television and set-top boxes with integrated digital video recorders (DVRs). Time Warner Cable is increasingly focused on marketing convenient, easy-to-understand bundles of these and other products and services to consumers. Time Warner Cable believes that it can attract and retain customers by providing these multiple-product bundles and supporting them with quality customer care.

      Cable operators are subject to regulation at the federal, state and local level. At the local level, cable operators are generally required to have a franchise with the local government. Franchise requirements and the rights and responsibilities of cable operators and local franchise authorities are themselves subject to provisions of federal and state law. See “Regulation and Legislation” below.

 
Video Services

      Time Warner Cable’s video subscribers are typically charged monthly subscription fees based on the level of service selected and, in some cases, equipment usage fees. Movies on demand, pay-per-view movies and special events are charged on a per use basis.

      Time Warner Cable offers subscribers different packages of video services, including basic, standard and digital packages, for a flat monthly fee. Basic and standard service together provide, on average, approximately 80 channels, including local broadcast signals. Subscribers to digital video service receive all the channels included in the basic and standard tiers plus up to 60 additional digital cable networks and up to 45 CD-quality audio music services. Digital subscribers also have access to “mini tiers” of specialized and niche programming (e.g., sports tiers, Spanish language tiers). As of December 31, 2004, over 44% of Time Warner Cable’s basic video subscribers also purchased digital services.

      Regardless of service level, subscribers may purchase premium channels for an additional monthly fee, with discounts generally available for the purchase of packages of more than one premium service. Increasingly, a digital set-top box or comparable device, such as a CableCARD®, is required in order to receive these services. Premium subscribers utilizing such a device typically receive multiplex versions of these premium services and, in some cases, digital set-top box users may receive subscription video on demand access to programming from such services as part of their monthly package. The digital set-top boxes that these subscribers receive also provide interactive program guides and access to other on demand offerings.

      The rates Time Warner Cable can charge for its basic tier, as well as for equipment rentals and installation services, are generally subject to regulation under federal law. For more information, see “Regulation and Legislation” below.

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On Demand Services and Pay Per View

      Time Warner Cable offers on demand content to customers with digital set-top boxes in all of its divisions. Time Warner Cable’s on demand services enable subscribers to instantaneously view programming stored on servers at the system’s headend, and to utilize functions such as pause, rewind and fast forward while watching this programming. Free on demand content provides subscribers with access to selected programming from a variety of sources, both local and national, with no incremental charges. Subscribers are charged for movies on demand on a per use basis. Subscription video on demand provides digital customers with the ability to view an array of content associated with a particular content provider for a separate monthly fee or as part of their monthly fee for the relevant service. Subscription video on demand is currently offered in connection with premium channels such as HBO and it is expected that other programming will be available over time.

      Traditional pay per view, with fixed start times and no pause or rewind functionality, has been largely eclipsed by the availability of video on demand in most Time Warner Cable divisions. However, in some areas, subscribers with older, analog set-top boxes can still order pay per view programming.

 
Digital Video Recorders (DVRs)

      Time Warner Cable offers set-top boxes with integrated DVRs in all 31 of its divisions. DVR users can record programming on a hard drive built into the set-top box through the interactive program guide and view the recorded programming using functions such as pause, rewind and fast-forward. DVR users can also record one show while watching another or record two shows simultaneously. DVR users have the ability to pause “live” television. During 2004, Time Warner Cable introduced HDTV-capable DVRs. In 2005, Time Warner Cable expects to introduce a multi-room DVR, which will allow programming to be captured on a DVR set-top box in one room and watched on other television sets around the house without the need for additional DVRs.

 
High Definition Television (HDTV)

      Time Warner Cable carries HDTV offerings of HBO, Showtime, ESPN, Discovery, HDNet and iN DEMAND, as well as high-definition sports programming from Fox’s Regional Sports Networks and NBA-TV. Time Warner Cable also carries the high definition television signals and other digital signals broadcast by numerous local television stations, including all stations owned and operated by the ABC, CBS, NBC and Fox networks and nearly all public television stations in Time Warner Cable’s operating areas.

 
Programming Rights

      Video programming rights represent a major cost component for Time Warner Cable. Time Warner Cable generally obtains the right to carry video programming services through negotiation of affiliation agreements with programmers. Most programming services impose a monthly license fee per subscriber upon the cable operator and these fees typically increase over time. Time Warner Cable’s programming costs continue to rise, especially for sports programming (See “Management’s Discussion and Analysis of Results of Operations and Financial Condition, Business Segment Results — Cable” in the financial pages herein). Time Warner Cable obtains the right to carry local broadcast television stations either through the stations’ exercise of their so-called “must carry” rights, or through negotiated retransmission consent agreements. See “Regulation and Legislation — Communications Act and FCC Regulation — Carriage of Broadcast Television Stations and Other Programming Regulation” below. Time Warner Cable’s existing programming and retransmission consent agreements expire at various times. Time Warner Cable cannot ensure that it will be able to renew any or all of its existing agreements upon expiration or obtain the rights to any other programming services or broadcast television stations on reasonable terms. It is not known whether the loss of any one popular programming supplier would have a material adverse effect on Time Warner Cable’s operations.

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High-Speed Data Services

      As of December 31, 2004, Time Warner Cable had 4.1 million high-speed data subscribers, consisting of over 3.9 million residential subscribers and approximately 173,000 commercial accounts, across its 31 divisions. Subscribers pay a flat monthly fee for high-speed data service based upon the level of service received. Generally, each Time Warner Cable division offers multiple levels of service, each with different maximum upstream and downstream data transfer rates. Due to their nature, commercial and bulk subscribers are charged at different rates than residential subscribers.

      Time Warner Cable’s residential customers can choose from a variety of ISPs, including the Company’s branded, high-speed Road Runner service. High-speed data customers connect their personal computers (PCs) to Time Warner Cable’s two-way hybrid fiber optic/coaxial plant using a cable modem. Time Warner Cable also offers networking options that allow customers to connect multiple PCs to a single cable modem.

      Time Warner Cable’s provision of ISP services is subject to compliance with the terms of the FTC Consent Decree and the FCC Order entered in connection with the regulatory clearance of the America Online-Historic TW Merger. (See “Regulation and Legislation” below, for a description of these terms).

      Time Warner Cable and AOL recently announced a strategic agreement under which Time Warner Cable will offer Road Runner customers the opportunity to receive both the Road Runner service and access to all of the AOL on-line offerings for a single price. Among other things, under the agreement, AOL is expected to actively encourage its existing dial-up customers located in Time Warner Cable service areas to convert to the offering. (See also, “America Online — AOL Service” above).

 
Voice Services

      By the end of 2004, Time Warner Cable’s new voice service, Digital Phone, had been launched in all 31 of Time Warner Cable’s divisions and was available to over two-thirds of Time Warner Cable’s homes passed. Digital Phone provides unlimited local, in-state and domestic long distance calling, as well as call waiting, caller ID, voice mail and enhanced “911” services, for a fixed monthly fee. Digital Phone subscribers can make and receive calls using virtually any commercially available telephone handset (including a cordless phone) connected to their normal in-home telephone wiring. Subscribers switching to Digital Phone can keep their existing landline phone numbers and retain their directory listings. Digital Phone enables Time Warner Cable to offer its customers a combined, easy-to-use package of video, high-speed data and voice services and to compete effectively against similar bundled products offered by competitors.

      Time Warner Cable has multi-year agreements with MCI and Sprint pursuant to which these companies assist Time Warner Cable in providing Digital Phone service to customers by routing voice traffic to the public switched network, delivering enhanced “911” service, and assisting in local number portability and long distance traffic carriage. In February 2005, MCI announced that it had agreed to be acquired by Verizon, a regional phone company that competes with Time Warner Cable in some areas. It is not known what impact, if any, the proposed acquisition will have on Time Warner Cable’s Digital Phone offering.

 
Advertising

      Time Warner Cable also generates revenue by selling advertising time to a variety of national, regional and local businesses.

      Cable operators generally receive an allocation of scheduled advertising time on cable programming services into which the operator can insert commercials. The clustering of Time Warner Cable’s systems expands the share of viewers that Time Warner Cable reaches within a local DMA (Designated Market Area), which helps local advertising sales personnel to compete more effectively with broadcast and other media. In addition, in many locations, contiguous cable system operators have formed advertising interconnects to deliver locally inserted commercials across wider geographic areas, replicating the reach of broadcast stations as much as possible. As of December 31, 2004, 15 of Time Warner Cable’s 31 divisions participated in local cable advertising interconnects.

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Local News Channels

      Time Warner Cable operates 24-hour local news channels in New York City (NY1 News and NY1 Noticias), Albany, NY (Capital News 9), Rochester, NY (R/ News), Syracuse, NY (News 10 Now), Charlotte and Raleigh, NC (Carolina News 14) and Austin, TX (News 8 Austin). During 2004, Time Warner Cable agreed to dissolve certain joint ventures with Belo Corp. which resulted in the closing of news channels in Houston and San Antonio, TX.

Cable Joint Ventures

 
Texas and Kansas City Cable Partners, L.P. Restructuring

      On May 1, 2004, Time Warner Cable completed the restructuring of two managed joint ventures, Kansas City Cable Partners (“KCCP”), previously a 50-50 joint venture between Comcast and Time Warner Entertainment Company, L.P. (“TWE”), serving approximately 295,000 basic video subscribers as of December 31, 2004, and Texas Cable Partners, L.P. (“TCP”), previously a 50-50 joint venture between Comcast and the TWE-A/ N partnership, serving over 1.2 million basic video subscribers as of December 31, 2004. As a result of the restructuring, KCCP was merged into TCP and renamed “Texas and Kansas City Cable Partners, L.P.” Following the restructuring, the combined partnership was owned 50% by Comcast and 50% by TWE and TWE-A/ N, collectively. In February 2005, TWE’s interest in the partnership was contributed to TWE-A/N in exchange for preferred equity in TWE-A/N. The Company continues to account for its investment in the restructured venture using the equity method. Beginning any time after June 1, 2006, either Time Warner Cable or Comcast can trigger the dissolution of the partnership. If a dissolution is triggered, the non-triggering party has the right to choose and take full ownership of one of two pools of the combined partnership’s systems — one pool consisting of the Houston systems and the other consisting of the Kansas City and southwest Texas systems — with an arrangement to distribute the partnership’s debt between the two pools. The party triggering the restructuring would own the remaining pool of systems and any debt associated with that pool.

Competition

      Time Warner Cable faces intense competition from a variety of alternative information and entertainment delivery sources, principally from direct-to-home satellite video providers and regional telephone companies offering phone and DSL services. Competition with regional telephone companies has intensified as Time Warner Cable has introduced its Digital Phone service, with a number of regional telephone companies having entered into cross-marketing arrangements with direct-to-home satellite service providers and a number indicating that they intend to begin to offer video services to consumers by installing video-capable fiber lines, sometimes directly to consumer’s homes. In the future, technological advances will most likely increase the number of alternatives available to Time Warner Cable’s customers.

      Direct Broadcast Satellite (DBS). Time Warner Cable’s video services face competition from satellite services, such as the Dish Network and DirecTV, which is controlled by News Corporation, a major Time Warner Cable programming supplier. DirecTV and Dish Network offer satellite-delivered pre-packaged programming services that can be received by relatively small and inexpensive receiving dishes. The video services provided by these satellite providers are comparable, in many respects, to Time Warner Cable’s analog and digital video services. DBS subscribers can obtain satellite receivers with integrated DVRs and, in nearly all areas in which Time Warner Cable operates, DBS subscribers also receive local broadcast signals, which were previously available from DBS only in limited areas. Both major DBS providers have entered into co-marketing arrangements with regional telephone companies in an effort to provide customers with both video and DSL service from what appears to the customer as a single source.

      “Online” Competition. Time Warner Cable’s high-speed data service faces competition from a variety of companies that offer other forms of online services, including DSL high-speed data service provided by regional telephone companies and dial-up services over ordinary telephone lines. DSL providers have engaged in aggressive price competition in some of Time Warner Cable’s operating areas and some DSL providers

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have entered into co-marketing arrangements with DBS operators in an effort to provide customers with both DSL and video service from what appears to the customer to be a single source. Monthly prices of dial-up services are typically less expensive than broadband services. Other developing technologies, such as Internet service via satellite, wireless connections, or over power lines, also compete or are likely to compete with cable and cable modem services.

      Digital Phone Competition. Time Warner Cable introduced its new Digital Phone service in all 31 of its regional divisions by the end of 2004. Digital Phone competes directly with the local and long distance offerings of the regional telephone companies which provide service in these areas, as well as with wireless phone providers and national providers of voice over Internet products such as Vonage. This has heightened the competitive environment in which Time Warner Cable operates. As noted above, the regional telephone companies, with whom Time Warner Cable is competing for phone customers, also offer online services that compete with Time Warner Cable’s high-speed data service. In addition, a number of regional telephone companies have entered into cross-marketing arrangements with DBS providers and a number have indicated that they intend to begin to offer video services to consumers.

      Overbuilds. Under the Cable Television Consumer Protection and Competition Act of 1992, franchising authorities are prohibited from unreasonably refusing to award additional franchises. As a result, from time to time, Time Warner Cable faces competition from overlapping cable systems operating in its franchise areas, including municipally-owned systems.

      SMATV (Satellite master antenna television). Additional competition comes from private cable television systems servicing condominiums, apartment complexes and certain other multiple dwelling units, often on an exclusive basis, with local broadcast signals and many of the same satellite-delivered program services offered by franchised cable systems. Some SMATV operators now offer voice and high-speed data services.

      MMDS/ Wireless Cable (Multichannel microwave distribution services). Time Warner Cable faces competition from wireless cable operators, including digital wireless operators, who use terrestrial microwave technology to distribute video programming. Some MMDS operators now offer voice and high-speed Internet services.

      Consumer Electronics Manufacturers. To the extent that Time Warner Cable’s products and services converge with theirs, Time Warner Cable competes with the manufacturers of consumer electronics products. For instance, Time Warner Cable’s DVRs compete with similar devices manufactured by consumer electronics companies. However, consumer electronics manufacturers have the potential to benefit Time Warner Cable as well. For instance, if consumer electronics manufacturers produce devices capable of attaching to Time Warner Cable’s network and providing authorized customers with access to Time Warner Cable’s products and services, Time Warner Cable could reduce the amount it spends on consumer premises equipment such as set-top boxes.

      Additional Competition. In addition to multichannel video providers, cable systems compete with all other sources of news, information and entertainment, including over-the-air television broadcast reception, live events, movie theaters, home video products and the Internet. In general, Time Warner Cable also faces competition from other media for advertising dollars.

FILMED ENTERTAINMENT

      The Company’s Filmed Entertainment businesses produce and distribute theatrical motion pictures, television shows, animation and other programming, distribute home video product and license rights to the Company’s feature films, television programming and characters. All of the foregoing businesses are principally conducted by various subsidiaries and affiliates of Warner Bros. Entertainment Inc., known collectively as the Warner Bros. Entertainment Group (“Warner Bros.”), and New Line Cinema Corporation (“New Line”).

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Feature Films

Warner Bros. Pictures

      Warner Bros. produces feature films both wholly on its own and under co-financing arrangements with others, and also distributes completed films produced and financed by others. The terms of Warner Bros.’ agreements with independent producers and other entities are separately negotiated and vary depending upon the production, the amount and type of financing by Warner Bros., the media and territories covered, the distribution term and other factors. Warner Bros.’ feature films are produced under both the Warner Bros. Pictures and Castle Rock banners and, commencing in 2004, also by Warner Independent Pictures.

      Warner Bros.’ strategy focuses on offering a diverse slate of films with a mix of genres, talent and budgets that includes four to six “event” movies per year. In response to the high cost of producing theatrical films, Warner Bros. has entered into certain film co-financing arrangements with other companies, decreasing its financial risk while in most cases retaining substantially all worldwide distribution rights. During 2004, Warner Bros. released a total of 22 original motion pictures for theatrical exhibition, including Harry Potter and the Prisoner of Azkaban, The Polar Express, Ocean’s Twelve and the Academy Award-winning Million Dollar Baby. Of Warner Bros.’ total 2004 releases, 6 were wholly financed by Warner Bros. and 16 were financed with or by others.

      Warner Bros.’ joint venture arrangements include a joint venture with Village Roadshow Pictures to co-finance the production of motion pictures. Additionally, Warner Bros. has an exclusive distribution arrangement with Alcon Entertainment (“Alcon”) for distribution of all of Alcon’s motion pictures in domestic and certain international territories.

      The newly-established Warner Independent Pictures (“WIP”) produces or acquires smaller budget and alternative films for domestic and/or worldwide release. In 2004, its first year, WIP released Before Sunset, We Don’t Live Here Anymore and A Very Long Engagement, among others.

      Warner Bros. distributes feature films to more than 125 international territories. In 2004, Warner Bros. released internationally 18 English-language motion pictures and 23 local language films that it either produced or acquired.

New Line

      Theatrical films are also produced and distributed by New Line, a leading independent producer and distributor of theatrical motion pictures with two film divisions, New Line Cinema and Fine Line Features. Included in its 14 films released during 2004 were The Notebook and The Butterfly Effect. New Line also continued to derive revenues during 2004 from theatrical and home video distribution of the popular titles Elf and The Lord of the Rings: The Return of the King, the third and final installment in the Lord of the Rings trilogy and the winner of eleven Academy Awards, including Best Picture. Like Warner Bros., New Line releases a diversified slate of films with an emphasis on building and leveraging franchises. As part of its strategy for reducing financial risk and dealing with the rising cost of film production, New Line typically pre-sells the international rights to its releases on a territory by territory basis, while still retaining a share of each film’s potential profitability in those foreign territories.

Home Video

      Warner Home Video Inc. (“WHV”) distributes for home video use DVDs and videocassettes containing filmed entertainment product produced or otherwise acquired by the Company’s various content-producing subsidiaries and divisions, including Warner Bros. Pictures, Warner Bros. Television, Castle Rock, New Line, Home Box Office and Turner Broadcasting System. In addition to the creation of DVDs from new content generated by the Company, WHV produces and distributes DVDs from the Company’s extensive filmed entertainment library. The library, which is owned or managed by Warner Bros., currently has more than 6,600 feature films, 40,000 television titles, and 14,000 animated titles (including 1,500 animated shorts). WHV also distributes other companies’ product, including DVDs and videocassettes for BBC and National

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Geographic, national sports leagues, and Leapfrog (a children’s learning toy company) in the U.S., and certain producers in Italy, the U.K., Australia and France.

      WHV sells and/or licenses its product in the U.S. and in major international territories to retailers and/or wholesalers through its own sales force, with warehousing and fulfillment handled by third parties. In some countries, WHV’s product is distributed through licensees. DVD product is replicated under long term contracts with third parties. Videocassette product is manufactured under contracts with independent duplicators. Among WHV’s 2004 DVD and videocassette releases, 16 film titles generated U.S. sales of more than one million units each.

      Since inception of the DVD format, WHV has released over 3,000 DVD titles in the U.S. and international markets, led by sales of Warner Bros.’ three Harry Potter films, which have had total net worldwide sales of over 68 million DVD units sold through to the consumer. DVD is the fastest selling consumer electronics product of all time, with an installed base at December 31, 2004 of over 70 million households in the U.S. and over 171 million households internationally (including approximately 42 million households in China).

Television

      Warner Bros. is one of the world’s leading suppliers of television programming, distributing programming in more than 175 countries and in more than 40 languages. Warner Bros. both develops and produces new television series, made-for-television movies, mini-series, reality-based entertainment shows and animation programs and also licenses programming from the Warner Bros. library for exhibition on media all over the world.

      Warner Bros.’ television programming is primarily produced by Warner Bros. Television Production Inc. (“WBTV”), which produces primetime dramatic and comedy programming for the major networks and for cable, and Telepictures Productions Inc. (“Telepictures”), which specializes in reality-based and talk/variety series for the syndication and primetime markets. For the 2004-05 season, WBTV is producing hits such as Gilmore Girls, Smallville and One Tree Hill for The WB Television Network (“The WB Network”) and ER, The West Wing, Two and a Half Men, Without a Trace, Cold Case, The O.C., The George Lopez Show and Nip/ Tuck for third party networks and cable distributors. Telepictures produces primetime reality series The Bachelor and The Bachelorette as well as first-run syndication staples, such as Extra, and the talk show, The Ellen DeGeneres Show.

      Warner Bros. Animation Inc. is responsible for the creation, development and production of contemporary television, made for DVD, and feature film animation, as well as for the creative use and production of classic animated characters from Warner Bros.’ and DC Comics’ libraries, including Looney Tunes and the Hanna-Barbera libraries.

Backlog

      Backlog represents the future revenue not yet recorded from cash contracts for the licensing of theatrical and television programming for pay cable, network (excluding certain license fees), basic cable and syndicated television exhibition. Backlog for all of Time Warner’s filmed entertainment companies amounted to $3.7 billion at December 31, 2004, compared to $3.9 billion at December 31, 2003 (including amounts relating to the intercompany licensing of film product to the Company’s cable television networks (including HBO and the Turner Networks) of $514 million and $740 million as of December 31, 2004 and December 31, 2003, respectively). The backlog excludes advertising barter contracts.

Other Entertainment Assets

      Warner Bros. Interactive Entertainment Inc. (“WBIE”), formed in January 2004, licenses and produces interactive games for a variety of platforms based on Warner Bros.’ and DC Comics’ properties, as well as original game properties. As part of its strategy to become more involved in game production, WBIE

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completed the acquisition of Monolith Productions, a game developer specializing in personal computer, console and online games, in October 2004. WBEI expects to release The Matrix Online, Warner Bros.’ first massively multiplayer online game, in the spring of 2005.

      Warner Bros. Consumer Products Inc. licenses rights in both domestic and international markets to the names, likenesses, images, logos and other representations of characters and copyrighted material from the films and television series produced or distributed by Warner Bros., including the superhero characters of DC Comics, Hanna-Barbera characters, classic films and Harry Potter.

      Through joint ventures, Warner Bros. International Cinemas Inc. (“WBIC”) owns interests in 81 multi-screen cinema complexes with over 700 screens in Japan, China, Italy and Spain. In early 2004, WBIC entered into agreements with local partners in China to acquire a majority interest in a multiplex in Nanjing and to manage certain others. WBIC also entered into an agreement in 2004 to sell its interest in its cinema circuit in Taiwan, completion of which is subject to certain regulatory approvals in Taiwan.

      DC Comics, wholly owned by the Company, publishes more than 50 regularly issued comics magazines featuring such popular characters as Superman, Batman, Wonder Woman and The Sandman. DC Comics also derives revenues from motion pictures, television, product licensing and books. The Company also owns E.C. Publications, Inc., the publisher of MAD magazine.

Competition

      The production and distribution of theatrical motion pictures, television and animation product and videocassettes/ DVDs are highly competitive businesses, as each vies with the other, as well as with other forms of entertainment and leisure time activities, including video games, the Internet and other computer-related activities for consumers’ attention. Furthermore, there is increased competition in the television industry evidenced by the increasing number and variety of broadcast networks and basic cable and pay television services now available. Despite this increasing variety of networks and services, access to primetime and syndicated television slots has actually tightened as networks and owned and operated stations increasingly source programming from content producers aligned with or owned by their parent companies. There is active competition among all production companies in these industries for the services of producers, directors, writers, actors and others and for the acquisition of literary properties. With respect to the distribution of television product, there is significant competition from independent distributors as well as major studios.

      Piracy and unauthorized recording, transmission and distribution of digital content and physical products are increasing challenges due to advances in compression technologies and proliferation of broadband access which make it easier to copy and distribute large files as well as to transfer such files to physical media. Additionally, the increase in usage of DVRs that allow consumers to skip commercials could significantly impact the advertising markets that drive the commercial television business. Revenues for filmed entertainment product depend in part upon general economic conditions, but the competitive position of a producer or distributor is still greatly affected by the quality of, and public response to, the entertainment product it makes available to the marketplace.

      Warner Bros. also competes in its character merchandising and other licensing activities with other licensors of character, brand and celebrity names.

NETWORKS

      The Company’s Networks business consists principally of domestic and international basic cable networks, pay television programming services and a broadcast television network. The basic cable networks (collectively, the “Turner Networks”) owned by Turner Broadcasting System, Inc. (“Turner”) constitute the principal component of the Company’s basic cable networks. Pay television programming consists of the multichannel HBO and Cinemax pay television programming services (collectively, the “Home Box Office Services”) operated by Home Box Office, Inc. The WB Network, a broadcast television network, is operated

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as a limited partnership in which WB Communications, a wholly owned subsidiary of the Company, holds a 77.75% interest and is the network’s managing general partner.

      The programming of the Turner Networks and the Home Box Office Services (collectively, the “Cable Networks”) is distributed via cable, satellite and other distribution technologies.

      The Turner Networks generate their revenue principally from the sale of advertising (other than Turner Classic Movies, which sells advertising only in certain European markets) and from receipt of monthly subscriber fees paid by cable system operators, satellite distribution services, hotels and other customers (known as affiliates) that have contracted to receive and distribute such networks. Turner Classic Movies is commercial-free in most of its distribution area and generates most of its revenue from the monthly fees paid by affiliates, which are generally charged on a per subscriber basis. The Home Box Office Services generate revenue principally from fees paid by affiliates for the delivery of the Home Box Office Services to subscribers who are generally free to cancel their subscriptions at any time. Home Box Office’s agreements with its affiliates are typically long-term arrangements that provide for annual service fee increases and retail promotion activities and have fee arrangements that are generally related to the number of subscribers served by the affiliate. The Home Box Office Services and their affiliates engage in ongoing marketing and promotional activities to retain existing subscribers and acquire new subscribers. Home Box Office also derives revenues from its original films and series through the sale of DVDs, as well as, in recent years, from its licensing of successful original programming in syndication and to basic cable channels.

      Although the Cable Networks believe prospects of continued carriage and marketing of their respective networks by the larger affiliates are good, the loss of one or more of them as distributors of any individual network or service could have a material adverse effect on their respective businesses. In addition, further consolidation of multiple-system cable operators could adversely impact the Cable Networks’ prospects for securing future carriage agreements on favorable terms.

      Advertising revenue on the basic cable networks and The WB Network consists of consumer advertising, which is sold primarily on a national basis (The WB Network sells time exclusively on a national basis, with local affiliates of The WB Network selling local advertising). Advertising contracts generally have terms of one year or less. Advertising revenue is generated from a wide variety of categories, including food and beverage, financial and business services, entertainment, drugs/health and medical and automotive. Advertising revenue is a function of the size and demographics of the audience delivered, the “CPM,” which is the cost per thousand viewers delivered, and the number of units of time sold. Units sold and CPMs are influenced by the quantitative and qualitative characteristics of the audience of each network as well as overall advertiser demand in the marketplace.

Turner Networks

 
Domestic Networks

      Turner’s entertainment networks include two general entertainment networks, TBS, with approximately 88.5 million U.S. households as of December 31, 2004, reported by Nielsen Media Research (“households”); and TNT, with approximately 88.7 million households in the U.S. as of December 31, 2004; as well as Cartoon Network, with approximately 87.1 million households in the U.S. as of December 31, 2004; and Turner Classic Movies, a commercial-free network presenting classic films from the Company’s MGM, RKO and pre-1950 Warner Bros. film libraries, among others, which had approximately 70.2 million households in the U.S. as of December 31, 2004. Programming for these entertainment networks is derived, in part, from the Company’s film, made-for-television and animation libraries as to which Turner or other divisions of the Company own the copyrights, plus licensed programming, including sports, and original films and series. Other networks include Turner South, a regional entertainment network featuring movies and sitcoms from the Company’s library and regional sports events and original programming targeted to viewers in the Southeast, and Boomerang, a network featuring classic cartoons.

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      Turner has licensed programming rights from the National Basketball Association (the “NBA”) to televise a certain number of regular season and playoff games on TNT through the 2007-08 season. TBS and Turner South televise Atlanta Braves baseball games, for which rights fee payments are made to Major League Baseball’s central fund for distribution to all Major League Baseball clubs. Through a joint venture with NBC, Turner also has rights to televise certain NASCAR Nextel Cup and Busch Series races through 2006.

      Turner’s CNN network, a 24-hour per day cable television news service, had more than 88.8 million households in the U.S. as of December 31, 2004. Together with CNN International (“CNNI”), CNN reached more than 200 countries and territories as of December 31, 2004. CNN operates 37 news bureaus, of which 11 are located in the U.S. and 26 are located around the world. In addition, Headline News provides updated half-hour newscasts throughout each day.

 
International Networks

      CNNI is distributed to multiple distribution platforms for delivery to cable systems, satellite platforms, broadcasters, hotels and other viewers around the world on a network of 11 regional satellites. CNN Headline News, which used to be broadcast only in the United States, was launched in the Asia Pacific region in November 2004. CNN en Español is a separate Spanish language all-news network in Latin America and CNNj is an all-news network in Japan. Turner also distributes region-specific and local-language feeds such as Pogo(an entertainment network for children) in India and versions of TNT, Cartoon Network, Turner Classic Movies and Boomerang on either a single channel or combined channel basis in over 125 countries around the world. In the U.K. and Ireland, Turner distributes Toonami, an all-action animation network.

      In a number of regions, Turner has launched international versions of its channels through joint ventures with local partners. These include CNN+, a Spanish language 24-hour news network distributed in Spain and Andorra; CNN Turk, a Turkish language 24-hour news network; CETV, a general entertainment network in China in which Turner has retained a minority interest; and Cartoon Network Japan. Turner has recently increased its shareholding in Japan Entertainment Network K.K., the joint venture company that operates Cartoon Network Japan, from 50% to 70%. Turner holds a significant interest in n-tv, a German language news network currently reaching over 48 million homes in Germany and contiguous countries in Europe, primarily via cable and satellite. In November 2004, Turner launched Boing, a new children’s/family channel under a joint venture with Mediaset in Italy. The channel offers animation and live action content and is carried on the new digital terrestrial (free to air) platform, currently reaching approximately one million households.

 
Internet Sites

      In addition to its cable networks, Turner manages various Internet sites that generate revenue from commercial advertising and consumer subscription fees. The CNN News Group has multiple sites, such as CNN.com and allpolitics.com, which are operated by CNN Interactive. Several localized editions of CNN.com operate in Turner’s international markets. The CNN News Group also produces CNNMoney.com in collaboration with Time Inc.’s Money Magazine. Turner also operates the NASCAR Website, NASCAR.com, pursuant to an agreement with NASCAR through 2006, and the PGA’s Website, PGA.com, pursuant to an agreement with PGA through 2011. Turner operates CartoonNetwork.com, a popular advertiser-supported site in the United States, as well as 15 international sites affiliated with the regional Cartoon Network feeds, Boing and Pogo.

Home Box Office

      HBO, operated by the wholly owned subsidiary Home Box Office, Inc., is the nation’s most widely distributed pay television service. Together with its sister service, Cinemax, HBO had approximately 39.4 million subscriptions as of December 31, 2004. Both HBO and Cinemax are made available on a number of multiplex channels and in high definition. Home Box Office also offers subscription video on demand

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products, which enable digital cable subscribers who subscribe to the Home Box Office Services to view programs at a time of their choice with VCR-like functionality.

      A major portion of the programming on HBO and Cinemax consists of recently released, uncut and uncensored theatrical motion pictures. Home Box Office’s practice has been to negotiate licensing agreements of varying duration with major motion picture studios and independent producers and distributors in order to ensure continued access to such films. These agreements typically grant pay television exhibition rights to recently released and certain older films owned by the particular studio, producer or distributor in exchange for negotiated fees, which may be a function of, among other things, the box office performances of the films.

      HBO is also defined by its award-winning original dramatic and comedy series, movies and mini-series such as The Sopranos, Six Feet Under, Deadwood and Angels in America, and boxing matches, sports documentaries and sports news programs, as well as concerts, comedy specials, family programming and documentaries. HBO won four Golden Globe Awards in January 2005 and also, in 2004, won 32 Primetime Emmys® — the most of any network, and the most in HBO history.

      Home Box Office produces Everybody Loves Raymond, now in its ninth and final season on CBS and its first syndication cycle. Home Box Office also licenses its successful original programming in syndication and to basic cable channels. HBO Sports operates HBO Pay-Per-View, an entity that distributes pay-per-view prizefights. HBO Video markets DVDs of a variety of HBO’s original programming, including movies, miniseries and dramatic and comedy series. Through various joint ventures, HBO-branded services are also distributed in more than 50 countries in Latin America, Asia and Central Europe.

The WB Television Network

      The WB Network provides a national group of affiliated television stations with 13 hours of prime time plus two additional hours of Sunday access programming during six days of the week (Sunday through Friday). The WB Network’s programming is primarily aimed at teenagers and adults, ages 12-34. The network’s line-up of programs includes series such as 7th Heaven, Everwood, One Tree Hill, Charmed, Reba, Smallville, Gilmore Girls and Summerland. As of December 31, 2004, Kids’ WB!, a programming service for young viewers, presented 14 hours of animated programming per week, including Mucha Lucha, Yu-Gi-Oh!, The Batman, Xiaolin Showdown and Pokemon.

      As of December 31, 2004, 88 primary and 10 secondary affiliates provide coverage for The WB Network in the top 100 television markets. Additional coverage reaching approximately 9 million homes in smaller markets is provided by The WB 100+ Station Group, a venture between The WB Network and local broadcasters under which WB programming is disseminated over the facilities of local cable operators.

      Tribune Broadcasting owns a 22.25% interest in The WB Network and the balance is held by WB Communications Inc., a wholly owned subsidiary of the Company. The WB Network is managed by the Warner Bros. Entertainment Group.

Other Network Interests

      The Company and Liberty Media (“Liberty”) each have a 50% interest in Court TV, which was available in approximately 83 million households as of December 31, 2004. Court TV is an advertiser-supported basic cable television service whose programming aims to provide an informative and entertaining view of the American system of justice. Focusing on “investigative television,” Court TV broadcasts trials by day and original programs such as Forensic Files and popular off-network series such as NYPD Blue in the evening. Under the Court TV Operating Agreement, beginning January 2006, Liberty may give written notice to the Company requiring the Company to purchase all of Liberty’s interest in Court TV (the “Liberty Put”). The agreement further provides that as of the same date, the Company may, by notice to Liberty, require Liberty to sell all of its interest in Court TV to the Company (the “Time Warner Call”). The price to be paid upon exercise of either the Liberty Put or the Time Warner Call will be an amount equal to one half of the fair market value of Court TV, determined by appraisal.

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      Through a wholly owned subsidiary, Turner owns the Atlanta Braves of Major League Baseball. The Braves derive revenue from ticket receipts, advertising and related sales, premium seating sales, concessions, local sponsorships and the sale of local broadcasting rights, and share pro rata in proceeds from national media contracts and licensing activities of Major League Baseball.

Competition

      Each of the Networks competes with other television programming services for marketing and distribution by cable and other distribution systems. All of the Networks compete for viewers’ attention and audience share with all other forms of programming provided to viewers, including broadcast networks, local over-the-air television stations, other pay and basic cable television services, home video, pay-per-view and video on demand services, online activities and other forms of news, information and entertainment. In addition, the Networks face competition for programming with those same commercial television networks, independent stations, and pay and basic cable television services, some of which have exclusive contracts with motion picture studios and independent motion picture distributors. The Turner Networks, The WB Network and Turner’s Internet sites compete for advertising with numerous direct competitors and other media.

      The Cable Networks’ production divisions compete with other producers and distributors of programs for air time on broadcast networks, independent commercial television stations, and pay and basic cable television networks.

PUBLISHING

      The Company’s magazine and book publishing businesses are conducted primarily by Time Inc., a wholly owned subsidiary of the Company, either directly or through its subsidiaries. Time Warner Book Group Inc., a Time Inc. subsidiary, conducts most of Publishing’s book publishing operations. In addition, Time Inc. operates certain direct marketing businesses.

Magazines

 
General

      As of February 1, 2005, Time Inc. published over 130 magazines worldwide, comprised of over 40 in the U.S. and over 90 in other countries. These magazines generally appeal to the broad consumer market and include People, Sports Illustrated, In Style, Southern Living, Time, Entertainment Weekly, Fortune, Real Simple, What’s On TV and Cooking Light.

      Time Inc. expands its core magazine businesses generally through the development of product extensions and international editions. Product extensions are generally managed by the individual magazines and involve, among other things, new magazines, specialized editions aimed at particular audiences, and distribution of editorial content through different media, such as the Internet, books and television.

      In 2004, Time Inc. launched more magazines in one year than ever before, including All You, a monthly U.S. women’s magazine distributed exclusively, at this time, in Wal-Mart stores, Cottage Living, a monthly U.S. women’s lifestyle magazine, and Nuts, a weekly U.K. mass-market, general lifestyle men’s magazine. Time Inc. also re-launched Life as a weekend magazine distributed in U.S. newspapers nationwide.

 
Description of Magazines

      Generally, each magazine published by Time Inc. in the U.S. has an editorial staff under the supervision of a managing editor and a business staff under the management of a president or publisher. Magazine production and distribution activities are generally centralized. Fulfillment activities for Time Inc.’s U.S. magazines are generally administered from a centralized facility in Tampa, Florida.

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      Time Inc.’s major magazines and their areas of editorial focus are summarized below:

      People is a weekly magazine that reports on celebrities and other notable personalities. People generated approximately 13% of Publishing’s revenues in 2004. People has expanded its franchise in recent years to include People en Español, a Spanish-language magazine aimed primarily at Hispanic readers in the U.S., and Teen People, aimed at teenage readers. Who Weekly is an Australian version of People managed by IPC Media, Time Inc.’s consumer magazine publisher in the U.K.

      Sports Illustrated is a weekly magazine that covers sports. Sports Illustrated for Kids is a sports magazine intended primarily for pre-teenagers. Sports Illustrated on Campus is a sports supplement inserted into major college newspapers weekly during the school year.

      In Style is a monthly magazine that focuses on celebrity, lifestyle, beauty and fashion. In recent years, In Style has expanded internationally by launching in Australia and the U.K. under the management of IPC Media; it is also published in Germany, Brazil, South Korea, Greece and Spain under licensing agreements.

      Time is a weekly newsmagazine that summarizes the news and interprets the week’s events, both national and international. Time also has 4 weekly English-language editions that circulate outside the United States. Time for Kids is a current events newsmagazine for children, ages 5 to 13.

      Entertainment Weekly is a weekly magazine that includes reviews and reports on movies, DVDs, video, television, music and books.

      Fortune is a bi-weekly magazine that reports on worldwide economic and business developments and compiles the annual Fortune 500 list of the largest U.S. corporations. Other business and financial magazines include Money, a monthly magazine that reports primarily on personal finance, FSB: Fortune Small Business, which covers small business, and Business 2.0, a magazine that reports on innovation in the worlds of business and technology.

      Real Simple is a monthly magazine that focuses on life, home, body and soul and provides practical solutions for simplifying various aspects of busy lives.

      IPC Media, the U.K.’s leading consumer magazine publisher, publishes over 80 magazines and numerous special issues and guides in the U.K. and Australia. These publications are largely focused in the television, women’s lifestyle, home and garden, leisure and men’s lifestyle categories. Its magazines include What’s on TV, TV Times, Woman, Marie Claire, Homes & Gardens, Country Life, Loaded, Horse & Hound and the new Nuts.

      Southern Progress Corporation publishes 8 magazines, including the regional lifestyle magazines Southern Living and Sunset and the specialty magazines Cooking Light and Health.

      Time4 Media publishes 17 sport and outdoor activity enthusiast magazines such as Golf, Field & Stream, Outdoor Life, Ski, Yachting, Salt Water Sportsman, Transworld Skateboarding and Transworld Snowboarding, as well as Popular Science. In addition, Time4 Media oversees the publication and production of This Old House magazine and several television series, including This Old House and Ask This Old House.

      The Parenting Group publishes Parenting and Babytalk magazines.

      Time Inc. also has management responsibility under a management contract for the American Express Publishing Corporation’s publishing operations, including its lifestyle magazines Travel & Leisure, Food & Wine and Departures.

      Time Inc. has a 49% equity stake in Essence Communications Partners, a partnership which publishes Essence, the premier magazine for African-American women. Time Inc. has signed an agreement in principle to acquire the remaining 51% of the partnership that it does not already own. This transaction is expected to close in the first quarter of 2005.

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Advertising

      Advertising carried in Time Inc.’s U.S. magazines is predominantly consumer advertising, including domestic and foreign automobiles, toiletries and cosmetics, food, media and entertainment, pharmaceuticals, retail and department stores, computers and technology, and financial services. In 2004, Time Inc. magazines accounted for approximately 24.2% of the total U.S. advertising revenue in consumer magazines, as measured by the Publishers Information Bureau (PIB). People, Sports Illustrated and Time were ranked 1, 2 and 4, respectively, by PIB, and Time Inc. had 8 of the 30 leading magazines in terms of advertising dollars.

 
Circulation

      Through the sale of magazines to consumers, circulation generates significant revenues for Time Inc. In addition, circulation is an important component in determining Time Inc.’s advertising revenues because advertising page rates are based on circulation and readership. Most of Time Inc.’s U.S. magazines are sold primarily by subscription and delivered to subscribers through the mail. Most of Time Inc.’s international magazines are sold primarily at newsstand. Subscriptions are sold primarily through direct mail and online solicitation, subscription sales agents, marketing agreements with other companies and insert cards in Time Inc. magazines and other publications.

      Time Inc. owns approximately 92% of Synapse Group, Inc. (“Synapse”), a leading magazine subscription agent in the U.S. Synapse sells magazine subscriptions principally through marketing relationships with credit card issuers, consumer catalog companies, commercial airlines with frequent flier programs and Internet businesses. Under the relevant agreements, in April 2006 the other Synapse shareholders may require Time Inc. to purchase their entire remaining interest in Synapse (the “Synapse Put”), and in May 2006 Time Inc. may require the Synapse shareholders to sell their entire interest in Synapse to Time Inc. (the “Time Inc. Call”). The price to be paid upon exercise of either the Synapse Put or the Time Inc. Call would be based upon Synapse’s earnings for 2005.

      Newsstand sales of magazines, which are reported as a component of Subscription revenues, are sold through traditional newsstands as well as other retail outlets such as Wal-Mart, supermarkets and convenience and drug stores, and may or may not result in repeat purchases and revenues. Magazines are supplied by wholesalers or directly through a Time Inc. subsidiary. Time/ Warner Retail Sales & Marketing Inc. is responsible for distributing and marketing newsstand copies of Time Inc. magazines and books and certain other publishers’ magazines and books sold through wholesalers primarily in the U.S. and Canada.

 
Paper and Printing

      Paper constitutes a significant component of physical costs in the production of magazines. During 2004, Time Inc. purchased over half a million tons of paper principally from four independent manufacturers.

      Printing and binding for Time Inc. magazines are performed primarily by major domestic and international independent printing concerns in multiple locations in the U.S. and in locations in approximately seven other countries. Magazine printing contracts are either fixed-term or open-ended at fixed prices with, in some cases, adjustments based on certain criteria.

Books

      Time Inc.’s trade book publishing operations are conducted primarily by the Time Warner Book Group Inc. through its three major publishing houses, Warner Books, Little, Brown and Company and Time Warner Book Group UK. During 2004, the Time Warner Book Group placed a record 58 books on The New York Times bestseller lists, including Publishers Weekly Book of the Year America (The Book) by Jon Stewart, Your Best Life Now by Joel Osteen and A Salty Piece of Land by Jimmy Buffett, and new releases from many of its major recurring bestselling authors, including David Baldacci, Nelson DeMille, James Patterson and Nicholas Sparks.

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      The Time Warner Book Group handles book distribution for Little, Brown and Warner Books, as well as Disney, Microsoft and other publishers, through its distribution center in Indiana. The marketing of trade books is primarily to retail stores, online outlets and wholesalers throughout the U.S., Canada and the U.K. Through their combined U.S. and U.K. operations, the Time Warner Book Group companies have the ability to acquire English-language publishing rights for the distribution of hard and soft-cover books throughout the world.

      Oxmoor House, Inc., Leisure Arts, Inc. and Sunset Books publish and distribute a variety of how-to and lifestyle books covering the areas of cooking, entertaining, health, home improvement, gardening, general crafts, needlecrafts, decorating and organizing. Time Inc. Home Entertainment publishes branded book specials and commemorative editions using Time Inc. magazine editorial content and content from third-party publishers.

Direct Marketing

      Through subsidiaries, Time Inc. conducts direct marketing businesses. In addition to selling magazine subscriptions, Synapse is a direct marketer of consumer products, including software, DVDs and other merchandise.

      Southern Living At Home, the direct selling division of Southern Progress Corporation, specializes in home décor products which are sold through approximately 35,000 independent consultants at parties hosted in people’s homes in the U.S.

      Book-of-the-Month Club, Inc. (“BOMC”) has a 50-50 joint venture with Bertelsmann’s Doubleday Direct, Inc. to operate the U.S. book clubs of BOMC and Doubleday jointly. The joint venture, named Bookspan, acquires the rights to manufacture and sell books to consumers through clubs. Bookspan operates its own fulfillment and warehousing operations in Pennsylvania. Under the relevant agreements, beginning in June 2005, either Bertelsmann or the Company may elect to terminate the venture by giving notice during specified termination periods. If such an election is made by either party, a confidential bid process will take place pursuant to which the highest bidder will purchase the other party’s entire venture interest. The Company is unable to predict whether this bid process will occur or the amount that may be paid out or received under it.

      On December 31, 2003, Time Inc. sold its Time Life Inc. business, a direct marketer of entertainment products such as music and videos.

Postal Rates

      Postal costs represent a significant operating expense for the Company’s magazine publishing and direct marketing activities. In 2004, the Company spent over $350 million for services provided by the U.S. Postal Service. Time Inc. strives to minimize postal expense through the use of certain cost-saving activities, including activities with respect to address quality, mail preparation and delivery of products to postal facilities. It has been the Company’s practice, generally, in selling books and other non-magazine products by mail to include a separate charge for postage and handling, which is adjusted from time to time to partially offset any increased postage or handling costs.

Competition

      Time Inc.’s magazine operations compete for circulation, audience and advertising with numerous other publishers, as well as other media. These magazine operations compete for advertising directed at the general public and also advertising directed at more focused demographic groups. The Time Warner Book Group faces competition from other major consumer publishers for top-selling authors and for third party distribution business.

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      Time Inc.’s direct marketing operations compete with other direct marketers through all media for the consumer’s attention. In addition to the traditional media sources for product sales, the Internet has become a strong vehicle in the direct marketing business and for subscription sales.

OTHER ASSETS

      The Company also has an aggregate equity interest in Time Warner Telecom Inc. (“Time Warner Telecom”) of approximately 44% and an aggregate voting interest (consisting of high-voting common stock) of approximately 71%. Time Warner Telecom is a provider of managed network solutions to business customers and organizations in 44 metropolitan markets across the United States. Time Warner Telecom integrates data, dedicated Internet access, and local and long distance voice services for long distance carriers, wireless communications companies, incumbent local exchange carriers and various organizations in the public and private sector. The Company’s nominees to the Board of Directors of Time Warner Telecom are limited to less than a majority by the terms of a stockholder agreement and Time Warner Telecom is a separately-managed public company whose stock is traded through Nasdaq. Its financial results are not consolidated with those of the Company. The Company has determined that it does not consider its interest in Time Warner Telecom to be strategic and has so advised Time Warner Telecom.

INTELLECTUAL PROPERTY

      Time Warner Inc. is one of the world’s leading creators, owners and distributors of intellectual property. The Company’s vast intellectual property assets include copyrights in motion pictures, television programs, books, magazines and software; trademarks in names, logos and characters; patents or patent applications for inventions related to its products and services; and licenses of intellectual property rights of various kinds. These intellectual property assets, both in the U.S. and in other countries around the world, are among the Company’s most valuable assets. The Company derives value from these assets through a range of business models, including the theatrical release of films, the licensing of its films and television programming to multiple domestic and international television and cable networks and pay television services, and the sale of products such as DVDs, videocassettes, books and magazines. It also derives revenues related to its intellectual property through advertising in its magazines, networks, cable systems and online services and from various types of licensing activities, including licensing of its trademarks and characters. To protect these assets, the Company relies upon a combination of copyright, trademark, unfair competition, patent and trade secret laws and contract provisions. The duration of the protection afforded to the Company’s intellectual property depends on the type of property in question and the laws and regulations of the relevant jurisdiction; in the case of licenses, it also depends on contractual and/or statutory provisions.

      The Company vigorously pursues all appropriate avenues of protection for its intellectual property. However, there can be no assurance of the degree to which these measures will be successful in any given case. Policing unauthorized use of the Company’s products and services is often difficult and the steps taken may not in every case prevent the misappropriation of the Company’s intellectual property. Piracy, particularly in the digital environment, continues to present a threat to revenues from products and services based on intellectual property. The Company seeks to limit that threat through a combination of approaches, including offering legitimate market alternatives, applying digital rights management technologies, pursuing legal sanctions for infringement, promoting appropriate legislative initiatives, and enhancing public awareness of the meaning and value of intellectual property. The Company works with various cross-industry groups and trade associations, as well as with strategic partners to develop and implement technological solutions to control digital piracy.

      Third parties may challenge the validity or scope of the Company’s intellectual property from time to time, and such challenges could result in the limitation or loss of intellectual property rights. In addition, domestic and international laws, statutes and regulations are constantly changing, and the Company’s assets may be either adversely or beneficially affected by such changes. Moreover, effective intellectual property protection may be either unavailable or limited in certain foreign territories. The Company therefore engages

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in efforts to strengthen and update intellectual property protection around the world, including efforts to ensure effective remedies for infringement.

REGULATION AND LEGISLATION

      The Company’s cable system, cable and broadcast television network and original programming businesses are subject, in part, to regulation by the Federal Communications Commission (“FCC”), and the cable system business is also subject to regulation by most local and some state governments where the Company has cable systems. The Company’s magazine, book and other direct marketing activities are also subject to regulation. In addition, in connection with regulatory clearance of the America Online-Historic TW Merger, the Company’s cable system and Internet businesses are subject to the terms of the Consent Decree (the “Consent Decree”) issued by the Federal Trade Commission (“FTC”), the Memorandum Opinion and Order (“Order”) issued by the FCC, as well as other conditions that have been fully satisfied and are no longer relevant. The Company is also subject to an FTC consent decree (the “Turner Consent Decree”) as a result of the FTC’s approval of the acquisition of Turner Broadcasting System, Inc. in 1996.

      The following is a summary of the terms of these orders as well as current significant federal, state and local laws and regulations affecting the growth and operation of these businesses. In addition, various legislative and regulatory proposals under consideration from time to time by Congress and various federal agencies have in the past materially affected, and may in the future materially affect, the Company.

FTC Consent Decree

      On December 14, 2000, the FTC issued a Consent Decree in connection with the America Online-Historic TW Merger. The consent decree provided that, with the exception of Road Runner, Time Warner Cable was not permitted to launch an affiliated ISP, like the AOL for Broadband service, in its 20 largest divisions, until it launched the EarthLink service, an unaffiliated ISP, on those systems. The Consent Decree also provided that for those systems, Time Warner Cable had to enter into agreements with two additional unaffiliated ISPs within 90 days after launching an affiliated ISP. In addition, the Consent Decree required that, in its remaining divisions, Time Warner Cable had to enter into agreements with three unaffiliated providers within 90 days after launching an affiliated ISP.

      Time Warner Cable has now entered into, and received FTC approval for, agreements with the required number of unaffiliated ISPs in all covered divisions. If any of the required agreements expires or is terminated during the term of the Consent Decree, Time Warner Cable will be required to replace it with another approved agreement.

      The Consent Decree also requires that Time Warner Cable’s FTC-approved agreements contain a provision that requires Time Warner Cable to give notice to the unaffiliated ISPs if Time Warner enters into an agreement for AOL to provide ISP Service, as defined under the Decree, with any one of six specified cable operators. In that event, the Company is required to give each unaffiliated ISP the option to adopt all terms and conditions of the relevant AOL ISP Service agreement. In addition, the Consent Decree requires that Time Warner continue to offer and promote DSL service in areas served by Time Warner Cable to the same extent and on terms comparable to the terms offered in areas not served by Time Warner Cable. America Online is also prohibited from entering into agreements with cable MSOs that restrict the ability of that MSO to enter into agreements with other ISPs or interactive television providers. The Company’s obligations under the Consent Decree expire on April 17, 2006.

FCC Memorandum Opinion and Order

      On January 11, 2001, the FCC issued an Order imposing certain requirements regarding Time Warner Cable’s provision of multiple ISPs. Specifically, the Order requires Time Warner Cable to provide consumers with a list of available ISPs upon request, to allow ISPs to determine the content on their first screen, and to allow ISPs to have direct billing arrangements with the subscribers they obtain. The Order prohibits Time

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Warner Cable from requiring customers to go through an affiliated ISP to reach an unaffiliated ISP, from requiring ISPs to include particular content, and from discriminating on the basis of affiliation with regard to technical system performance.

      In addition, the FCC’s Order prohibits the Company from entering into any agreement with Comcast that gives any ISP affiliated with the Company exclusive carriage rights on any former AT&T cable system for broadband ISP services or that affects Comcast’s ability to offer rates or other carriage terms to ISPs that are not affiliated with the Company.

Turner FTC Consent Decree

      The Company is also subject to the terms of a consent decree (the “Turner Consent Decree”) entered in connection with the FTC’s approval of the acquisition of Turner by Historic TW in 1996. Certain requirements imposed by the Turner Consent Decree, such as carriage commitments for Time Warner Cable for the rollout of at least one independent national news video programming service, have been fully satisfied by the Company. Various other conditions remain in effect, including certain restrictions which prohibit the Company from offering programming upon terms that (1) condition the availability of, or the carriage terms for, the HBO service upon whether a multichannel video programming distributor carries a video programming service affiliated with Turner; and (2) condition the availability of, or the carriage terms for, CNN, TBS and TNT upon whether a multichannel video programming distributor carries any video programming service affiliated with TWE. The Turner Consent Decree also imposes certain restrictions on the terms by which a Turner video programming service may be offered to an unaffiliated programming distributor that competes in areas served by Time Warner Cable.

      Other conditions of the Turner Consent Decree prohibit Time Warner Cable from requiring, as a condition of carriage, that any national video programming vendor provide a financial interest in its programming service or that such programming vendor provide exclusive rights against any other multichannel programming distributor. In addition, Time Warner Cable may not discriminate on the basis of affiliation in the selection, terms or conditions of carriage for national video programming vendors.

      The Turner Consent Decree also requires that any Time Warner stock held by Liberty Media Corporation (“Liberty Media”), its former corporate parent, Tele-Communications, Inc. (“TCI”), which was merged with AT&T in 1999 and was subsequently acquired by Comcast in 2002, as well as by the late Bob Magness and John C. Malone as individuals, be non-voting except that such securities are entitled to a vote of one-one hundredth (1/100) of a vote per share owned when voting with the outstanding common stock on the election of directors and a vote equal to the vote of the common stock with respect to corporate matters that would adversely change the rights or terms of these non-voting securities. Upon the sale of these non-voting securities to any independent third party, the securities may be converted into voting stock of Time Warner. The Turner Consent Decree also prohibits Liberty Media, TCI (now Comcast), the late Bob Magness and John C. Malone as individuals, from holding ownership interests, collectively, of more than 9.2% of the fully diluted equity of Time Warner. In 2002, Liberty Media sought to eliminate these restrictions from the Turner Consent Decree; the petition was denied by the FTC without prejudice.

      The Turner Consent Decree was modified by the FTC on December 21, 2004, upon application by Liberty Media, to permit Liberty Media to lend to a third party the Company common stock into which the non-voting stock held by it is convertible, provided that Liberty has no right to vote or to direct the voting of the loaned common stock and will not directly or indirectly influence or attempt to influence the voting of such stock. The Turner Consent Decree will expire in February 2007.

Cable System Regulation

 
Communications Act and FCC Regulation

      The Communications Act of 1934, as amended (the “Communications Act”) and the regulations and policies of the FCC affect significant aspects of Time Warner Cable’s cable system operations, including

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subscriber rates; carriage of broadcast television stations, as well as the way Time Warner Cable sells its program packages to subscribers; the use of cable systems by franchising authorities and other third parties; cable system ownership; and use of utility poles and conduits.

      Subscriber Rates. The Communications Act and the FCC’s rules regulate rates for basic cable service and equipment in communities that are not subject to “effective competition,” as defined by federal law. Where there is no effective competition, federal law authorizes franchising authorities to regulate the monthly rates charged by the operator for the minimum level of video programming service, referred to as basic service, which generally includes local broadcast channels and public access or governmental channels required by the franchise. This kind of regulation also applies to the installation, sale and lease of equipment used by subscribers to receive basic service, such as set-top boxes and remote control units. In many localities, Time Warner Cable is no longer subject to this rate regulation, either because the local franchising authority has not asked the FCC for permission to regulate or because the FCC has found that there is effective competition.

      Carriage of Broadcast Television Stations and Other Programming Regulation. The Communications Act and the FCC’s regulations contain broadcast signal carriage requirements that allow local commercial television broadcast stations to elect once every three years to require a cable system to carry their stations, subject to some exceptions, or to negotiate with cable systems the terms by which the cable systems may carry their stations, commonly called “retransmission consent.” The most recent election by broadcasters became effective on January 1, 2003.

      The Communications Act and the FCC’s regulations require a cable operator to devote up to one-third of its activated channel capacity for the mandatory carriage of local commercial television stations. The Communications Act and the FCC’s regulations give local non-commercial television stations mandatory carriage rights, but non-commercial stations do not have the option to negotiate retransmission consent for the carriage of their signals by cable systems. Additionally, cable systems must obtain retransmission consent for all “distant” commercial television stations except for commercial satellite-delivered independent “superstations,” commercial radio stations, and some low-power television stations.

      FCC regulations require Time Warner Cable to carry the signals of both commercial and non-commercial local digital-only broadcast stations and the digital signals of local broadcast stations that return their analog spectrum to the government and convert to a digital broadcast format. The FCC’s rules give digital-only broadcast stations discretion to elect whether the operator will carry the station’s primary signal in a digital or converted analog format, and the rules also permit broadcasters with both analog and digital signals to tie the carriage of their digital signals to the carriage of their analog signals as a retransmission consent condition.

      The Communications Act also permits franchising authorities to negotiate with cable operators for channels for public, educational and governmental access programming. Moreover, it requires a cable system with 36 or more activated channels to designate a significant portion of its channel capacity for commercial leased access by third parties to provide programming that may compete with services offered by the cable operator. The FCC regulates various aspects of such third-party commercial use of channel capacity on our cable systems, including the rates and some terms and conditions of the commercial use.

      High-Speed Internet Access. From time to time, industry groups, telephone companies and ISPs have sought local, state and federal regulations that would require cable operators to sell capacity on their systems to ISPs under a common carrier regulatory scheme. Cable operators have successfully challenged regulations requiring this “forced access,” although courts that have considered these cases have employed varying legal rationales in rejecting these regulations.

      In 2002, the FCC released an order in which it determined that cable-modem service constitutes an “information service” rather than a “cable service” or a “telecommunications service,” as those terms are used in the Communications Act. According to the FCC, this conclusion may permit but does not require it to impose “multiple ISP” requirements. In 2002, the FCC also initiated a rulemaking proceeding to consider whether it may and should do so and whether local franchising authorities should be permitted to do so. This rulemaking proceeding remains pending.

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      Several ISPs appealed the FCC’s order in federal court, arguing that cable modem service is a “telecommunications service.” If the ISPs prevail, cable operators may become subject to a requirement that they carry any ISP desiring carriage. In addition, several local franchising authorities also appealed the order in federal court, arguing that the FCC should have held that cable-modem service is a “cable service.” If the local franchising authorities prevail, cable operators may be required to collect and pay franchise fees on cable modem service. In October 2003, the U.S. Court of Appeals for the 9th Circuit vacated in part, and remanded in part for further proceedings, the FCC’s 2002 order. The FCC and various cable-industry parties then filed a petition with the Supreme Court asking it to review the 9th Circuit decision, which, on December 3, 2004, was granted. Local franchising authorities also filed a petition for review, which, on December 6, 2004, was denied. A decision on the merits is expected by June 2005.

      Ownership Limitations. There are various rules prohibiting joint ownership of cable systems and other kinds of communications facilities. Local telephone companies generally may not acquire more than a small equity interest in an existing cable system in the telephone company’s service area, and cable operators generally may not acquire more than a small equity interest in a local telephone company providing service within the cable operator’s franchise area. In addition, cable operators may not have more than a small interest in “multichannel multipoint distribution services” facilities or “satellite master antenna television” systems in their service areas. Finally, the FCC has been exploring whether it should prohibit cable operators from holding ownership interests in satellite operators.

      The Communications Act also required the FCC to adopt “reasonable limits” on the number of subscribers a cable operator may reach through systems in which it holds an ownership interest. In September 1993, the FCC adopted a rule that was later amended to prohibit any cable operator from serving more than 30% of all cable, satellite and other multi-channel subscribers nationwide. The Communications Act also required the FCC to adopt “reasonable limits” on the number of channels that cable operators may fill with programming services in which they hold an ownership interest. In September 1993, the FCC imposed a limit of 40% of a cable operator’s first 75 activated channels. In March 2001, a federal appeals court struck down both limits. The FCC is currently exploring whether it should re-impose any limits. The Company believes that it is unlikely that the FCC will adopt limits more stringent than those struck down.

      Local telephone companies may provide service as traditional cable operators with local franchises or they may opt to provide their programming over unfranchised “open video systems.” Open video systems are subject to specified requirements, including, but not limited to, a requirement that they set aside a portion of their channel capacity for use by unaffiliated program distributors on a non-discriminatory basis. A federal appellate court overturned various parts of the FCC’s open video rules, including the FCC’s preemption of local franchising requirements for open video operators. The FCC has modified its open video rules to comply with the federal court’s decision.

      Pole Attachment Regulation. The Communications Act requires that utilities provide cable systems and telecommunications carriers with nondiscriminatory access to any pole, conduit or right-of-way controlled by the utility. The Communications Act also requires the FCC to regulate the rates, terms and conditions imposed by public utilities for cable systems’ use of utility pole and conduit space unless state authorities demonstrate to the FCC that they adequately regulate pole attachment rates, as is the case in some states in which Time Warner Cable operates. In the absence of state regulation, the FCC administers pole attachment rates on a formula basis. The FCC’s original rate formula governs the maximum rate utilities may charge for attachments to their poles and conduit by cable operators providing cable services. The FCC also adopted a second rate formula that became effective in February 2001 and governs the maximum rate utilities may charge for attachments to their poles and conduit by companies providing telecommunications services. Any increase in attachment rates resulting from the FCC’s new rate formula is being phased in (in equal annual installments) over a five-year period that began in February 2001. The U.S. Supreme Court has upheld the FCC’s jurisdiction to regulate the rates, terms and conditions of cable operators’ pole attachments that are being used to provide both cable service and high-speed data service.

      Other Regulatory Requirements of the Communications Act and the FCC. The Communications Act also includes provisions regulating customer service, subscriber privacy, marketing practices, equal employ-

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ment opportunity, technical standards and equipment compatibility, antenna structure notification, marking, lighting, emergency alert system requirements and the collection from cable operators of annual regulatory fees, which are calculated based on the number of subscribers served and the types of FCC licenses held.

      Certain regulatory requirements are also applicable to set-top boxes. Currently, many cable subscribers rent from their cable operator a set-top box that performs both signal-reception functions and conditional-access security functions. The lease rates cable operators charge for this equipment are subject to rate regulation to the same extent as basic cable service. In 1996, Congress enacted a statute seeking to allow subscribers to use set-top boxes obtained from third-party retailers. The most important of the FCC’s implementing regulations requires cable operators to offer separate equipment providing only the conditional-access security function (so that subscribers can purchase set-top boxes or other navigational devices from other sources) and to cease placing into service new set-top boxes that have integrated conditional-access security. The regulations requiring cable operators to cease distributing set-top boxes with integrated conditional-access security are currently scheduled to go into effect on July 1, 2006. Some cable operators have asked the FCC to reconsider these regulations or, in the alternative, to extend the deadline. Those requests are pending as of March 1, 2005.

      In December 2002, cable operators and consumer-electronics companies entered into a standard-setting agreement relating to interoperability between cable systems and reception equipment. Among other things, the agreement envisions consumer electronics devices with a slot for a conditional-access security card — a CableCARD® — provided by the cable operator. To implement the agreement, the FCC promulgated regulations that require cable systems with activated spectrum of 750 MHz or greater to support unidirectional digital devices; establish a voluntary labeling system for unidirectional devices; prohibit so-called “selectable output controls”; and adopt content-encoding rules. The FCC has issued a further notice of proposed rulemaking to consider additional changes. Cable operators, consumer-electronics companies and other market participants are holding discussions that are expected to lead to a similar set of interoperability agreements covering digital devices capable of carrying cable operators’ two-way and interactive products and services.

      Separately, the FCC has adopted cable inside wiring rules to provide specific procedures for the disposition of residential home wiring and internal building wiring where a subscriber terminates service or where an incumbent cable operator is forced by a building owner to terminate service in a multiple dwelling unit building. The FCC has also adopted rules providing that, in the event that an incumbent cable operator sells the inside wiring, it must make the wiring available to the multiple dwelling unit owner or the alternative cable service provider during the 24-hour period prior to the actual service termination by the incumbent, in order to avoid service interruption.

      Compulsory Copyright Licenses for Carriage of Broadcast Stations, Music Performance Licenses. Time Warner Cable’s cable systems provide subscribers with, among other things, local and distant television broadcast stations. Time Warner Cable generally does not obtain a license to use this programming directly from program owners. Instead, it obtains this programming pursuant to a compulsory license provided by federal law, which requires it to make payments to a copyright pool. The elimination or substantial modification of the cable compulsory license could adversely affect Time Warner Cable’s ability to obtain suitable programming and could substantially increase the cost of programming that remains available for distribution to its subscribers.

      When Time Warner Cable obtains programming from third parties, it generally obtains licenses that include any necessary authorizations to transmit the music included in it. When Time Warner Cable creates its own programming and provides various other programming or related content, including local origination programming and advertising that it inserts into cable-programming networks, it is required to obtain any necessary music performance licenses directly from the rights holders. These rights are generally controlled by three music performance rights organizations, each with rights to the music of various artists. Time Warner Cable generally has obtained the necessary licenses, either through negotiated licenses or through procedures established by consent decrees entered into by some of the music performance rights organizations.

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State and Local Regulation

      Cable operators operate their systems under non-exclusive franchises. Franchises are awarded, and cable operators are regulated, by municipal or other local franchising authorities. In some states, cable regulation is imposed at the state level as well. The Company believes it generally has good relations with state and local cable regulators.

      Franchise agreements typically require payment of franchise fees and contain regulatory provisions addressing, among other things, upgrades, service quality, cable service to schools and other public institutions, insurance and indemnity bonds. The terms and conditions of cable franchises vary from jurisdiction to jurisdiction. The Communications Act provides protections against many unreasonable terms. In particular, the Communications Act imposes a ceiling on franchise fees of five percent of revenues derived from cable service. Time Warner Cable generally passes the franchise fee on to its subscribers, listing it as a separate item on the bill.

      Franchise agreements usually have a term of ten to 15 years from the date of grant, although some renewals may be for shorter terms. Franchises usually are terminable only if the cable operator fails to comply with material provisions. Time Warner Cable has not had a franchise terminated due to breach. After a franchise agreement expires, a franchising authority may seek to impose new and more onerous requirements, including requirements to upgrade facilities, to increase channel capacity and to provide various new services. Federal law, however, provides significant substantive and procedural protections for cable operators seeking renewal of their franchises. In addition, although Time Warner Cable occasionally reaches the expiration date of a franchise agreement without having a written renewal or extension, it generally has the right to continue to operate, either by agreement with the franchising authority or by law, while continuing to negotiate a renewal. In the past, substantially all of the material franchises relating to its systems have been renewed by the relevant local franchising authority, though sometimes only after significant time and effort. Despite its efforts and the protections of federal law, it is possible that some Time Warner Cable franchises may not be renewed, and Time Warner Cable may be required to make significant additional investments in its cable systems in response to requirements imposed in the course of the franchise renewal process.

      Franchises usually require the consent of franchising authorities prior to the sale, assignment, transfer or change of control of a cable system. Federal law imposes various limitations on the conditions local authorities may impose and requires localities to act on such requests within 120 days.

 
Regulation of Telephony

      As of December 31, 2004, it was unclear whether and to what extent regulators will subject Voice over Internet Protocol (“VoIP”) service provided by cable operators to the regulations that apply to traditional circuit switch telephone service provided by incumbent telephone companies. In February 2004, the FCC opened a rulemaking proceeding to consider these and other issues. This proceeding remains pending. In November 2004, the FCC issued an order preempting certain kinds of state regulation of VoIP services, including state requirements to obtain a certificate and to file a tariff. The order did not decide, however, what federal rules should apply. In particular, there is uncertainty as to whether and to what extent the “access charge” and “universal service” rules that apply to traditional circuit switch telephone service will also apply to VoIP service. It is also possible that regulators will allow utility pole owners to charge cable operators offering VoIP service higher rates for pole rental than for traditional cable service and cable-modem service.

Network Regulation

      Under the Communications Act and its implementing regulations, vertically integrated cable programmers like the Turner Networks and the Home Box Office Services, are generally prohibited from offering different prices, terms, or conditions to competing unaffiliated multichannel video programming distributors unless the differential is justified by certain permissible factors set forth in the regulations. The rules also place certain restrictions on the ability of vertically integrated programmers to enter into exclusive distribution arrangements with cable operators. Certain other federal laws also contain provisions relating to violent and

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sexually explicit programming, including relating to the voluntary promulgation of ratings by the industry and requiring manufacturers to build television sets with the capability of blocking certain coded programming (the so-called “V-chip”).

Marketing Regulation

      Time Inc.’s magazine and book marketing activities, as well as other marketing and billing activities by America Online and other divisions of the Company, are subject to regulation by the FTC and each of the state Attorneys General under general consumer protection statutes prohibiting unfair or deceptive acts or practices. Certain areas of marketing activity are also subject to specific federal statutes and rules, such as the Telephone Consumer Protection Act, the Children’s Online Privacy Protection Act, the Gramm-Leach-Bliley Act (relating to financial privacy), the FTC Mail or Telephone Order Merchandise Rule and the FTC Telemarketing Sales Rule. There are also certain specific state statutes and rules that regulate conduct in areas such as privacy, data security and telemarketing. In addition, Time Inc. regularly receives and resolves routine inquiries from state Attorneys General and is subject to standing agreements with state Attorneys General addressing some of Time Inc.’s marketing activities. Certain of Time Inc.’s specific marketing methods, such as automatic subscription renewal and free trial, are being examined by the Attorneys General of several states. America Online is also subject to a 2004 FTC Consent Decree, a 1998 FTC Consent Decree and Assurances of Voluntary Compliance with state governments regarding America Online’s marketing and billing activities, including its cancel/save processes, billing practices, rebates and other marketing promotions.

DESCRIPTION OF CERTAIN PROVISIONS OF AGREEMENTS

RELATED TO TWC INC.

Background

      Time Warner Cable Inc., referred to herein as TWC Inc., was created in connection with the March 31, 2003 restructuring (the “TWE Restructuring”) of Time Warner Entertainment Company, L.P. (“TWE”), a limited partnership which formerly held a substantial portion of the Company’s filmed entertainment and cable television assets.

      Among other things, as a result of the TWE Restructuring, all of Time Warner’s interests in cable, including those that were wholly owned and those that were held through TWE, became controlled by TWC Inc. As part of the TWE Restructuring, Time Warner received a 79% economic interest in TWC Inc.’s cable systems and TWE, which continues to own the interests in the cable systems that it held prior to the TWE Restructuring, became a subsidiary of TWC Inc. In exchange for the 27.64% stake in TWE previously held by Comcast, TWC Inc. issued to Comcast, among other things, a 21% effective interest in TWC Inc.’s business, consisting of a 17.9% stock interest in TWC Inc and a 4.7% limited partnership interest in TWE. Under the arrangements entered into by Comcast as part of the process of obtaining FCC approval of Comcast’s acquisition of AT&T Broadband, Comcast (and/or the Comcast trust referred to below) are obligated to take steps to dispose of their entire interest in TWC Inc. and TWE held by Comcast or such Comcast trust in an orderly process by November 2007, and in any event by May 2008.

      In connection with the TWE Restructuring, Comcast also received Series A Mandatorily Convertible Preferred Stock of Time Warner that will convert automatically on March 31, 2005 into shares of Time Warner Common Stock having a value equal to $1.5 billion at the time of conversion, up to a maximum of 225,056,264 shares. For additional information with respect to the TWE Restructuring, see “Description of Certain Provisions of the TWE Partnership Agreement” below.

Recent Developments

      On September 24, 2004, TWC Inc. entered into a Tolling and Optional Redemption Agreement with Comcast and certain of its affiliates, including the trust that holds shares of TWC Inc. on behalf of Comcast (the “Redemption Agreement”). Pursuant to the Redemption Agreement, Comcast was granted an option

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(the “Option”), originally exercisable between December 1, 2004 and April 1, 2005, to require TWC Inc. to redeem a portion of the TWC Inc. stock held by Comcast in exchange for the stock of a TWC Inc. subsidiary with cable systems servicing approximately 90,000 basic cable subscribers as of December 31, 2004, plus approximately $750 million in cash. The Redemption Agreement was amended in February 2005 to extend the expiration date of the Option to 60 days following notice by either TWC Inc. or Comcast or, after April 1, 2005, immediately if Comcast irrevocably elects not to exercise the Option.

      If the Option is exercised, Comcast’s current 21% effective interest in TWC Inc.’s business will be reduced to approximately 17% — consisting of a 13.7% common stock interest in TWC Inc. and a 4.7% limited partnership interest in TWE. The closing of the transaction will be subject to required governmental and regulatory approvals and other customary closing conditions. For details related to the accounting of this transaction, see Note 6, “TWE and TWC Inc. Related Transactions,” to the Company’s financial statements.

Management and Operation of TWC Inc.

      The following description summarizes certain provisions of agreements related to, and constituent documents of, TWC Inc. that affect and govern the ongoing operations of TWC Inc. Such description does not purport to be complete and is subject to, and is qualified in its entirety by reference to, the provisions of such agreements and constituent documents.

      Stockholders of TWC Inc. As a result of the TWE Restructuring, Time Warner and its subsidiaries received shares of TWC Inc. Class A common stock, which generally has one vote per share, and shares of TWC Inc. Class B common stock, which generally has ten votes per share, which together represent 89.3% of the voting power of TWC Inc. and 82.1% of the equity of TWC Inc. A Comcast trust (the “Comcast Trust”) received shares of Class A common stock of TWC Inc. representing the remaining 10.7% of the voting power and 17.9% of the equity of TWC Inc. The Class B common stock is not convertible into Class A common stock upon transfer or otherwise. The Class A common stock and the Class B common stock vote together as a single class on all matters, except with respect to the election of directors and certain matters described below.

      Board of Directors of TWC Inc. The Class A common stock votes, as a separate class, with respect to the election of the Class A directors of TWC Inc. (the “Class A Directors”), and the Class B common stock votes, as a separate class, with respect to the election of the Class B directors of TWC Inc. (the “Class B Directors”). Pursuant to the restated certificate of incorporation of TWC Inc. (the “Certificate of Incorporation”), the Class A Directors must represent not less than one-sixth and not more than one-fifth of the directors of TWC Inc., and the Class B Directors must represent not less than four-fifths of the directors of TWC Inc. As a result of its shareholdings, Time Warner has the ability to cause the election of all Class A Directors and Class B Directors, subject to certain restrictions on the identity of these directors discussed below.

      The TWC Inc. Certificate of Incorporation requires that there be at least two independent directors on the board of directors of TWC Inc. In addition, a parent agreement (the “Parent Agreement”) among Time Warner, TWC Inc. and Comcast provides that until such time that an initial public offering of TWC Inc. common stock is effected, at least 50% of the independent directors must be reasonably satisfactory to the Comcast Trust. To the extent possible, all such independent directors will be Class A Directors. If an initial public offering of TWC Inc. is effected, the Certificate of Incorporation requires that at least 50% of the board of directors of TWC Inc. consist of independent directors for three years.

      Protections of Minority Class A Common Stockholders. The approval of the holders of a majority of the voting power of the outstanding shares of Class A common stock held by persons other than Time Warner is necessary in connection with:

  •  any merger, consolidation or business combination of TWC Inc. in which the holders of Class A common stock do not receive per share consideration identical to that received by the holders of Class B common stock (other than with respect to voting power) or which would adversely affect the Class A common stock relative to the Class B common stock;

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  •  any change to the Certificate of Incorporation that would have a material adverse effect on the rights of the holders of the Class A common stock in a manner different from the effect on the holders of the Class B common stock;
 
  •  through and until the fifth anniversary of the completion of an initial public offering of TWC Inc., any change to provisions of TWC Inc.’s by-laws concerning restrictions on transactions between TWC Inc. and Time Warner and its affiliates;
 
  •  any change to the provisions of the Certificate of Incorporation that would affect the right of the Class A common stock to vote as a class in connection with any of the events discussed above; and
 
  •  any change to the Certificate of Incorporation that would alter the number of independent directors required on the TWC Inc. board of directors.

Matters Affecting the Relationship between Time Warner and TWC Inc.

      Indebtedness Approval Right. For so long as the indebtedness of TWC Inc. is attributable to Time Warner, in Time Warner’s reasonable judgment, TWC Inc., its subsidiaries and entities that it manages will not, without the consent of Time Warner, create, incur or guarantee any indebtedness, including preferred equity, or rental obligations if its ratio of indebtedness plus six times its annual rental expense to EBITDA (as EBITDA is defined in the applicable agreement and which is comparable to operating income (loss) before depreciation and amortization) plus rental expense, or “EBITDAR,” then exceeds or would exceed 3:1.

      Other Time Warner Rights. Under the Parent Agreement, as long as Time Warner has the right to elect more than a majority of the directors of TWC Inc., TWC Inc. must obtain Time Warner’s consent before it enters into any agreement that binds or purports to bind Time Warner or its affiliates or that would subject TWC Inc. to significant penalties or restrictions as a result of any action or omission of Time Warner; or adopts a stockholder rights plan, becomes subject to Section 203 of the Delaware General Corporation Law, adopts a “fair price” provision or takes any similar action.

      Time Warner Standstill. Under the Parent Agreement, Time Warner has agreed that for a period of three years following the completion of an initial public offering of TWC Inc., Time Warner will not make or announce a tender offer or exchange offer for the Class A common stock of TWC Inc. without the approval of a majority of the independent directors of TWC Inc.; and for a period of ten years following an initial public offering of TWC Inc., Time Warner will not enter into any business combination with TWC Inc., including a short-form merger, without the approval of a majority of the independent directors of TWC Inc.

      Transactions between Time Warner and TWC Inc. The by-laws of TWC Inc. provide that Time Warner may only enter into transactions with TWC Inc. and its subsidiaries, including TWE, that are on terms that, at the time of entering into such transaction, are substantially as favorable to TWC Inc. or its subsidiaries as they would be able to receive in a comparable arm’s-length transaction with a third party. Any such transaction involving reasonably anticipated payments or other consideration of $50 million or greater also requires the prior approval of a majority of the independent directors of TWC Inc.

TWC Inc. Registration Rights Agreements

      TWC Inc. Registration Rights Agreement with Comcast Trust. At the closing of the TWE Restructuring, a Comcast Trust entered into a registration rights agreement with TWC Inc. relating to its shares of Class A common stock, as well as any common stock of TWC Inc. that it or another Comcast trust may receive in connection with a sale of a partnership interest in TWE under the Partnership Interest Sale Agreement (see “Description of Certain Provisions of the TWE Partnership Agreement — Exit Rights,” below).

      Subject to several exceptions, including TWC Inc.’s right to defer a demand registration under some circumstances, the Comcast Trust has the right to require that TWC Inc. take commercially reasonable steps to register for public resale under the Securities Act of 1933 all shares of Class A common stock owned by it that it requests be registered. On December 29, 2003, TWC Inc. received a notice from the Comcast Trust

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requesting that TWC Inc. commence to register for sale in a firm underwritten offering all of Comcast’s 17.9% common interest in TWC Inc. Under the Redemption Agreement described above, as amended, Comcast agreed not to exercise or pursue its registration rights until the Option expires. This provision of the Redemption Agreement supersedes Comcast’s request to TWC Inc. in December 2003 to register its TWC Inc. stock. Under the registration rights agreement, TWC Inc. is not obligated to effect more than one demand registration on behalf of the Comcast Trust in any 270-day period. TWC Inc. is not obligated to effect a demand registration on behalf of the Comcast Trust if the Comcast Trust has received proceeds in excess of $250 million (or 10% of TWC Inc.’s market capitalization) from private placements of and hedging transactions relating to TWC Inc.’s common stock in the preceding 270-day period. Any registered hedging transaction or other monetization with respect to TWC Inc. common stock by the Comcast Trust will be deemed to constitute a demand registration.

      In addition, the Comcast Trust has “piggyback” registration rights subject to customary restrictions on any registration for TWC Inc.’s account or the account of another stockholder, and TWC Inc. and Time Warner are permitted to piggyback on the Comcast Trust’s demand registrations.

      If any registration requested by the Comcast Trust or Time Warner is in the form of a firm underwritten offering, and if the managing underwriter of the offering determines that the number of securities to be offered would jeopardize the success of the offering, the number of shares included in the offering shall be determined as follows:

  •  first, securities to be offered for TWC Inc.’s account must be included until TWC Inc. has sold $2.1 billion worth of securities, whether through public offerings, private placements or hedging transactions;
 
  •  second, securities to be offered for the account of the Comcast Trust must be included until it has sold $3.0 billion worth of securities; and
 
  •  third, TWC Inc. and the Comcast Trust have equal priority, and Time Warner has last priority until the earlier of (x) the fifth anniversary of the closing of the TWE Restructuring and (y) the date the Comcast Trust holds less than $250 million of TWC Inc. common stock. After that date, TWC Inc., the Comcast Trust and Time Warner have equal priority.

      Registration Rights Agreement between TWC Inc. and Time Warner. At the closing of the TWE Restructuring, Time Warner and TWC Inc. entered into a registration rights agreement relating to Time Warner’s shares of TWC Inc. common stock. Subject to several exceptions, including TWC Inc.’s right to defer a demand registration under some circumstances, Time Warner may, under that agreement, require that TWC Inc. take commercially reasonable steps to register for public resale under the Securities Act of 1933 all shares of common stock that Time Warner requests be registered. Time Warner may demand an unlimited number of registrations. In addition, Time Warner has been granted “piggyback” registration rights subject to customary restrictions, and TWC Inc. is permitted to piggyback on Time Warner’s registrations. Any registration statement filed under the agreement is subject to the cut-back priority discussed above. Time Warner has agreed that it will not, until the fifth anniversary of the closing of the TWE Restructuring, dispose of its shares of TWC Inc. common stock other than in registered offerings.

      In connection with the registrations described above under both registration rights agreements, TWC Inc. will indemnify the selling stockholders and bear all fees, costs and expenses, except underwriting discounts and selling commissions.

DESCRIPTION OF CERTAIN PROVISIONS OF THE

TWE PARTNERSHIP AGREEMENT

      The TWE Partnership Agreement was amended in connection with the closing of the TWE Restructuring (as amended, the “New TWE Partnership Agreement”) on March 31, 2003. The following description summarizes certain provisions of the New TWE Partnership Agreement relating to the ongoing operations of TWE. Such description does not purport to be complete and is subject to, and is qualified in its entirety by reference to, the provisions of the New TWE Partnership Agreement.

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Management and Operations of TWE

      Partners. Following the TWE Restructuring, the partnership interests in TWE were recapitalized with one of the Comcast Trusts holding a partnership interest representing a 4.7% residual equity interest in TWE, with a subsidiary of the Company holding a partnership interest consisting of a $2.4 billion preferred component and a 1% residual equity interest in TWE and with TWC Inc. holding a partnership interest representing a 94.3% residual equity interest in TWE.

      Upon the completion of the TWE Restructuring, TWC Inc. became the general partner of TWE and a subsidiary of Time Warner and one of the Comcast Trusts became the limited partners of TWE. Since then, there have been further restructurings such that, as of March 1, 2005, the general partnership interests in TWE were held collectively by three wholly owned subsidiaries of TWC Inc.

      Following the completion of these restructurings, TWC Inc., through its subsidiaries, has assumed the exclusive authority to manage the business and affairs of TWE, subject to certain protections over extraordinary actions afforded the Comcast Trust under the New TWE Partnership Agreement. These protections consist of consent rights over the dissolution or liquidation of TWE and the transfer of control of TWE to a third party, in each case, prior to March 31, 2006, and the right to approve of certain amendments to the New TWE Partnership Agreement.

Certain Covenants

      Transactions with Affiliates. The New TWE Partnership Agreement requires that transactions between TWC Inc. and its subsidiaries, on the one hand, and TWE and its subsidiaries on the other hand, be conducted on an arm’s-length basis, with management, corporate or similar services being provided by TWC Inc. on a “no mark-up” basis with fair allocations of administrative costs and general overhead.

Exit Rights

      Sale and Appraisal Rights of Trust. Under a partnership interest sale agreement (the “Partnership Interest Sale Agreement”) entered in connection with the closing of the TWE Restructuring, at any time following March 31, 2005, the Comcast Trust has the right to require TWC Inc. to purchase all or a portion of the Comcast Trust’s 4.7% residual limited partnership interest in TWE at an appraised fair market value. If Comcast exercises this right, Time Warner can elect to purchase Comcast’s interest in TWE instead of TWC Inc. The fair market value of the interest will be determined separately by two investment banks, one appointed by the Comcast Trust and one appointed by TWC Inc. If the higher of the two valuations presented by the investment banks is within 110% of the lower valuation, then the fair market value of the offered partnership interest will be the average of the two valuations. If the higher valuation is not within 110% of the lower valuation, a third investment bank selected by the other two investment banks, or, if they are unable to agree on a third investment bank, an investment bank selected by the American Arbitration Association will choose one of the two valuations to be the fair market value of the offered partnership interest, and that determination will be final and binding.

      Following March 31, 2005, the Comcast Trust also has the right, at any time, to sell all or a portion of its interest in TWE to a third party in a bona fide transaction, subject to a right of first refusal, first, in favor of Time Warner and, second, in favor of TWC Inc. If TWC Inc. and Time Warner do not collectively elect to purchase all of the Comcast Trust’s offered partnership interest, the Comcast Trust may proceed with the sale of the offered partnership interest to that third party on terms no more favorable than those offered to TWC Inc. and Time Warner, if that third party agrees to be bound by the same terms and conditions applicable to the Comcast Trust as a limited partner in TWE and under the Partnership Interest Sale Agreement.

      In all cases, the purchase price payable by TWC Inc. or Time Warner as consideration for the Comcast Trust’s partnership interest may be cash; common stock, if the common stock of the purchaser is then publicly traded, or a combination of both, at the purchaser’s election. Any Time Warner or TWC Inc. common stock issued to purchase the Comcast Trust’s partnership interests will be valued based on the average of the

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volume-weighted trading price of the common stock for a period of time prior to issuance and will be entitled to registration rights.

      Redemption of Preferred Component. The preferred component of Time Warner’s partnership interest must be redeemed by TWE on April 1, 2023.

Restrictions on Transfer

      The New TWE Partnership Agreement provides that TWC Inc. and Time Warner may generally transfer their partnership interests in TWE at any time, except that TWC Inc. may not transfer control of TWE prior to March 31, 2006. However, the Comcast Trust may not transfer its partnership interest in TWE prior to March 31, 2005 and, after that, the Comcast Trust may only transfer its partnership interest pursuant to the Partnership Interest Sale Agreement, described above.

      No transfer of partnership interests may be made by any partner through securities markets, and no transfer may be made by any partner if the transfer causes TWE to have more than 100 partners or would result in, or have a material risk of, TWE being treated as a corporation for federal income tax purposes.

DESCRIPTION OF CERTAIN PROVISIONS OF THE

TWE-A/ N PARTNERSHIP AGREEMENT

      The following description summarizes certain provisions of the TWE-A/N Partnership Agreement relating to the ongoing operations of the TWE-Advance/Newhouse Partnership (“TWE-A/N”). Such description does not purport to be complete and is subject to, and is qualified in its entirety by reference to, the provisions of the TWE-A/N Partnership Agreement.

Partners of TWE-A/N

      The general partnership interests in TWE-A/N are held by TWE, TWC Inc. (TWE and TWC Inc. are together, the “TW Partners”), and Advance/Newhouse Partnership, a partnership owned by wholly owned subsidiaries of Advance Publications Inc. and Newhouse Broadcasting Corporation (“A/N”). The TW Partners also hold preferred partnership interests.

2002 Restructuring of TWE-A/N

      The TWE-A/N cable television joint venture was formed by TWE and Advance/Newhouse in December 1995. A restructuring of the partnership was completed during 2002. As a result of this restructuring, cable systems and their related assets and liabilities serving 2.1 million subscribers as of December 31, 2002 located primarily in Florida (the “A/N Systems”), were transferred to a subsidiary of TWE-A/N (the “A/N Subsidiary”). As part of the restructuring, effective August 1, 2002, A/N’s interest in TWE-A/N was converted into an interest that tracks the economic performance of the A/N Systems, while the Company and TWE retain the economic interests and associated liabilities in the remaining TWE-A/N cable systems. Also, in connection with the restructuring, Time Warner effectively acquired A/N’s interest in Road Runner. All of the systems owned by TWE-A/N and the A/N Subsidiary continue to support multiple ISPs, including AOL for Broadband, Road Runner and EarthLink. TWE-A/N’s financial results, other than the results of the A/N Systems, are consolidated with the Company’s.

Management and Operations of TWE-A/N

      Management Powers and Services Agreement. Subject to the requirement to act by unanimous consent with respect to some actions as described below, TWE is the managing partner, with exclusive management rights of TWE-A/N, other than with respect to the A/N Systems. As managing partner, TWE manages TWE-A/N, other than the A/N Systems, on a day-to-day basis. Also, subject to the requirement to act by unanimous consent with respect to some actions as described below, A/N has authority for the supervision of the day-to-day operations of the A/N Subsidiary and the A/N Systems. TWE entered into a services agreement with A/N and the A/N Subsidiary under which TWE agreed to exercise various management

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functions, including oversight of programming and various engineering-related matters. TWE and A/N also agreed to periodically discuss cooperation with respect to new product development.

      Actions Requiring Unanimous Consent. Some actions cannot be taken by TWE-A/N, TWE or A/N without the unanimous consent of the TW Partners and A/N or the unanimous consent of an executive committee consisting of members designated by the TW Partners and A/N. These actions include, among other things:

  •  any merger, consolidation or disposition of all or substantially all of the assets of TWE-A/N (excluding the A/N Subsidiary) or the A/N Subsidiary;
 
  •  any liquidation or dissolution of TWE-A/N or the A/N Subsidiary;
 
  •  specified incurrences of debt by TWE-A/N or by the A/N Subsidiary; and
 
  •  admission of a new partner or other issuances of equity interests in TWE-A/N or the A/N Subsidiary.

Restrictions on Transfer

      TW Partners. Each TW Partner is generally permitted to directly or indirectly dispose of its entire partnership interest at any time to a wholly owned affiliate of TWE (in the case of transfers by TWE) or to TWE, the Company or a wholly owned affiliate of TWE or the Company (in the case of transfers by TWC Inc.). In addition, the TW Partners are also permitted to transfer their partnership interests through a pledge to secure a loan, or a liquidation of TWE in which the Company, or its affiliates, receives a majority of the interests of TWE-A/N held by the TW Partners. TWE is allowed to issue additional partnership interests in TWE so long as the Company continues to own, directly or indirectly, either 35% or 43.75% of the residual equity capital of TWE, depending on when the issuance occurs.

      A/N Partner. A/N is generally permitted to directly or indirectly transfer its entire partnership interest at any time to certain members of the Newhouse family or specified affiliates of A/N. A/N is also permitted to dispose of its partnership interest through a pledge to secure a loan and in connection with specified restructurings of A/N.

Restructuring Rights of the Partners

      TWE and A/N each have the right to cause TWE-A/N to be restructured at any time. Upon a restructuring, TWE-A/N would be required to distribute the A/N Subsidiary with all of the A/N Systems to A/N in complete redemption of A/N’s interests in TWE-A/N, and A/N would be required to assume all liabilities of the A/N Subsidiary and the A/N Systems. Following such a restructuring, TWE’s obligations to provide management services to A/N and the A/N Subsidiary would terminate. As of the date of this annual report, neither TWE nor A/N has delivered notice of the intent to cause a restructuring of TWE-A/N.

Rights of First Offer

      TWE’s Regular Right of First Offer. Subject to exceptions, A/N and its affiliates are obligated to grant TWE a right of first offer with respect to any sale of assets of the A/N Systems.

      TWE’s Special Right of First Offer. Within a specified time period following the first, seventh, thirteenth and nineteenth anniversaries of the deaths of two specified members of the Newhouse family (those deaths have not yet occurred), A/N has the right to deliver notice to TWE stating that it wishes to transfer some or all of the assets of the A/N Systems, thereby granting TWE the right of first offer to purchase the specified assets. Following delivery of this notice, an appraiser will determine the value of the assets proposed to be transferred. Once the value of the assets has been determined, A/N has the right to terminate its offer to sell the specified assets. If A/N does not terminate its offer, TWE will have the right to purchase the specified assets at a price equal to the value of the specified assets determined by the appraiser. If TWE does not exercise its right to purchase the specified assets, A/N has the right to sell the specified assets to an unrelated third party within 180 days on substantially the same terms as were available to TWE.

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DESCRIPTION OF AGREEMENT WITH LIBERTY MEDIA CORPORATION

      The following description summarizes certain provisions of the Company’s agreement with Liberty Media and certain of its subsidiaries (collectively, “LMC”) that was entered into in connection with the merger of Turner Broadcasting System, Inc. in 1996 (the “Turner Transaction”) and the Turner Consent Decree. Such description does not purport to be complete and is subject to, and is qualified in its entirety by reference to, the provisions of the Second Amended and Restated LMC Agreement dated as of September 22, 1995 among Historic TW, Time Warner Companies, Inc. and LMC (the “LMC Agreement”).

Ownership of Time Warner Common Stock

      Pursuant to the LMC Agreement, immediately following consummation of the Turner Transaction, LMC exchanged the 50.6 million shares of Historic TW common stock, par value $.01 per share received by LMC in the Turner Transaction on a one-for-one basis for 50.6 million shares of Series LMCN-V Common Stock of Historic TW. In June 1997, LMC and its affiliates received 6.4 million additional shares of Series LMCN-V Common Stock pursuant to the provisions of an option agreement between Historic TW and LMC and its affiliates. In May 1999, the terms of the Series LMCN-V Common Stock were amended, which effectively resulted in a two-for-one stock split. At the time of the America Online-Historic TW Merger, each share of Series LMCN-V Common Stock was exchanged for one and one half shares of a substantially identical Series LMCN-V Common Stock of the Company. Each share of Series LMCN-V Common Stock receives the same dividends and otherwise has the same rights as a share of Time Warner Common Stock except that (a) holders of Series LMCN-V Common Stock are entitled to 1/100th of a vote per share on the election of directors and do not have any other voting rights, except as required by law or with respect to limited matters, including amendments to the terms of the Series LMCN-V Common Stock adverse to such holders, and (b) unlike shares of Time Warner Common Stock, shares of Series LMCN-V Common Stock are not subject to redemption by the Company if necessary to prevent the loss by the Company of any governmental license or franchise. The Series LMCN-V Common Stock is not transferable, except in limited circumstances, and is not listed on any securities exchange.

      LMC exchanged its shares of Historic TW common stock for Series LMCN-V Common Stock in order to comply with the Turner Consent Decree, which effectively prohibits LMC and its affiliates (including TCI) from owning voting securities of the Company other than securities that have limited voting rights. In 2002, LMC sought to eliminate these restrictions from the Turner Consent Decree; the petition was denied by the FTC without prejudice. See “Regulation and Legislation — Turner FTC Consent Decree,” above. The Turner Consent Decree will expire in February 2007.

      Each share of Series LMCN-V Common Stock is convertible into one share of Time Warner Common Stock at any time when such conversion would no longer violate the Turner Consent Decree or have a Prohibited Effect (as defined below), including following a transfer to a third party. Following application by LMC, the Turner Consent Decree was modified by the FTC on December 21, 2004 to permit LMC, in connection with a hedging transaction, to lend the Time Warner Common Stock into which its Series LMCN-V Common Stock is convertible. As a result, approximately 74,870,395 of the 171,185,826 shares of Series LMCN-V Common Stock owned by LMC have been converted into Time Warner Common Stock as of February 28, 2005 but are still deemed beneficially owned by LMC. Under the terms of the modification, LMC has no right to vote or to direct the voting of the loaned Common Stock and may not directly or indirectly influence or attempt to influence its voting.

Other Agreements

      Under the LMC Agreement, if the Company takes certain actions that have the effect of (a) making the continued ownership by LMC of the Company’s equity securities illegal under any federal or state law, (b) imposing damages or penalties on LMC under any federal or state law as a result of such continued ownership, (c) requiring LMC to divest any such Company equity securities, or (d) requiring LMC to discontinue or divest any business or assets or lose or significantly modify any license under any communications law (each a “Prohibited Effect”), then the Company will be required to compensate LMC for income

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taxes incurred by it in disposing of all the Company’s equity securities received by LMC in connection with the Turner Transaction and related agreements (whether or not the disposition of all such equity securities is necessary to avoid such Prohibited Effect).

      The agreements described in the preceding paragraph may have the effect of requiring the Company to pay amounts to LMC in order to engage in (or requiring the Company to refrain from engaging in) activities that LMC would be prohibited under the federal communications laws from engaging in. Based on the current businesses of the Company and LMC and based upon the Company’s understanding of applicable law, the Company does not expect these requirements to have a material effect on its business.

CURRENCY RATES AND REGULATIONS

      Time Warner’s foreign operations are subject to the risk of fluctuation in currency exchange rates and to exchange controls. Time Warner cannot predict the extent to which such controls and fluctuations in currency exchange rates may affect its operations in the future or its ability to remit dollars from abroad. See Note 16, “Derivative Instruments — Foreign Currency Risk Management” to the consolidated financial statements set forth in the financial pages herein. For a discussion of revenues of international operations, see Note 17, “Segment Information” to the consolidated financial statements set forth in the financial pages herein.

 
Item 2.     Properties.

      The following table sets forth certain information as of December 31, 2004 with respect to the Company’s principal properties (over 250,000 square feet in area) that are occupied for corporate offices or used primarily by the Company’s divisions, all of which the Company considers adequate for its present needs, and all of which were substantially used by the Company or were leased to outside tenants:

                         
Approximate
Square Feet Type of Ownership
Location Principal Use Floor Space/Acres Expiration Date of Lease




New York, NY
One Time Warner Center
 
Executive and administrative offices, studio and technical space (Corporate HQ, Turner, CNN)
    1,007,350     Owned and occupied by the Company.
New York, NY
75 Rockefeller Plaza
Rockefeller Center
 
Business offices (AOL); partially subleased to third party tenants.
     560,000     Leased by the Company. Lease expires in 2014.
 
Dulles, VA
22000 AOL Way
 
Executive, administrative and business offices (AOL HQ Campus)
    1,573,050     Owned and occupied by the Company.
 
Mt. View, CA
Middlefield Rd
 
Executive, administrative and business offices (AOL Campus)
     432,950     Leased by the Company. (Leases expire from 2006- 2013). Approximately 8,000 sq. ft is sublet to outside tenants and approximately 200,000 sq. ft. is being marketed for sublease.
 
Columbus, OH
Arlington Centre Blvd.
 
Executive, administrative and business offices (CompuServe/Netscape Campus)
     280,900     Owned and occupied by the Company. Approximately 11,000 sq. ft. is sublet to a third party tenant.

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Approximate
Square Feet Type of Ownership
Location Principal Use Floor Space/Acres Expiration Date of Lease




Reston, VA
Sunrise Valley
 
Reston Tech Center with executive and administrative offices (AOL)
     278,000     Owned and occupied by the Company.
 
New York, NY
Time & Life Bldg.
Rockefeller Center
 
Business and editorial offices (Time Inc.)
    1,600,000     Leased by the Company. Most leases expire in 2017. Approximately 116,000 sq. ft. is sublet to outside tenants, including approximately 75,000 sq. ft. leased to Bookspan.
 
Atlanta, GA
One CNN Center
 
Executive and administrative offices, studios, technical space and retail (Turner)
    1,274,000     Owned by the Company. Approximately 47,000 sq. ft. is sublet to outside tenants.
 
Atlanta, GA
100 CNN Center
 
Hotel
    1,100,000     Turner has 50% ownership in joint venture with Omni International Hotels.
 
Atlanta, GA
1050 Techwood Dr.
 
Offices and studios (Turner)
    865,000     Owned and occupied by the Company.
 
London, England
Kings Reach Tower
 
Executive and administrative offices (Time Inc.)
    251,000     Leased by the Company. Lease expires in 2007.(a)
 
Lebanon, IN
121 N. Enterprise
 
Warehouse space (Time Inc.)
    500,450     Leased by the Company. Lease expires in 2012.
 
Lebanon, IN
Lebanon Business Park
 
Warehouse space (Time Inc.)
    395,700     Leased by the Company. Lease expires in 2012.
 
New York, NY
1100 and 1114  Ave.
of the Americas
 
Business offices (HBO)
    612,500     Leased by the Company under two leases expiring in 2018.
 
Columbia, SC
3325 Platt Spring Road
 
Divisional HQ, call center, warehouse (Time Warner Cable)
    318,550     Owned by the Company. Approximately 50% of space is leased to a third party tenant.
 
Burbank, CA
The Warner Bros. Studio
 
Sound stages, administrative, technical and dressing room structures, screening theaters, machinery and equipment facilities, back lot and parking lot and other Burbank properties (Warner Bros.)
  4,216,900 sq. ft. of improved space on 158 acres(b)     Owned by the Company.  

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Approximate
Square Feet Type of Ownership
Location Principal Use Floor Space/Acres Expiration Date of Lease




 
Burbank, CA
3400 Riverside Drive
 
Executive and administrative offices (Warner Bros.)
     421,000     Leased by the Company. Lease expires in 2019 with rights to terminate starting in 2012. Approximately 17,000 sq. ft. sublet to outside tenants.
 
Valencia, CA
Undeveloped land
 
Location filming (Warner Bros.)
    232 acres       Owned by the Company.  


(a) IPC Media is constructing a new 500,000 sq. ft. facility in London which is expected to be completed in 2006 and occupied in early 2007.
(b) Ten acres consist of various parcels adjoining The Warner Bros. Studio, with mixed commercial and office uses.

Item 3.     Legal Proceedings.

Securities Matters

      As of March 1, 2005, 30 shareholder class action lawsuits have been filed naming as defendants the Company, certain current and former executives of the Company and, in several instances, America Online, Inc. (“America Online”). These lawsuits were filed in U.S. District Courts for the Southern District of New York, the Eastern District of Virginia and 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 Time Warner stock, that the Company failed to disclose that the America Online-Historic TW 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. All of these lawsuits have been centralized in the U.S. District Court for the Southern District of New York for coordinated or consolidated pretrial proceedings (along with the federal derivative lawsuits and certain lawsuits brought under the Employee Retirement Income Security Act (“ERISA”) described below) under the caption In re AOL Time Warner Inc. Securities and “ERISA” Litigation. Additional lawsuits filed by individual shareholders have also been consolidated for pretrial proceedings. The Minnesota State Board of Investment (“MSBI”) has been designated lead plaintiff for the consolidated securities actions and filed a consolidated amended complaint on April 15, 2003, adding additional defendants including additional officers and directors of the Company, Morgan Stanley & Co., Salomon Smith Barney Inc., Citigroup Inc., Banc of America Securities LLC and JP Morgan Chase & Co. Plaintiffs also added additional allegations, including that the Company made material misrepresentations in its Registration Statements and Joint Proxy Statement-Prospectus related to the America Online-Historic TW Merger and in its registration statements pursuant to which debt securities were issued in April 2001 and April 2002, allegedly in violation of Section 11 and Section 12 of the Securities Act of 1933. On July 14, 2003, the defendants filed a motion to dismiss the consolidated amended complaint. On May 5, 2004, the district court granted in part the defendants’ motion, dismissing all claims with respect to the registration statements pursuant to which debt securities were issued in April 2001 and April 2002 and certain other claims against other defendants, but otherwise allowing the remaining claims against the Company and certain other defendants to proceed. On August 11, 2004, the court granted MSBI’s motion to file a second amended complaint. On July 30, 2004, defendants filed a motion for summary judgment on the basis that plaintiffs cannot establish loss causation for any of their claims, and thus plaintiffs do not have any recoverable damages. That motion is pending. 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.

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      As of March 1, 2005, three putative class action lawsuits have been filed alleging violations of ERISA in the U.S. District Court for the Southern District of New York on behalf of current and former participants in the Time Warner Savings Plan, the Time Warner Thrift Plan and/or the TWC Savings Plan (the “Plans”). Collectively, these lawsuits name as defendants the Company, certain current and former directors and officers of the Company and members of the Administrative Committees of the Plans. The lawsuits allege that the Company and other defendants breached certain fiduciary duties to plan participants by, inter alia, continuing to offer Time Warner stock as an investment under the Plans, and 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 complaints seek unspecified damages and unspecified equitable relief. The ERISA actions have been consolidated as part of the In re AOL Time Warner Inc. Securities and “ERISA” Litigation described above. On July 3, 2003, plaintiffs filed a consolidated amended complaint naming additional defendants, including Time Warner Entertainment Company, L.P. (“TWE”), certain current and former officers, directors and employees of the Company and Fidelity Management Trust Company. On September 12, 2003, the Company filed a motion to dismiss the consolidated ERISA complaint. On March 9, 2005, the Court granted in part, and denied in part, the Company’s motion to dismiss. The Court dismissed two individual defendants and TWE for all purposes, dismissed other individuals with respect to claims plaintiffs had asserted involving the TWC Savings Plan, and dismissed all individuals who were named in a claim asserting that their stock sales had constituted a breach of fiduciary duty to the Plans. The Company intends to defend against these lawsuits vigorously. The Company is unable to predict the outcome of these cases or reasonably estimate a range of possible loss.

      As of March 1, 2005, 11 shareholder derivative lawsuits have been filed naming as defendants certain current and former directors and officers of the Company, as well as the Company as a nominal defendant. Three have been filed in New York State Supreme Court for the County of New York, four have been filed in the U.S. District Court for the Southern District of New York and four have been filed 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 represent that America Online had declining advertising revenues, that the America Online-Historic TW 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 Time Warner securities. The lawsuits request that (i) all proceeds from defendants’ sales of 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 four lawsuits filed in the Court of Chancery for the State of Delaware for New Castle County have been consolidated under the caption, In re AOL Time Warner Inc. Derivative Litigation. A consolidated complaint was filed on March 7, 2003 in that action, and on June 9, 2003, the Company filed a notice of motion to dismiss the consolidated complaint. On May 2, 2003, the three lawsuits filed in New York State Supreme Court for the County of New York were dismissed on forum non conveniens grounds and plaintiffs’ time to appeal has expired. The four lawsuits pending in the U.S. District Court for the Southern District of New York have been centralized for coordinated or consolidated pre-trial proceedings with the securities and ERISA lawsuits described above under the caption In re AOL Time Warner Inc. Securities and “ERISA” Litigation. On October 6, 2004, plaintiffs filed an amended consolidated complaint in the three of these four cases. 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.

      On July 1, 2003, Stichting Pensioenfonds ABP v. AOL Time Warner Inc. et al. was filed in the U.S. District Court for the Southern District of New York against the Company, current and former officers, directors and employees of the Company and Ernst & Young LLP. Plaintiff alleges that the Company made material misrepresentations and/or omissions of material fact in violation of Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder, Section 11, Section 12, Section 14(a) and Rule 14a-9 promulgated thereunder, Section 18 and Section 20(a) of the Exchange Act. The complaint also alleges common law fraud and negligent misrepresentation. The plaintiff seeks an unspecified amount of compensa-

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tory and punitive damages. This lawsuit has been consolidated for coordinated pretrial proceedings under the caption In re AOL Time Warner Inc. Securities and “ERISA” Litigation described above. On July 16, 2004, plaintiff filed an amended complaint adding certain institutional defendants, including Historic TW, and certain current directors of the Company. On November 22, 2004, the Company filed a motion to dismiss the complaint. The Company intends to defend against this lawsuit vigorously. The Company is unable to predict the outcome of this suit or reasonably estimate a range of possible loss.

      On November 11, 2002, Staro Asset Management, LLC filed a putative class action complaint in the U.S. District Court for the Southern District of New York on behalf of certain purchasers of Reliant 2.0% Zero-Premium Exchangeable Subordinated Notes for alleged violations of the federal securities laws. Plaintiff is a purchaser of subordinated notes, the price of which was purportedly tied to the market value of Time Warner stock. Plaintiff alleges that the Company made misstatements and/or omissions of material fact that artificially inflated the value of Time Warner stock and directly affected the price of the notes. Plaintiff seeks compensatory damages and/or rescission. This lawsuit has been consolidated for coordinated pretrial proceedings under the caption In re AOL Time Warner Inc. Securities and “ERISA” Litigation described above. The Company intends to defend against this lawsuit vigorously. The Company is unable to predict the outcome of this suit or reasonably estimate a range of possible loss.

      On April 14, 2003, Regents of the University of California et al. v. Parsons et al., was filed in California Superior Court, County of Los Angeles, naming as defendants the Company, certain current and former officers, directors and employees of the Company, Ernst & Young LLP, Citigroup Inc., Salomon Smith Barney Inc. and Morgan Stanley & Co. Plaintiffs allege that the Company made material misrepresentations in its registration statements related to the America Online — Historic TW Merger and stock option plans in violation of Sections 11 and 12 of the Securities Act of 1933. The complaint also alleges common law fraud and breach of fiduciary duties under California state law. Plaintiffs seek disgorgement of alleged insider trading proceeds and restitution for their stock losses. Three related cases have been filed in California Supreme Court and have been coordinated in the County of Los Angeles (the “California Actions”). On January 26, 2004, certain individuals filed motions to dismiss for lack of personal jurisdiction. On September 10, 2004, the Company filed a motion to dismiss plaintiffs’ complaints and certain individual defendants (who had not previously moved to dismiss plaintiffs’ complaints for lack of personal jurisdiction) filed a motion to dismiss plaintiffs’ complaints. 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.

      On May 23, 2003, Treasurer of New Jersey v. AOL Time Warner Inc. et al., was filed in the Superior Court of New Jersey, Mercer County, naming as defendants the Company, certain current and former officers, directors and employees of the Company, Ernst & Young LLP, Citigroup Inc., Salomon Smith Barney, Morgan Stanley, JP Morgan Chase and Banc of America Securities. The complaint is brought by the Treasurer of New Jersey and purports to be made on behalf of the State of New Jersey, Department of Treasury, Division of Investments (the “Division”) and certain funds administered by the Division. Plaintiff alleges that the Company made material misrepresentations in its registration statements in violation of Sections 11 and 12 of the Securities Act of 1933. Plaintiff also alleges violations of New Jersey state law for fraud and negligent misrepresentation. Plaintiffs seek an unspecified amount of damages. On October 29, 2003, the Company moved to stay the proceedings or, in the alternative, dismiss the complaint. Also on October 29, 2003, all named individual defendants moved to dismiss the complaint for lack of personal jurisdiction. The parties have agreed to stay this action and to coordinate discovery proceedings with the securities and ERISA lawsuits described above under the caption In re AOL Time Warner Inc. Securities and “ERISA” Litigation. The Company intends to defend against this lawsuit vigorously. The Company is unable to predict the outcome of this suit or reasonably estimate a range of possible loss.

      On July 18, 2003, Ohio Public Employees Retirement System et al. v. Parsons et al. was filed in Ohio, Court of Common Pleas, Franklin County, naming as defendants the Company, certain current and former officers, directors and employees of the Company, Citigroup Inc., Salomon Smith Barney Inc., Morgan Stanley & Co. and Ernst & Young LLP. Plaintiffs allege that the Company made material misrepresentations in its registration statements in violation of Sections 11 and 12 of the Securities Act of 1933. Plaintiffs also allege violations of Ohio law, breach of fiduciary duty and common law fraud. Plaintiffs seek disgorgement of

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alleged insider trading proceeds, restitution and unspecified compensatory damages. On October 29, 2003, the Company moved to stay the proceedings or, in the alternative, dismiss the complaint. Also on October 29, 2003, all named individual defendants moved to dismiss the complaint for lack of personal jurisdiction. On October 8, 2004, the court granted in part defendants’ motion to dismiss plaintiffs’ complaint; specifically, the court dismissed plaintiffs’ common law claims but otherwise allowed plaintiffs’ remaining statutory claims against the Company and certain other defendants to proceed. The Company intends to defend against this lawsuit vigorously. The Company is unable to predict the outcome of this suit or reasonably estimate a range of possible loss.

      On July 18, 2003, West Virginia Investment Management Board v. Parsons et al. was filed in West Virginia, Circuit Court, Kanawha County naming as defendants the Company, certain current and former officers, directors and employees of the Company, Citigroup Inc., Salomon Smith Barney Inc., Morgan Stanley & Co., and Ernst & Young LLP. Plaintiff alleges the Company made material misrepresentations in its registration statements in violation of Sections 11 and 12 of the Securities Act of 1933. Plaintiff also alleges violations of West Virginia law, breach of fiduciary duty and common law fraud. Plaintiff seeks disgorgement of alleged insider trading proceeds, restitution and unspecified compensatory damages. On May 27, 2004, the Company filed a motion to dismiss the complaint. Also on May 27, 2004, all named individual defendants moved to dismiss the complaint for lack of personal jurisdiction. The Company intends to defend against this lawsuit vigorously. The Company is unable to predict the outcome of this suit or reasonably estimate a range of possible loss.

      On January 28, 2004, McClure et al. v. AOL Time Warner Inc. et al. was filed in the District Court of Cass County, Texas (purportedly on behalf of several purchasers of Company stock) naming as defendants the Company and certain current and former officers, directors and employees of the Company. Plaintiffs allege that the Company made material misrepresentations in its registration statements in violation of Sections 11 and 12 of the Securities Act of 1933. Plaintiffs also allege breach of fiduciary duty and common law fraud. Plaintiffs seek unspecified compensatory damages. On May 8, 2004, the Company filed a general denial and a motion to dismiss for improper venue. Also on May 8, 2004, all named individual defendants moved to dismiss the complaint for lack of personal jurisdiction. The Company intends to defend against this lawsuit vigorously. The Company is unable to predict the outcome of this suit or reasonably estimate a range of possible loss.

      On February 24, 2004, Commonwealth of Pennsylvania Public School Employees’ Retirement System et al. v. Time Warner Inc. et al. was filed in the Court of Common Pleas of Philadelphia County naming as defendants the Company, certain current and former officers, directors and employees of the Company, America Online, Historic TW, Morgan Stanley & Co., Inc., Citigroup Global Markets Inc., Banc of America Securities LLC, J.P. Morgan Chase & Co and Ernst & Young LLP. Plaintiffs had previously filed a request for a writ of summons notifying defendants of commencement of an action. Plaintiffs allege that the Company made material misrepresentations in its registration statements in violation of Sections 11 and 12 of the Securities Act of 1933. Plaintiffs also allege violations of Pennsylvania Law, breach of fiduciary duty and common law fraud. The plaintiffs seek unspecified compensatory and punitive damages. The parties have agreed to stay this action and to coordinate discovery proceedings with the securities and ERISA lawsuits described above under the caption In re AOL Time Warner Inc. Securities and “ERISA” Litigation. The Company intends to defend against this lawsuit vigorously. The Company is unable to predict the outcome of this suit or reasonably estimate a range of possible loss.

      On April 1, 2004, Alaska State Department of Revenue et al. v. America Online, Inc. et al. was filed in Superior Court in Juneau County, Alaska naming as defendants the Company, certain current and former officers, directors and employees of the Company, America Online, Historic TW, Morgan Stanley & Co., Inc., and Ernst & Young LLP. Plaintiffs allege that the Company made material misrepresentations in its registration statements in violation of Alaska law and common law fraud. The plaintiffs seek unspecified compensatory and punitive damages. On July 26, 2004, all named individual defendants moved to dismiss the complaint for lack of personal jurisdiction. On August 13, 2004, the Company filed a motion to dismiss plaintiffs’ complaint. The Company intends to defend against this lawsuit vigorously. The Company is unable to predict the outcome of this suit or reasonably estimate a range of possible loss.

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      On November 15, 2002, the California State Teachers’ Retirement System filed an amended consolidated complaint in the U.S. District Court for the Central District of California on behalf of a putative class of purchasers of stock in Homestore.com, Inc. (“Homestore”). Plaintiff alleges that Homestore engaged in a scheme to defraud its shareholders in violation of Section 10(b) of the Exchange Act. The Company and two former employees of its America Online division were named as defendants in the amended consolidated complaint because of their alleged participation in the scheme through certain advertising transactions entered into with Homestore. Motions to dismiss filed by the Company and the two former employees were granted on March 7, 2003, and a final judgment of dismissal was entered on March 8, 2004. On April 7, 2004, plaintiff filed a notice of appeal in the Ninth Circuit Court of Appeals; that appeal was fully briefed as of January 10, 2005. The Company intends to defend against this lawsuit vigorously. The Company is unable to predict the outcome of this suit or reasonably estimate a range of possible loss.

      On April 30, 2004, a second amended complaint was filed in the U.S. District Court for the District of Nevada on behalf of a putative class of purchasers of stock in PurchasePro.com, Inc. (“PurchasePro”). Plaintiffs allege that PurchasePro engaged in a scheme to defraud its shareholders in violation of Section 10(b) of the Exchange Act. The Company and four former officers and employees were added as defendants in the second amended complaint and are alleged to have participated in the scheme through certain advertising transactions entered into with PurchasePro. Three similar putative class actions had previously been filed against the Company, America Online and certain former officers and employees, and have been consolidated with the Nevada action. On February 17, 2005, the Judge in the consolidated action granted the Company’s motion to dismiss the second amended complaint with prejudice. On September 13, 2004, in a related matter, PurchasePro filed an adversary proceeding against the Company in the U.S. Bankruptcy Court for the District of Nevada alleging fraudulent conveyance and unjust enrichment in connection with PurchasePro warrants issued to the Company. On December 15, 2004, the Bankruptcy Court granted the Company’s motion to dismiss the complaint without prejudice. On January 26, 2005, PurchasePro filed an amended complaint. 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.

Update on Status of Government Investigations

      As previously disclosed by the Company, the Securities and Exchange Commission (“SEC”) and the U.S. Department of Justice (“DOJ”) have been conducting investigations into the accounting and disclosure practices of the Company. Those investigations focused on transactions principally involving the Company’s America Online segment that were entered into after July 1, 1999, including advertising arrangements, the methods used by the America Online segment to report its subscriber numbers and the accounting related to the Company’s interest in AOL Europe prior to January 2002.

      As announced on December 15, 2004, the Company and its subsidiary, America Online, have reached a definitive agreement with the DOJ that resolves the DOJ’s investigation of the Company. The Company also announced that it has proposed a settlement to the staff of the SEC that the staff has agreed to recommend to the SEC Commissioners.

      Under the terms of the settlement in connection with the investigation of the DOJ, the DOJ filed a criminal complaint against AOL for the conduct of certain employees in connection with securities fraud by PurchasePro.com, but the DOJ will defer prosecution of AOL. After two years, provided the Company fulfills its obligations under the agreement, the DOJ will dismiss the criminal complaint filed against AOL. In addition, the DOJ will not prosecute the Company or AOL for conduct relating to certain other transactions entered into by AOL or the Company from July 1, 1999, including transactions that were the subject of the DOJ or SEC investigations. In connection with the settlement with the DOJ, in December 2004, the Company paid a penalty of $60 million and established a $150 million fund, which the Company may use to settle related securities litigation. The fund is reflected as restricted cash on the Company’s consolidated balance sheet as of December 31, 2004. The Company’s other obligations under the settlement agreement are to (a) accept responsibility for the conduct of certain AOL employees with respect to PurchasePro.com transactions; (b) cooperate fully with the DOJ or any other federal criminal law enforcement agency regarding the transactions covered by the settlement; and (c) retain and cooperate with an independent monitor, who

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will review the effectiveness of AOL’s internal controls, including those related to the accounting for advertising and related transactions.

      Under the settlement the SEC staff will recommend to the SEC Commissioners, Time Warner will agree, without admitting or denying the Commission’s allegations, to be enjoined from future violations of certain provisions of the securities laws. Under the proposed settlement:

  •  The Company would pay a $300 million penalty, which the SEC staff will request be used for a Fair Fund, as authorized under the Sarbanes-Oxley Act;
 
  •  The Company would adjust its historical accounting for Advertising revenues in certain transactions with Bertelsmann, A.G. (“Bertelsmann”) that were improperly recognized or prematurely recognized primarily in the second half of 2000, during 2001 and during 2002. Additionally, the Company would adjust its accounting for transactions involving three other AOL customers where there were Advertising revenues recognized in the second half of 2000 and during 2001;
 
  •  Consistent with its previous announcement, the Company would adjust its historical accounting for its investment in and consolidation of AOL Europe S.A. (“AOL Europe”); and
 
  •  The Company would also agree to the appointment of an independent examiner, who will either be or hire a certified public accountant. The independent examiner would review whether the Company’s historical accounting for transactions with 17 counterparties identified by the SEC staff, including three cable programming affiliation agreements with related advertising elements, was in conformity with generally accepted accounting principles, and provide a report to the Company’s audit and finance committee of its conclusions within 180 days of being engaged. The transactions that would be reviewed were entered into between June 1, 2000 and December 31, 2001, including subsequent amendments thereto, and involved online advertising and related transactions for which revenue was principally recognized before January 1, 2002.

      Final settlement is subject to both agreement on final documentation and approval by the SEC Commissioners. The Company will not be able to deduct the $300 million penalty to be paid under the proposed settlement for income tax purposes, be reimbursed or indemnified for such payment through insurance or any other source, or use such payment to setoff or reduce any award of compensatory damages to plaintiffs in related securities litigation pending against the Company. In connection with the proposed settlement with the SEC, the Company’s financial results for each of the years ended December 31, 2000 through December 31, 2003 have been restated to adjust the accounting. See “Management’s Discussion and Analysis of Results of Operations and Financial Condition” in the accompanying financial pages.

Other Matters

      On August 18, 2004, The Saul Zaentz Company filed a complaint in California Superior Court, County of Los Angeles, against New Line Cinema Corporation, a wholly owned subsidiary of the Company (“New Line”), for alleged breach of contract, declaratory relief and other claims. New Line and plaintiff are parties to a license agreement concerning rights in and to literary works written by J.R.R. Tolkien titled The Hobbit and The Lord of the Rings. The complaint alleges, among other things, that New Line owes royalties to plaintiff based on a percentage of gross receipts received by New Line’s international third party distributors from its motion picture “The Lord of the Rings: The Fellowship of the Rings.” On September 27, 2004, New Line filed an answer and cross-complaint for breach of contract and declaratory relief against plaintiff. A trial date has been set for July 19, 2005. The Company intends to defend against this lawsuit vigorously, but is unable to predict the outcome of this suit.

      Warner Bros. (South) Inc. (“WBS”), a wholly owned subsidiary of the Company, is litigating numerous tax cases in Brazil. WBS currently is the theatrical distribution licensee for Warner Bros. in Brazil and acts as a service provider to the Warner Bros. home video licensee. All of the ongoing tax litigation involves WBS’ distribution activities prior to January 2004, when WBS conducted both theatrical and home video distribution. Much of the tax litigation stems from WBS’ position that in distributing videos to rental retailers, it was conducting a distribution service, subject to a municipal service tax, and not the “industrialization” or

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sale of videos, subject to Brazilian federal and state VAT-like taxes. Both the federal tax authorities and the State of Sao Paulo, where WBS is based, have challenged this position. In some additional tax cases, WBS, often together with other film distributors, is challenging the imposition of taxes on royalties remitted outside of Brazil and the constitutionality of certain taxes. The Company intends to defend all of these various tax cases vigorously, but is unable to predict the outcome of these suits.

      As of March 1, 2005, 22 putative consumer class action suits have been filed in various state and federal courts naming as defendants the Company or America Online. Plaintiffs allege that America Online violated various consumer protection laws by charging members for services or goods without authorization, including unauthorized secondary accounts offered in connection with America Online’s “Spin-Off a Second Account” (“SOSA”) program, and/or by continuing to charge members for services after receiving requests for cancellation. Motions to dismiss have been denied in O’Leary v. America Online, Inc., which was filed in the Circuit Court for St. Clair County, Illinois, and White v. America Online, Inc., which was filed in the Circuit Court for Madison County, Illinois. Eleven class actions involving SOSA accounts have been transferred by the Judicial Panel on Multidistrict Litigation to the U.S. District Court for the Central District of California for consolidated or coordinated pretrial proceedings (In re America Online Spin-Off Accounts Litigation), and the Company’s motion to dismiss that complaint has been denied. On January 5, 2004, the SOSA case pending in the Superior Court of Washington, Spokane County, titled Dix v. ICT Group and America Online, was dismissed without prejudice based on the forum selection clause set forth in the plaintiffs’ Member Agreement with AOL. On February 17, 2005, the Washington Court of Appeals reversed the lower court’s dismissal; the Company intends to file a motion for reconsideration of the Court of Appeals’ decision. On October 12, 2004, the SOSA case pending in the Court of Common Pleas of Hamilton County, Ohio, titled Robert Schwartz v. America Online, Inc., was dismissed based on the forum selection clause and that dismissal is now final. McCall v America Online, Inc., the SOSA case which was pending in the Superior Court of Cape May County, New Jersey, has been voluntarily dismissed. America Online has filed or will file motions to dismiss in the remaining cases. The Company intends to defend against these lawsuits vigorously, but is unable to predict the outcome of these suits.

      On May 24, 1999, two former AOL Community Leader volunteers filed Hallissey et al. v. America Online, Inc. in the U.S. District Court for the Southern District of New York. This lawsuit was brought as a collective action under the Fair Labor Standards Act (“FLSA”) and as a class action under New York state law against America Online and AOL Community, Inc. The plaintiffs allege that, in serving as Community Leader volunteers, they were acting as employees rather than volunteers for purposes of the FLSA and New York state law and are entitled to minimum wages. On December 8, 2000, defendants filed a motion to dismiss on the ground that the plaintiffs were volunteers and not employees covered by the FLSA. The motion to dismiss is pending. A related case was filed by several of the Hallissey plaintiffs in the U.S. District Court for the Southern District of New York alleging violations of the retaliation provisions of the FLSA. This case has been stayed pending the outcome of the Hallissey motion to dismiss. Three related class actions have been filed in state courts in New Jersey, California and Ohio, alleging violations of the FLSA and/or the respective state laws. The New Jersey and Ohio cases were removed to federal court and subsequently transferred to the U.S. District Court for the Southern District of New York for consolidated pretrial proceedings with Hallissey. The California action was remanded to California state court and on January 6, 2004, the court denied plaintiffs’ motion for class certification. Plaintiffs in that case have filed an appeal of the order denying class certification, and the trial court has stayed proceedings pending that appeal. 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.

      On January 17, 2002, Community Leader volunteers filed a class action lawsuit in the U.S. District Court for the Southern District of New York against the Company, America Online and AOL Community, Inc. under ERISA. Plaintiffs allege that they are entitled to pension and/or welfare benefits and/or other employee benefits subject to ERISA. In March 2003, plaintiffs filed and served a second amended complaint, adding as defendants the Company’s Administrative Committee and the AOL Administrative Committee. On May 19, 2003, the Company, America Online and AOL Community, Inc. filed a motion to dismiss and the Administrative Committees filed a motion for judgment on the pleadings. Both of these motions are pending.

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The Company intends to defend against these lawsuits vigorously, but is unable to predict the outcome of these suits.

      On October 7, 2003, Kim Sevier and Eric M. Payne vs. Time Warner Inc. and Time Warner Cable Inc., a putative nationwide consumer class action, was filed in the U.S. District Court for the Southern District of New York, and on October 23, 2003, Heidi D. Knight v. Time Warner Inc. and Time Warner Cable Inc., also a putative nationwide consumer class action, was filed in the same court. In each case, the plaintiffs allege that defendants unlawfully tie the provision of high-speed cable Internet service to leases of cable modem equipment, because they do not provide a discount to customers who provide their own cable modems, in violation of Section 1 of the Sherman Act and the New York Donnelly Act, and, further, that defendants’ conduct resulted in unjust enrichment. On November 19, 2003, the court ordered plaintiffs’ complaints to be consolidated. Plaintiffs filed their amended consolidated class action complaint on December 17, 2003, seeking compensatory damages, disgorgement, attorneys’ fees and injunctive and declaratory relief. On February 6, 2004, the Company moved to compel arbitration and to stay the matter pending arbitration or, alternatively, to dismiss the case; the court denied this motion on April 19, 2004, and the Company filed a notice to appeal the decision on arbitration to the U.S. Court of Appeals for the Second Circuit. On March 7, 2005, the Second Circuit remanded the case to the district court so that the parties may seek approval of a proposed classwide settlement. The proposed settlement is immaterial to the Company.

      On June 16, 1998, plaintiffs in Andrew Parker and Eric DeBrauwere, et al. v. Time Warner Entertainment Company, L.P. and Time Warner Cable filed a purported nationwide class action in U.S. District Court for the Eastern District of New York claiming that TWE sold its subscribers’ personally identifiable information and failed to inform subscribers of their privacy rights in violation of the Cable Communications Policy Act of 1984 and common law. The plaintiffs are seeking damages and declaratory and injunctive relief. On August 6, 1998, TWE filed a motion to dismiss, which was denied on September 7, 1999. On December 8, 1999, TWE filed a motion to deny class certification, which was granted on January 9, 2001 with respect to monetary damages, but denied with respect to injunctive relief. On June 2, 2003, the U.S. Court of Appeals for the Second Circuit vacated the District Court’s decision denying class certification as a matter of law and remanded the case for further proceedings on class certification and other matters. On May 4, 2004, plaintiffs filed a motion for class certification, which the Company has opposed. The Company intends to defend against this lawsuit vigorously, but is unable to predict the outcome of this suit.

      In the normal course of business, the Company’s tax returns are subject to examination by various domestic and foreign taxing authorities. Such examinations may result in future tax and interest assessments on the Company. In instances where the Company believes that it is probable that it will be assessed, it has accrued a liability. The Company does not believe that these liabilities are material, individually or in the aggregate, to its financial condition or liquidity. Similarly, the Company does not expect the final resolution of tax examinations to have a material impact on the Company’s financial results.

      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.

 
Item 4. Submission of Matters to a Vote of Security Holders.

      Not applicable.

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EXECUTIVE OFFICERS OF THE COMPANY

      Pursuant to General Instruction G(3), the information regarding the Company’s executive officers required by Item 401(b) of Regulation S-K is hereby included in Part I of this report.

      The following table sets forth the name of each executive officer of the Company, the office held by such officer and the age of such officer as of March 1, 2005.

             
Name Age Office



Richard D. Parsons
    56     Chairman of the Board & Chief Executive Officer
Jeffrey L. Bewkes
    52     Chairman, Entertainment & Networks Group
Don Logan
    61     Chairman, Media & Communications Group
Edward I. Adler
    51     Executive Vice President, Corporate Communications
Paul T. Cappuccio
    43     Executive Vice President and General Counsel
Patricia Fili-Krushel
    51     Executive Vice President, Administration
Olaf Olafsson
    42     Executive Vice President
Wayne H. Pace
    58     Executive Vice President and Chief Financial Officer

      Set forth below are the principal positions held by each of the executive officers named above:

 
Mr. Parsons Chairman of the Board and Chief Executive Officer since May 2003, having served as Chief Executive Officer from May 2002. Prior to May 2002, Mr. Parsons served as Co-Chief Operating Officer from the consummation of the Merger and was President of Historic TW pre-Merger from February 1995. He previously served as Chairman and Chief Executive Officer of The Dime Savings Bank of New York, FSB from January 1991.
 
Mr. Bewkes Chairman, Entertainment & Networks Group since July 2002; prior to that, Mr. Bewkes served as Chairman and Chief Executive Officer of the Home Box Office division of the Company from May 1995 and President and Chief Operating Officer for the preceding five years.
 
Mr. Logan Chairman, Media & Communications Group since July 2002; prior to that, Mr. Logan served as Chairman and Chief Executive Officer of Time Inc., the Company’s publishing subsidiary, from August 1994, and as its President and Chief Operating Officer from June 1992. Prior to that, he held various executive positions with Southern Progress Corporation, which was acquired by Time Inc. in 1985.
 
Mr. Adler Executive Vice President, Corporate Communications since January 2004; prior to that, Mr. Adler served as Senior Vice President, Corporate Communications from the consummation of the Merger, Senior Vice President, Corporate Communications of Historic TW pre-Merger from January 2000 and Vice President, Corporate Communications of Historic TW prior to that.
 
Mr. Cappuccio Executive Vice President and General Counsel since the consummation of the Merger, and Secretary until January 2004; prior to the Merger, he served as Senior Vice President and General Counsel of America Online from August 1999. Before joining

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America Online, from 1993 to 1999, Mr. Cappuccio was a partner at the Washington, D.C. office of the law firm of Kirkland & Ellis. Mr. Cappuccio was also an Associate Deputy Attorney General at the U.S. Department of Justice from 1991 to 1993.
 
Ms. Fili-Krushel Executive Vice President, Administration since July 2001; prior to that, she was Chief Executive Officer of WebMD Health division of WebMD Corporation, an Internet portal providing health information and service for the consumer, from April 2000 to July 2001 and President of ABC Television Network from July 1998 to April 2000. Prior to that, she was President, ABC Daytime from 1993 to 1998.
 
Mr. Olafsson Executive Vice President since March 2003. During 2002, Mr. Olafsson pursued personal interests, including working on a novel that was published in the fall of 2003. Prior to that, he was Vice Chairman of Time Warner Digital Media from November 1999 through December 2001 and prior to that, Mr. Olafsson served as President of Advanta Corp., a financial services company, from March of 1998 until November 1999.
 
Mr. Pace Executive Vice President and Chief Financial Officer since November 2001; prior to that, he was Vice Chairman, Chief Financial and Administrative Officer of Turner from March 2001, having held other executive positions, including Chief Financial Officer, at Turner since July 1993. Prior to joining Turner, Mr. Pace was an audit partner with Price Waterhouse, now PricewaterhouseCoopers, an international accounting firm.

PART II

 
Item 5. Market For Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

      The principal market for the Company’s Common Stock is the New York Stock Exchange. For quarterly price information with respect to the Company’s Common Stock for the two years ended December 31, 2004, see “Quarterly Financial Information” at pages 215 through 216 herein, which information is incorporated herein by reference. The number of holders of record of the Company’s Common Stock as of February 28, 2005 was approximately 60,000.

      The Company has not paid any dividends since its formation.

      There is no established public trading market for the Company’s Series LMCN-V Common Stock, which as of February 28, 2005 was held of record by eight holders.

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      The following table provides information about purchases by the Company during the quarter ended December 31, 2004 of equity securities registered by the Company pursuant to Section 12 of the Exchange Act.

Issuer Purchases of Equity Securities

                                 
Total Number of Maximum Number
Shares Purchased as of Shares that May
Part of Publicly Yet Be Purchased
Total Number of Average Price Announced Plans or Under the Plans or
Period Shares Purchased(1) Paid Per Share Programs Programs





Oct. 1, 2004-Oct. 31, 2004
    0     $ 0       0       0  
Nov. 1, 2004-Nov. 31, 2004
    36,794     $ 17.44       0       0  
Dec. 1, 2004-Dec. 30, 2004
    44,057     $ 18.40       0       0  
     
             
     
 
Total
    80,051     $ 18.14       0       0  


(1) These shares represent shares of Common Stock that were tendered by employees to the Company to (a) pay the exercise price in connection with exercises of stock options or (b) satisfy tax withholding obligations in connection with exercises of stock options or the vesting of awards of restricted stock. Such shares are repurchased by the Company based on their fair market value on the exercise or vesting date, as applicable.
 
Item 6. Selected Financial Data.

      The selected financial information of the Company for the five years ended December 31, 2004 is set forth at pages 213 through 214 herein and is incorporated herein by reference.

 
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

      The information set forth under the caption “Management’s Discussion and Analysis” at pages 56 through 132 herein is incorporated herein by reference.

 
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.

      The information set forth under the caption “Market Risk Management” at pages 115 through 117 herein is incorporated herein by reference.

 
Item 8. Financial Statements and Supplementary Data.

      The consolidated financial statements and supplementary data of the Company and the report of the independent auditors thereon set forth at pages 133 through 208, 217 through 224 and 210 herein are incorporated herein by reference.

      Quarterly Financial Information set forth at pages 215 through 216 herein is incorporated herein by reference.

 
Item 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure.

      Not applicable.

 
Item 9A. Controls and Procedures.

Evaluation of Disclosure Controls and Procedures

      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 such term is defined in Rule 13a-15(e) under the Exchange Act) as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the Company’s disclosure controls and

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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 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. As discussed elsewhere in this Form 10-K, the Company began consolidating the financial results of AOLA effective March 31, 2004 pursuant to the requirements of FASB Interpretation No. 46, “Consolidation of Variable Interest Entities — an Interpretation of ARB No. 51,” as revised (“FIN 46R”). Because the Company does not control AOLA, the Company’s disclosure controls and procedures with respect to information regarding AOLA also are more limited than those for consolidated subsidiaries the Company controls. See “Management’s Discussion and Analysis of Results of Operations and Financial Condition – Consolidation of Variable Interest Entities” for more information regarding the consolidation of the financial results of AOLA.

Management’s Report on Internal Control Over Financial Reporting

      Management’s report and the report of the independent auditors thereon set forth at pages 209 and 211 through 212 are incorporated herein by reference.

Changes in Internal Control Over Financial Reporting

      There have not been any changes in the Company’s internal control over financial reporting during the quarter ended December 31, 2004 that have materially affected, or are reasonably likely to materially affect, its internal control over financial reporting.

 
Item 9B. Other Information.

      Not applicable.

PART III

 
Items 10, 11, 12, 13 and 14. Directors and Executive Officers of the Registrant; Executive Compensation; Security Ownership of Certain Beneficial Owners and Management; Certain Relationships and Related Transactions; Principal Accounting Fees and Services.

      Information called for by Items 10, 11, 12, 13 and 14 of Part III is incorporated by reference from the Company’s definitive Proxy Statement to be filed in connection with its 2005 Annual Meeting of Stockholders pursuant to Regulation 14A, except that (i) the information regarding the Company’s executive officers called for by Item 401(b) of Regulation S-K has been included in Part I of this report; (ii) the information called for by Items 402(k) and 402(l) of Regulation S-K is not incorporated by reference; and (iii) the information regarding certain Company equity compensation plans called for by Item 201(d) of Regulation S-K is set forth below.

      The Company has adopted a Code of Ethics for its Senior Executive and Senior Financial Officers. A copy of the Code is publicly available on the Company’s website at www.timewarner.com/corporate-information. Amendments to the Code or any grant of a waiver from a provision of the Code requiring disclosure under applicable SEC rules will also be disclosed on the Company’s website.

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Equity Compensation Plan Information

      The following table summarizes information as of December 31, 2004, about the Company’s outstanding stock options and shares of Common Stock reserved for future issuance under the Company’s equity compensation plans.

                         
Number of securities
remaining available for
future issuance under
Number of securities to be equity compensation plans
issued upon exercise of Weighted-average exercise (excluding securities
outstanding options, price of outstanding options, reflected in
Plan Category warrants and rights warrants and rights column (a))(4)




(a) (b) (c)
Equity compensation plans approved by security holders(1)
    135,135,263     $ 31.68       181,089,137  
Equity compensation plans not approved by security holders(2)
    341,554,383     $ 31.04       0  
Total(3)
    476,689,646     $ 31.22       181,089,137  


(1)  Equity compensation plans approved by security holders are the (i) Time Warner Inc. 2003 Stock Incentive Plan, (ii) Time Warner Inc. 1999 Stock Plan, (iii) Time Warner Inc. 1999 Restricted Stock and Restricted Stock Unit Plan, (iv) Time Warner Inc. 1988 Restricted Stock and Restricted Stock Unit Plan for Non-Employee Directors, and (v) Time Warner Inc. Employee Stock Purchase Plan (column (c) includes 7,565,878 shares that were available for future issuance under this plan). The Time Warner Inc. 2003 Stock Incentive Plan was approved by the Company’s stockholders in May 2003. The other plans or amendments to such plans were approved by the stockholders of either America Online or Historic TW in either 1998 or 1999. These other plans were assumed by the Company in connection with the America Online-Historic TW Merger, which was approved by the stockholders of both America Online and Historic TW on June 23, 2000.
 
(2)  Equity compensation plans not approved by security holders consist of the AOL Time Warner Inc. 1994 Stock Option Plan, which expired in November 2003.
 
(3)  Does not include options to purchase an aggregate of 142,308,826 shares of Common Stock (131,583,262 of which were awarded under plans that were approved by the stockholders of either America Online or Historic TW prior to the America Online-Historic TW Merger), at a weighted average exercise price of $27.68, granted under plans assumed in connection with transactions and under which no additional options may be granted.
 
(4)  Includes securities available under the Time Warner Inc. 1988 Restricted Stock and Restricted Stock Unit Plan for Non-Employee Directors, which uses the formula of .003% of the shares of Common Stock outstanding on December 31 of the prior calendar year to determine the maximum amount of securities available for issuance each year under the plan (resulting in 13,449,514, shares available for issuance in 2005). Also includes securities available under the following plan that previously used a formula for determining the maximum amount of securities available for issuance based on the number of shares outstanding at December 31 of the prior year, but for which the maximum number of shares is not subject to further adjustment: (i) the Time Warner Inc. 1999 Restricted Stock and Restricted Stock Unit Plan, which provided for a maximum number of shares of Common Stock available for restricted stock awards of .08% of the shares of Common Stock outstanding on December 31 of the prior year. Of the shares available for future issuance under the Time Warner Inc. 1999 Stock Plan and the Time Warner Inc. 2003 Stock Incentive Plan, a maximum of 990,333 shares and 39,282,000 shares, respectively, may be awarded as restricted stock as of December 31, 2004.

    The Time Warner Inc. 1999 Stock Plan (the “1999 Stock Plan”) was approved by the stockholders of America Online in October 1999 and was assumed by the Company in connection with the America Online-Historic TW Merger in 2001. Under the 1999 Stock Plan, stock options (non-qualified and incentive), stock purchase rights, i.e., restricted stock, and restricted stock units can be granted to employees, directors and consultants of the Company and its consolidated subsidiaries. No incentive stock options have been awarded under the 1999 Stock Plan. The exercise price of a stock option under the 1999 Stock Plan cannot be less than the fair market value of the Common Stock on the date of grant. The stock options generally become exercisable, or vest, in installments of 25% over a four-year period, subject to acceleration upon the occurrence of certain events such as death or disability, and expire ten years from the grant date. No more than 5 million of the total 100 million shares of Common Stock that can be issued pursuant to the 1999 Stock Plan can be issued for awards of restricted stock and restricted stock units. Awards of restricted stock and restricted stock units vest in amounts and at times designated at the time of award, and generally have vested over a four- or five-year period. Awards of restricted stock and restricted stock units are subject to restrictions on transfer and forfeiture prior to vesting. The awards of stock options made to non-employee directors of the Company are made pursuant to the 1999 Stock Plan, which provides for an award of 8,000 stock options when a non-employee director is first elected to the Board of Directors and then annual awards of 8,000 stock options following the annual meeting of stockholders. Stock options awarded to non-employee directors vest in

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installments of 25% over a four-year period or earlier if the director does not stand for re-election or is not re-elected after being nominated.

      The AOL Time Warner Inc. 1994 Stock Option Plan (the “1994 Plan”) was assumed by the Company in connection with the America Online-Historic TW Merger. The 1994 Plan expired on November 18, 2003 and stock options may no longer be awarded under the 1994 Plan. Under the 1994 Plan, nonqualified stock options and related stock appreciation rights could be granted to employees (other than executive officers) of and consultants and advisors to the Company and certain of its subsidiaries. No stock appreciation rights are currently outstanding under the 1994 Plan. The exercise price of a stock option under the 1994 Plan could not be less than the fair market value of the Common Stock on the date of grant. The outstanding options under the 1994 Plan generally become exercisable in installments of one-third or one-quarter on each of the first three or four anniversaries, respectively, of the date of grant, subject to acceleration upon the occurrence of certain events, and expire ten years from the grant date.

      The Time Warner Inc. 1999 Restricted Stock and Restricted Stock Unit Plan (the “1999 Restricted Stock Plan”) was approved by the stockholders of Historic TW in May 1999 and was assumed by the Company in connection with the America Online-Historic TW Merger. The 1999 Restricted Stock Plan will terminate on May 19, 2009. Under the 1999 Restricted Stock Plan, awards of restricted stock and restricted stock units can be made to employees of the Company and its consolidated subsidiaries. Awards of restricted stock and restricted stock units vest in amounts and at times designated at the time of award, but at least 95% of the awards must vest at least three years after the date of award. Since 2004, most awards of restricted stock and restricted stock units have vested 50% on the third anniversary of the grant date and 50% on the fourth anniversary of the grant date. Awards of restricted stock and restricted stock units are subject to restrictions on transfer and forfeiture prior to vesting. As of December 31, 2004, 152,341 shares were available for issuance under the 1999 Restricted Stock Plan.

      The Time Warner Inc. 1988 Restricted Stock and Restricted Stock Unit Plan for Non-Employee Directors (the “Directors’ Restricted Stock Plan”) was approved most recently in May 1999 by the stockholders of Historic TW and was assumed by the Company in connection with the America Online-Historic TW Merger. The Directors’ Restricted Stock Plan will terminate on May 19, 2009. The Directors’ Restricted Stock Plan provides for the award each year on the date of the annual stockholders meeting of either restricted stock or restricted stock units, as determined by the Board of Directors, to non-employee directors of the Company with value established by the Board of Directors. The awards of restricted stock and restricted stock units vest in equal annual installments on the first four anniversaries of the first day of the month in which the restricted stock or restricted stock units were awarded and in full if the director ends his or her service as a director due to (a) mandatory retirement, (b) failure to be re-elected after being nominated, (c) death or disability, (d) the occurrence of certain transactions involving a change in control of the Company and (e) with the approval of the Board of Directors on a case-by-case basis, under certain other designated circumstances. Restricted stock units also vest in full if a director retires from the Board of Directors after serving as a director for five years. If a non-employee director leaves the Board for any other reason, then his or her unvested restricted stock and restricted stock units are forfeited to the Company. The Board of Directors has determined that restricted stock units will be awarded in 2005.

      The Time Warner Inc. Employee Stock Purchase Plan (the “ESPP”) was approved most recently in October 1998 by the stockholders of America Online and was assumed by the Company in connection with the America Online-Historic TW Merger. Under the ESPP, employees of America Online and certain subsidiaries of America Online may purchase shares of the Company’s Common Stock at a 15% discount from the closing price of the Common Stock at the beginning or end of a six-month participation period, whichever is lower. The purchases are made through payroll deductions during the participation period and are subject to annual limits.

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PART IV

 
Item 15. Exhibits and Financial Statements Schedules

      (a)(1)-(2) Financial Statements and Schedules:

        (i) The list of consolidated financial statements and schedules set forth in the accompanying Index to Consolidated Financial Statements and Other Financial Information at page 55 herein is incorporated herein by reference. Such consolidated financial statements and schedules are filed as part of this report.
 
        (ii) All other financial statement schedules are omitted because the required information is not applicable, or because the information required is included in the consolidated financial statements and notes thereto.

      (3) Exhibits:

      The exhibits listed on the accompanying Exhibit Index are filed or incorporated by reference as part of this report and such Exhibit Index is incorporated herein by reference. Exhibits 10.1 through 10.42 listed on the accompanying Exhibit Index identify management contracts or compensatory plans or arrangements required to be filed as exhibits to this report, and such listing is incorporated herein by reference.

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SIGNATURES

      Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

  TIME WARNER INC.

  By:  /s/ WAYNE H. PACE
 
  Name: Wayne H. Pace
  Title: Executive Vice President and
        Chief Financial Officer

Date: March 11, 2005

      Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

             
Signature Title Date



 
/s/ RICHARD D. PARSONS

(Richard D. Parsons)
  Director, Chairman of the Board and Chief Executive Officer
(principal executive officer)
  March 11, 2005
 
/s/ WAYNE H. PACE

(Wayne H. Pace)
  Executive Vice President and Chief Financial Officer
(principal financial officer)
  March 11, 2005
 
/s/ JAMES W. BARGE

(James W. Barge)
  Sr. Vice President and
Controller (principal
accounting officer)
  March 11, 2005
 
/s/ JAMES L. BARKSDALE

(James L. Barksdale)
  Director   March 11, 2005
 
/s/ STEPHEN F. BOLLENBACH

(Stephen F. Bollenbach)
  Director   March 11, 2005
 
/s/ STEPHEN M. CASE

(Stephen M. Case)
  Director   March 11, 2005

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Signature Title Date



 
/s/ FRANK J. CAUFIELD

(Frank J. Caufield)
  Director   March 11, 2005
 
/s/ ROBERT C. CLARK

(Robert C. Clark)
  Director   March 11, 2005
 
/s/ MILES R. GILBURNE

(Miles R. Gilburne)
  Director   March 11, 2005
 
/s/ CARLA A. HILLS

(Carla A. Hills)
  Director   March 11, 2005
 
/s/ REUBEN MARK

(Reuben Mark)
  Director   March 11, 2005
 
/s/ MICHAEL A. MILES

(Michael A. Miles)
  Director   March 11, 2005
 
/s/ KENNETH J. NOVACK

(Kenneth J. Novack)
  Director   March 11, 2005
 
/s/ R.E. TURNER

(R.E. Turner)
  Director   March 11, 2005
 
/s/ FRANCIS T. VINCENT, JR.

(Francis T. Vincent, Jr.)
  Director   March 11, 2005

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TIME WARNER INC.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND OTHER FINANCIAL INFORMATION
           
Page

Management’s Discussion and Analysis of Results of Operations and Financial Condition
    56  
Consolidated Financial Statements:
       
 
Consolidated Balance Sheet
    133  
 
Consolidated Statement of Operations
    134  
 
Consolidated Statement of Cash Flows
    135  
 
Consolidated Statement of Shareholders’ Equity
    136  
 
Notes to Consolidated Financial Statements
    137  
Management’s Report on Internal Control Over Financial Reporting
    209  
Reports of Independent Registered Public Accounting Firm
    210  
Selected Financial Information
    213  
Quarterly Financial Information
    215  
Supplementary Information
    217  
Financial Statement Schedule II — Valuation and Qualifying Accounts
    225  

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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 Time Warner Inc.’s (“Time Warner” or the “Company”) financial condition, changes in financial condition and results of operations. MD&A is organized as follows:

  •  Overview. This section provides a general description of Time Warner’s business segments, as well as recent developments the Company believes are important in understanding the results of operations and financial condition or in understanding anticipated future trends.
 
  •  Results of operations. This section provides an analysis of the Company’s results of operations for the three years ended December 31, 2004. This analysis is presented on both a consolidated and a business segment basis. In addition, a brief description is provided of significant 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 cash flows for the three years ended December 31, 2004, as well as a discussion of the Company’s outstanding debt and commitments that existed as of December 31, 2004. Included in the discussion of outstanding debt is a discussion of the amount of financial capacity available to fund the Company’s future commitments, as well as a discussion of other financing arrangements.
 
  •  Critical accounting policies. This section discusses accounting policies that are considered important to the Company’s financial condition and results of operations, require significant judgment and require estimates on the part of management in application. The Company’s significant accounting policies, including those considered to be critical accounting policies, are summarized in Note 1 to the accompanying consolidated financial statements.
 
  •  Market risk management. This section discusses how the Company manages exposure to potential loss arising from adverse changes in interest rates, foreign currency exchange rates and changes in the market value of financial instruments.
 
  •  Risk factors and caution concerning forward-looking statements. This section provides a description of risk factors that could adversely affect the operations, business or financial results of the Company or its business segments and the use of forward-looking information appearing in this report, including in MD&A and the consolidated financial statements. Such information is based on management’s current expectations about future events, which are inherently susceptible to uncertainty and changes in circumstances.

Use of Operating Income (Loss) before Depreciation and Amortization and Free Cash Flow

      The Company utilizes Operating Income (Loss) before Depreciation and Amortization, among other measures, to evaluate the performance of its businesses. Operating Income (Loss) before Depreciation and Amortization is considered an important indicator of the operational strength of the Company’s businesses. Operating Income (Loss) before Depreciation and Amortization eliminates the uneven effect across all business segments of considerable amounts of noncash depreciation of tangible assets and amortization of certain intangible assets that were recognized in business combinations. A limitation of this measure, however, is that it does not reflect the periodic costs of certain capitalized tangible and intangible assets used in generating revenues in the Company’s businesses. Management evaluates the costs of such tangible and intangible assets, the impact of related impairments, as well as asset sales through other financial measures, such as capital expenditures, investment spending and return on capital.

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

      Free Cash Flow is cash provided by operations (as defined by U.S. generally accepted accounting principles) less cash provided by discontinued operations, capital expenditures and product development costs, principal payments on capital leases, and partnership distributions, if any. Free Cash Flow is considered to be an important indicator of the Company’s liquidity, including its ability to reduce net debt, make strategic investments, pay dividends to common shareholders and repurchase stock.

      Both Operating Income (Loss) before Depreciation and Amortization and Free Cash Flow should be considered in addition to, not as a substitute for, the Company’s Operating Income (Loss), Net Income (Loss) and various cash flow measures (e.g., Cash Provided by Operations), as well as other measures of financial performance and liquidity reported in accordance with U.S. generally accepted accounting principles.

OVERVIEW

      Time Warner is a leading media and entertainment company whose major businesses encompass an array of the most respected and successful media brands. Among the Company’s brands are HBO, CNN, AOL, People, Sports Illustrated, Time and Time Warner Cable. The Company has produced and distributed films including The Lord of the Rings trilogy, the Harry Potter series, Million Dollar Baby and The Polar Express and television programs including ER, Two and a Half Men and The West Wing. As of February 1, 2005, the Company had approximately 85,000 employees worldwide. During 2004, the Company generated revenues of $42.089 billion (up 6% from $39.563 billion in 2003), Operating Income before Depreciation and Amortization of $9.372 billion (up 12% from $8.393 billion in 2003), Operating Income of $6.165 billion (up 17% from $5.254 billion in 2003), Net Income of $3.364 billion (up 27% from $2.639 billion in 2003), Cash Provided by Operations of $6.618 billion (up slightly from $6.601 billion in 2003) and Free Cash Flow of $3.280 billion (down 1% from $3.312 billion in 2003).

 
Time Warner Businesses

      Time Warner classifies its operations into five reportable segments: AOL, Cable, Filmed Entertainment, Networks and Publishing.

      AOL. America Online, Inc. (“AOL” or “America Online”) is a leader in interactive services, web brands, Internet technologies and e-commerce services, with 28.5 million total AOL brand subscribers in the U.S. and Europe at the end of 2004. In 2004, AOL had total revenues of $8.692 billion (21% of the Company’s overall revenues), $1.772 billion in Operating Income before Depreciation and Amortization and $934 million in Operating Income. AOL generates its revenues primarily from subscription fees charged to subscribers and advertising services.

      During the fourth quarter of 2004, America Online reorganized its operations into four business units: Access, Audience, Digital Services and International (refer to Part I, Business), to streamline management and more closely align these business units to the users that America Online serves. In connection with this reorganization, AOL effected a restructuring, which eliminated approximately 860 positions, to align the workforce with the current business outlook. The reorganization is intended to position AOL to implement its strategy of better balancing the subscription and advertising businesses. In other words, AOL plans to place more emphasis on generating higher margin advertising and search revenues, which the Company believes will continue to grow for the foreseeable future.

      Over the past several years, the AOL Access business has experienced significant declines in U.S. subscribers and subscriber revenues, and these declines are expected to continue. Driving this decrease is the continued industry-wide maturing of premium dial-up services business, as consumers migrate to high-speed broadband and lower-cost dial-up services. AOL continues to develop, change, test and implement marketing strategies to attract and retain subscribers. For example, AOL recently launched AOL 9.0 Security

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Edition, which includes enhanced security features and includes the McAfee VirusScan Online product, previously sold as a premium service, at no additional charge.

      AOL’s Audience business strategy relies on expanding its audience and increasing usage across all of its properties, including properties such as MapQuest, Moviefone and AOL Instant Messenger. AOL seeks to generate revenue from this increased traffic through the use of paid-search, branded advertising and increased utilization and optimization of AOL advertising inventory space. The acquisition of Advertising.com Inc., (“Advertising.com”) in the third quarter of 2004, as discussed later, also provides incremental growth in Advertising revenues primarily through third-party performance-based advertising. A component of the Audience business strategy is the planned re-launch in 2005 of the publicly-available version of the AOL.com web portal that will include a limited portion of AOL’s content that, today, is only available to AOL subscribers.

      In the first quarter of 2005, AOL and Time Warner Cable Inc. announced a strategic agreement to develop a customized broadband offering for their current AOL and Road Runner subscribers as well as prospects across the Time Warner Cable coverage area. The Road Runner service will continue to be available on a stand-alone basis for those subscribers who elect not to take the new offering. This agreement will allow AOL to proactively migrate its subscribers to the customized broadband offering and also to share in future subscriber revenues generated. AOL anticipates some decline in near-term profits from this migration, but expects to experience an increase in the life of its revenue stream. Under the agreement, AOL will manage the advertising and search opportunities for both the new offering and the Road Runner portal, providing an increase in its audience size and the potential to earn from online advertising, search, commerce and premium services. Time Warner Cable will share in a portion of the Advertising revenues generated. The agreement should benefit Time Warner Cable in accelerating its acquisition of high-speed data subscribers and provide its high-speed data customers additional value through access to AOL’s programming and features. The impact on Time Warner’s consolidated financial results is not expected to be significant in 2005. AOL anticipates pursuing similar agreements with other entities offering broadband services.

      AOL has taken steps over the past several years to align costs with the declining dial-up subscriber base. These efforts have resulted in reductions in the cost of operating AOL’s network through improved pricing and decreased levels of service commitments. These factors are expected to result in continued declines in operating costs during 2005.

      Consistent with AOL’s domestic strategy, AOL’s International business unit has focused on balancing its subscription and advertising businesses. Recently, the International business unit entered into a new, multi-year search arrangement that is expected to provide incremental Advertising revenues.

      Cable. Time Warner’s cable business, Time Warner Cable Inc. and its subsidiaries (“TWC Inc.”), is the second-largest cable operator in the U.S. (in terms of subscribers served). TWC Inc. managed approximately 10.9 million basic cable subscribers (including approximately 1.6 million subscribers of unconsolidated investees) at the end of 2004, in highly clustered and upgraded systems in 27 states. TWC Inc. delivered $3.278 billion of Operating Income before Depreciation and Amortization, more than any of the Company’s other reporting segments, and had revenues of $8.484 billion (20% of the Company’s overall revenues) and $1.764 billion in Operating Income during 2004.

      TWC Inc. offers three product lines — video, high-speed data and its newest service, Digital Phone. Video is TWC Inc.’s largest product line in terms of revenues generated; however, the growth of its customer base for video cable service is limited because the customer base has matured and industry-wide competition from direct-to-home satellite services has increased. Nevertheless, TWC Inc. is continuing to increase its video revenues through its offerings of advanced digital video services. Digital video, Video-on-Demand (VOD), Subscription-Video-on-Demand (SVOD) and Digital Video Recorders (DVR) are available in all of TWC Inc.’s 31 divisions. TWC Inc.’s digital video penetration provides a broad base of potential customers for

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these advanced services. Video programming costs represent a major component of TWC Inc.’s expenses and continue to rise across the sector, especially for sports programming.

      High-speed data service has been one of TWC Inc.’s fastest-growing products over the past several years and is a key driver of its results. However, its rate of subscriber growth has begun to slow, reflecting increasing penetration rates and increased competition from digital subscriber lines (DSL).

      TWC Inc.’s new voice product, Digital Phone, was launched in all of its divisions at December 31, 2004. Digital Phone enables TWC Inc. to offer its customers a combined, easy-to-use package of video, high-speed data and voice services and to compete effectively against similar bundled products that are available from its competitors. Included in Operating Income before Depreciation and Amortization during 2004 are approximately $45 million of losses associated with the roll-out of the Digital Phone service.

      In addition to the subscription services described above, TWC Inc. also earns revenue by selling advertising time to national, regional and local businesses.

      As noted above, TWC Inc. and AOL recently announced a strategic agreement to develop a customized broadband offering. This arrangement should benefit Time Warner Cable in accelerating its acquisition of high-speed data subscribers and provide its high-speed data customers additional value through access to AOL’s programming and features. TWC Inc. will also share in a portion of the Advertising revenues generated.

      Filmed Entertainment. Time Warner’s Filmed Entertainment businesses, Warner Bros. Entertainment Group (“Warner Bros.”) and New Line Cinema Corporation (“New Line”), generated revenues of $11.853 billion (26% of the Company’s overall revenues), $1.474 billion in Operating Income before Depreciation and Amortization and $1.157 billion in Operating Income during 2004.

      One of the world’s leading studios, Warner Bros. has diversified sources of revenues with its film, television and home video businesses, combined with an extensive film library and global distribution infrastructure. This diversification helps Warner Bros. deliver consistent growth and performance. New Line is the oldest independent film company in the world. Its primary source of revenues is the creation and distribution of theatrical motion pictures.

      The sale of DVDs has been one of the largest drivers of the segment’s profit growth over the last few years. Warner Bros.’ library, consisting of more than 6,600 theatrical titles and 54,000 live-action and animated television titles, positions it to benefit from continuing growth in DVD hardware penetration. With DVD hardware penetration levels relatively low on a worldwide basis, the Company believes that a significant opportunity for DVD sales growth remains.

      Warner Bros.’ industry-leading television business has experienced growing revenues, including the successful releases of television series into the home video market. For the 2004-2005 television season, Warner Bros. has more current productions on the air than any other studio, with prime-time series on all six broadcast networks (including such hits as Two and a Half Men, ER, Third Watch, The O.C., Cold Case, Smallville and The West Wing).

      Piracy, including physical piracy as well as illegal online file-sharing, continues to be a significant issue for the filmed entertainment industry. Piracy has expanded from music to movies and television programming due to advances in technology. The Company has taken a variety of actions to combat piracy over the last several years and will continue to do so, both individually and together with industry associations.

      Networks. Time Warner’s Networks group is composed of Turner Broadcasting System, Inc. (“Turner”), Home Box Office (“HBO”) and The WB Television Network (“The WB Network”). The segment delivered revenues of $9.054 billion (20% of the Company’s overall revenues), $2.694 billion in Operating Income before Depreciation and Amortization and $2.461 billion in Operating Income during 2004.

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      The Turner networks — including such recognized brands as TBS, TNT, CNN, Cartoon Network and CNN Headline News — are among the leaders in advertising-supported cable TV networks. For the third straight year, more prime-time viewers watched advertising-supported cable TV networks than the national broadcast networks. For 2004, TNT and TBS ranked first and second, respectively, among ad-supported cable networks in total day delivery of their key demographic, adults 18-49 and adults 25-54.

      The Turner networks generate revenues principally from the sale of advertising time and monthly subscriber fees paid by cable system operators, satellite companies and other affiliates. Turner has benefited from strong ratings and a strong advertising market. Key contributors to Turner’s success are its continued investments in high-quality programming focused on original movies, sports, network premieres, licensed and original series, news and animation, as well as brand awareness and operating efficiency. In 2004, Turner launched a rebranding of TBS under the “tbs very funny” slogan following an earlier, successful rebranding of TNT as “We Know Drama.”

      HBO operates the HBO and Cinemax multichannel pay television programming services, with the HBO service being the nation’s most widely distributed pay television network. HBO generates revenues principally from monthly subscriber fees from cable system operators, satellite companies and other affiliates. An additional source of revenue is from the ancillary sales of its original programming, including such programs as The Sopranos, Sex and the City, Six Feet Under and Band of Brothers.

      The WB Network is a broadcast television network whose target audience is the 12-34 age group demographic. The WB Network generates revenues almost exclusively from the sale of advertising time. Like many of its broadcast network competitors, The WB Network experienced a decline in its audience of young adults in the 2003-2004 television season and continues to be down in the 2004-2005 television season. Because this is The WB Network’s target demographic, the loss had a proportionally larger effect on its overall audience delivery. Among other measures, The WB Network is now developing new programming to reach the higher end of its target demographic with shows that will increase viewership among adults 18-34.

      Publishing. Time Warner’s Publishing segment consists principally of magazine publishing through Time Inc. and book publishing through Time Warner Book Group Inc. and a number of direct-marketing and direct-selling businesses. The segment generated revenues of $5.565 billion (13% of the Company’s overall revenues), $1.196 billion in Operating Income before Depreciation and Amortization and $934 million in Operating Income during 2004.

      Time Inc. publishes over 130 magazines globally, including People, Sports Illustrated, In Style, Southern Living, Time, Entertainment Weekly, Fortune, Real Simple, What’s on TV and Cooking Light. It generates revenues primarily from advertising, magazine subscription and newsstand sales, and drives growth through higher circulation and advertising on existing magazines, acquisitions and new magazine launches. Time Inc. owns IPC Media (the U.K.’s largest magazine company) and is the majority shareholder of magazine subscription marketer Synapse Group, Inc. In addition, Time Inc. is continuing to invest in new magazine launches, including All You, Cottage Living and Nuts, and has recently re-launched Life as a weekend magazine distributed in the U.S. in newspapers nationwide. In 2005, Time Inc. signed an agreement to acquire the remaining 51% stake it does not already own in Essence Communications Partners, the publisher of Essence. This transaction is expected to close in the first quarter of 2005. Time Inc.’s direct-selling division, Southern Living At Home, sells home decor products through approximately 35,000 independent consultants at parties hosted in people’s homes throughout the United States.

      Time Inc.’s book publishing operations are conducted primarily by Time Warner Book Group through its three major publishing houses, Warner Books, Little, Brown and Company, and Time Warner Book Group UK. During 2004, Time Warner Book Group placed a record 58 books on the New York Times bestseller lists, including the Publishers Weekly Book of the Year America (The Book) by Jon Stewart, Your Best Life Now by Joel Osteen, and A Salty Piece of Land by Jimmy Buffett, and new releases from many of its major

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recurring bestselling authors, including David Baldacci, Nelson DeMille, James Patterson and Nicholas Sparks.

 
Other Recent Developments
 
Update on Status of Government Investigations and Restatement of Financial Statements

      As previously disclosed by the Company, the Securities and Exchange Commission (“SEC”) and the U.S. Department of Justice (“DOJ”) have been conducting investigations into the accounting and disclosure practices of the Company. Those investigations focused on transactions principally involving the Company’s America Online segment that were entered into after July 1, 1999, including advertising arrangements, the methods used by the America Online segment to report its subscriber numbers and the accounting related to the Company’s interest in AOL Europe prior to January 2002.

      As announced on December 15, 2004, the Company and its subsidiary, AOL, have reached a definitive agreement with the DOJ that resolves the DOJ’s investigation of the Company. The Company also announced that it has proposed a settlement to the staff of the SEC that the staff has agreed to recommend to the SEC Commissioners.

      Under the terms of the settlement in connection with the DOJ investigation, the DOJ filed a criminal complaint against AOL for the conduct of certain employees in connection with securities fraud by PurchasePro.com, but the DOJ will defer prosecution of AOL. After two years, provided the Company fulfills its obligations under the agreement, the DOJ will dismiss the criminal complaint filed against AOL. In addition, the DOJ will not prosecute the Company or AOL for conduct relating to certain other transactions entered into by AOL or the Company from July 1, 1999, including transactions that were the subject of the DOJ or SEC investigations.

      In connection with the settlement with the DOJ, in December 2004, the Company paid a penalty of $60 million and established a $150 million fund, which the Company may use to settle related securities litigation. The fund is reflected as restricted cash on the Company’s accompanying consolidated balance sheet as of December 31, 2004. The Company’s other obligations under the settlement agreement are to (a) accept responsibility for the conduct of certain AOL employees with respect to PurchasePro.com transactions; (b) cooperate fully with the DOJ or any other federal criminal law enforcement agency regarding the transactions covered by the settlement; and (c) retain and cooperate with an independent monitor, who will review the effectiveness of AOL’s internal controls, including those related to the accounting for advertising and related transactions.

      Under the settlement the SEC staff will recommend to the SEC Commissioners, Time Warner will agree, without admitting or denying the Commission’s allegations, to be enjoined from future violations of certain provisions of the securities laws. Under the proposed settlement:

  •  The Company would pay a $300 million penalty, which the SEC staff will request be used for a Fair Fund, as authorized under the Sarbanes-Oxley Act;
 
  •  The Company would adjust its historical accounting for Advertising revenues in certain transactions with Bertelsmann, A.G. (“Bertelsmann”) that were improperly recognized or prematurely recognized primarily in the second half of 2000, during 2001 and during 2002. Additionally, the Company would adjust its accounting for transactions involving three other AOL customers where there were Advertising revenues recognized in the second half of 2000 and during 2001;
 
  •  Consistent with its previous announcement, the Company would adjust its historical accounting for its investment in and consolidation of AOL Europe S.A. (“AOL Europe”); and

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  •  The Company would also agree to the appointment of an independent examiner, who will either be or hire a certified public accountant. The independent examiner would review whether the Company’s historical accounting for transactions with 17 counterparties identified by the SEC staff, including three cable programming affiliation agreements with related advertising elements, was in conformity with generally accepted accounting principles, and provide a report to the Company’s audit and finance committee of its conclusions within 180 days of being engaged. The transactions that would be reviewed were entered into between June 1, 2000 and December 31, 2001, including subsequent amendments thereto, and involved online advertising and related transactions for which revenue was principally recognized before January 1, 2002.

      Final settlement is subject to both agreement on final documentation and approval by the SEC Commissioners. The Company will not be able to deduct the $300 million penalty to be paid under the proposed settlement for income tax purposes, be reimbursed or indemnified for such payment through insurance or any other source, or use such payment to setoff or reduce any award of compensatory damages to plaintiffs in related securities litigation pending against the Company.

      In connection with the proposed settlement with the SEC, the financial results for each of the years ended December 31, 2000 through December 31, 2003 have been restated for the following:

  •  To adjust the accounting for transactions with certain counterparties resulting in the recognition of Advertising revenues of approximately $489 million in the aggregate, including the previously disclosed $400 million with Bertelsmann that the Company has reflected as a reduction in the purchase price of AOL Europe in 2002 rather than as Advertising revenues during 2001 and 2002.
 
  •  To adjust the accounting for $20 million of Advertising revenues that were recognized in 2001, but should have been recognized in 2002.
 
  •  To adjust the accounting for the Company’s investment in AOL Europe to reflect the consolidation of AOL Europe in 2000. Previously, the Company began consolidating AOL Europe’s operations in January 2002.

      The accompanying financial information reflects the impact of the adjustments that were made in the restatement of the Company’s consolidated financial statements.

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      The following tables reflect the impact of the restatement on the Company’s consolidated financial statements for the years ended December 31, 2002, 2001 and 2000:

                           
Time Warner
(as reported) Impact of Restated
(unaudited) Restatement Time Warner



(millions)
2002:
                       
Income Statement:
                       
 
Revenues
  $ 37,314     $ (254 )   $ 37,060  
 
Operating loss(a)
    (38,688 )     1,274       (37,414 )
 
Loss before discontinued operations and cumulative effect of accounting change
    (43,449 )     1,479       (41,970 )
 
Net loss(a)
    (98,696 )     1,479       (97,217 )
 
Basic loss per common share before discontinued operations and cumulative effect of accounting change
  $ (9.75 )   $ 0.33     $ (9.42 )
 
Diluted loss per common share before discontinued operations and cumulative effect of accounting change
  $ (9.75 )   $ 0.33     $ (9.42 )
 
Basic net loss per common share
  $ (22.15 )   $ 0.33     $ (21.82 )
 
Diluted net loss per common share
  $ (22.15 )   $ 0.33     $ (21.82 )
Balance Sheet:
                       
 
Total assets
  $ 115,518     $ (5 )   $ 115,513  
 
Total liabilities
    62,701       (179 )     62,522  
 
Shareholders’ equity
    52,817       174       52,991  
Cash Flow:
                       
 
Cash provided by operations
  $ 7,032     $ (275 )   $ 6,757  
 
Cash used by investing activities
    (10,460 )     223       (10,237 )
 
Cash provided by financing activities
    4,439             4,439  
 
Total change in cash
    1,011       (52 )     959  


(a)  There is a positive impact on the Operating Loss and Net Loss in 2002 due to a lower goodwill impairment charge at the AOL segment than originally reported. Specifically, the (1) incremental losses assumed by AOL related to the consolidation of AOL Europe beginning in 2000 and (2) the treatment of consideration received on certain other transactions as a reduction of the purchase price of AOL Europe as opposed to Advertising revenue reduce the goodwill recognized in connection with the Company’s purchase of Bertelsmann’s interest in AOL Europe in January 2002. There is a corresponding reduction in the impairment charge recognized thereon in the fourth quarter of 2002.

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MANAGEMENT’S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION — (Continued)
                           
Time
Warner Impact of Restated
(as reported) Restatement Time Warner
(unaudited) (unaudited) (unaudited)



(millions)
2001:
                       
Income Statement:
                       
 
Revenues
  $ 33,507     $ 589     $ 34,096  
 
Operating income (loss)
    500       (892 )     (392 )
 
Loss before discontinued operations and cumulative effect of accounting change
    (4,221 )     (926 )     (5,147 )
 
Net loss
    (4,934 )     (926 )     (5,860 )
 
Basic loss per common share before discontinued operations and cumulative effect of accounting change
  $ (0.95 )   $ (0.21 )   $ (1.16 )
 
Diluted loss per common share before discontinued operations and cumulative effect of accounting change
  $ (0.95 )   $ (0.21 )   $ (1.16 )
 
Basic net loss per common share
  $ (1.11 )   $ (0.21 )   $ (1.32 )
 
Diluted net loss per common share
  $ (1.11 )   $ (0.21 )   $ (1.32 )
Balance Sheet:
                       
 
Total assets
  $ 208,563     $ 901     $ 209,464  
 
Total liabilities
    56,536       2,099       58,635  
 
Shareholders’ equity
    152,027       (1,198 )     150,829  
Cash Flow:
                       
 
Cash provided by operations
  $ 5,281     $ (800 )   $ 4,481  
 
Cash used by investing activities
    (5,257 )     108       (5,149 )
 
Cash used by financing activities
    (1,915 )     594       (1,321 )
 
Total change in cash
    (1,891 )     (98 )     (1,989 )

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TIME WARNER INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION — (Continued)
                           
Time
Warner Impact of Restated
(as reported) Restatement Time Warner
(unaudited) (unaudited)(b) (unaudited)



(millions)
2000(a):
                       
Income Statement:
                       
 
Revenues
  $ 7,605     $ 515     $ 8,120  
 
Operating income
    1,766       (307 )     1,459  
 
Income before discontinued operations and cumulative effect of accounting change
    1,121       (254 )     867  
 
Net income
    1,121       (254 )     867  
 
Basic income per common share before discontinued operations and cumulative effect of accounting change
  $ 0.48     $ (0.11 )   $ 0.37  
 
Diluted income per common share before discontinued operations and cumulative effect of accounting change
  $ 0.43     $ (0.10 )   $ 0.33  
 
Basic net income per common share
  $ 0.48     $ (0.11 )   $ 0.37  
 
Diluted net income per common share
  $ 0.43     $ (0.10 )   $ 0.33  
Balance Sheet:
                       
 
Total assets
  $ 10,778     $ 272     $ 11,050  
 
Total liabilities
    4,051       546       4,597  
 
Shareholders’ equity
    6,727       (274 )     6,453  
Cash Flow:
                       
 
Cash provided by operations
  $ 1,951     $ (226 )   $ 1,725  
 
Cash used by investing activities
    (2,316 )     79       (2,237 )
 
Cash provided by financing activities
    421       297       718  
 
Total change in cash
    56       150       206  


(a)  Because the America Online — Historic TW merger was not consummated until January 2001, the historical information for 2000 included herein reflects only the financial results of America Online. As a result, Time Warner’s 2000 historical operating results and financial condition are not comparable to 2001 and 2002.
(b)  The Company is required to consolidate AOL Europe for periods subsequent to the change in AOL Europe’s governance rights in late March 2000. However, for purposes of convenience, and as permitted under the accounting rules, the Company has consolidated AOL Europe retroactive to January 1, 2000 and AOL began to recognize 100% of AOL Europe’s losses effective March 31, 2000.

    Additionally, for the year ended December 31, 2003, the results of operations reflect a reduction in the Company’s consolidated revenues and Operating Income of approximately $2 million and $1 million, respectively. The impact on the consolidated Net Income was less than $1 million for the year ended December 31, 2003. There was no impact on the previously reported results of operations for the first three quarters of the year ended December 31, 2004. For additional information, see Note 1 to the accompanying consolidated financial statements.

      As noted above, as part of the proposed settlement with the SEC, the Company has agreed to appoint an independent examiner, who — within 180 days after starting work — will review whether the Company’s historical accounting for transactions with a limited number of specified counterparties, principally involving online advertising revenues, was in accordance with GAAP. Depending on the examiner’s conclusions, a further restatement might be necessary. It is also possible that, so long as there are unresolved issues associated with the Company’s financial statements, the effectiveness of any registration statement of the Company or its affiliates may be delayed.

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Agreements with Comcast Corporation

      Comcast currently owns an effective interest of approximately 21% in TWC Inc.’s business — held through a 17.9% common stock interest in TWC Inc. and 4.7% limited partnership interest in Time Warner Entertainment Company, L.P. (“TWE”).

      On September 24, 2004, TWC Inc. entered into a Tolling and Optional Redemption Agreement (the “Agreement”) with Comcast Corporation (“Comcast”) and certain affiliates of Comcast, including the trust that holds shares of TWC Inc. on behalf of Comcast. Pursuant to the Agreement, Comcast was granted an option (the “Option”), which originally could be exercised between December 1, 2004 and April 1, 2005, to require TWC Inc. to redeem a portion of the TWC Inc. stock held by Comcast in exchange for a TWC Inc. subsidiary with cable systems serving approximately 90,000 basic subscribers as of December 31, 2004, plus approximately $750 million in cash. The Agreement was amended in February 2005 to extend the expiration date of the Option to 60 days following notice by either TWC Inc. or Comcast or, after April 1, 2005, immediately if Comcast irrevocably elects not to exercise the Option. Closing of the transactions contemplated by the Agreement is subject to the exercise of the Option, required governmental and regulatory approvals and other customary closing conditions. As of the date of this filing, Comcast has not exercised the Option.

      If the Option is exercised, Comcast will reduce its effective interest in TWC Inc.’s business to approximately 17% — consisting of a 13.7% common stock interest in TWC Inc. and a 4.7% limited partnership interest in TWE. Other than as provided in the Agreement, Comcast cannot require TWC Inc. to purchase its interest in TWC Inc. Under the arrangements entered into by Comcast as part of the process of obtaining FCC approval of Comcast’s acquisition of AT&T Broadband, Comcast is obligated to take steps to dispose of its entire interest in TWC Inc. and TWE in an orderly process by November 2007, and in any event by May 2008.

      In connection with the restructuring of TWE completed in 2003 (the “TWE Restructuring”), Comcast received (1) customary registration rights relating to its 17.9% interest in the common stock of TWC Inc. and (2) the right, at any time following March 31, 2005, to require TWC Inc. or Time Warner to purchase all or a portion of Comcast’s 4.7% limited partnership interest in TWE at an appraised fair market value. The purchase price payable by TWC Inc. or Time Warner as consideration for Comcast’s limited partnership interest may be paid in cash, Time Warner or TWC Inc. common stock (if TWC Inc. common stock is then publicly traded) or a combination of cash and stock. Following March 31, 2005, Comcast also has the right to sell all or a portion of its interest in TWE to a third party, subject to rights of first refusal by the Company and TWC Inc.

      The Agreement, as amended, also provides that Comcast will not exercise or pursue registration rights with respect to the TWC Inc. stock owned by it until the Option expires. This provision of the Agreement supersedes Comcast’s request to TWC Inc. in December 2003 to register its TWC Inc. stock. For details related to the accounting for this transaction, see Note 6, “TWE and TWC Inc. Related Transactions.”

      In connection with the TWE Restructuring, Comcast also received Series A mandatorily convertible preferred stock of Time Warner that will convert automatically on March 31, 2005 into shares of Time Warner Common Stock having a value equal to $1.5 billion at the time of conversion, up to a maximum of 225,056,264 shares.

 
Google Inc.

      In May 2004, America Online exercised a warrant for approximately $22 million and received approximately 7.4 million shares of Series D Preferred Stock of Google Inc. (“Google”). Each of these shares converted automatically into shares of Google’s Class B Common Stock immediately prior to the closing of

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

Google’s initial public offering on August 24, 2004. In connection with this offering, America Online converted 2,355,559 shares of its Google Class B Common Stock into an equal number of shares of Google’s Class A Common Stock. Such Class A shares were sold in the offering for $195 million, net of the underwriters’ discounts and commissions, and the Company recorded a gain of approximately $188 million, which is included in Other income (expense), net in the accompanying consolidated statement of operations. Following this transaction, America Online continues to hold 5,081,893 shares of Google’s Class B Common Stock. Transfers of these shares are subject to applicable securities laws requiring that sales be made either pursuant to a registration statement or under exemptions from registration.

      The Company does not consider its remaining interest in Google to be a strategic investment. As of December 31, 2004, the shares are recorded on the Company’s consolidated balance sheet (classified as available-for-sale securities) at their fair value of approximately $980 million. There is a corresponding unrealized gain of approximately $579 million, net of deferred taxes of approximately $386 million, reflected in shareholders’ equity. The fair value of the investment is calculated based on Google’s stock price ($192.79 at December 31, 2004) times the number of Google shares owned by the Company.

 
Acquisition of Advertising.com

      On August 2, 2004, America Online completed the acquisition of Advertising.com, Inc. for $445 million (net of cash acquired). Advertising.com purchases online advertising inventory from third-party websites and principally sells this inventory using performance-based advertising arrangements. From the time it was acquired through December 31, 2004, Advertising.com contributed Advertising revenues of $97 million from sales of advertising run on third-party websites.

 
Sale of Investment in Gateway

      At December 31, 2003, AOL owned both preferred and common stock in Gateway, Inc. (“Gateway”). Specifically, AOL owned Gateway Series A and Series C preferred stock and 2.7 million shares of Gateway common stock (collectively, the “Gateway Securities”). The Series A preferred stock was subject to automatic conversion into approximately 22.2 million shares of Gateway common stock in December 2004. The Series C preferred stock was also redeemable, at AOL’s option, in December 2004 for $200 million. Gateway had the option to pay the $200 million redemption price in cash, Gateway common stock (based on the average price of Gateway’s common stock during a pricing period prior to the redemption date) or a combination thereof. AOL’s ability to resell the Gateway Securities was limited by both contractual restrictions and applicable securities laws and regulations.

      On December 22, 2004, AOL sold to Gateway all of the Gateway Securities for total consideration of approximately $316 million, consisting of approximately $280 million in cash and the offset of approximately $36 million of amounts owed to Gateway by AOL under certain existing customer acquisition agreements. The $316 million purchase price was based on a negotiated discount to Gateway’s closing stock price of $5.54 on October 18, 2004 (the agreed reference date in the definitive transaction documents), which, after considering the aggregate impairment losses recognized by the Company on its investment in Gateway, resulted in the recognition of a net gain on the sale of approximately $44 million, which is included in Other income (expense), net in the accompanying consolidated statement of operations. AOL has recognized marketing expense in respect of the amounts offset under the customer acquisition agreements with Gateway. Concurrently with the agreement to sell the Gateway Securities, AOL and Gateway agreed to settle existing commercial disputes, resulting in AOL separately paying Gateway approximately $3 million in cash.

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MANAGEMENT’S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION — (Continued)
 
Urban Cable Works of Philadelphia, L.P.

      Urban Cable Works of Philadelphia, L.P. (“Urban Cable”) is an unconsolidated joint venture of TWC Inc., with approximately 50,000 basic subscribers at December 31, 2004, that operates cable television systems in Philadelphia, Pennsylvania. Urban Cable is 40% owned by TWC Inc. and 60% owned by an investment group led by Inner City Broadcasting (“Inner City”). Under a management agreement, TWC Inc. is responsible for the day-to-day management of Urban Cable. During 2004, TWC Inc. and Inner City settled certain disputes regarding the joint venture for $34 million in cash.

      TWC Inc. has also agreed to purchase, subject to receipt of applicable regulatory approvals, all of Inner City’s interests in the Urban Cable venture for approximately $53 million in cash. In addition, upon closing, TWC Inc. will eliminate in consolidation $67 million of debt and interest owed to it by Urban Cable and will assume $53 million of Urban Cable’s third-party debt. On March 3, 2005, the City Council of Philadelphia denied TWC Inc.’s request for approval of this transaction. TWC Inc. believes the denial was invalid, but is unable to predict when the transaction may be completed. For the year ended December 31, 2004, Urban Cable’s revenues and Operating Income were $47 million and $3 million, respectively.

 
Sale of VIVA Media AG and VIVA Plus

      In August 2004, Turner completed the previously announced sale of its 30.6% ownership stake in VIVA Media AG (“VIVA”) and its 49% stake in VIVA Plus to Viacom Inc. for approximately 109 million Euros (approximately $134 million). VIVA primarily owns a music television channel in Germany and also operates a portfolio of music channels in other European countries, as well as Brainpool TV GmbH, a major independent television producer in Germany. VIVA Plus is a smaller music television channel that operates in Germany. The Company accounted for these assets as equity investments prior to the sale. The Company recorded a gain from the sale of approximately $113 million as a component of Other income (expense), net, in the accompanying 2004 consolidated statement of operations.

 
Consolidation of Warner Village Cinemas S.P.A.

      Warner Village Cinemas S.P.A. (“Warner Village”) is a joint-venture arrangement that operates cinemas in Italy. Prior to December 2004, this entity was owned 45% by Warner Bros., 45% by Village Cinemas International Pty. Ltd. (“Village Cinemas”) and 10% by a third-party investor. The 10% owner was bought out by Warner Bros. and Village Cinemas in December 2004. As previously announced, in April 2004, Warner Bros. and Village Cinemas agreed that: (i) Warner Bros. would control the voting rights associated with Village Cinemas’ interest and (ii) beginning in March 2007 and continuing for one year, Village Cinemas can require that both Warner Bros. and Village Cinemas place their collective interests for sale and, to the extent that a bona fide offer is received, can require Warner Bros. to acquire the Village Cinemas interest at that value in the event that Warner Bros. elects not to proceed with such sale. If such right is not exercised by Village Cinemas, the voting rights associated with its interest will revert to Village Cinemas in March 2008.

      As a result of controlling Village Cinemas’ voting interest, Warner Bros. began consolidating the results of Warner Village in the second quarter of 2004. As permitted by U.S. generally accepted accounting principles, Warner Village results have been consolidated retroactive to the beginning of the year. For the year ended December 31, 2004, Warner Village revenues were $101 million and its Operating Income was $3 million.

 
Discontinued Operations Presentation of Music Segment

      On March 1, 2004, the Company completed the sale of the Warner Music Group’s (“WMG”) recorded music and music publishing operations to a private investment group for approximately $2.6 billion in cash and an option to re-acquire a minority interest in the operations sold. In addition, on October  24, 2003, the Company completed the sale of WMG’s CD and DVD manufacturing, printing, packaging and physical

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

distribution operations (“Warner Manufacturing”) to Cinram International Inc. for approximately $1.05 billion in cash (Note 4).

      With the completion of these transactions, the Company disposed of its entire Music segment. Accordingly, the Company has presented the financial condition and results of operations of the Music segment as discontinued operations for all periods presented.

 
Sale of the Winter Sports Teams

      On March 31, 2004, the Company completed the sale of the Turner winter sports teams (the Atlanta Thrashers, an NHL team, and the Atlanta Hawks, an NBA team) and the entity holding the operating rights to Philips Arena, an Atlanta sports and entertainment venue, to Atlanta Spirit LLC (“Atlanta Spirit”). In addition to the $219 million of impairment charges recognized in 2003, the Company recorded an approximate $7 million loss on the closing of the sale in the first quarter of 2004. As of December 31, 2004, Turner owns an approximate 10% interest in Atlanta Spirit and accounts for its interest in the limited liability company under the equity method of accounting.

RESULTS OF OPERATIONS

Transactions and Accounting Principles Affecting Comparability of Results of Operations

      The comparability of the Company’s results of operations, financial position and cash flows has been affected by certain new accounting principles adopted by the Company and certain significant transactions occurring during each period, as discussed further below.

 
New Accounting Principles To Be Adopted
 
Stock-Based Compensation

      In December 2004, the Financial Accounting Standards Board (“FASB”) issued FASB Statement 123 (Revised), “Share-Based Payment” (“FAS 123R”). FAS 123R requires all companies to measure compensation costs for all share-based payments (including employee stock options) at fair value and recognize such costs in the statement of operations. FAS 123R is effective for public companies for periods beginning after June 15, 2005. The Company will continue to account for stock-based compensation using the intrinsic value method set forth in Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”) until adoption of FAS 123R on July 1, 2005. In accordance with APB 25 and related interpretations, compensation expense for stock options is generally recognized in income based on the excess, if any, of the quoted market price of the stock at the grant date of the award or other measurement date over the amount an employee must pay to acquire the stock. The compensation costs related to stock options recognized by the Company pursuant to APB 25 were minimal. As a result, the application of the provisions of FAS 123R will have a significant impact on Operating Income before Depreciation and Amortization, Operating Income, net income and earnings per share. See Note 1 for the pro forma impact if compensation costs for the Company’s stock option plans had been determined based on the fair value method set forth in FAS 123.

 
Recently Adopted New Accounting Principles
 
Consolidation of Variable Interest Entities

      Pursuant to the provisions of FASB Interpretation No. 46, “Consolidation of Variable Interest Entities — an Interpretation of ARB No. 51,” (as revised, “FIN 46R”), the Company began consolidating the operations of America Online Latin America, Inc. (“AOLA”) as of March 31, 2004. AOLA is a publicly traded entity whose significant shareholders include the Company, AOL, the Cisneros Group (a private investment

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

company) and Banco Itau (a leading Brazilian bank). AOLA provides online services principally to customers in Brazil, Mexico, Puerto Rico and Argentina. The Company has no obligation to provide additional funding for AOLA’s operations, and the creditors of AOLA have no recourse to the Company.

      In accordance with the transition provisions of FIN 46R, the assets and liabilities of AOLA were recorded in the Company’s consolidated balance sheet as of March 31, 2004, in the amounts at which they would have been carried if FIN 46R had been effective when the Company first met the conditions to be considered the primary beneficiary of AOLA. Upon consolidating the balance sheet of AOLA, the Company recorded incremental assets of approximately $85 million and liabilities of $29 million, with the difference of $56 million recognized as the pretax cumulative effect of an accounting change ($34 million on an after-tax basis). Prior periods have not been restated. The Company consolidated the operating results of AOLA’s operations commencing April 1, 2004. In order to provide the time necessary to consolidate and evaluate the AOLA financial information, the AOLA financial statements are consolidated by the Company on a one-quarter time lag. For the year ended December 31, 2004, the Company recognized revenues of $40 million and an Operating Loss of $20 million associated with AOLA.

 
Significant Transactions and Other Items Affecting Comparability

      As more fully described herein and in the related footnotes to the accompanying consolidated financial statements, the comparability of Time Warner’s results from continuing operations has been affected by certain significant transactions and other items in each period as follows:

                         
Year Ended December 31,

2004 2003 2002



(restated)
(millions)
Merger and restructuring costs
  $ (50 )   $ (109 )   $ (327 )
Legal reserves related to government investigations
    (510 )            
Asset impairments
    (10 )     (318 )     (42,511 )
Net gain on disposal of assets
    21       14       6  
     
     
     
 
Impact on Operating Income
    (549 )     (413 )     (42,832 )
Microsoft Settlement
          760        
Investment gains
    453       797       124  
Gain on WMG option
    50              
Loss on investments, net
    (29 )     (204 )     (2,199 )
     
     
     
 
Impact on other income (expense), net
    474       1,353       (2,075 )
     
     
     
 
Pretax impact
    (75 )     940       (44,907 )
Income tax impact
    (82 )     (394 )     958  
     
     
     
 
After-tax impact
  $ (157 )   $ 546     $ (43,949 )
     
     
     
 
 
Merger and Restructuring Costs

      Merger and restructuring costs consist of charges related to mergers, employee terminations and exit activities. During the year ended December 31, 2004, the Company incurred restructuring costs at AOL related to various employee terminations of $55 million, which were partially offset by a $5 million reduction in restructuring costs, reflecting changes in estimates of previously established restructuring accruals. During the year ended December 31, 2003, the Company incurred restructuring costs related to various employee and contractual lease terminations of $109 million, including $52 million at AOL, $15 million at Cable,

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

$21 million at Networks and $21 million at Publishing. During the year ended December 31, 2002, the Company incurred restructuring costs of $327 million, including $266 million at AOL, $15 million at Cable and $46 million at Corporate. These costs are included in Merger and restructuring costs in the accompanying consolidated statement of operations and are discussed in more detail in Note 3 to the accompanying consolidated financial statements.

 
Legal Reserves Related to the Government Investigations

      As previously discussed, during 2004, the Company (a) incurred a $210 million charge in connection with the definitive agreement with the DOJ that resolves the DOJ’s investigation of the Company and (b) established a $300 million reserve in connection with the proposed settlement with the SEC, which the SEC staff will request be used for a Fair Fund, as authorized under the Sarbanes-Oxley Act. The $210 million DOJ settlement amount consists of a $60 million penalty to the DOJ and the establishment of a $150 million fund that the Company may use to settle any related shareholder or securities litigation.

 
Asset Impairments

      During 2004, the Company recognized a $10 million impairment charge related to a building at the AOL segment that is held for sale. During 2003, the Company’s results included $318 million of noncash impairment charges, including $219 million related to intangible assets of the winter sports teams at the Networks segment and $99 million at the Publishing segment related to goodwill and intangible assets of the Time Warner Book Group. These impairment amounts are included in Operating income (loss) in the accompanying consolidated statement of operations (Note 2).

      In the fourth quarter of each year, the Company performs its annual impairment review for goodwill and intangible assets. The 2004 and 2003 annual impairment reviews for goodwill and intangible assets did not result in any impairment charges being recorded. The 2002 annual impairment review resulted in a noncash charge of $42.511 billion, which was recorded as a component of Operating income (loss) in the accompanying consolidated statement of operations. The $42.511 billion included charges to reduce the carrying value of goodwill at the AOL segment ($31.961 billion) and the Cable segment ($10.550 billion) (Note 2).

 
Net Gain on Disposal of Assets

      For the year ended December 31, 2004, the Company recognized a $13 million gain related to the sale of AOL Japan and a $7 million gain related to the sale of Netscape Security Solutions at the AOL segment, an $8 million gain at the Publishing segment related to the sale of a building and an approximate $7 million loss (after taking into consideration the $219 million of impairment charges described above) on the closing of the sale of the winter sports teams at the Networks segment. These amounts are reflected as components of Operating income (loss) in the accompanying consolidated statement of operations.

      During the year ended December 31, 2003, the Company recognized a $43 million gain on the sale of its interest in U.K. cinemas, which previously had been consolidated by the Filmed Entertainment segment, partially offset by a loss of $29 million on the sale of Time Life at the Publishing segment. During the year ended December 31, 2002, the Company recognized a $6 million gain on the sale of certain consolidated cable television systems at TWE. These gains are included in Operating income (loss) in the accompanying consolidated statement of operations.

 
Microsoft Settlement

      As more fully described in Note 8 to the consolidated financial statements, in the second quarter of 2003 the Company recognized a gain of approximately $760 million as a result of the settlement with Microsoft

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

Corporation of then-pending litigation between Microsoft and Netscape Communications Corporation (the “Microsoft Settlement”). The gain is included in Other income (expense), net, in the accompanying 2003 consolidated statement of operations.

 
Investment Gains

      For the year ended December 31, 2004, the Company recognized $453 million of gains from the sale of investments, including a $188 million gain related to the sale of a portion of the Company’s interest in Google, a $113 million gain related to the sale of the Company’s interest in VIVA and VIVA Plus and a $44 million gain on the sale of the Company’s interest in Gateway (Note 7).

      For the year ended December 31, 2003, the Company recognized $797 million of gains from the sale of investments, including a $513 million gain from the sale of the Company’s interest in Comedy Central, a $52 million gain from the sale of the Company’s interest in chinadotcom, a $50 million gain from the sale of the Company’s interest in Hughes Electronics Corp. (“Hughes”) and gains of $66 million on the sale of the Company’s equity interests in international cinemas not previously consolidated (Note 7).

      For the year ended December 31, 2002, the Company recognized investment gains of $124 million, including a $59 million gain from the sale of a portion of the Company’s interest in The Columbia House Company Partnerships and a $31 million gain on the redemption of approximately 1.6 million shares of preferred stock of TiVo Inc. (Note 7).

      These gains are included as a component of Other income (expense), net, in the accompanying consolidated statement of operations.

 
Gain on WMG Option

      For the year ended December 31, 2004, the Company recorded a $50 million fair value adjustment related to the Company’s option in WMG (Note 4). This gain is included as a component of Other income (expense), net in the accompanying consolidated statement of operations.

 
Loss on Investments, Net

      For the year ended December 31, 2004, noncash charges to reflect other-than-temporary declines in the Company’s investments were $29 million. These amounts consisted of $15 million to reduce the carrying value of certain investments that experienced other-than-temporary declines in market value and $14 million of losses related to market fluctuations in equity derivative instruments.

      For the year ended December 31, 2003, noncash charges to reflect other-than-temporary declines in the Company’s investments were $204 million. These amounts consisted of $212 million to reduce the carrying value of certain investments that experienced other-than-temporary declines in market value, offset in part by $8 million of gains related to market fluctuations in equity derivative instruments. Included in the 2003 charges were a writedown of $77 million related to the Company’s equity interest in AOL Japan and a $71 million writedown related to the Company’s equity interest in n-tv KG (“NTV-Germany”), a German news broadcaster (Note 7).

      For the year ended December 31, 2002, noncash charges to reflect other-than-temporary declines in the Company’s investments were $2.199 billion. These amounts consisted of $2.212 billion to reduce the carrying value of certain investments that experienced other-than-temporary declines in market value, offset in part by $13 million of gains related to market fluctuations in equity derivative instruments. Included in the $2.212 billion charge relating to other-than-temporary declines in value were noncash charges to reduce the carrying value of the Company’s investments in Time Warner Telecom Inc. (“Time Warner Telecom”) by

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OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION — (Continued)

$796 million, Hughes by $505 million, Gateway by $140 million, AOLA by $131 million and certain unconsolidated cable television system joint ventures by $420 million (Note 7).

      These writedowns are included as a component of Other income (expense), net in the accompanying consolidated statement of operations.

2004 vs. 2003

Consolidated Results

      Revenues. Consolidated revenues increased 6% to $42.089 billion in 2004 from $39.563 billion in 2003. As shown below, these increases were led by growth in Subscription, Advertising and Content revenues, offset, in part, by declines in Other revenues:

                         
Year Ended December 31,

2004 2003 % Change



(restated)
(millions)
Subscription
  $ 21,605     $ 20,448       6 %
Advertising
    6,955       6,180       13 %
Content
    12,350       11,446       8 %
Other
    1,179       1,489       (21 )%
     
     
         
Total revenues
  $ 42,089     $ 39,563       6 %
     
     
         

      The increase in Subscription revenues primarily related to the Cable and Networks segments, and, to a lesser extent, the Publishing segment. This increase was offset partially by a decline at AOL. The increase at Cable was principally due to the continued penetration of new services (primarily high-speed data and advanced digital video services) and video rate increases. The increase at the Networks segment was due to higher subscription rates and an increase in the number of subscribers at both Turner and HBO. The increase at the Publishing segment was due to a decrease in subscription allowances (which are netted against revenue) and the favorable effects of foreign currency exchange rates. The AOL segment declined primarily as a result of lower domestic subscribers and related Subscription revenues, partially offset by growth in international subscription revenues due primarily to the favorable effects of foreign currency exchange rates.

      The increase in Advertising revenues was primarily due to growth at the Publishing, Networks and AOL segments. The increase at the Publishing segment was due to the strength of magazine advertising and the favorable effects of foreign currency exchange rates. The increase at the Networks segment was driven by higher CPMs (advertising cost per one thousand viewers) and sellouts at Turner’s entertainment networks. The increase at AOL was due primarily to growth in paid-search advertising and revenues associated with the acquisition of Advertising.com.

      The increase in Content revenues was principally due to growth at the Filmed Entertainment segment related to both television and theatrical product. The increase in television product revenues was attributable to an increase in worldwide license fees and an increase in home video sales. Revenue from theatrical product increased primarily as a result of higher television license fees and, to a lesser extent, higher home video sales and worldwide theatrical film revenues.

      The decline in Other revenues was primarily attributable to the December 31, 2003 sale of Time Life, a direct-marketing business formerly a part of the Publishing segment. Time Life contributed $312 million to Other revenues in 2003.

      Each of the revenue categories is discussed in greater detail by segment in the “Business Segment Results.”

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

      Costs of Revenues. For 2004 and 2003, costs of revenues totaled $24.449 billion and $23.422 billion, respectively, and as a percentage of revenues were 58% and 59%, respectively. The improvement in costs of revenues as a percentage of revenues related primarily to improved margins at the AOL, Networks and Filmed Entertainment segments, as discussed in detail in “Business Segment Results.”

      Selling, General and Administrative Expenses. Selling, general and administrative expenses increased 5% to $10.300 billion in 2004 from $9.834 billion in 2003 primarily reflecting increases at all segments, including higher advertising and marketing expenses. The segment variations are discussed in detail in “Business Segment Results.”

 
Reconciliation of Operating Income before Depreciation and Amortization to Operating Income and Net Income.

      The following table reconciles Operating Income before Depreciation and Amortization to Operating Income. In addition, the table provides the components from Operating Income to Net Income for purposes of the discussions that follow:

                         
Year Ended December 31,

2004 2003 % Change



(restated)
(millions)
Operating Income before Depreciation and Amortization
  $ 9,372     $ 8,393       12 %
Depreciation
    (2,581 )     (2,499 )     3 %
Amortization
    (626 )     (640 )     (2 )%
     
     
         
Operating Income
    6,165       5,254       17 %
Interest expense, net
    (1,533 )     (1,734 )     (12 )%
Other income, net
    521       1,210       (57 )%
Minority interest expense, net
    (246 )     (214 )     15 %
     
     
         
Income before income taxes, discontinued operations and cumulative effect of accounting change
    4,907       4,516       9 %
Income tax provision
    (1,698 )     (1,370 )     24 %
     
     
         
Income before discontinued operations and cumulative effect of accounting change
    3,209       3,146       2 %
Discontinued operations, net of tax
    121       (495 )     NM  
Cumulative effect of accounting change, net of tax
    34       (12 )     NM  
     
     
         
Net income
  $ 3,364     $ 2,639       27 %
     
     
         

      Operating Income before Depreciation and Amortization. Time Warner’s Operating Income before Depreciation and Amortization increased 12% to $9.372 billion in 2004 from $8.393 billion in 2003 principally as a result of solid growth at all business segments, partially offset by increased expenses at Corporate. The segment variations are discussed in detail under “Business Segment Results.”

      Corporate Operating Loss before Depreciation and Amortization. Time Warner’s Corporate Operating Loss before Depreciation and Amortization was $1.020 billion for 2004 compared to $424 million for 2003.

      As previously discussed, during 2004 the Company (a) incurred a $210 million charge in connection with the definitive agreement with the DOJ that resolves the DOJ’s investigation of the Company and (b) established a $300 million reserve in connection with the proposed settlement with the SEC, which the SEC staff will request be used for a Fair Fund, as authorized under the Sarbanes-Oxley Act. The $210 million

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

DOJ settlement amount consists of a $60 million penalty paid to the DOJ and the establishment of a $150 million fund that the Company may use to settle any related shareholder or securities litigation.

      Also included in Corporate Operating Loss before Depreciation and Amortization are legal and other professional fees related to the SEC and DOJ investigations into the Company’s accounting and disclosure practices and the defense of various shareholder lawsuits ($26 million and $56 million in 2004 and 2003, respectively). It is not yet possible to predict the outcome of these lawsuits, and costs are expected to continue to be incurred in future periods.

      Included in the 2004 amounts are $53 million of costs associated with the relocation from the Company’s former corporate headquarters. Of the $53 million charge, approximately $26 million relates to a noncash write-off of the fair value lease adjustment, which was established in purchase accounting at the time of the merger of America Online and Time Warner Inc., now known as Historic TW Inc. (“Historic TW”).

      Excluding the items previously discussed, Corporate Operating Loss before Depreciation and Amortization increased primarily as a result of higher severance costs and insurance premiums and a $29 million adjustment to increase self insurance liabilities, partially related to prior periods.

      Depreciation Expense. Depreciation expense increased to $2.581 billion in 2004 from $2.499 billion in 2003. The increase in depreciation primarily related to the Cable segment and, to a lesser extent, growth at all other segments except AOL. The growth in depreciation expense at Cable reflects higher levels of spending related to the roll-out of digital services and increased spending on customer premise equipment that is depreciated over a significantly shorter useful life compared to the mix of assets previously purchased. In 2004 and 2003, AOL benefited from an approximate $13 million and $60 million decrease, respectively, to reduce excess depreciation inadvertently recorded at AOL over several prior years. Management does not believe that the understatement of prior years results were material to any of the applicable year’s financial statements. Similarly, management does not believe that the adjustments made are material to either the 2004 or 2003 results. Excluding these decreases, depreciation expense at the AOL segment declined due to a reduction in network assets.

      Amortization Expense. Amortization expense decreased to $626 million in 2004 from $640 million in 2003. The decrease relates primarily to a decline in amortization at the Publishing segment as a result of certain intangibles with short useful lives, such as customer lists, becoming fully amortized, partially offset by an increase in the amortization associated with customer-related intangible assets at the Cable segment, which were established with the purchase price allocation associated with the TWE Restructuring. The purchase price allocation was finalized on March 31, 2004.

      Operating Income. Time Warner’s Operating Income increased to $6.165 billion in 2004 from $5.254 billion in 2003, reflecting the changes in business segment Operating Income before Depreciation and Amortization, partially offset by the increase in depreciation expense, as discussed above.

      Interest Expense, Net. Interest expense, net, decreased to $1.533 billion in 2004 from $1.734 billion in 2003 due primarily to lower average net debt levels.

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

      Other Income, Net. Other income, net, detail is shown in the table below:

                 
Year Ended
December 31,

2004 2003


(millions)
Investment gains
  $ 453     $ 797  
Gain on WMG option
    50        
Loss on investments
    (29 )     (204 )
Microsoft Settlement
          760  
Income (losses) from equity investees
    35       (97 )
Other
    12       (46 )
     
     
 
Other income, net
  $ 521     $ 1,210  
     
     
 

      The Microsoft Settlement, changes in investment gains, the gain on the WMG option and the declines in the losses on writedown of investments are discussed above in detail under “Significant Transactions and Other Items Affecting Comparability.” Excluding the impact of these items, Other income, net, improved in 2004 as compared to the prior year, primarily from an increase in income from equity method investees. This increase was principally due to the impact from the consolidation of AOLA in 2004. Prior to the consolidation in 2003, AOLA losses were recognized as losses from equity investees.

      Minority Interest Expense. Time Warner had $246 million of minority interest expense in 2004 compared to $214 million in 2003. The increase relates primarily to larger profits recorded by TWC Inc., in which Comcast has a minority interest.

      Income Tax Provision. Income tax expense from continuing operations was $1.698 billion in 2004, compared to $1.370 billion in 2003. The Company’s effective tax rate for continuing operations was 35% and 30% in 2004 and 2003, respectively. The increase in the effective tax rate results primarily from a decrease in tax benefits realized on capital losses (from $450 million to $110 million) and the impact of legal reserves recognized in 2004 related to the government investigations (as discussed under “Significant Transactions and Other Items Affecting Comparability”), most of which ultimately may not be deductible for income tax purposes. The increase in the effective tax rate was partially offset by the release of certain tax reserves and related interest which includes amounts recognized from the finalization of prior tax filings as well as additional benefits associated with certain foreign source income.

      U.S. federal tax attribute carryforwards at December 31, 2004, consist primarily of $6.9 billion of net operating losses, $607 million of capital losses and $166 million of alternative minimum tax credits. The utilization of these carryforwards as an available offset to future taxable income is subject to limitations under U.S. federal income tax laws. If the net operating losses are not utilized, they expire in varying amounts, starting in 2018 and continuing through 2021. The capital losses expire in 2008 and the alternative minimum tax credits do not expire (Note 11).

      Income before Discontinued Operations and Cumulative Effect of Accounting Change. Income before discontinued operations and cumulative effect of accounting change was $3.209 billion in 2004 compared to $3.146 billion in 2003. Basic and diluted net income per share before discontinued operations and cumulative effect of accounting change were $0.70 and $0.68, respectively, in 2004 compared to $0.70 and $0.68 in 2003, respectively. In addition, excluding the items previously discussed under “Significant Transactions and Other Items Affecting Comparability” of $157 million of expense and $546 million of income in 2004 and 2003, respectively, income before discontinued operations and cumulative effect of accounting change increased by $766 million. This increase reflects primarily the after-tax effect of the increase in Operating Income and lower interest expense.

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

      Discontinued Operations, Net of Tax. The 2004 and 2003 results include the impact of the treatment of the Music segment as a discontinued operation. Included in the 2004 results are a pretax loss of $2 million and a related tax benefit of $123 million. The loss and the corresponding taxes relate primarily to adjustments to the initial estimates of the assets sold to, and liabilities assumed by, the acquirers in such transactions and to the resolution of various tax matters surrounding the music business dispositions.

      Included in the 2003 results are a pretax gain of approximately $560 million for the sale of Warner Manufacturing, a $1.1 billion pretax impairment charge taken to reduce the carrying value of the net assets of WMG, a $27 million pretax loss from the music operations and $72 million of income tax benefits.

      Cumulative Effect of Accounting Change, Net of Tax. As previously discussed, the Company recorded an approximate $34 million benefit, net of tax, as a cumulative effect of accounting change upon the consolidation of AOLA in 2004 in accordance with FIN 46R. In addition, during 2003 the Company recorded an approximate $12 million charge, net of tax, as the cumulative effect of the adoption of FIN 46.

      Net Income and Net Income Per Common Share. Net income was $3.364 billion in 2004 compared to $2.639 billion in 2003. Basic and diluted net income per common share were $0.74 and $0.72 in 2004 compared to $0.59 and $0.57 in 2003, respectively. Net income includes the items discussed above under “Significant Transactions and Other Items Affecting Comparability,” discontinued operations, net of tax, and cumulative effect of accounting change.

Business Segment Results

      AOL. Revenues, Operating Income before Depreciation and Amortization and Operating Income of the AOL segment for the years ended December 31, 2004 and 2003 are as follows:

                           
Year Ended December 31,

2004 2003 % Change



(restated)
(millions)
Revenues:
                       
 
Subscription
  $ 7,477     $ 7,593       (2) %
 
Advertising
    1,005       785       28 %
 
Other
    210       220       (5) %
     
     
         
Total revenues
    8,692       8,598       1 %
Costs of revenues(a)
    (4,186 )     (4,499 )     (7) %
Selling, general and administrative(a)
    (2,694 )     (2,542 )     6 %
Gain on disposal of consolidated businesses
    20             NM  
Asset impairments
    (10 )           NM  
Restructuring charges
    (50 )     (52 )     (4) %
     
     
         
Operating Income before Depreciation and Amortization
    1,772       1,505       18 %
Depreciation
    (662 )     (668 )     (1) %
Amortization
    (176 )     (175 )     1 %
     
     
         
Operating Income
  $ 934     $ 662       41 %
     
     
         


(a)   Costs of revenues and selling, general and administrative expenses exclude depreciation.

    The reduction in Subscription revenues primarily reflects a decrease in domestic Subscription revenues (from $6.095 billion in 2003 to $5.725 billion in 2004), offset in part by an increase in Subscription revenues at

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

AOL Europe (from $1.498 billion in 2003 to $1.677 billion in 2004). AOL’s domestic Subscription revenues declined due primarily to a decrease in the number of domestic AOL brand subscribers and related revenues, partially offset by an increase in premium service revenue. AOL Europe’s Subscription revenues benefited from the favorable impact of foreign currency exchange rates ($156 million) and growth in bundled broadband subscribers. These increases more than offset an increase in value-added taxes (“VAT”) (which is netted against revenue) due to a change in European tax law that took effect July 1, 2003. In addition, total Subscription revenues benefited from the consolidation of AOLA effective March 31, 2004 ($37 million), and AOL Japan ($37 million), which was consolidated effective January 1, 2004, but then sold on July 1, 2004.

      Through September 30, 2004, AOL classified its domestic AOL brand subscribers as narrowband or broadband subscribers based on the price plan marketed by AOL and selected by subscribers. This price plan classification did not necessarily reflect a subscriber’s speed of connection (e.g., high-speed or dial-up), nor did this classification necessarily reflect a member’s usage pattern. In America Online’s restructuring in the fourth quarter of 2004, the broadband and narrowband access businesses were combined into one Access business. Because it determined that the classification between narrowband and broadband subscribers no longer provided as meaningful information in describing AOL’s subscriber base, AOL undertook a review of possible methods to provide subscriber information. As a result of this review, the discussion of subscribers has been updated to focus on the total AOL brand subscriber base, with additional information provided on subscribers with price plans above and below $15 per month. Information is also provided regarding the related average subscription revenue per subscriber (“ARPU”) for price plans above and below $15, which ARPU corresponds to the price plan and level of service selected by the customer.

      The number of AOL brand domestic and European subscribers is as follows at December 31, 2004, September 30, 2004 and December 31, 2003 (millions):

                             
December 31, September 30, December 31,
2004 2004 2003



Subscriber category:
                       
AOL brand domestic(1)
                       
 
$15 and over
    17.5       18.1       19.9  
 
Under $15
    4.7       4.6       4.4  
     
     
     
 
   
Total AOL brand domestic
    22.2       22.7       24.3  
     
     
     
 
AOL Europe
    6.3       6.3       6.4  
     
     
     
 


(1)  AOL includes in its subscriber count individuals, households or entities that have provided billing information and completed the registration process sufficiently to allow for an initial log-on to the AOL service.

    The ARPU for each significant category of subscribers, calculated as total subscription revenue for the category divided by the average subscribers in the category for the applicable year, is as follows:

                     
Year Ended December 31,

2004 2003


Subscriber category:
               
AOL brand domestic
               
 
$15 and over
  $ 20.97     $ 20.25  
 
Under $15
    13.07       12.11  
   
Total AOL brand domestic
    19.44       18.98  
AOL Europe
    21.48       19.03  

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

      Domestic subscribers to the AOL brand service include subscribers during introductory free-trial periods and subscribers at no or reduced monthly fees through member service and retention programs. Total AOL brand domestic subscribers include free-trial and retention members of approximately 13% at December 31, 2004 and 17% at December 31, 2003. Domestic subscribers to the AOL brand service also include subscriptions sold at a discount to employees and customers of selected America Online strategic partners. Domestic AOL brand subscribers also include subscribers to America Online’s bundled broadband service, which combines the AOL service with high-speed Internet access provided by third-party broadband Internet access providers such as cable companies and telephone companies. AOL did not actively market the bundled broadband service domestically during 2004.

      The largest component of the AOL brand domestic $15 and over price plans is the $23.90 price plan, which provides unlimited access to the AOL service using America Online’s dial-up network and unlimited usage of the AOL service through any other Internet connection. The largest component of the AOL brand domestic under $15 price plans is the $14.95 per month price plan, which is primarily marketed as a bring your own access (“BYOA”) plan, which includes unlimited usage of the AOL service through an Internet connection not provided by America Online, such as a high-speed broadband Internet connection via cable or DSL. This BYOA price plan also includes a limited number of hours per month of dial-up telephone access in the U.S. to the AOL service using America Online’s dial-up network. America Online continues to develop, test, change and implement price plans, service offerings and payment methods to attract and retain members to its AOL brand interactive service and, therefore, the composition of AOL’s subscriber base may change over time.

      The decline in AOL brand subscribers on plans priced $15 and over per month resulted from a number of factors, principally the continued maturing of dial-up services and subscribers adopting other dial-up and high-speed services, and a reduction in direct marketing response rates over the prior period. Further, during the year, subscribers migrated from the premium priced unlimited dial-up plans, including the $23.90 plan, to lower priced limited dial-up plans, such as the $14.95 plan. The decline in AOL brand subscribers overall and in the $15 and over per month price plans is expected to continue into the foreseeable future.

      Growth in AOL brand subscribers on plans below $15 per month was driven principally by the migration of subscribers from plans $15 and over per month, and to a lesser extent by new subscribers on the $14.95 BYOA plan. America Online believes that subscribers on plans priced below $15 per month will continue to grow sequentially and will grow as a percentage of total membership. Subscribers to the AOL/TWC Inc. bundled broadband offering will be included within the price plans below $15 per month category.

      Within the $15 and over per month category, the increase in ARPU over the prior year was due primarily to an increase in the percentage of total subscribers who generate revenue. Also contributing to the increase in ARPU was an increase in premium services revenues from subscribers in this category. Premium services revenues included in ARPU for the year ended December 31, 2004 and 2003 were $92 million and $37 million, respectively. ARPU was unfavorably impacted by the mix of subscriber price plans, as subscribers on bundled broadband plans became a smaller portion of the total membership in the $15 and over category.

      ARPU for subscribers in the below $15 per month category increased primarily due to growth in subscribers to the $14.95 price plan year over year, which resulted in a favorable impact as the portion of these subscribers grew in relation to the total membership in the below $15 per month category. Also contributing to the increase in ARPU was an increase in premium services revenues from subscribers in this category. In the below $15 per month category, premium services revenues included in ARPU for the years ended December 31, 2004 and 2003 were $24 million and $8 million, respectively.

      AOL Europe offers a variety of price plans, including bundled broadband, unlimited access to the AOL service using America Online’s dial-up network and limited access plans, which are generally billed based on actual usage. AOL Europe continues to actively market bundled broadband plans, as AOL Europe’s

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

subscribers have been migrating from dial-up plans to bundled broadband plans, and this trend is expected to continue.

      ARPU for AOL Europe for the first three quarters of 2004 has been revised to $21.72 from $22.06, $20.84 from $21.38, and $21.19 from $21.46 for the 2004 quarters ending March 31, June 30 and September 30, respectively, to exclude amounts of non-AOL brand revenues inadvertently included in the historical amounts. The ARPU for European subscribers increased primarily because of the positive effect of changes in foreign currency exchange rates related to the strengthening of the Euro and British Pound relative to the U.S. Dollar, as well as a change in the mix of price plans, with bundled broadband subscribers growing as a percentage of total subscribers. The total number of AOL brand subscribers reflects a year-over-year increase in subscribers in the U.K., offset by declines in France and Germany.

      In addition to the AOL brand service, the Company has subscribers to lower cost services, both domestically and internationally, including the Netscape and CompuServe brands. These other brand services are not a significant source of revenue.

      The increase in Advertising revenues primarily reflects an increase from domestic paid-search advertising contracts (from approximately $200 million in 2003 to $302 million in 2004), $97 million generated by Advertising.com from sales of advertising run on third-party websites and a $33 million increase at AOL Europe, including foreign exchange gains. These increases were partially offset by a decrease in intercompany sales of advertising to other business segments of Time Warner in 2004, as compared to 2003 (from $40 million in 2003 to $11 million in 2004). AOL expects Advertising revenues to continue to increase during 2005 due to expected growth in both traditional online and paid-search advertising, as well as Advertising.com’s performance-based advertising. Paid-search advertising revenues for AOL Europe are also expected to increase in 2005 as the result of a multi-year paid-search deal executed in the fourth quarter of 2004.

      Other revenues primarily include software licensing revenue, revenue from providing the Cable segment access to the AOL Transit Data Network for high-speed access to the Internet and merchandising revenue. Other revenues decreased due primarily to AOL’s decision in the first quarter of 2003 to reduce the promotion of its merchandise business (i.e., reducing pop-up advertisements) to improve the member experience, partially offset by higher software licensing revenues.

      Costs of revenues decreased 7% and, as a percentage of revenues, decreased to 48% in 2004 from 52% in 2003. The declines related primarily to lower network-related expenses, which decreased 27% to $1.777 billion in 2004 from $2.446 billion in 2003. The decline in network-related expenses was principally attributable to improved pricing and decreased levels of service commitments as well as increased amounts of network assets under capital leases (which are included within depreciation expense) versus operating leases. These factors are expected to result in continued declines in network expenses during 2005. These declines were partially offset by an increase in other costs of service, which included higher domestic salary and consulting costs as well as higher broadband and member service costs at AOL Europe. In addition, there were incremental costs associated with the acquisition of Advertising.com and the consolidation of AOLA and AOL Japan during 2004 (AOL Japan was subsequently sold, effective July 1, 2004).

      The increase in selling, general and administrative expenses is primarily related to an increase in marketing costs, additional costs resulting from the acquisition of Advertising.com and higher costs associated with the consolidation of AOLA and the consolidation of AOL Japan for the first half of 2004. The increase in marketing costs resulted from higher spending on member acquisition activities, partially offset by a decline in brand advertising. The increase in marketing expense was partially offset by an approximate $25 million adjustment to reduce excess marketing accruals made in prior years, primarily related to AOL Europe. Management does not believe that the understatement of prior years’ results was material to any of the years’ financial statements. Similarly, management does not believe that the adjustment made is material to the

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

current-year results. The overall increase in marketing costs was also partially offset by the change in the treatment of intercompany advertising barter transactions (refer to the 2003 versus 2002 AOL results below).

      As previously discussed under “Significant Transactions and Other Items Affecting Comparability,” 2004 results included a $55 million restructuring charge partially offset by a $5 million reversal of previously-established restructuring accruals, reflecting changes in estimates, a $13 million gain on the sale of AOL Japan, a $7 million gain on the sale of Netscape Security Solutions and a $10 million impairment charge related to a building that is held for sale. Included in 2003 results were $52 million of restructuring charges.

      The increases in Operating Income before Depreciation and Amortization and Operating Income are due primarily to a modest increase in overall revenues and lower costs of revenues, offset in part by higher selling, general and administrative expenses.

      AOL’s 2004 fourth-quarter results also reflect a benefit related to AOL’s reversal of a liability of approximately $56 million related to the November 2003 expiration of the federal moratorium on Internet sales taxes. This liability had previously been accrued during the period from November 2003 through September 30, 2004 (of which $47 million was accrued in 2004). In the fourth quarter of 2004, the U.S. government enacted the Internet Tax Nondiscrimination Act, which retroactively reinstated the federal moratorium on Internet sales taxes to November 2003 and extended the federal moratorium on Internet sales taxes through 2007. As a result of the retroactive application of the legislation, AOL was no longer subject to the sales tax exposure for which it had previously accrued.

      Cable. Revenues, Operating Income before Depreciation and Amortization and Operating Income of the Cable segment for the years ended December 31, 2004 and 2003 are as follows:

                           
Year Ended December 31,

2004 2003 % Change



(millions)
Revenues:
                       
 
Subscription
  $ 7,969     $ 7,233       10 %
 
Advertising
    515       466       11 %
     
     
         
Total revenues
    8,484       7,699       10 %
Costs of revenues(a)
    (3,723 )     (3,343 )     11 %
Selling, general and administrative(a)
    (1,483 )     (1,349 )     10 %
Restructuring charges
          (15 )     NM  
     
     
         
Operating Income before Depreciation and Amortization
    3,278       2,992       10 %
Depreciation
    (1,438 )     (1,403 )     2 %
Amortization
    (76 )     (58 )     31 %
     
     
         
Operating Income
  $ 1,764     $ 1,531       15 %
     
     
         


(a) Costs of revenues and selling, general and administrative expenses exclude depreciation.

    Subscription revenues increased due to the continued penetration of new services (primarily high-speed data and advanced digital video services) and video rate increases. High-speed data subscription revenues increased to $1.760 billion for 2004 from $1.422 billion in 2003. The Company anticipates that revenues in 2005 will be positively impacted by revenues associated with its high-speed data and Digital Phone services.

      Basic cable subscribers include all subscribers receiving cable service. Digital video subscribers reflect subscribers on any level of service received via digital technology. High-speed data subscribers include subscribers of TWC Inc.’s Road Runner Internet service, as well as other Internet services offered by TWC

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

Inc. At December 31, 2004, as compared to December 31, 2003, basic cable subscribers declined by 0.3% and totaled 10.884 million (including 1.569 million subscribers of unconsolidated investees, which are managed by TWC Inc.), digital video subscribers increased by 11% to 4.806 million (including 747,000 subscribers of unconsolidated investees, which are managed by TWC Inc.), residential high-speed data subscribers increased by 21% to 3.913 million (including 551,000 subscribers of unconsolidated investees, which are managed by TWC Inc.) and commercial high-speed data subscribers increased by 35% to 173,000 (including 22,000 subscribers of unconsolidated investees, which are managed by TWC Inc.). Digital Phone subscribers totaled 220,000 (including 38,000 subscribers of unconsolidated investees, which are managed by TWC Inc.).

      The increase in Advertising revenues was attributable to an increase in both the rates and volume of advertising spots sold.

      Costs of revenues increased 11% and, as a percentage of revenues, were 44% for 2004 compared to 43% for 2003. The increase in costs of revenues is primarily related to increases in video programming costs and higher employee costs. Video programming costs increased 12% to $1.865 billion in 2004 due primarily to contractual rate increases across TWC Inc.’s programming line-up (including sports programming). Video programming costs are expected to increase in 2005 at a rate in line with the rate of increase experienced during 2004, reflecting the expansion of service offerings and contractual rate increases across TWC Inc.’s programming line-up (including sports programming). Employee costs increased primarily due to merit increases and higher headcount resulting from the roll-out of new services. High-speed data connectivity costs were relatively flat resulting in a decline on a per subscriber basis.

      The increase in selling, general and administrative expenses is primarily the result of higher marketing costs and $34 million incurred in connection with the previously discussed Urban Cable dispute, which was settled in 2004. As a percentage of revenue, selling, general and administrative expenses were constant at approximately 17.5%.

      Operating Income before Depreciation and Amortization increased principally as a result of revenue gains, offset in part by higher costs of revenues and selling, general and administrative expenses. As previously discussed in “Significant Transactions and Other Items Affecting Comparability,” 2003 results also included $15 million of restructuring charges.

      Included in Operating Income before Depreciation and Amortization during 2004 are approximately $45 million of losses associated with the roll-out of the Digital Phone service. At December 31, 2004, Digital Phone service was launched in all of TWC Inc.’s divisions.

      Operating Income increased due primarily to the increase in Operating Income before Depreciation and Amortization described above, offset in part by an increase in depreciation and amortization expense. Depreciation expense increased $35 million due primarily to the increased investment in customer premise equipment in recent years, which generally has a significantly shorter useful life compared to the mix of assets previously purchased. Amortization expense increased $18 million, primarily as a result of a full year of amortization of customer-related intangibles in 2004 compared to nine months of amortization in 2003. These assets were established in connection with the TWE Restructuring.

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

      Filmed Entertainment. Revenues, Operating Income before Depreciation and Amortization and Operating Income of the Filmed Entertainment segment for the years ended December 31, 2004 and 2003 are as follows:

                           
Year Ended December 31,

2004 2003 % Change



(millions)
Revenues:
                       
 
Advertising
  $ 10     $ 6       67 %
 
Content
    11,628       10,800       8 %
 
Other
    215       161       34 %
     
     
         
Total revenues
    11,853       10,967       8 %
Costs of revenues(a)
    (8,941 )     (8,430 )     6 %
Selling, general and administrative(a)
    (1,438 )     (1,225 )     17 %
Gain on disposal of consolidated businesses
          43       NM  
     
     
         
Operating Income before Depreciation and Amortization
    1,474       1,355       9 %
Depreciation
    (104 )     (86 )     21 %
Amortization
    (213 )     (206 )     3 %
     
     
         
Operating Income
  $ 1,157     $ 1,063       9 %
     
     
         


(a) Costs of revenues and selling, general and administrative expenses exclude depreciation.

    Content revenues increased during 2004 primarily due to a $631 million and $175 million improvement in revenues from television and theatrical product, respectively. The increase in television product revenues was attributable to a $431 million increase in worldwide license fees and a $200 million increase in home video sales. Revenue from theatrical product included a $106 million increase in television license fees, a $43 million increase in home video sales and a $26 million increase in worldwide theatrical film revenues.

      The increase in worldwide license fees from television product was primarily attributable to the third-cycle syndication continuance license arrangements for Seinfeld, partially offset by reduced revenues stemming from the conclusion of Friends at the end of the 2003-2004 broadcast season. The growth in home video sales of television product was attributable to an increased number of titles released and now sold in this format, including such properties as Friends, Babylon 5 and Smallville.

      The increase in television license fees from theatrical product was due primarily to the network television availability of The Lord of the Rings: The Fellowship of the Ring to Turner and The WB Network and from the network television availability of Harry Potter and the Sorcerer’s Stone. Home video sales from theatrical product increased primarily due to a strong release slate at New Line, including The Lord of the Rings: The Return of the King, Elf, Freddy vs. Jason and The Texas Chainsaw Massacre. The increase in worldwide theatrical film revenues was attributable primarily to the international success of Harry Potter and the Prisoner of Azkaban, The Last Samurai and Troy and from international overages associated with The Lord of the Rings: The Return of the King. This increase was partially offset by a decline in domestic theatrical revenues primarily resulting from difficult comparisons at New Line to the prior year, which included The Lord of the Rings: The Return of the King and Elf.

      Other revenues increased primarily due to the consolidation of the results of Warner Village in 2004, as previously discussed, which contributed $95 million of Other revenues during 2004. The Company’s U.K. cinema interests, which were sold in the second quarter of 2003, contributed Other revenues of $51 million during 2003.

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

      The increase in costs of revenues resulted from higher film costs ($5.870 billion in 2004 compared to $5.358 billion in 2003), primarily resulting from the quantity and mix of product released and increased production of new episodic television series (new series are generally produced at a cost in excess of their network license fees, with such excess costs expensed as incurred). Included in film costs are theatrical valuation adjustments, which declined from $245 million in 2003 to $215 million in 2004. Marketing and distribution costs increased slightly due to the quantity and mix of films released during these years. Costs of revenues as a percentage of revenues decreased to 75% for 2004 from 77% for 2003.

      Selling, general and administrative expenses increased due to additional distribution fees associated with the off-network television syndication of Seinfeld, costs resulting from the consolidation of Warner Village in 2004, additional headcount and merit increases and increased rent expense, partially offset by a reduction in employee incentive compensation.

      As previously discussed in “Significant Transactions and Other Items Affecting Comparability,” the Company recorded a $43 million gain on the sale of its interest in U.K. cinemas, which previously had been consolidated, during the second quarter of 2003.

      Operating Income before Depreciation and Amortization and Operating Income increased due to an increase in revenues, which was partially offset by increases in costs of revenue, selling, general and administrative expenses and the absence of the gain on disposal of a consolidated business, as discussed above.

      The Company anticipates that both Operating Income before Depreciation and Amortization and Operating Income will decline in 2005 in comparison to 2004 due primarily to difficult comparisons to 2004 theatrical results, which included significant contributions from The Lord of the Rings: The Return of the King and Elf, and television results, which included the third-cycle syndication continuance license arrangements for Seinfeld.

      Networks. Revenues, Operating Income before Depreciation and Amortization and Operating Income of the Networks segment for the years ended December 31, 2004 and 2003 are as follows:

                           
Year Ended December 31,

2004 2003 % Change



(millions)
Revenues:
                       
 
Subscription
  $ 5,058     $ 4,588       10 %
 
Advertising
    2,895       2,675       8 %
 
Content
    973       981       (1 )%
 
Other
    128       190       (33 )%
     
     
         
Total revenues
    9,054       8,434       7 %
Costs of revenues(a)
    (4,600 )     (4,499 )     2 %
Selling, general and administrative(a)
    (1,753 )     (1,668 )     5 %
Impairment of intangible assets
          (219 )     NM  
Loss on sale of assets
    (7 )           NM  
Restructuring charges
          (21 )     NM  
     
     
         
Operating Income before Depreciation and Amortization
    2,694       2,027       33 %
Depreciation
    (212 )     (192 )     10 %
Amortization
    (21 )     (26 )     (19 )%
     
     
         
Operating Income
  $ 2,461     $ 1,809       36 %
     
     
         


(a) Costs of revenues and selling, general and administrative expenses exclude depreciation.

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

    The increase in Subscription revenues was due primarily to higher subscription rates and an increase in the number of subscribers at both Turner and HBO. In addition, 2004 and 2003 each include a benefit (approximately $50 million and $45 million, respectively) related to the favorable resolution of certain contractual agreements, which resulted in previously deferred revenue being recognized when the fees became fixed and determinable.

      The increase in Advertising revenues was driven primarily by higher CPMs and sellouts at Turner’s entertainment networks.

      The slight decrease in Content revenues was primarily due to the success of HBO’s first-quarter 2003 home video release of My Big Fat Greek Wedding and the absence of Content revenues from the winter sports teams after the first quarter of 2004, partially offset by higher 2004 ancillary sales of HBO’s original programming and higher license fees from Everybody Loves Raymond.

      Other revenues declined primarily due to the sale of the winter sports teams in the first quarter of 2004.

      Costs of revenues increased 2%. This increase was primarily due to an increase in programming costs, which grew to $3.225 billion for 2004 from $3.021 billion for 2003. The increase in programming costs is primarily due to higher costs for sports rights, network premieres, licensed series and original series at Turner, and higher theatrical film and original series costs at HBO. Costs of revenues for 2004 benefited from the sale of the winter sports teams in the first quarter of 2004 and a reduction in player payroll at the Atlanta Braves. Costs of revenues as a percentage of revenues were 51% and 53% in 2004 and 2003, respectively.

      The increase in selling, general and administrative expenses primarily related to higher marketing and promotion costs at Turner and higher general and administrative costs across the networks. These increases were partially offset by a $110 million decrease in bad debt expense that was primarily related to the first and second quarter 2004 reversals of approximately $75 million of bad debt reserves at Turner and HBO on receivables from Adelphia Communications Corporation (“Adelphia”), a major cable operator that declared bankruptcy in 2002, and higher second quarter 2003 bad debt charges incurred at Turner related to certain cable operators. During 2004, the Company sold a portion of its Adelphia receivables to a third-party investor and also collected a portion of its remaining receivables from Adelphia.

      As discussed in “Significant Transactions and Other Items Affecting Comparability,” the 2004 results include an approximate $7 million loss on the sale of the winter sports teams. The 2003 results include a $219 million impairment charge related to the writedown of intangible assets of the winter sports teams and $21 million of restructuring costs at Turner.

      Operating Income before Depreciation and Amortization and Operating Income improved during 2004 due to an increase in revenues and the absence of the 2003 impairment and restructuring charges, partially offset by increases in costs of revenues and selling, general and administrative expenses, as described above.

      The sale of the winter sports teams was completed on March 31, 2004. The winter sports teams contributed revenues of $66 million and an Operating Loss of $8 million during 2004. For 2003, the winter sports teams contributed approximately $160 million of revenues and an Operating Loss of $37 million.

      The Company anticipates that the rate of growth in both Operating Income before Depreciation and Amortization and Operating Income during 2005 will be lower than that experienced during 2004. The lower expected rate of growth is due partially to the absence of the benefit of the approximate $75 million reversal of bad debt reserves on receivables from Adelphia, the approximate $50 million benefit from the favorable resolution of certain contractual agreements in 2004 and the impacts of growth trends across 2003, 2004 and 2005 from the sale of the winter sports teams.

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

      Publishing. Revenues, Operating Income before Depreciation and Amortization and Operating Income of the Publishing segment for the years ended December 31, 2004 and 2003 are as follows:

                           
Year Ended December 31,

2004 2003 % Change



(millions)
Revenues:
                       
 
Subscription
  $ 1,615     $ 1,533       5 %
 
Advertising
    2,692       2,459       9 %
 
Content
    544       522       4 %
 
Other
    714       1,019       (30 )%
     
     
         
Total revenues
    5,565       5,533       1 %
Costs of revenues(a)
    (2,282 )     (2,288 )      
Selling, general and administrative(a)
    (2,095 )     (2,141 )     (2 )%
Impairment of goodwill and intangible assets
          (99 )     NM  
Gain (loss) on sale of assets
    8       (29 )     NM  
Merger and restructuring charges
          (21 )     NM  
     
     
         
Operating Income before Depreciation and Amortization
    1,196       955       25 %
Depreciation
    (122 )     (116 )     5 %
Amortization
    (140 )     (175 )     (20 )%
     
     
         
Operating Income
  $ 934     $ 664       41 %
     
     
         


(a) Costs of revenues and selling, general and administrative expenses exclude depreciation.

    Subscription revenues increased primarily due to a decrease in subscription allowances (which are netted against revenue), due in part to timing, and the favorable effects of foreign currency exchange rates.

      Advertising revenues benefited from strength in print advertising, including growth at Real Simple, Time, In Style, Sports Illustrated, Fortune and Entertainment Weekly, among others. The favorable effects of foreign currency exchange rates and new magazine launches also contributed to growth in Advertising revenues.

      Content revenues increased due to several strong titles at Time Warner Book Group. This increase was partially offset by the absence of revenues from Time Life, which was sold at the end of 2003. During 2003, Time Life contributed $40 million of Content revenues.

      Other revenues declined primarily due to the sale of Time Life at the end of 2003, which contributed $312 million of Other revenues during 2003.

      Costs of revenues for 2003 included $164 million of costs associated with Time Life. Excluding Time Life, costs of revenues increased 7% and, as a percentage of revenues, were 41% for both 2004 and 2003. Costs of revenues for the magazine publishing business include manufacturing (paper, printing and distribution) and editorial-related costs, which together increased 8% to $1.747 billion due primarily to growth in advertising page volume, magazine launch-related costs and the effects of foreign currency exchange rates.

      Selling, general and administrative expenses included $251 million of costs associated with Time Life during 2003. Excluding Time Life, selling, general and administrative expenses increased 11%, driven by higher advertising and marketing expense, due primarily to an increase in consumer promotion costs, incremental magazine launch-related costs and costs associated with the coverage and sponsorship of the 2004 Summer Olympics.

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

      As previously discussed in “Significant Transactions and Other Items Affecting Comparability,” 2004 results reflect an $8 million gain on the sale of a building and 2003 results include a $99 million impairment charge related to goodwill and intangible assets at the Time Warner Book Group, a $29 million loss on sale of Time Life and $21 million of restructuring costs.

      Excluding the 2004 first quarter gain on the sale of a building, the 2003 impairment charges of goodwill and intangible assets, the losses at Time Life, the loss on the sale of Time Life and restructuring charges in 2003, Operating Income before Depreciation and Amortization increased $21 million, and Operating Income increased $40 million, reflecting an increase in overall revenues, partially offset by higher costs of revenues and selling, general and administrative expenses, including $44 million of incremental start-up operating losses associated with the launch of new magazines. Operating Income also benefited from a decline in amortization as a result of certain short-lived intangibles, such as customer lists, becoming fully amortized.

2003 vs. 2002

Consolidated Results

      Revenues. Consolidated revenues increased 7% to $39.563 billion in 2003 from $37.060 billion in 2002. As shown below, these increases were led by growth in Subscription, Advertising and Content revenues, offset in part by a decline in Other revenues:

                         
Year Ended December 31,

2003 2002 % Change



(restated; millions)
Subscription
  $ 20,448     $ 18,959       8 %
Advertising
    6,180       6,045       2 %
Content
    11,446       10,216       12 %
Other
    1,489       1,840       (19 )%
     
     
         
Total revenues
  $ 39,563     $ 37,060       7 %
     
     
         

      The increase in Subscription revenues was driven principally by increases at the Cable segment due primarily to the continued deployment of new services and higher rates, at the AOL segment primarily related to the favorable changes in foreign currency exchange rates and increases in subscriber rates outside the U.S., at the Networks segment primarily driven by higher subscription rates at both Turner and HBO and an increase in the number of subscribers at Turner, and at the Publishing segment due to lower subscription agent commissions (which are netted against revenue) and the favorable effects of foreign currency translation.

      Advertising revenues increased due to growth at the Networks segment resulting from improved CPMs and ratings that benefited Turner’s domestic entertainment networks and The WB Network, partially offset by declines at the AOL segment, due principally to the decline in the current benefit from prior-period contract sales, and the Cable segment, due to a decrease in program vendor advertising.

      The increase in Content revenues related primarily to the Filmed Entertainment segment, due to the worldwide box office success of The Matrix and The Lord of the Rings franchises, higher worldwide DVD revenues and higher television network license fees, and at the Networks segment, due to HBO’s first quarter 2003 home video release of My Big Fat Greek Wedding and, to a lesser extent, higher ancillary sales of HBO programming and licensing and syndication revenue associated with Everybody Loves Raymond.

      The decline in Other revenues was due primarily to the AOL segment’s decision to reduce the promotion of its merchandise business (i.e., reducing pop-up advertisements) to improve the member experience. Other revenues were also reduced, due to the sale of the Company’s interest in the consolidated U.K. cinemas at the Filmed Entertainment segment in the second quarter of 2003.

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

      Each of the revenue categories is discussed in greater detail by segment in the “Business Segment Results” section below.

      Cost of Revenues. For the years ended December 31, 2003 and 2002, cost of revenues as a percentage of revenues was 59% and 60% in 2003 and 2002, respectively. Increases in the percentage at Cable (higher programming and depreciation costs) were offset by decreases at AOL (lower network costs) and Filmed Entertainment (overall higher-margin films in 2003).

      Selling, General and Administrative Expenses. Selling, general and administrative costs as a percentage of revenues increased from 24% for the year ended December 31, 2002 to 25% for the year ended December 31, 2003. These increases were driven primarily by AOL and Cable, which had higher personnel and marketing costs associated with the roll-out of new products and services.

 
Reconciliation of Operating Income (Loss) before Depreciation and Amortization to Operating Income and Net Income (Loss).

      The following table reconciles Operating Income (Loss) before Depreciation and Amortization to Operating Income (Loss). In addition, the table provides the components from Operating Income (Loss) to Net Income (Loss) for purposes of the discussions that follow:

                         
Year Ended December 31,

2003 2002 % Change



(restated; millions)
Operating Income (Loss) before Depreciation and Amortization
  $ 8,393     $ (34,651 )     NM  
Depreciation
    (2,499 )     (2,206 )     13 %
Amortization
    (640 )     (557 )     15 %
     
     
         
Operating Income (Loss)
    5,254       (37,414 )     NM  
Interest expense, net
    (1,734 )     (1,624 )     7 %
Other income (expense), net
    1,210       (2,341 )     NM  
Minority interest expense
    (214 )     (278 )     (23 )%
     
     
         
Income (loss) before income taxes, discontinued operations and cumulative effect of accounting change
    4,516       (41,657 )     NM  
Income tax provision
    (1,370 )     (313 )     338 %
     
     
         
Income (loss) before discontinued operations and cumulative effect of accounting change
    3,146       (41,970 )     NM  
Discontinued operations
    (495 )     (1,012 )     (51 )%
Cumulative effect of accounting change
    (12 )     (54,235 )     NM  
     
     
         
Net income (loss)
  $ 2,639     $ (97,217 )     NM  
     
     
         

      Operating Income (Loss) before Depreciation and Amortization. Operating Income (Loss) before Depreciation and Amortization improved to $8.393 billion in 2003 from a loss of $34.651 billion in 2002.

      Included in these results were several items affecting comparability, including impairments of goodwill and intangible assets, net gains on the disposition of consolidated businesses and restructuring costs, as discussed in “Significant Transactions and Other Items Affecting Comparability” above. Excluding these items from both periods, Operating Income (Loss) before Depreciation and Amortization in 2003 increased (from $8.181 billion to $8.806 billion) as a result of improvements at the Cable, Filmed Entertainment, Networks and AOL segments, offset in part by a decline at the Publishing segment. The segment results are

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

discussed below in detail in “Business Segment Results.” Also impacting Operating Income (Loss) before Depreciation and Amortization is an increase in the Corporate Operating Loss before Depreciation and Amortization.

      Corporate Operating Loss before Depreciation and Amortization. Time Warner’s Corporate Operating Loss before Depreciation and Amortization increased to $424 million in 2003 from $398 million in 2002. Included in these amounts are legal and other professional fees related to the SEC and DOJ investigations into the Company’s accounting and disclosure practices and the defense of various shareholder lawsuits ($56 million incurred in 2003 compared to $28 million in 2002). 2002 also included $46 million of restructuring charges, which primarily related to severance costs. In addition, 2003 includes higher compensation costs primarily related to incentive compensation plans.

      Depreciation Expense. Depreciation expense increased to $2.499 billion in 2003 from $2.206 billion in 2002, principally due to increases at the Cable and AOL segments. For Cable, as a result of an increase in the amount of capital spending on customer premise equipment in recent years, a larger portion of the Cable segment’s property, plant and equipment consisted of assets with shorter useful lives in 2003 than in 2002. Additionally, the Cable division completed the upgrades of its cable systems in mid-2002. Depreciation expense related to these shorter-lived assets, coupled with incremental depreciation expense on the upgraded cable systems, resulted in the increase in overall depreciation expense.

      For the AOL segment, the higher expense was due to an increase in network assets acquired under capital leases, offset by an approximate $60 million decrease in depreciation in the fourth quarter of 2003, to reduce excess depreciation inadvertently recorded at AOL over several years prior to 2003. This adjustment is reflected as a reduction of depreciation expense recorded in “selling, general and administrative” expenses (approximately $30 million) and “cost of revenues” (approximately $30 million) in the accompanying consolidated statement of operations. Management does not believe that the understatement of prior years’ results was material to any of the applicable year’s financial statements. Similarly, management does not believe that the adjustment made is material to the 2003 results.

      Amortization Expense. Amortization expense increased to $640 million in 2003 from $557 million in 2002. The increase relates principally to an increase in the carrying values and related amortization of film library assets at Filmed Entertainment and customer-related intangible assets at Cable as a result of the TWE Restructuring.

      Operating Income (Loss). Time Warner’s Operating Income (Loss) increased from a loss of $37.414 billion in 2002 to income of $5.254 billion in 2003. This reflects the increase in business segment Operating Income (Loss) before Depreciation and Amortization, partially offset by an increase in depreciation and amortization expense.

      Interest Expense, Net. Interest expense, net, increased to $1.734 billion in 2003 from $1.624 billion in 2002, due primarily to a change in the mix of debt from lower rate short-term floating rate debt to higher rate long-term fixed-rate debt, as well as lower interest income resulting from the conversion of Hughes preferred stock to common stock during 2002. This was offset in part by lower average rates in 2003 on floating rate debt.

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

      Other Income (Expense), Net. Other income (expense), net, detail is shown in the table below:

                 
Year Ended
December 31,

2003 2002


(restated)
(millions)
Investment gains
  $ 797     $ 124  
Loss on writedown of investments
    (204 )     (2,199 )
Microsoft Settlement
    760        
Losses from equity investees
    (97 )     (312 )
Other
    (46 )     46  
     
     
 
Other income (expense), net
  $ 1,210     $ (2,341 )
     
     
 

      The changes in investment gains, loss on writedown of investments and the Microsoft Settlement are discussed above in detail under “Significant Transactions and Other Items Affecting Comparability.” Excluding the impact of the items discussed above, Other income (expense), net, improved in 2003 as compared to the prior year, primarily from a reduction of losses from equity method investees.

      Minority Interest Expense. Time Warner had $214 million of minority interest expense in 2003 compared to $278 million in 2002. The decrease in minority interest expense was primarily related to the elimination of the minority interest in AOL Europe as a result of the Company’s purchase of the remaining preferred securities and payment of accrued dividends in April 2003.

      Income Tax Provision. The Company had income tax expense of $1.370 billion in 2003, compared to $313 million in 2002. The Company’s pretax income (loss) before discontinued operations and cumulative effect of accounting change was income of $4.516 billion in 2003, compared to a loss of $41.657 billion in 2002. Applying the 35% U.S. Federal statutory rate to pretax income (loss) would result in income tax expense of $1.581 billion in 2003 and a benefit of $14.580 billion in 2002. The Company’s actual income tax expense (benefit) differs from these amounts as a result of several factors, including non-temporary differences (i.e., certain financial statement expenses that are not deductible for income tax purposes), foreign income taxed at different rates, state and local income taxes and the recognition in the fourth quarter of 2003 of a $450 million tax benefit on capital losses. The most significant non-temporary difference in 2002 relates to approximately $42.5 billion of non-deductible losses on the writedown of goodwill (Note 11).

      Income (Loss) before Discontinued Operations and Cumulative Effect of Accounting Change. Income (loss) before discontinued operations and cumulative effect of accounting change was $3.146 billion in 2003 compared to a loss of $41.970 billion in 2002. Basic and diluted net income (loss) per share before discontinued operations and cumulative effect of accounting change were income of $0.70 and $0.68, respectively, in 2003 compared to basic and diluted net loss per share of $9.42 in 2002. In addition, excluding the items discussed under “Significant Transactions and Other Items Affecting Comparability” of $546 million of income in 2003 and $43.949 billion of losses in 2002, Income (Loss) before Discontinued Operations and Cumulative Effect of Accounting Change increased by $621 million. Of the increase, $450 million was from the income tax benefit from capital losses. The remainder reflects a slight increase in Operating Income and a decrease in losses from equity method investees.

      Discontinued Operations, Net of Tax. The 2003 and 2002 results include the impact of the treatment of the Music segment as discontinued operations. In addition, 2002 reflects the deconsolidation of a portion of the TWE-Advance/ Newhouse Partnership (“TWE-A/N”) (Note 6). Included in the 2003 discontinued operations for the Music segment is a pretax gain of approximately $560 million for the sale of Warner Manufacturing, a $1.1 billion pretax impairment charge taken to reduce the carrying value of the net assets of

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

the recorded music and music publishing businesses, a $27 million pretax loss from the operations of the Music business and $72 million of income tax benefits (Note 4). The 2002 amounts include pretax income of $101 million from the operations of the Music business, impairments of the Music segment’s goodwill of $646 million, brands and trademarks of $853 million and $273 million of income tax benefit related to Music. Additionally, 2002 amounts include $113 million of net income from the operations of TWE-A/N.

      Cumulative Effect of Accounting Change. As previously discussed, the Company recorded an approximate $12 million charge, net of tax, as a cumulative effect of accounting change upon adoption of FIN 46 in 2003. During 2002, the Company recorded a $54.235 billion cumulative effect charge upon adoption of SFAS 142. Included in this charge was $4.796 billion related to the Music segment.

      Net Income (Loss) and Net Income (Loss) Per Common Share. Net income was $2.639 billion in 2003, compared to a net loss of $97.217 billion in 2002. Basic net income per common share was $0.59 and diluted net income per share was $0.57 in 2003, compared to basic and diluted net loss per common share of $21.82 in 2002. Net Income (Loss) includes the items discussed under “Significant Transactions and Other Items Affecting Comparability,” discontinued operations, net of tax, and the cumulative effect of accounting change discussed above.

Business Segment Results

      AOL. Revenues, Operating Income (Loss) before Depreciation and Amortization and Operating Income (Loss) of the AOL segment for the years ended December 31, 2003 and 2002 are as follows:

                           
Year Ended December 31,

2003 2002 % Change



(restated; millions)
Revenues:
                       
 
Subscription
  $ 7,593     $ 7,216       5 %
 
Advertising
    785       1,082       (27 )%
 
Other
    220       562       (61 )%
     
     
         
Total revenues
    8,598       8,860       (3 )%
Costs of revenues(a)
    (4,499 )     (5,081 )     (11 )%
Selling, general and administrative(a)
    (2,542 )     (2,235 )     14 %
Goodwill impairment charge
          (31,961 )     NM  
Restructuring charges
    (52 )     (266 )     (80 )%
     
     
         
Operating Income (Loss) before Depreciation and Amortization
    1,505       (30,683 )     NM  
Depreciation
    (668 )     (624 )     7 %
Amortization
    (175 )     (161 )     9 %
     
     
         
Operating Income (Loss)
  $ 662     $ (31,468 )     NM  
     
     
         


(a)  Costs of revenues and selling, general and administrative expenses exclude depreciation.

    The growth in Subscription revenues at AOL was primarily attributable to an increase in Subscription revenues at AOL Europe (from $1.153 billion to $1.498 billion). The growth in AOL Europe’s Subscription revenues resulted from a $240 million favorable impact of foreign currency exchange rates and higher pricing that more than offset an increase in VAT (which is netted against revenue) due to a change in European tax law that took effect July 1, 2003. AOL’s domestic Subscription revenues grew $32 million (from $6.063 billion to $6.095 billion) in 2003 compared to 2002. The expansion of domestic broadband subscribers and increased

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

premium services revenue accounted for the increase. These gains were offset in part by year-over-year declines in revenues related to declines in domestic AOL narrowband subscribers.

      The number of AOL brand subscribers in the U.S. was approximately 24.3 million at December 31, 2003, compared to approximately 26.5 million at December 31, 2002, and 24.7 million at September 30, 2003 (total AOL brand subscribers included subscribers receiving the service under various unlimited usage price plans, limited usage price plans, BYOA plans, Original Equipment Manufacturers (“OEMs”) bundled plans, and bulk subscriptions sold at a discount rate to AOL’s selected strategic partners, as well as members receiving the AOL service during introductory free-trial periods and members who are receiving the AOL service at no or reduced costs through member service and retention programs). The sequential quarterly decline in domestic AOL brand subscribers resulted from a number of factors, including continued subscriber cancellations and terminations, a reduction in direct marketing response rates, the continued maturing of narrowband services, subscribers adopting other narrowband and broadband services, and a reassessment of various marketing programs, partially offset by growth in broadband subscribers.

      The year-over-year decline in subscribers also reflects the continued maturing of narrowband services described above and the Company’s identification of and removal from the subscriber base of members failing to complete appropriately the registration and payment authorization process and members who were prevented from using the service due to online conduct violations (e.g., spamming, inappropriate language) and who did not properly address the violation.

      AOL brand subscribers are classified based on price plans, rather than the speed of a member’s connection. The majority of AOL’s domestic subscribers are on unlimited usage pricing plans. Additionally, AOL has entered into certain bundling programs with OEMs that generally do not result in Subscription revenues during introductory periods, and previously had sold bulk subscriptions at a discounted rate to AOL’s selected strategic partners for distribution to their employees. The following table summarizes the percentage of AOL’s domestic members on each type of price plan:

                                 
Year Ended December 31,

Percentage of
Total Subs ARPU


2003 2002 2003 2002




Unlimited(a)
    78 %     81 %   $ 20.38     $ 19.47  
Lower-priced plans(b)
    18 %     13 %   $ 11.15     $ 11.03  
OEM bundled
    4 %     6 %            
     
     
                 
Total
    100 %     100 %   $ 18.98     $ 18.31  
     
     
     
     
 


(a) Includes 10% in both 2003 and 2002 under various free-trial and retention programs.
(b) Includes 2% in 2003 and 1% in 2002 under various free-trial and retention programs. These plans include BYOA plans, limited usage plans and bulk programs with strategic partners.

    ARPU, defined as total AOL brand domestic Subscription revenue divided by the average subscribers for the period, for 2003 increased 4% to $18.98 as compared to $18.31 in 2002. The change in domestic subscription ARPU primarily related to the termination of non-paying members. In addition, ARPU was impacted by changes in the mix of narrowband and broadband product, customer pricing plans, the level of service provided (full connectivity versus BYOA) and by changes in the terms of AOL’s relationships with its broadband cable, DSL and satellite partners.

      The number of AOL brand subscribers in Europe was 6.4 million at December 31, 2003, and the average monthly Subscription revenue per European subscriber for 2003 was $19.03. This compares to AOL brand subscribers in Europe of 6.4 million and 6.3 million at December 31, 2002, and September 30, 2003, respectively, and an average monthly Subscription revenue per European subscriber for 2002 of $14.88. The

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OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION — (Continued)

average monthly Subscription revenue per European subscriber in 2003 was impacted primarily by the positive effects of changes in foreign currency exchange rates related to the strengthening of the Euro and British Pound relative to the U.S. Dollar and price increases implemented in the second quarter of 2003 and in mid-2002 in various European countries offering the AOL service. The growth in the number of AOL brand subscribers in Europe was essentially flat in 2003, as growth in U.K. subscribers was offset by subscriber declines in Germany and France.

      The decline in Advertising revenues is principally due to a $338 million reduction in revenues from domestic contractual commitments received in prior periods (from $655 million to $317 million) and continued softness in AOL online advertising sales. Of the $655 million of Advertising revenue from contractual commitments for 2002, $15 million was recognized as the result of terminations. There were no terminations in 2003 that resulted in additional revenues. The decline in Advertising revenues also reflects a decrease in the intercompany sales of advertising to other business segments of Time Warner in 2003 as compared to 2002 (from $178 million to $40 million). This reduction also reflects a change in the treatment of intercompany advertising barter transactions. During the second quarter of 2003, there was a change in the application of AOL’s policy for intercompany advertising barter transactions, which reduced both the amount of intercompany advertising revenues and advertising expenses by $51 million for the year. This change, however, had no impact on the AOL segment’s Operating Income (Loss) or its Operating Income (Loss) before Depreciation and Amortization. In addition, because intercompany transactions are eliminated on a consolidated basis, this change in policy did not impact the Company’s consolidated results of operations. The decline in Advertising revenues was partially offset by increased revenues from certain transaction-based advertising contracts (from $35 million in 2002 to approximately $200 million in 2003) related to paid-search categories.

      Of the $785 million of Advertising revenues for 2003, $317 million was generated from the five most significant advertisers. Similarly, of the $1.082 billion of Advertising revenues for 2002, $213 million related to the five most significant advertisers.

      Domestic advertising commitments for future periods declined to $204 million as of December 31, 2003, as compared to $514 million as of December 31, 2002. In addition to the prior period commitments recognized in revenue, the remaining commitments were reduced by $196 million and $261 million for 2003 and 2002, respectively, 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 $204 million of advertising commitments for future periods as of December 31, 2003 is $120 million for the five largest advertising commitments. Similarly, the $514 million of advertising commitments for future periods as of December 31, 2002 includes $217 million for the five largest commitments.

      Other revenues include merchandising revenue and revenue from providing the Cable segment access to the AOL Transit Data Network for high-speed access to the Internet. The decrease in Other revenues for 2003 was due primarily to the Company’s decision to reduce the promotion of its merchandise business (i.e., reducing pop-up advertisements) to improve the member experience.

      Operating Income (Loss) before Depreciation and Amortization in 2002 included a $31.961 billion impairment charge taken to reduce the carrying value of goodwill. Excluding this impairment charge, Operating Income before Depreciation and Amortization increased by $227 million in 2003. The increase is due primarily to lower costs of revenue and lower merger and restructuring costs, offset in part by lower Advertising revenues, as discussed above, and higher selling, general and administrative expenses. The 11% decline in cost of revenues primarily related to lower domestic network and merchandise expenses. Network-related expenses decreased 14% to $2.446 billion in 2003, principally attributable to improved pricing and decreased levels of service commitments entered into during 2003, as well as the increased utilization of network assets under capital leases. Merger and restructuring costs declined in 2003 to $52 million as

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compared to $266 million in 2002 (Note 3). The 14% increase in selling, general and administrative expenses primarily related to higher marketing costs, consulting costs, commissions, and personnel costs associated with the roll-out of new services, as well as higher legal and insurance costs.

      Excluding the $31.961 billion impairment in 2002, Operating Income (Loss) increased in 2003 due to an increase in Operating Income before Depreciation and Amortization, as discussed above, partially offset by an increase in depreciation and amortization expense. The increase in depreciation expense primarily related to an increase in network assets acquired under capital leases. This was partially offset by an adjustment of approximately $60 million in the fourth quarter of 2003 to reduce excess depreciation inadvertently recorded at AOL over several years prior to 2003. Management does not believe that the understatement of prior years’ results was material to any of the given years’ financial statements. Similarly, management does not believe that the adjustment made is material to the 2003 results. The increase in amortization expense is primarily related to a reduction in useful lives of certain intangible assets that would cease to be used in early 2004.

      Cable. Revenues, Operating Income (Loss) before Depreciation and Amortization and Operating Income (Loss) of the Cable segment for the years ended December 31, 2003 and 2002 are as follows:

                           
Year Ended December 31,

2003 2002 % Change



(millions)
Revenues:
                       
 
Subscription
  $ 7,233     $ 6,374       13 %
 
Advertising
    466       661       (30 )%
     
     
         
Total revenues
    7,699       7,035       9 %
Costs of revenues(a)
    (3,343 )     (3,033 )     10 %
Selling, general and administrative(a)
    (1,349 )     (1,242 )     9 %
Goodwill impairment charge
          (10,550 )     NM  
Restructuring charges
    (15 )     (15 )      
Gain on disposal of consolidated businesses
          6       NM  
     
     
         
Operating Income (Loss) before Depreciation and Amortization
    2,992       (7,799 )     NM  
Depreciation
    (1,403 )     (1,206 )     16 %
Amortization
    (58 )     (7 )     NM  
     
     
         
Operating Income (Loss)
  $ 1,531     $ (9,012 )     NM  
     
     
         


(a) Costs of revenues and selling, general and administrative expenses exclude depreciation.

    The increase in Subscription revenues for 2003 was due to the growth in high-speed data subscribers, higher basic cable rates and an increase in digital video subscribers. High-speed data revenues increased from $1.009 billion in 2002 to $1.422 billion in 2003.

      Basic cable subscribers include all subscribers receiving basic cable service. Digital video subscribers reflect subscribers on any level of service received via digital technology. High-speed data subscribers include subscribers to TWC Inc.’s Road Runner service, as well as other Internet services offered by TWC Inc. For the period from December 31, 2002 to December 31, 2003, residential high-speed data subscribers increased by 33% to 3.228 million (including 443,000 million subscribers of unconsolidated investees, which are managed by TWC Inc.), commercial high-speed data subscribers increased by 54% to 128,000 (including 13,000 subscribers of unconsolidated investees, which are managed by TWC Inc.), digital video subscribers increased by 16% to 4.349 million (including 696,000 million subscribers of unconsolidated investees, which

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

are managed by TWC Inc.) and basic cable subscribers increased 0.1% to 10.919 million (including 1.572 million subscribers of unconsolidated investees, which are managed by TWC Inc.).

      The decrease in Advertising revenues was primarily related to a decrease in advertising purchased by programming vendors to promote their channels, including new channel launches (from $124 million to $12 million) and a decrease in the intercompany sale of advertising to other business segments of Time Warner (from $125 million to $11 million). This was offset in part by an 8%, or $31 million, increase in general third-party advertising sales.

      Operating Income (Loss) before Depreciation and Amortization for 2002 included a $10.550 billion impairment charge to reduce the carrying value of goodwill and a $6 million gain on the sale of certain consolidated cable systems. Excluding the impairment charge and gain, Operating Income before Depreciation and Amortization in 2003 increased by $247 million, principally as a result of the Subscription revenue gains described above, offset in part by higher costs of revenue and selling, general and administrative expenses. The increase in costs of revenue was primarily related to increases in video programming costs, offset in part by reduced high-speed data network expenses. Video programming costs increased 15% to $1.661 billion in 2003, principally attributable to contractual rate increases across the Company’s programming lineup (including sports programming). The increase in selling, general and administrative expenses was primarily related to higher employee-related costs, due in part to the roll-out of new services and, to a lesser extent, higher pension expenses.

      Excluding the $10.550 billion impairment, Operating Income increased in 2003 due primarily to the increase in Operating Income before Depreciation and Amortization described above, offset in part by an increase in depreciation and amortization expense. As a result of an increase in the amount of capital spending on customer premise equipment in recent years, a larger proportion of the Cable segment’s property, plant and equipment consisted of assets with shorter useful lives in 2003 than in 2002. Additionally, the Cable division completed the upgrades of its cable systems in mid-2002. Depreciation expense related to these shorter-lived assets, coupled with incremental depreciation expense on the upgraded cable systems, has resulted in the increase in overall depreciation expense. Amortization expense increased $51 million, primarily as a result of amortization of subscriber lists that were established in connection with the TWE Restructuring.

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

      Filmed Entertainment. Revenues, Operating Income before Depreciation and Amortization and Operating Income of the Filmed Entertainment segment for the years ended December 31, 2003 and 2002 are as follows:

                           
Year Ended December 31,

2003 2002 % Change



(millions)
Revenues:
                       
 
Advertising
  $ 6     $ 10       (40 )%
 
Content
    10,800       9,824       10 %
 
Other
    161       206       (22 )%
     
     
         
Total revenues
    10,967       10,040       9 %
Costs of revenues(a)
    (8,430 )     (7,891 )     7 %
Selling, general and administrative(a)
    (1,225 )     (1,051 )     17 %
Gain on disposal of consolidated businesses
    43             NM  
     
     
         
Operating Income before Depreciation and Amortization
    1,355       1,098       23 %
Depreciation
    (86 )     (79 )     9 %
Amortization
    (206 )     (191 )     8 %
     
     
         
Operating Income
  $ 1,063     $ 828       28 %
     
     
         


(a) Costs of revenues and selling, general and administrative expenses exclude depreciation.

    For 2003, Content revenues increased as a result of improvements from theatrical and television product. Increases in revenue from theatrical product included higher worldwide theatrical film rentals ($109 million), higher worldwide home video sales ($174 million) and higher television license fees ($118 million). Increases in revenue from television product is attributable to higher worldwide license fees ($288 million) and improved home video sales ($251 million). The increase in worldwide theatrical film rentals was primarily driven by the success of Harry Potter and the Chamber of Secrets, The Matrix Reloaded, The Lord of the Rings: The Fellowship of the Ring and The Lord of the Rings: The Two Towers. The increase in worldwide home video sales reflects increased DVD unit sales for both feature films and episodic television series, offset in part by lower VHS revenues. The growth in DVD revenues is attributable to a combination of the popularity of the Company’s film and television releases as well as the expanding worldwide DVD player base. The increase in television revenues is primarily attributable to improved network license fees from several returning series, as well as a higher number of new episodes produced and delivered in 2003 versus 2002. In addition, revenues were negatively impacted by a $40 million reserve established during the fourth quarter in connection with an international VAT tax matter (which is netted against revenue).

      Other revenues consist primarily of comic-book publishing sales and revenues from the portion of the Company’s U.K. cinema operations consolidated for financial reporting purposes. Other revenues declined as a result of the sale of the Company’s U.K. cinema interests in the second quarter of 2003. This operation contributed $51 million of Other revenues in 2003, compared to $108 million in 2002.

      Operating Income before Depreciation and Amortization reflects improved contributions from theatrical product, which were offset in part by lower gross profits from television product stemming from an increase in the production of new episodic series (new series are generally produced at a cost in excess of their network license fees). Specifically, Operating Income before Depreciation and Amortization includes increased Content revenues, which was partially offset by decreases in Other revenues discussed above, increases in costs of revenue and selling, general and administrative expenses. The increase in costs of revenue is primarily related to increased film and exploitation costs and by increased television production costs as discussed above.

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OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION — (Continued)

The increase in selling, general and administrative expenses is primarily related to third party distribution fees associated with higher revenue, general cost increases (including annual salary increases), additional headcount and approximately $45 million of additional accruals for employee incentive compensation. In addition, Operating Income before Depreciation and Amortization includes a $43 million gain related to the sale of the Company’s interest in consolidated U.K. cinemas in 2003.

      The increase in Operating Income was due primarily to the aforementioned changes in Operating Income before Depreciation and Amortization, offset in part by higher depreciation expense due to asset additions to property and equipment, as well as higher amortization expense relating to a step-up in the valuation of the Warner Bros. film library assets, which were established in connection with the TWE Restructuring.

      Networks. Revenues, Operating Income before Depreciation and Amortization and Operating Income of the Networks segment for the years ended December 31, 2003 and 2002 are as follows:

                           
Year Ended December 31,

2003 2002 % Change



(millions)
Revenues:
                       
 
Subscription
  $ 4,588     $ 4,310       6 %
 
Advertising
    2,675       2,423       10 %
 
Content
    981       736       33 %
 
Other
    190       186       2 %
     
     
         
Total revenues
    8,434       7,655       10 %
Costs of revenues(a)
    (4,499 )     (4,057 )     11 %
Selling, general and administrative(a)
    (1,668 )     (1,566 )     7 %
Impairment of intangible assets
    (219 )           NM  
Restructuring charges
    (21 )           NM  
     
     
         
Operating Income before Depreciation and Amortization
    2,027       2,032        
Depreciation
    (192 )     (172 )     12 %
Amortization
    (26 )     (21 )     24 %
     
     
         
Operating Income
  $ 1,809     $ 1,839       (2 )%
     
     
         


(a) Costs of revenues and selling, general and administrative expenses exclude depreciation.

    The increase in Subscription revenues was due primarily to higher subscription rates at both the cable networks of Turner and at HBO and an increase in the number of subscribers at Turner. In addition, as a result of the resolution of certain contractual agreements, certain previously deferred revenues were recognized when the fees became fixed and determinable. As a result, approximately $45 million of revenue that had been deferred was recognized in the third quarter of 2003.

      The increase in Advertising revenues was driven by higher CPMs, sellouts and ratings at Turner’s entertainment networks, reflecting improvement in the cable television advertising market, and, at The WB Network, from higher advertising rates and the impact of an expanded Sunday night schedule that began in September 2002.

      The increase in Content revenues was primarily due to the success of HBO’s first quarter 2003 home video release of My Big Fat Greek Wedding and, to a lesser extent, higher ancillary sales of HBO programming and higher licensing and syndication revenue associated with Everybody Loves Raymond.

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

      Operating Income before Depreciation and Amortization for 2003 includes the previously discussed $219 million of impairment charges at Turner related to the writedown of intangible assets of the winter sports teams. Excluding this impairment charge, Operating Income before Depreciation and Amortization improved due to the increase in total revenues described above, offset in part by an increase in costs of revenue and selling, general and administrative expenses. The 11% increase in costs of revenue is primarily due to increases in programming costs and higher distribution costs related to the increase in HBO’s Content revenues. Partially offsetting the higher programming costs was a $45 million deferral of programming costs associated with future revenues from syndication and home video distribution of original programming. The 7% increase in selling, general and administrative expenses is primarily related to higher employee costs at Turner and HBO due to business growth, and an increase in marketing costs. 2002 also included a benefit from the finalization of certain licensing agreements at HBO. In addition, 2003 included $13 million of restructuring costs related to a lease termination and a sublease associated with the planned move of Turner’s New York-based advertising sales department to the Time Warner Center and an additional $8 million of restructuring costs related to various employee and contractual terminations. Both years reflect bad debt reserves on receivables from Adelphia, which declared bankruptcy in 2002.

      Excluding the impairment charge, Operating Income increased primarily due to the changes in Operating Income before Depreciation and Amortization noted above, partially offset by an increase in depreciation expense related to fixed asset additions, primarily at Turner.

      The winter sports teams, which were sold in the first quarter of 2004, contributed approximately $160 million and $152 million of revenues in 2003 and 2002, respectively. Operating Losses were $37 million and $45 million in 2003 and 2002, respectively.

      Publishing. Revenues, Operating Income before Depreciation and Amortization and Operating Income of the Publishing segment for the years ended December 31, 2003 and 2002 are as follows:

                           
Year Ended December 31,

2003 2002 % Change



(millions)
Revenues:
                       
 
Subscription
  $ 1,533     $ 1,484       3 %
 
Advertising
    2,459       2,422       2 %
 
Content
    522       513       2 %
 
Other
    1,019       1,003       2 %
     
     
         
Total revenues
    5,533       5,422       2 %
Costs of revenues(a)
    (2,288 )     (2,233 )     2 %
Selling, general and administrative(a)
    (2,141 )     (2,034 )     5 %
Impairment of goodwill and intangible assets
    (99 )           NM  
Loss on sale of assets
    (29 )           NM  
Merger and restructuring charges
    (21 )           NM  
     
     
         
Operating Income before Depreciation and Amortization
    955       1,155       (17 )%
Depreciation
    (116 )     (97 )     20 %
Amortization
    (175 )     (177 )     (1 )%
     
     
         
Operating Income
  $ 664     $ 881       (25 )%
     
     
         


(a) Costs of revenues and selling, general and administrative expenses exclude depreciation.

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

    The 3% increase in Subscription revenues was due to $36 million of favorable effects of foreign exchange rates and a $49 million reduction in subscription agents’ commissions, which are netted against revenue, partially offset by lower subscription revenue per subscriber.

      The 2% increase in Advertising revenues reflects easier comparisons to 2002 during the early part of the year, resulting from the aftermath of the events of September 11, 2001, offset in part by a soft print advertising market in the latter part of 2003.

      The increase in Other revenues resulted from increases at Southern Living At Home, a division that sells merchandise via in-home parties, and Synapse, a direct subscription marketing company. These gains were partially offset by a $52 million decrease at Time Life.

      The decrease in Operating Income before Depreciation and Amortization includes the previously discussed $99 million impairment charge related to the goodwill and intangible assets of the Time Warner Book Group. It also includes an $84 million decline at Time Life (a $72 million loss in 2003 versus income of $12 million in 2002) and an increase in pension-related expenses of $44 million. These items were partially offset by an overall increase in revenue. Restructuring charges of $21 million were also recorded in 2003, including $9 million for Time Life workforce reductions. As previously discussed, in December 2003, the Company sold Time Life and recorded a loss on disposal of $29 million. Operating expenses for the magazine publishing business include manufacturing (paper, printing and distribution) and editorial-related costs, which together increased 2% to $1.627 billion due primarily to the effects of foreign exchange rates.

      The decrease in Operating Income was due primarily to lower Operating Income before Depreciation and Amortization, as discussed above, and higher depreciation expense, primarily related to increased capitalized software and building improvements. Time Life contributed $82 million of Operating Losses in 2003 and Operating Income of $6 million in 2002.

FINANCIAL CONDITION AND LIQUIDITY

 
Current Financial Condition

      At December 31, 2004, Time Warner had $22.375 billion of debt, $6.139 billion of cash and equivalents (net debt of $16.236 billion, defined as total debt less cash and equivalents) and $60.771 billion of shareholders’ equity, compared to $25.745 billion of debt, $3.040 billion of cash and equivalents (net debt of $22.705 billion) and $56.213 billion of shareholders’ equity at December 31, 2003.

      As discussed in more detail below, management believes that Time Warner’s cash provided by operations, cash and equivalents, borrowing capacity under its committed credit facilities and availability under its commercial paper programs are sufficient to fund its capital and liquidity needs for the foreseeable future.

 
Debt Reduction Program

      In January 2003, the Company announced its intention to reduce its overall level of indebtedness. Specifically, the Company indicated its intention was to reduce consolidated net debt to approximately $20 billion by the end of 2004.

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

      The following table shows the change in net debt from December 31, 2003 to December 31, 2004 (millions):

         
Net debt at December 31, 2003
  $ 22,705  
Free Cash Flow(a)
    (3,280 )
Acquisition of Advertising.com
    445  
Acquisition of additional interest in Synapse Group Inc. 
    120  
Net proceeds from sale of WMG(b)
    (2,501 )
Proceeds from sale of a portion of the Company’s investment in Google
    (195 )
Proceeds from sale of the Company’s investment in Gateway
    (280 )
Proceeds from sale of the Company’s investment in VIVA and VIVA Plus
    (134 )
Other
    (644 )
     
 
Net debt at December 31, 2004(c)
  $ 16,236  
     
 


(a) See Free Cash Flow discussion under “Cash Flows” below for a reconciliation of the Company’s Free Cash Flow to cash provided by operations ($6.618 billion in 2004).
 
(b) Represents $2.6 billion of proceeds received from the sale of WMG less certain working capital adjustments.
 
(c) Included in the net debt balance is approximately $299 million, which represents the net unamortized fair value adjustment recognized as a result of the merger of America Online and Historic TW.

    With the receipt of the proceeds upon the closing of the sale of the Company’s recorded music and music publishing businesses in the first quarter of 2004, as well as the generation of significant Free Cash Flow, the Company achieved its previously announced net debt reduction target in the first quarter, almost a full year ahead of schedule.

      The Company employs a disciplined approach to capital management, including investment opportunities and the potential return of capital to shareholders. Depending upon the timing and magnitude of such transactions, the Company’s net debt may continue to decline due to the prospective generation of Free Cash Flow.

      The Company has submitted a joint bid with Comcast for the acquisition of Adelphia. If successful, the Company’s net debt would increase.

Cash Flows

      Cash and equivalents increased to $6.139 billion as of December 31, 2004, from $3.040 billion as of December 31, 2003. Components of this change are discussed in more detail in the pages that follow.

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

      Sources of cash provided by operations are as follows:

                           
Year Ended December 31,

2004 2003 2002



(restated) (restated)
(millions)
Operating Income (Loss) before Depreciation and Amortization
  $ 9,372     $ 8,393     $ (34,651 )
Noncash asset impairments
    10       318       42,511  
Noncash legal reserves related to government investigations
    300              
Net interest payments(a)
    (1,578 )     (1,633 )     (1,548 )
Net income taxes paid(b)
    (382 )     (489 )     (246 )
Adjustments relating to discontinued operations(c)
    123       350       639  
Merger and restructuring payments(d)
    (90 )     (293 )     (512 )
Domestic pension plan contributions
    (358 )     (648 )     (119 )
Microsoft Settlement
          750        
Cash paid for litigation settlements
          (391 )      
All other, net, including working capital changes
    (779 )     244       683  
     
     
     
 
 
Cash provided by operations
  $ 6,618     $ 6,601     $ 6,757  
     
     
     
 


(a) Includes interest income received of $94 million, $61 million and $93 million in 2004, 2003 and 2002, respectively.
(b) Includes income tax refunds received of $107 million, $15 million and $49 million in 2004, 2003 and 2002, respectively.
(c) Includes net income (loss) from discontinued operations of $121 million, ($495) million and ($1.012) billion in 2004, 2003 and 2002, respectively. Amounts also include working capital related adjustments associated with discontinued operations of $2 million, $845 million and $1.651 billion in 2004, 2003 and 2002, respectively.
(d) Includes payments for merger and restructuring costs, as well as payment for certain other merger-related liabilities.

    Cash provided by operations increased to $6.618 billion in 2004 compared to $6.601 billion in 2003. The increase in cash provided by operations is related primarily to an increase in Operating Income before Depreciation and Amortization and lower domestic qualified pension plan contributions, tax, interest and merger and restructuring payments. These increases were partially offset by a reduction in cash provided by working capital, a reduction in cash relating to discontinued operations and the absence of net cash received from litigation settlements in 2004. The changes in working capital are subject to wide fluctuations based on the timing of cash transactions related to production schedules, the acquisition of programming, collection of accounts receivables and sales proceeds and similar items. The change in working capital between periods included higher production and programming spending and the timing of accounts payable and accrual payments.

      Cash provided by operations decreased to $6.601 billion for 2003, compared to $6.757 billion in 2002. The decline in cash provided by operations is related primarily to higher net interest and tax payments, lower cash generated from discontinued operations, higher domestic pension contributions and decreased contributions from working capital primarily related to higher production spending at Warner Bros. These factors causing declines were offset in part by an increase in Operating Income before Depreciation and Amortization (excluding noncash impairment charges of intangible assets), a decrease in cash paid for restructuring and merger liabilities and $359 million of net cash received in connection with litigation settlements.

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

      Sources of cash provided (used) by investing activities are as follows:

                           
Year Ended December 31,

2004 2003 2002



(restated)
(millions)
Investment and acquisitions, net of cash acquired:
                       
 
Synapse(a)
  $ (120 )   $ (40 )   $  
 
Advertising.com
    (445 )            
 
The WB Network
          (128 )      
 
Consolidation of AOLA(b)
    33              
 
AOL Europe
                (6,475 )
 
All other, principally funding of joint ventures
    (345 )     (402 )     (919 )
Investments and acquisitions, net from discontinued operations
          (52 )     (162 )
Capital expenditures and product development costs from continuing operations
    (3,024 )     (2,761 )     (2,843 )
Capital expenditures and product development costs from discontinued operations
          (126 )     (386 )
Proceeds from sale of the Company’s investment in Hughes
          783        
Proceeds from the sale of a portion of the Company’s investment in Google
    195              
Proceeds from the sale of the Company’s investment in Gateway
    280              
Proceeds from the sale of other available-for-sale securities
    57       296       187  
Net proceeds from the sale of WMG(c)
    2,501              
Proceeds from the sale of the Company’s investment in VIVA and VIVA Plus
    134              
Proceeds from sale of the Company’s investment in Comedy Central
          1,225        
Proceeds from sale of Warner Manufacturing
          1,050        
All other investment proceeds
    231       232       361  
     
     
     
 
 
Cash provided (used) by investing activities
  $ (503 )   $ 77     $ (10,237 )
     
     
     
 


(a) Represents purchase of additional interest in Synapse Group Inc.
(b) Represents cash balance of AOLA upon consolidation.
(c) Represents $2.6 billion of proceeds received from the sale of WMG less certain working capital adjustments.

    Cash used by investing activities was $503 million in 2004 compared to cash provided by investing activities of $77 million in 2003. The decrease in cash provided (used) by investing activities is due to lower proceeds from sale of investments, an increase in capital expenditures and product development costs and an increase in investments and acquisitions during 2004. Capital expenditures increased across all business segments and included capital expenditures related to the Company’s new corporate headquarters and the construction of a building by IPC Media.

      Cash provided by investing activities was $77 million in 2003, compared to cash used by investing activities of $10.237 billion in 2002. The increase in cash provided by investing activities is due primarily to the lower level of cash used for investments and acquisitions than in 2002, when the Company spent $6.475 billion

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

in connection with the acquisition of Bertelsmann’s interest in AOL Europe. In addition, as noted above, 2003 had higher investment proceeds from the sale of non-strategic assets. Capital expenditures and product development costs from continuing operations were essentially flat.

      As previously discussed under “Other Recent Developments,” Comcast has been granted an option, which generally can be exercised until 60 days following delivery of a termination notice from either TWC Inc. or Comcast, to require TWC Inc. to redeem a portion of the TWC Inc. stock held by Comcast in exchange for certain cable systems and approximately $750 million in cash.

 
Financing Activities

      Sources of cash provided (used) by financing activities are as follows:

                           
Year Ended December 31,

2004 2003 2002



(millions)
Borrowings
  $ 1,631     $ 2,492     $ 23,535  
Debt repayments
    (4,834 )     (7,230 )     (18,984 )
Redemption of mandatorily redeemable preferred securities of a subsidiary
          (813 )     (255 )
Current period repurchases of common stock
                (102 )
Partnership distributions
                (11 )
Principal payments on capital leases
    (191 )     (178 )     (61 )
Proceeds from exercise of stock options
    353       372       297  
Other financing activities
    25       (11 )     20  
     
     
     
 
 
Cash provided (used) by financing activities
  $ (3,016 )   $ (5,368 )   $ 4,439  
     
     
     
 

      Cash used by financing activities was $3.016 billion in 2004 compared to $5.368 billion in 2003. The decrease in cash used by financing activities was due principally to lower incremental debt repayments in 2004 and the absence of the 2003 redemption of mandatorily redeemable preferred securities of a subsidiary.

      Cash used by financing activities was $5.368 billion in 2003 compared to cash provided by financing activities of $4.439 billion in 2002. The increase in cash used by financing activities was due principally to incremental debt repayments in 2003. These were pursuant to the Company’s debt reduction plan. This is in contrast to incremental borrowings in 2002 that were used to finance the acquisition of Bertelsmann’s interest in AOL Europe.

 
Free Cash Flow

      Free Cash Flow is cash provided (used) by operations (as defined by U.S. generally accepted accounting principles) less cash provided by discontinued operations, capital expenditures and product development costs, principal payments on capital leases, and partnership distributions, if any. Free Cash Flow is considered to be an important indicator of the Company’s liquidity, including its ability to reduce net debt, make strategic investments, pay dividends to common shareholders and repurchase stock. Free Cash Flow should be considered in addition to, and not as a substitute for, the Company’s various cash flow measures (e.g., Cash Provided by Operations) reported in accordance with U.S. generally accepted accounting principles.

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

      The following table provides a reconciliation from the Company’s cash provided by operations to Free Cash Flow.

                           
Year Ended December 31,

2004 2003 2002



(restated)
(millions)
Cash provided by operations
  $ 6,618     $ 6,601     $ 6,757  
 
Capital expenditures and product development costs
    (3,024 )     (2,887 )     (3,229 )
 
Partnership distributions
                (11 )
 
Principal payments on capital leases
    (191 )     (178 )     (61 )
     
     
     
 
Free Cash Flow including discontinued operations
    3,403       3,536       3,456  
 
Less: Free Cash Flow from discontinued operations
    (123 )     (224 )     (242 )
     
     
     
 
Free Cash Flow
  $ 3,280     $ 3,312     $ 3,214  
     
     
     
 

Capital Expenditures and Product Development Costs

      Time Warner’s total capital expenditures and product development costs were $3.024 billion in 2004 compared to $2.887 billion in 2003 and $3.229 billion in 2002. Capital expenditures and product development costs from continuing operations were $2.761 billion in 2003 and $2.843 billion in 2002. Capital expenditures and product development costs from continuing operations principally relate to the Company’s Cable segment, which had capital expenditures from continuing operations of $1.712 billion in 2004, $1.637 billion in 2003 and $1.813 billion in 2002.

      The Cable segment’s capital expenditures from continuing operations comprise the following categories:

                             
Year Ended December 31,

2004 2003 2002



(millions)
Cable Segment Capital Expenditures
                       
 
Customer premise equipment
  $ 719     $ 715     $ 813  
 
Scaleable infrastructure
    205       173       188  
 
Line extensions
    239       214       192  
 
Upgrade/rebuild
    139       175       224  
 
Support capital
    410       360       396  
     
     
     
 
   
Total capital expenditures
  $ 1,712     $ 1,637     $ 1,813  
     
     
     
 

      Time Warner’s Cable segment generally capitalizes expenditures for tangible fixed assets having a useful life 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., initial customer installations), converters (i.e., analog and digital boxes that convert transmitted signals to analog and/or digital TV signal) and cable modems used in the delivery of high-speed data and Digital Phone services. 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 generally provided using the straight-line method over their estimated useful life. For converters and modems, such life is 3-5 years and for plant upgrades, such useful life is 3-16 years.

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

Outstanding Debt and Other Financing Arrangements

 
Outstanding Debt and Available Committed Financial Capacity

      At December 31, 2004, Time Warner had total committed capacity, defined as maximum available borrowings under various existing debt arrangements and cash and short term investments, of $37.991 billion. Of this committed capacity, $15.265 billion was available to fund future obligations and $22.375 billion was outstanding as debt (refer to Note 10 to the accompanying consolidated financial statements for more details on outstanding debt). At December 31, 2004, total committed capacity, unused capacity and outstanding debt were as follows:

                                   
Unused
Committed Letters of Committed Outstanding
Capacity Credit(a) Capacity Debt(c)




(millions)
Cash and equivalents
  $ 6,139     $     $ 6,139     $  
Bank credit agreement and commercial paper programs
    11,000       351       9,126       1,523  
Fixed-rate public debt(b)
    20,393                   20,393  
Other fixed-rate obligations
    459                   459  
     
     
     
     
 
 
Total
  $ 37,991     $ 351     $ 15,265     $ 22,375  
     
     
     
     
 


(a) Represents the portion of committed capacity reserved for outstanding and undrawn letters of credit.
(b) Includes debt due within one year of $1.672 billion, which primarily relates to $1.5 billion of bonds that mature in 2005.
(c) Represents principal amounts adjusted for fair value adjustments, premiums and discounts.
 
Time Warner Credit Agreement

      Time Warner has a $7.0 billion senior unsecured five-year revolving credit facility with a maturity date of June 30, 2009 (the “TW Facility”). The permitted borrowers under the TW Facility are Time Warner and Time Warner Finance Ireland (the “Borrowers”). The obligations of both Time Warner and Time Warner Finance Ireland are directly or indirectly guaranteed by America Online, Historic TW, Turner and Time Warner Companies, Inc. The obligations of Time Warner Finance Ireland are also guaranteed by Time Warner.

      Borrowings under the TW Facility bear interest at a rate determined by the credit rating of Time Warner, which rate is currently LIBOR plus 0.39%. In addition, the Borrowers are required to pay a facility fee on the aggregate commitments under the TW Facility at a rate determined by the credit rating of Time Warner, which rate is currently 0.11% per annum. The Borrowers also incur an additional usage fee of 0.10% per annum on the outstanding loans and other extensions of credit under the TW Facility if and when such amounts exceed 50% of the aggregate commitments thereunder.

      The TW Facility provides same-day funding and multi-currency capability, and a portion of the commitment, not to exceed $500 million at any time, may be used for the issuance of letters of credit. The TW Facility contains a maximum leverage ratio covenant of 4.5 times consolidated EBITDA of Time Warner and an interest coverage covenant of 2.0 times consolidated cash interest expense of Time Warner. Each of these terms, ratios and related financial metrics is defined in the agreement. At December 31, 2004, the Company was in compliance with all of these covenants, with a leverage ratio and interest coverage ratio, as calculated in accordance with the agreement, of approximately 1.8 times and 5.5 times, respectively. The TW Facility does not contain any credit ratings-based defaults or covenants, or any ongoing covenant or representations specifically relating to a material adverse change in Time Warner’s financial condition or results of operations. Borrowings may be used for general corporate purposes, and unused credit is available to support borrowings

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

under commercial paper programs. As of December 31, 2004, there were no loans outstanding and $351 million in outstanding face amount of letters of credit were issued under the TW Facility.

 
TWC Inc. and TWE Credit Agreement

      TWC Inc. and TWE have a $4.0 billion senior unsecured five-year revolving credit facility with a maturity date of November 23, 2009 (the “Cable Facility”). TWC Inc. and TWE have cross-guaranteed their respective obligations under the Cable Facility, and Warner Communications Inc. and American Television and Communications Corporation (both indirect wholly-owned subsidiaries of Time Warner but not subsidiaries of TWC Inc.) have each guaranteed a pro-rata portion of TWE’s obligations under the Cable Facility (including TWE’s obligations under its guarantee of TWC Inc.’s obligations). There are generally no restrictions on the ability of Warner Communications Inc. and American Television and Communications Corporation to transfer material assets (other than their interests in TWC Inc. or TWE) to parties that are not guarantors.

      Borrowings under the Cable Facility bear interest at a rate based on the credit rating of TWC Inc., which rate is currently LIBOR plus 0.39%. In addition, the borrowers are required to pay a facility fee on the aggregate commitments under the Cable Facility at a rate determined by the credit rating of TWC Inc., which rate is currently 0.11% per annum. The borrowers also incur an additional usage fee of 0.10% per annum on the outstanding loans and other extensions of credit under the Cable Facility if and when such amounts exceed 50% of the aggregate commitments thereunder.

      The Cable Facility provides same-day funding capability and a portion of the commitment, not to exceed $300 million at any time, may be used for the issuance of letters of credit. The Cable Facility contains a maximum leverage ratio covenant of 5.0 times consolidated EBITDA of TWC Inc. and an interest coverage covenant of 2.0 times consolidated cash interest expense of TWC Inc. Each of these terms, ratios and related financial metrics is defined in the agreement. At December 31, 2004, TWC Inc. was in compliance with all of these covenants with a leverage ratio and interest coverage ratio, as calculated in accordance with the agreement, of approximately 1.4 times and 6.7 times, respectively. The Cable Facility does not contain any credit ratings-based defaults or covenants, or any ongoing covenant or representations specifically relating to a material adverse change in the financial condition or results of operations of Time Warner, TWC Inc. or TWE. Borrowings may be used for general corporate purposes and unused credit is available to support borrowings under commercial paper programs. As of December 31, 2004, there were no loans or letters of credit outstanding, and approximately $1.523 billion of commercial paper was supported by the Cable Facility.

 
Commercial Paper Programs

      Time Warner maintains a $5.0 billion unsecured commercial paper program. Included as part of the $5.0 billion commercial paper program is a $2.0 billion European commercial paper program under which Time Warner and Time Warner Finance Ireland can issue European commercial paper. The obligations of both Time Warner and Time Warner Finance Ireland are directly and indirectly guaranteed by America Online, Historic TW, Turner and Time Warner Companies, Inc. The obligations of Time Warner Finance Ireland are also guaranteed by Time Warner. Proceeds from the commercial paper program may be used for general corporate purposes, including investments, repayment of debt and acquisitions. Commercial paper borrowings at Time Warner and Time Warner Finance Ireland are supported by the unused committed capacity of the $7.0 billion TW Facility. As of December 31, 2004, there was no commercial paper outstanding under the Time Warner commercial paper programs.

      In the second quarter of 2004, TWC Inc. established a $2.0 billion unsecured commercial paper program. TWE continues to maintain its own $1.5 billion unsecured commercial paper program, although the combined total of the unsecured notes outstanding at any time under these commercial paper programs (the “Notes”)

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

may not exceed $3.0 billion. Commercial paper borrowings at TWC Inc. and TWE are supported by the unused committed capacity of the $4.0 billion Cable Facility. TWC Inc. is a guarantor of Notes issued by TWE, and TWE is a guarantor of Notes issued by TWC Inc. In addition, Warner Communications Inc. and American Television and Communications Corporation (each indirect wholly-owned subsidiaries of the Company, but not subsidiaries of TWC Inc. or TWE) have each guaranteed a pro-rata portion of the obligations under the Notes, although there are generally no restrictions on the ability of Warner Communications Inc. and American Television and Communications Corporation to transfer material assets (other than their interests in TWC Inc. or TWE) to parties that are not guarantors. The Notes rank pari passu with TWC Inc.’s and TWE’s other unsecured senior indebtedness. As of December 31, 2004, there were approximately $1.523 billion of Notes outstanding under the TWC Inc. and TWE commercial paper programs.

 
Other Financing Arrangements

      From time to time, the Company enters into various other financing arrangements that provide for the accelerated receipt of cash on certain accounts receivable and film backlog licensing contracts. The Company employs these arrangements because they provide a cost-efficient form of financing, as well as an added level of diversification of funding sources. The Company is able to realize cost efficiencies under these arrangements since the assets securing the financing are held by a legally separate, bankruptcy-remote entity and provide direct security for the funding being provided. These arrangements do not contain any rating-based defaults or covenants. For more details, see Note 10 to the accompanying consolidated financial statements.

      The following table summarizes the Company’s other financing arrangements at December 31, 2004:

                           
Committed Unused Outstanding
Capacity(a) Capacity Utilization



(millions)
Accounts receivable securitization facilities
  $ 805     $ 97     $ 708  
Backlog securitization facility(b)
    500       52       448  
     
     
     
 
 
Total other financing arrangements
  $ 1,305     $ 149     $ 1,156  
     
     
     
 


(a) Ability to use accounts receivable securitization facilities and backlog securitization facility depends on availability of qualified assets.
(b) The outstanding utilization on the backlog securitization facility is classified as deferred revenue on the accompanying consolidated balance sheet.
 
Film Sale-Leaseback Arrangements

      From time to time the Company has entered into arrangements where certain film assets are sold to third-party investors that generate tax benefits to the investors that are not otherwise available to the Company. The forms of these transactions differ, but it is generally that of a sale-leaseback arrangement with a third-party special purpose entity (“SPE”). Such SPEs are capitalized with approximately $3.7 billion of debt and equity from the third-party investors. The Company does not guarantee and is not otherwise responsible for the equity and debt in these SPEs and does not participate in the profits or losses of these SPEs but does have a performance guarantee to produce such films. Accordingly, the Company does not consolidate these SPEs. Instead, the Company accounts for these arrangements based on their substance. That is, the net benefit paid to the Company from these transactions is recorded as a reduction of film costs. These transactions resulted in reductions of film costs totaling $177 million, $80 million and $60 million for the years ended December 31, 2004, 2003 and 2002, respectively.

      Once executed, the sale-leaseback arrangement obligates the Company to deliver a completed film to the SPE. As of December 31, 2004, the Company is obligated (based on current production budgets) to spend approximately $440 million to complete films covered by these arrangements.

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MANAGEMENT’S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION — (Continued)
 
Covenants and Rating Triggers

      Each of the Company’s bank credit agreements, public debt and financing arrangements with SPEs contain customary covenants. A breach of such covenants in the bank credit agreements that continues beyond any grace period constitutes a default, which can limit the Company’s ability to borrow and can give rise to a right of the lenders to terminate the applicable facility and/or require immediate payment of any outstanding debt. A breach of such covenants in the public debt beyond any grace period constitutes a default which can require immediate payment of the outstanding debt. A breach of such covenants in the financing arrangements with SPEs that continues beyond any grace period can constitute a termination event, which can limit the facility as a future source of liquidity; however, there would be no claims on the Company for the receivables or backlog contracts previously sold. Additionally, in the event that the Company’s credit ratings decrease, the cost of maintaining the bank credit agreements and facilities and of borrowing increases and, conversely, if the ratings improve, such costs decrease. There are no rating-based defaults or covenants in the credit agreements, public debt or financing arrangements with SPEs.

      As of December 31, 2004, and through the date of this filing, the Company was in compliance with all covenants. Management does not foresee that the Company will have any difficulty in the foreseeable future complying with the existing covenants.

Contractual and Other Obligations

 
Contractual Obligations

      In addition to the previously discussed financing arrangements, the Company has obligations under certain contractual arrangements to make future payments for goods and services. These contractual obligations secure the future rights to various assets and services to be used in the normal course of operations. For example, the Company is contractually committed to make certain minimum lease payments for the use of property under operating lease agreements. In accordance with applicable accounting rules, the future rights and obligations pertaining to firm commitments, such as operating lease obligations and certain purchase obligations under contracts, are not reflected as assets or liabilities on the accompanying consolidated balance sheet.

      The following table summarizes the Company’s aggregate contractual obligations at December 31, 2004, and the estimated timing and effect that such obligations are expected to have on the Company’s liquidity and cash flow in future periods.