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Time Warner Inc. – ‘10-Q’ for 6/30/04

On:  Thursday, 8/5/04, at 4:35pm ET   ·   For:  6/30/04   ·   Accession #:  950144-4-7792   ·   File #:  1-15062

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 8/05/04  Time Warner Inc.                  10-Q        6/30/04    5:1.2M                                   Bowne of Atlanta Inc/FA

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Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549

FORM 10-Q

[ x ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT of 1934 for the quarterly period ended June 30, 2004 or

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

Commission File Number 1-15062

TIME WARNER INC.

Delaware (State or other jurisdiction of incorporation or organization)		13-4099534 (I.R.S. Employer Identification Number)

One Time Warner Center
New York, New York 10019
(212) 484-8000

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes  x  No     

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes  x  No     

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

TIME WARNER INC.
INDEX TO FORM 10-Q

Table of Contents

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:

Use of Operating Income before Depreciation and Amortization and Free Cash Flow

     The Company utilizes Operating Income before Depreciation and Amortization, among other measures, to evaluate the performance of its businesses. Operating Income before Depreciation and Amortization is considered an important indicator of the operational strength of the Company’s businesses. Operating Income before Depreciation and Amortization eliminates the uneven effect across all business segments of considerable amounts of non-cash 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.

     The Company also utilizes Free Cash Flow to evaluate the performance of its businesses. Free Cash Flow is cash provided by operations (as defined by accounting principles generally accepted in the United States) less cash provided by discontinued operations, capital expenditures and product development costs, principal payments on capital leases, dividends paid and partnership distributions, if any. Free Cash Flow is considered to be an important indicator of the Company’s ability to reduce debt and make strategic investments.

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

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Table of Contents

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

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, Time, People, Sports Illustrated, and Time Warner Cable, and the Company has made such films as The Lord of the Rings trilogy, the Harry Potter series and Troy and such television programs as Friends, ER and The West Wing. During the six months ended June 30, 2004, the Company generated revenues of $21.014 billion (up 10% from $19.158 billion in 2003), Operating Income before Depreciation and Amortization of $5.042 billion (up 29% from $3.901 billion in 2003), Operating Income of $3.454 billion (up 45% from $2.387 billion in 2003), Net Income of $1.738 billion (up 19% from $1.460 billion in 2003), Cash Provided by Operations of $3.306 billion (down 13% from $3.795 billion in 2003) and Free Cash Flow of $1.743 billion (down 25% from $2.309 billion in 2003).

Time Warner Businesses

     Time Warner classifies its businesses into five fundamental areas: AOL, Cable, Filmed Entertainment, Networks and Publishing.

     AOL. America Online, Inc. (“AOL” or “America Online”) is the world’s leader in interactive services with 29.7 million AOL brand subscribers in the U.S. and Europe at June 30, 2004. AOL reported total revenues of $4.368 billion (21% of the Company’s overall revenues), $976 million in Operating Income before Depreciation and Amortization and $553 million in Operating Income for the six months ended June 30, 2004. AOL generates its revenues primarily from subscription fees charged to subscribers and advertising services rendered.

     AOL’s subscription trends have been in transition. The AOL narrowband (or dial-up) service has experienced significant declines in U.S. subscribers, which is expected to continue. Driving this decrease is the continued industry-wide maturing of the premium narrowband business, as consumers migrate to high-speed broadband or lower-cost dial-up services. In response, AOL put a new strategy in place, aiming to expand its offerings to reduce its reliance on its traditional narrowband service. It began actively marketing a Bring-Your-Own-Access (“BYOA”) broadband service (AOL FOR BROADBAND) in 2003 and a new, lower-cost dial-up ISP (Netscape Internet Service) in early 2004. In addition, AOL has launched a number of specialized premium services, including a McAfee VirusScan Online product.

     Over the past few years, AOL’s advertising revenues have been in a period of decline as the dynamics of the business have changed. Over this period, management has shifted its focus away from longer-term agreements and is now focused on more traditional and paid-search forms of advertising. For the first six months of 2004, traditional and paid-search forms of advertising increased strongly as compared to the prior-year comparable period. However, this growth was partially offset by declines in intercompany sales to other business segments of Time Warner and the runoff of longer-term advertising agreements. AOL expects overall advertising revenue to increase during the remainder of 2004 from continued growth in paid-search and traditional advertising. In addition, the acquisition of Advertising.com in the third quarter of 2004, as discussed later, is expected to contribute incremental growth.

     The Company expects that AOL’s strategic initiatives, as well as its continuing focus on cost management (particularly involving network costs) and continued improvement in its AOL Europe S.A. (“AOL Europe”) operations, will position the business for continued growth through the remainder of 2004.

     Cable. Time Warner’s cable business, Time Warner Cable Inc. (“TWC Inc.”), is the second largest cable operator in the U.S. (in terms of subscribers served). TWC Inc. managed 10.909 million basic cable subscribers (including 1.581 million subscribers of unconsolidated investees) at June 30, 2004, in highly clustered and upgraded systems in 27 states. TWC Inc. delivered $1.567 billion of Operating Income before Depreciation and Amortization, more than any of the Company’s other business segments, had revenues of $4.159 billion (20% of the Company’s overall revenues) and $829 million in Operating Income for the six months ended June 30, 2004.

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

     TWC Inc. offers three product lines — video, high-speed data and its newest service, Digital Phone. Video is TWC Inc.’s largest business, however, the growth of its customer base for basic video cable service is limited, as the customer base has matured and industry-wide competition from direct-to-home satellite services has increased. Nevertheless, TWC Inc. is continuing to grow through its offerings of advanced digital video services. With digital video, High-Definition television (HDTV), Video-on-Demand, Subscription-Video-on-Demand and Digital Video Recorders available in nearly all of its divisions, digital video penetration provides TWC Inc. with a broad base of potential customers for these advanced services.

     High-speed data service has been TWC Inc.’s fastest-growing business 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 DSL.

     The new voice business, Digital Phone, is expected to become available across the entire TWC Inc. footprint by the end of 2004. As of June 30, 2004, Digital Phone was commercially available in 15 of TWC Inc.’s cable divisions. Digital Phone will enable 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 offerings expected to be made available by its competitors. Included in Operating Income before Depreciation and Amortization for the first six months of the year are start-up costs associated with the rollout of Digital Phone services, which are expected to increase throughout 2004.

     In addition to the subscription services described above, TWC Inc. also earns revenue by selling advertising time to national, regional and local businesses. Video programming costs represent a major component of TWC Inc.’s expenses and continues to rise across the industry at double-digit rates, especially for sports.

     Filmed Entertainment. Time Warner’s Filmed Entertainment businesses, Warner Bros. Entertainment Group (“Warner Bros.”) and New Line Cinema (“New Line”), generated revenues of $6.078 billion (27% of the Company’s overall revenues), $829 million in Operating Income before Depreciation and Amortization and $674 million in Operating Income for the six months ended June 30, 2004.

     One of the world’s leading studios, Warner Bros. has diversified sources of revenue with its film, TV production and video businesses, combined with an extensive film library and global distribution infrastructure. This diversification helps Warner Bros. deliver consistent growth and performance. The vast majority of New Line’s revenues come from theatrical films and related video revenues and therefore are generally more variable. In the first six months of 2004, New Line has continued its recent success, benefiting from DVD sales of The Lord of the Rings trilogy and from lower cost films, such as Freddy vs. Jason and The Texas Chainsaw Massacre.

     The sale of DVDs has been the largest driver of the segment’s profit growth over the last few years. Warner Bros.’ library, consisting of more than 6,600 theatrical titles and 53,000 live-action and animated television titles, positions it to benefit from continuing growth in DVD hardware penetration. Specifically, DVDs continue to generate a growing share of home video revenues, with higher unit margins than VHS. With DVD hardware penetration levels worldwide relatively low compared to the penetration of VHS hardware, the Company believes that a significant opportunity for DVD sales growth remains.

     Warner Bros.’ industry-leading television business has experienced growing revenues, including the success of releasing television series into the home video market. For the 2003/2004 television season, Warner Bros. had more current production on the air than any other studio, with prime-time series on all six broadcast networks (including such hits as Friends, ER, The O.C., Cold Case, Smallville and The West Wing).

     Piracy, including physical piracy as well as 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 changes 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.

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Table of Contents

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

     The Company anticipates the rate of growth in both Operating Income before Depreciation and Amortization and Operating Income will be slower during the remainder of 2004 in comparison to that experienced in the first-half due to difficult 2003 second-half comparisons in theatrical results.

     Networks. Time Warner’s Networks group is comprised of Turner Broadcasting System, Inc. (“Turner”), Home Box Office (“HBO”) and The WB Television Network (“The WB Network”). The segment delivered revenues of $4.573 billion (20% of the Company’s overall revenues), $1.396 billion in Operating Income before Depreciation and Amortization and $1.285 billion in Operating Income for the six months ended June 30, 2004.

     The Turner networks — including TBS, TNT, CNN, Cartoon Network and CNN Headline News — are among the leaders in advertising-supported cable TV networks. In a shift that has been underway for years, prime-time viewing of all advertising-supported cable television networks surpassed, for the first time in 2003, the aggregate share for the major broadcast networks. For the first six months of 2004, TNT and TBS ranked first and second among cable networks in total day delivery in their key demographic, adults 18-49.

     The Turner networks generate revenue 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 growing advertising opportunity in the latter months of 2003 and first half of 2004. Keys to Turner’s success are its continued investments in high-quality programming focused on kids, sports, series, movies and news, as well as brand awareness and operating efficiency. In the second quarter of 2004, Turner launched a rebranding of TBS under the “tbs very funny” slogan.

     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 revenues is from the ancillary sales of its original programming, including The Sopranos, Sex and the City, Six Feet Under and Band of Brothers.

     The WB Network is a broadcast television network whose target audience are persons in the 12-34 age group demographic. The WB Network generates revenues almost exclusively from the sale of advertising time. Like its broadcast network competitors, The WB Network experienced a decline in its audience of young adults in the 2003/2004 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 now is developing new programming to not only reach the younger end of the 12-34 age group demographic, but is also now reaching out to the higher end of that same demographic group with a strong focus on adults 18-34.

     Publishing. Time Warner’s Publishing segment consists principally of magazine publishing (Time Inc.) and book publishing (Time Warner Book Group). The segment generated revenues of $2.559 billion (12% of the Company’s overall revenues), $527 million in Operating Income before Depreciation and Amortization and $390 million in Operating Income for the six months ended June 30, 2004.

     Time Inc. publishes more than 130 magazines including Time, People, Sports Illustrated, Entertainment Weekly, Southern Living, In Style, Fortune, Money, Real Simple and Cooking Light. It generates revenues primarily from advertising, magazine circulation and newsstand sales, and drives growth through higher circulation and advertising on existing magazines, acquisitions and the launch of new magazines. Time Inc. also owns IPC Media (the U.K.’s largest magazine company), magazine subscription marketer Synapse Group Inc. and Time4Media (previously Times Mirror Magazines), a leading publisher of leisure-time magazines. In addition, Time Inc. is continuing to invest in new magazine launches, including four launches in 2004. Its 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 Warner Book Group’s Warner Books and Little, Brown and Company offer a full range of titles spanning entertainment, literature and informative non-fiction. In the first six months of 2004, Time Warner Book Group had 30 titles on The New York Times bestseller list, including 20 new releases and 10 continuing bestsellers from prior-

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

years. Significant new additions to The New York Times bestseller list include James Patterson’s 3rd Degree, Nicholas Sparks’ Three Weeks With My Brother, and David Sedaris’s Dress Your Family in Corduroy and Denim.

     The Publishing segment’s Operating Income before Depreciation and Amortization increased in the first six months of 2004, due primarily to the absence of losses at Time Inc.’s former Time Life direct-marketing business and a $99 million impairment charge at Time Warner Book Group in 2003. Recently, the Company has seen some strengthening in print advertising revenues as second quarter Advertising revenues grew 10%. The Company anticipates that this growth trend in Advertising revenues will continue into the second half of 2004. As a result of the loss of revenues resulting from the sale of Time Life on December 31, 2003, revenue growth at the Publishing segment for the full year of 2004 will be negatively impacted by $352 million when compared to 2003. Conversely, with the absence of losses from Time Life in 2004, the Operating Income before Depreciation and Amortization growth at the Publishing segment will be positively impacted by $72 million for the full year of 2004, when compared to 2003.

Other Key 2004 Developments

Advertising.com

     In June 2004, America Online announced that it had agreed to purchase Advertising.com Inc. (“Advertising.com”) for $435 million (net of cash acquired). Advertising.com is a company that purchases online advertising inventory from third-party web sites and sells this inventory to advertisers.

     This transaction closed on August 2, 2004. In 2003, Advertising.com generated approximately $132 million of revenues, had Operating Income before Depreciation and Amortization of approximately $15 million and had Operating Income of approximately $12 million.

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 52,000 basic subscribers, 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 day-to-day management of Urban Cable. TWC Inc. and Inner City have agreed to settle certain disputes regarding the joint venture. TWC Inc. accrued $27 million in March 2004, based on an estimate of TWC Inc.’s cost to resolve this dispute, and accrued an additional $7 million during the second quarter in connection with the final settlement. TWC Inc. has also agreed to purchase, subject to receipt of applicable regulatory approvals, all of Inner City’s interests in the venture for approximately $53 million in cash. In addition, upon closing, TWC Inc. will eliminate debt and interest owed to it by Urban Cable of $65 million and will assume $58 million of Urban Cable’s third-party debt. This transaction is expected to close before the end of the year. For the six months ended June 30, 2004, Urban Cable’s revenues, Operating Income before Depreciation and Amortization and Operating Income were $24 million, $8 million, and $2 million, respectively.

VIVA Media AG and VIVA Plus

     In June 2004, Turner agreed to sell its 30.6% ownership stake in VIVA Media AG (“VIVA”) and its 49% stake in VIVA Plus to Viacom Inc. (“Viacom”) for approximately 109 million Euros (approximately $132 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 accounts for these assets as equity investments. This transaction is expected to close in the third quarter of 2004, subject to receipt of applicable regulatory approvals, and is expected to generate a pretax gain of approximately $110 million.

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Table of Contents

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

Warner Village Cinemas S.P.A.

     Warner Village Cinemas S.P.A. (“Warner Village”) is a joint venture arrangement that operates cinemas in Italy and is owned 45% by Warner Bros., 45% by Village Cinemas International Pty. Ltd. (“Village Cinemas”) and 10% by a third-party investor. In April 2004, Warner Bros. and Village Cinemas agreed that: (i) Warner Bros. would control the voting rights associated with Village Cinemas’ 45% interest and (ii) beginning in March 2007 and continuing for one year, Village Cinemas can request that Warner Bros. buy Village Cinemas’ interest at fair value. In the event Warner Bros. does not agree to buy such interests, both Warner Bros. and Village Cinemas would place their collective interests for sale. If such right is not exercised by Village Cinemas, the voting rights associated with the 45% 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 accounting principles generally accepted in the United States, Warner Village results have been consolidated retroactive to the beginning of the year. For the three and six months ended June 30, 2004, Warner Village revenues were $23 million and $59 million, respectively, its Operating Income before Depreciation and Amortization was $2 million and $12 million, respectively, and its Operating Income was $0 and $8 million, respectively.

Discontinued Operations Presentation of Music Segment

     On March 1, 2004, the Company closed on its previously announced agreement to sell 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 distribution operations to Cinram International Inc. for approximately $1.05 billion in cash (Note 3).

     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.

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 (defined as total debt less cash and cash equivalents) to approximately $20 billion by the end of 2004.

     As of June 30, 2004, the Company’s net debt totaled $18.1 billion, down from $22.7 billion at December 31, 2003, as described in more detail under “Financial Condition and Liquidity.” With the receipt of the $2.6 billion in cash 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 pursuing investment opportunities. Depending upon the timing and magnitude of future incremental investments, the Company’s net debt may continue to decline due to the prospective generation of Free Cash Flow.

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Table of Contents

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

SEC and DOJ Investigations

     The Securities and Exchange Commission (“SEC”) and the Department of Justice (“DOJ”) continue to conduct investigations into accounting and disclosure practices of the Company. Those investigations have focused on transactions principally involving the Company’s America Online segment that were entered into after July 1, 1999, including advertising arrangements and the methods used by the America Online segment to report its subscriber numbers.

     The Company itself had commenced an internal review under the direction of the Company’s Chief Financial Officer into advertising transactions at the America Online segment (“CFO review”) during 2002. As a result of the CFO review, the Company announced on October 23, 2002 that it intended to adjust the accounting for certain transactions. The adjustment had an aggregate impact of reducing the advertising and commerce revenues of the Company during the period from the third quarter of 2000 through the second quarter of 2002 by $190 million. On January 28, 2003, the Company filed amendments to its Annual Report on Form 10-K/A for the year ended December 31, 2001 and its Quarterly Reports on Form 10-Q for the quarters ended March 31, 2002 and June 30, 2002 that included restated financial statements reflecting the adjustments announced on October 23, 2002. Although the Company has continued its CFO review process, the Company has not, to date, determined that any further restatement is necessary.

     In its Annual Report on Form 10-K for the year ended December 31, 2002, which was filed with the SEC on March 28, 2003, the Company disclosed that the staff of the SEC had recently informed the Company that, based on information provided to the SEC by the Company, it was the preliminary view of the SEC staff that the Company’s accounting for two related transactions between America Online and Bertelsmann AG (“Bertelsmann”) should be adjusted. For more details on the transactions, see Note 9, “Commitments and Contingencies - Update on SEC and DOJ Investigations.” At the time, the Company further disclosed that it had provided the SEC a written explanation of the basis for the Company’s accounting for the transactions and the reasons why both the Company and its auditors continued to believe that these transactions had been accounted for correctly.

     The SEC staff has continued to review the Company’s accounting for the Bertelsmann transactions, as well as other transactions primarily at the America Online unit. In July 2003, the SEC’s Office of the Chief Accountant informed the Company that it had concluded that the accounting for the Bertelsmann transactions is incorrect. Specifically, in the view of the Office of the Chief Accountant, the Company should have allocated some portion of the $400 million paid by Bertelsmann to America Online for advertising, which was run by the Company and recognized as revenue, as consideration for the Company’s decision to relinquish its option to pay Bertelsmann in stock for its interests in AOL Europe, and, therefore, such portion of the payment should have been reflected as a reduction in the purchase price for Bertelsmann’s interest in AOL Europe, rather than as advertising revenue. The SEC’s Division of Enforcement continues to investigate the facts and circumstances of the negotiation and performance of these agreements with Bertelsmann, including the value of advertising provided thereunder, and, more recently, the staff of the SEC has reiterated its conclusion that the Company’s accounting for the Bertelsmann transactions was incorrect.

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

     The staff of the SEC continues to investigate, and the Company continues to discuss with the SEC staff, these and other transactions principally involving the America Online unit. It is possible that the Company may learn information as a result of its discussions with the SEC, the Company’s ongoing review, and/or the SEC’s ongoing investigation that would lead the Company to reconsider its views of the accounting for these transactions. It is also possible that restatement of the Company’s financial statements with respect to these transactions may be necessary. In light of the conclusion of the Office of the Chief Accountant that the accounting for the Bertelsmann transactions is incorrect, it is likely that the SEC would not declare effective any registration statement of the Company or its affiliates, such as any potential initial public offering of TWC Inc., until this matter is resolved.

     As noted, the SEC staff continues to investigate a range of transactions principally involving the Company’s America Online segment, including advertising arrangements and the methods used by the America Online segment to report its subscriber numbers. The DOJ also continues to investigate matters relating to these transactions and transactions involving certain third parties with whom America Online had commercial relationships. The Company intends to continue its efforts to cooperate with both the SEC and the DOJ investigations to resolve these matters. As part of its ongoing review, the Company reviews information that comes to its attention. For example, following a press report, the Company has recently begun a review of the accounting related to the consolidation of, and equity accounting for, its interest in AOL Europe prior to January 2002. The Company may not currently have access to all relevant information that may come to light in these investigations, including but not limited to information in the possession of third parties who entered into agreements with America Online during the relevant time period. It is not yet possible to predict the outcome of these investigations, but it is possible that further restatement of the Company’s financial statements may 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.

Sale of Winter Sports Teams

     On March 31, 2004, the Company closed the previously announced agreement to sell an 85% interest in the Turner winter sports teams (the Atlanta Thrashers, an NHL team, and the Atlanta Hawks, an NBA team) and operating rights to Philips Arena, an Atlanta sports and entertainment venue. In addition to the $219 million impairment charge recognized in the second and third quarters of 2003, the Company recorded a $7 million pretax loss on the closing of the sale in the first quarter of 2004.

Comcast Registration Rights

     On December 29, 2003, TWC Inc. received a notice from Comcast requesting that TWC Inc. start the registration process under the Securities Act of 1933 for the sale in a firm underwritten offering of Comcast’s 17.9% common interest in TWC Inc. The notice was delivered pursuant to a registration rights agreement related to the TWC Inc. securities. The Company cannot predict the timing of an effective registration in response to the notice. The Company is not required to purchase Comcast’s shares in TWC Inc.

RESULTS OF OPERATIONS

Transactions 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

     The Company adopted new accounting guidance that impacted comparability as follows:

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” (“FIN 46”) and the revision of FIN 46 (“FIN 46R”) issued in December 2003 to replace FIN 46, 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, the Cisneros Group (a private investment 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

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

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 three months ended June 30, 2004, the Company recognized revenues of $14 million, an Operating Loss before Depreciation and Amortization of $3 million and an Operating Loss of $6 million associated with AOLA.

Reclassifications

     Certain reclassifications have been made to prior-year’s financial information to conform to the current year presentation, including a reclassification impacting the Company and the Filmed Entertainment segment’s operating results to reflect a change in how the Company classifies the accretion of discounts on long-term film licensing arrangements. Previously, the Company classified the accretion of discounts on long-term film licensing arrangements within Operating Income. To become more consistent with what the Company believes to be film industry practice, such accretion is now being classified as a reduction of interest expense, net. The accretion for the three and six months ended June 30, 2004 was $28 million and $53 million, respectively, and for the three and six months ended June 30, 2003 was $25 million and $57 million, respectively. Such reclassifications did not affect Net Income, Cash Provided by Operations or Free Cash Flow.

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:

Restructuring Costs

     Restructuring costs consist of charges related to employee terminations and exit activities, which are expensed in accordance with accounting principles generally accepted in the United States. During the three and six months ended June 30, 2004, the Company recorded a $2 million reduction in restructuring costs at AOL, reflecting changes in estimates of previously established restructuring accruals. During the three months ended June 30, 2003, the Company incurred restructuring costs of $6 million at the Publishing segment. During the six months ended June 30, 2003, the Company incurred restructuring costs totaling $30 million, including $4 million at AOL, $8 million at Networks, and $18 million at Publishing. The 2003 costs related to various employee and contractual terminations. These costs are included in “Restructuring Costs” in the accompanying consolidated statement of operations and are discussed in more detail in Note 2 to the accompanying consolidated statement of operations.

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

Asset Impairments

     For the three and six months ended June 30, 2004, the Company recognized a $10 million impairment charge related to the pending sale of a building at the AOL segment, which is expected to close in the third quarter of 2004. For the three and six months ended June 30, 2003, Operating Income before Depreciation and Amortization includes a $178 million impairment charge at the Networks segment, related to the writedown of the intangible assets of the winter sports teams, and a $99 million impairment charge at the Publishing segment related to the writedown of goodwill and intangible assets of the Time Warner Book Group. These impairments were recognized as a result of fair value information obtained during the periods through negotiations with third parties about the potential disposition of these businesses.

Gain (Loss) on Disposal of Assets

     For the six months ended June 30, 2004, the Company recognized an $8 million pretax gain at the Publishing segment related to the sale of a building and a $7 million pretax loss (after taking into consideration the $178 million impairment charge described above and an additional $41 million impairment charge taken in the third quarter of 2003) on the closing of the sale of the winter sports teams at the Networks segment. These amounts are reflected as components of Operating Income in the accompanying consolidated statement of operations.

     For the three and six months ended June 30, 2003, the Company recorded a $43 million gain on the sale of its interest in U.K. cinemas, which previously had been consolidated by the Filmed Entertainment segment.

Microsoft Settlement

     As more fully described in Note 8 in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003, in the second quarter of 2003, the Company recognized a gain of approximately $760 million as a result of the settlement with Microsoft Corporation of then-pending litigation between Microsoft and Netscape Communications Corporation (the “Microsoft Settlement”). The gain is included in other income, net, in the accompanying 2003 consolidated statement of operations.

Investment Gains

     For the three months ended June 30, 2004, the Company recognized $16 million of gains from the sale of investments. For the six months ended June 30, 2004, the Company recognized $55 million of gains from the sale of investments. For the three months ended June 30, 2003, the Company recognized $542 million of gains from the sale of investments, including a $513 million gain from the sale of the Company’s interest in Comedy Central. For the six months ended June 30, 2003, the Company recognized gains from the sale of certain investments of $651 million, including a $513 million gain on the sale of the Company’s interest in Comedy Central, a $50 million gain from the sale of the Company’s interest in Hughes Electronics Corp. (“Hughes”) and a $49 million gain from the sale of the Company’s equity interest in certain international theater chains.

     These gains are included as a component of “Other Income, net” in the accompanying consolidated statement of operations.

Loss on Investments, net

     For the three and six months ended June 30, 2004, non-cash charges to reflect other-than-temporary declines in the Company’s investments were $6 million and $9 million, respectively. This amount reflects $1 million and $2 million, respectively, to reduce the carrying value of certain investments that experienced other-than-temporary declines in market value and $5 million and $7 million of losses, respectively, related to market fluctuations in equity derivative instruments.

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

     For the three months ended June 30, 2003, non-cash pretax charges to reflect other-than-temporary declines in the Company’s investments were $151 million. These amounts were comprised of $160 million to reduce the carrying value of certain investments that experienced other-than-temporary declines in market value and income of $9 million to reflect market fluctuations in equity derivative instruments. For the six months ended June 30, 2003, non-cash pretax charges to reflect other-than-temporary declines in the Company’s investments were $157 million. These amounts were comprised on $170 million to reduce the carrying value of certain investments that experienced other-than-temporary declines in market value and income of $13 million to reflect market fluctuations in equity derivative instruments. Included in these charges were a $71 million loss associated with the writedown of the Company’s then equity interest in n-tv KG (“NTV-Germany”), a German news broadcaster, and a $77 million loss associated with the Company’s equity interest in AOL Japan.

     These writedowns are included as a component of “Other Income, net” in the accompanying consolidated statement of operations.

Three and Six Months Ended June 30, 2004 Compared to Three and Six Months Ended June 30, 2003

Consolidated Results

     Revenues. For the three months ended June 30, 2004, consolidated revenues increased 10% to $10.888 billion. For the six months ended June 30, 2004, consolidated revenues also increased 10% to $21.014 billion. As shown below, these increases were led by growth in Subscription, Advertising and Content revenues, offset, in part, by declines in Other revenues:

     The increase in Subscription revenues for the three and six months ended June 30, 2004 was principally due to the continued penetration of new services (primarily high-speed data and advanced digital video services) and higher basic cable rates at the Cable segment, higher subscription rates, an increase in the number of subscribers and the resolution of certain contractual agreements at both Turner and HBO at the Networks segment, and a decrease in subscription allowances (which are netted against revenue) and the effects of foreign currency exchange rates at the Publishing segment.

     The increase in Advertising revenues for the three and six months ended June 30, 2004 was primarily due to growth at the Networks, Publishing and AOL segments. The increase at the Networks segment for the three and six months was driven by higher CPMs and sellouts at Turner’s entertainment networks. The increase at Publishing was due to growth at several publications and due to the effects of foreign currency exchange rates. The increase at AOL for the three and six months was due primarily to growth in paid-search advertising.

     The increase in Content revenues for the three and six months was principally due to improved results at the Filmed Entertainment segment related to both television and theatrical product. For the six months, this increase was partially offset by a decline at the Networks segment related primarily to difficult comparisons to the prior-year, which included the home video release of My Big Fat Greek Wedding.

     The decline in Other revenues was attributable to the sale of Time Life, a direct-marketing business at the Publishing segment, which was sold at the end of 2003, and the sale of Warner Bros.’ interest in U.K. cinemas

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

in the second quarter of 2003 at the Filmed Entertainment segment. Time Life and the U.K. cinemas contributed $77 million and $17 million, respectively, of Other revenues for the second quarter of 2003 and $153 million and $46 million, respectively, of Other revenues for the first six months of 2003. This decline was partially offset by the consolidation of Warner Village in 2004, as previously discussed.

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

     Costs of Revenues. For the three months ended June 30, 2004 and 2003, costs of revenues totaled $6.341 billion and $5.839 billion, respectively, and as a percentage of revenues was 58% and 59%, respectively. For the six months ended June 30, 2004 and 2003, costs of revenues totaled $12.321 billion and $11.503 billion, respectively, and as a percentage of revenues, was 59% and 60%, respectively. The improvement in costs of revenues as a percentage of revenues related primarily to improved margins at the Networks segment, including the revenue benefits of the resolution of certain contractual agreements as discussed in more detail under “Business Segment Results,” contributions from theatrical and television products at the Filmed Entertainment segment, and lower network expenses at the AOL segment.

     Selling, General and Administrative Expenses. For the three months ended June 30, 2004 and 2003, selling, general and administrative expenses increased to $2.544 billion in 2004 from $2.439 billion in 2003. For the six months, selling, general and administrative costs increased to $4.921 billion in 2004 from $4.722 billion in 2003. The increase for the three months resulted primarily from increases at AOL, due to higher marketing costs; at Cable, due to higher marketing costs and costs associated with the rollout of new services; and at Networks, due to higher overall marketing and general and administrative costs, partially offset by the reversal of certain accounts receivable reserves, principally related to Adelphia Communications. For the six months, the increase was due to increases at Filmed Entertainment, due primarily to distribution fees associated with the off-network television syndication of Seinfeld; at Cable, primarily due to a reserve established for the Urban Cable dispute, higher marketing costs and additional costs associated with the rollout of new services; at AOL, primarily due to higher marketing costs; and at Corporate, primarily due to costs associated with the relocation from the Company’s former corporate headquarters. These items were partially offset by improvements at Publishing, resulting from the absence of Time Life in 2004, and at Networks, due to the reversal of certain accounts receivable reserves.

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

     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:

     Operating Income before Depreciation and Amortization. Time Warner’s Operating Income before Depreciation and Amortization increased 30% to $2.637 billion for the three months ended June 30, 2004 from $2.035 billion for the three months ended June 30, 2003 as a result of growth at all business segments, with double-digit growth at the Networks, Publishing and AOL segments. For the six months ended June 30, 2004, Operating Income before Depreciation and Amortization increased 29% to $5.042 billion in 2004 from $3.901 billion in 2003 principally as a result of double-digit growth at the Filmed Entertainment, Networks, Publishing and AOL segments. The segment variations are discussed in detail under “Business Segment Results.” The increase in business segment Operating Income before Depreciation and Amortization for the six months was offset, in part, by an increase in Corporate Operating Loss before Depreciation and Amortization.

     The Company expects the rate of growth in Operating Income before Depreciation and Amortization for the full year to slow relative to the growth rate in the first-half of 2004 due to a decrease in growth rates at the Filmed Entertainment and Networks segments, which are discussed under “Business Segment Results.” Partially offsetting this is a reduction in pension expense due to the effects of considerable Company contributions and a strong return on plan assets in 2003.

     Corporate Operating Loss before Depreciation and Amortization. Time Warner’s Corporate Operating Loss before Depreciation and Amortization was $112 million and $276 million for the three and six months ended June 30, 2004 compared to $112 million and $213 million for the three and six months ended June 30, 2003, respectively. Included in the 2004 amounts are $14 million and $67 million of costs for the three and six months, respectively, associated with the relocation from the Company’s former corporate headquarters. Of the $67 million charge, approximately $26 million relates to a non-cash 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”).

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

     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 ($6 million and $14 million for the three and six months ended June 30, 2004, respectively, compared to $20 million and $35 million for the three and six months ended June 30, 2003, respectively). It is not yet possible to predict the outcome of these investigations and lawsuits, and costs are expected to continue to be incurred in future periods.

     Excluding the items previously discussed, Corporate Operating Income before Depreciation and Amortization was flat for the three months and increased for the six months primarily as a result of higher severance costs and insurance premiums.

     Depreciation Expense. Depreciation expense increased to $642 million and $1.277 billion for the three and six months ended June 30, 2004 from $631 million and $1.232 billion for the three and six months ended June 30, 2003, respectively. The increase in depreciation expense for the three months was the result of slight increases in depreciation at all segments, except AOL. The increase in depreciation for the six months primarily related to the Cable segment, and to a lesser extent, growth at all other segments except AOL. The growth at Cable reflects higher levels of spending related to the rollout of digital services over the past three years and increased spending on customer premise equipment that is depreciated over a significantly shorter useful life compared to the mix of assets previously purchased.

     Amortization Expense. Amortization expense increased to $157 million and $311 million for the three and six months ended June 30, 2004 from $150 million and $282 million for the three and six months ended June 30, 2003, respectively. The increase relates principally to 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 2003 restructuring of Time Warner Entertainment Company, L.P. (the “TWE Restructuring”). The purchase price allocation was finalized on March 31, 2004.

     Operating Income. Time Warner’s Operating Income increased to $1.838 billion and $3.454 billion for the three and six months ended June 30, 2004, respectively, from $1.254 billion and $2.387 billion for the three and six months ended June 30, 2003, respectively. This reflects the increase in business segment Operating Income before Depreciation and Amortization, partially offset by an increase in depreciation and amortization expense.

     Interest Expense, Net. Interest expense, net, decreased to $383 million and $787 million for the three and six months ended June 30, 2004 from $453 million and $881 million for the three and six months ended June 30, 2003, respectively, due primarily to lower average net debt levels.

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

     The Microsoft Settlement, declines in investment-related gains 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.

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

     Minority Interest Expense. Time Warner had $62 million and $118 million of minority interest expense for the three and six months ended June 30, 2004 compared to $60 million and $116 million for the three and six months ended June 30, 2003, respectively. The increase reflects higher earnings at the Cable segment allocated to Comcast, which for the six months, was offset partially by the elimination of 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. Income tax expense from continuing operations was $544 million for the three months ended June 30, 2004, compared to $792 million for the three months ended June 30, 2003 and was $1.019 billion for the six months ended June 30, 2004, compared to $1.105 billion for the six months ended June 30, 2003. The Company’s actual income tax expense differs from the amounts derived by applying the 35% U.S. Federal statutory rate to pretax income 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 and state and local income taxes. The Company’s effective tax rate for continuing operations was 38% and 39% for the three and six months ended June 30, 2004, respectively, as compared to 43% for both the same periods in the prior year. The decline in the effective tax rate results primarily from increased foreign tax credit utilization, additional deductions related to certain foreign source income and an increase in state and local tax attribute utilization.

     Income before Discontinued Operations and Cumulative Effect of Accounting Change. Income before discontinued operations and cumulative effect of accounting change was $882 million for the three months ended June 30, 2004 compared to $1.061 billion for the three months ended June 30, 2003. Basic and diluted net income per share before discontinued operations and cumulative effect of accounting change were both $0.19 in 2004 compared to $0.24 and $0.23, respectively, for basic and diluted net income before discontinued operations in 2003. In addition, excluding the items previously discussed under “Significant Transactions and Other Items Affecting Comparability” of $1 million and $528 million of income in 2004 and 2003, respectively, income before discontinued operations and cumulative effect of accounting change increased by $348 million. The increase reflects primarily an increase in Operating Income and lower interest expense.

     Income before discontinued operations and cumulative effect of accounting change was $1.594 billion for the six months ended June 30, 2004 compared to $1.491 billion for the six months ended June 30, 2003. Basic and diluted net income per share before discontinued operations and cumulative effect of accounting change were $0.35 and $0.34, respectively, in 2004 compared to $0.33 for both in 2003. In addition, excluding the items previously discussed under “Significant Transactions and Other Items Affecting Comparability” of $23 million and $575 million of income in 2004 and 2003, respectively, income before discontinued operations and cumulative effect of accounting change increased by $655 million. The increase reflects primarily an increase in Operating Income and lower interest expense.

     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 results for the three and six months ended June 30, 2004 are pretax losses of $93 million and $16 million, respectively, and a related tax provision of $12 million and tax benefit of $126 million, respectively. Such losses and the corresponding taxes relate primarily to adjustments to the initial estimates of the assets sold to, and liabilities assumed by, the acquirors in such transactions and to the resolution of various tax matters surrounding the music business dispositions.

     Included in the results for the three and six months ended June 30, 2003 are $2 million of pretax income and a pretax loss of $48 million, respectively, from the music operations and $1 million and $17 million, respectively, 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 the first quarter of 2004 in accordance with FIN 46R.

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

     Net Income and Net Income Per Common Share. Net income was $777 million for the three months ended June 30, 2004 compared to $1.064 billion for the three months ended June 30, 2003. Basic and diluted net income per common share were both $0.17 in 2004 compared to $0.24 and $0.23, respectively, for basic and diluted net income per common share in 2003. Net income was $1.738 billion for the six months ended June 30, 2004 compared to $1.460 billion for the six months ended June 30, 2003. Basic and diluted net income per share were $0.38 and $0.37 in 2004 compared to $0.33 and $0.32 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 three and six months ended June 30, 2004 and 2003 are as follows:

     Subscription revenues were essentially flat at AOL for the three and six months ended June 30, 2004 as compared to the same periods in 2003. Increases in Subscription revenues at AOL Europe (from $376 million to $407 million for the three months and from $732 million to $836 million for the six months), were offset in part by declines in domestic subscription revenues (from $1.525 billion to $1.463 billion for the three months and from $3.067 billion to $2.934 billion for the six months). The growth in AOL Europe’s Subscription revenues primarily resulted from a favorable impact of foreign currency exchange rates ($28 million and $92 million for the three and six months, respectively) and growth in broadband subscribers. These increases more than offset an increase in value-added taxes (which is netted against revenue) due to a change in European tax law that took effect July 1, 2003. AOL’s domestic Subscription revenues declined in 2004 due to decreases in AOL narrowband subscribers and related revenues, partially offset by the expansion of domestic broadband subscription revenues and increased premium service revenue. The remaining increase in Subscription revenues is the result of the acquisition of AOL Japan, which was consolidated effective January 1, 2004, and has contributed $18 million and $37 million of Subscription revenues for the three and six months, respectively, and the consolidation of AOLA effective on March 31, 2004, which has contributed $13 million of Subscription revenues for the three and six months. On July 1, 2004, the Company sold AOL Japan.

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

     The number of AOL brand domestic subscribers was as follows at June 30, 2004, March 31, 2004 and June 30, 2003:

     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. AOL classifies domestic AOL brand subscribers as narrowband or broadband subscribers based on the price plan marketed by the Company and selected by the subscriber, rather than the speed (e.g., high-speed or dial-up) of a subscriber’s connection, member usage patterns, or some other possible measure. For example, a subscriber who, in response to a promotional offer, agrees to sign-up for the AOL for Broadband service would be considered a broadband subscriber even if the subscriber predominantly accesses the AOL service via a dial-up connection.

     The primary narrowband price plan for U.S. subscribers is an unlimited usage plan for $23.90 per month that includes unlimited access to the AOL service using AOL’s dial-up network, and unlimited usage of the AOL service through any Internet connection. Narrowband subscribers may also select from other pricing plans with lower rates, including limited usage plans and an annual payment plan that allows members to pay for a year of the AOL service in advance at a reduced rate. Narrowband subscribers also include subscriptions sold at a discount to employees and customers of selected AOL strategic partners.

     AOL offers multiple “bring your own access” (BYOA) price plans, all of which allow unlimited usage on the AOL service through an Internet connection not provided by AOL (“BYOA access”), including a high-speed broadband Internet connection such as cable or digital subscriber lines (DSL) not provided by America Online. These BYOA price plans also allow for multiple simultaneous log-ins (MSL) for one account, and depending on the particular price plan, include varying amounts of dial-up telephone access in the U.S. from America Online. The primary BYOA price plan is $14.95 per month, which, in addition to unlimited BYOA access and MSL, provides for a limited number of hours of AOL-provided dial-up access each month. Another significant BYOA price plan is $24.95 per month, which allows unlimited BYOA access and MSL, and also includes unlimited access to the AOL service using AOL’s dial-up network. AOL considers all BYOA price plan subscribers to be broadband subscribers. Although not currently actively marketed, AOL also provides bundled broadband services to existing subscribers through a number of DSL and cable partners.

     Both narrowband and broadband plans include subscribers to the AOL service during introductory free trial periods and subscribers to the AOL service at no or reduced costs through member service and retention programs.

     During the first half of 2004, most of the net additions to broadband subscribers were in the $24.95 BYOA price plan. This BYOA price plan was introduced in early 2003 and has been actively marketed since late 2003. During the first half of 2004, most of the subscribers added to this BYOA price plan have migrated from AOL’s narrowband service. As of June 30, 2004, there were approximately 1.4 million $24.95 BYOA subscribers classified as broadband subscribers.

     It is important to note that these price plan classifications do not necessarily reflect subscriber access patterns. The Company believes that a significant number of its subscribers who have selected a broadband price plan actually access the AOL service via narrowband connections for a majority of their sessions. Likewise, a significant

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

number of its subscribers on narrowband price plans actually access the AOL service via a broadband connection for a majority of their sessions. In addition, many of AOL’s subscribers continue to switch from narrowband to broadband price plans and from broadband to narrowband price plans. As the marketplace and business evolve, AOL explores new pricing and marketing programs on an ongoing basis and continues to review the current narrowband and broadband subscriber classifications.

     The sequential quarterly decline in domestic AOL brand subscribers resulted from a number of factors, including continued subscriber cancellations and terminations, the continued maturing of narrowband services, seasonality and subscribers adopting other narrowband and broadband services, partially offset by growth in broadband subscribers. The Company anticipates that the decline in its narrowband subscriber base will likely continue because of these factors. In addition, the movement toward AOL for Broadband price plans could negatively impact future results of operations due to lower average pricing on broadband price plans than for narrowband price plans. In addition to the above, the year-over-year decline in subscribers also reflects a reduction in direct marketing response rates.

     The average monthly Subscription revenue per domestic subscriber (“ARPU”), defined as total AOL brand domestic Subscription revenue divided by the average subscribers for the period, increased 5% to $19.58 and 4% to $19.41 for the three and six months ended June 30, 2004, respectively, as compared to $18.63 and $18.58 for the three and six months ended June 30, 2003, respectively. The change in domestic subscription ARPU primarily related to an increase in the portion of AOL narrowband subscribers who generate revenue (e.g., not receiving free service) and increased premium services revenues. In addition, ARPU was impacted by changes in the mix of narrowband and broadband product, changes in 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 and DSL partners. In general, the Company does not expect ARPU to sustain this increase in the foreseeable future as the Company continues to introduce new products, such as lower-priced narrowband services, and subscribers continue to migrate from unlimited plans to lower-priced plans.

     The number of AOL brand subscribers in Europe was 6.3 million at June 30, 2004, and the average monthly Subscription revenue per European subscriber for the three and six months ended June 30, 2004 was $21.38 and $21.72, respectively. This compares to AOL brand subscribers in Europe of 6.4 million at March 31, 2004 and 6.2 million at June 30, 2003, and average monthly Subscription revenue per European subscriber of $19.13 for the three months ended June 30, 2003 and $18.49 for the six months ended June 30, 2003. The average monthly Subscription revenue per European subscriber 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. The six months was also impacted by price increases implemented in the second quarter of 2003. The sequential number of AOL brand subscribers reflected a net decline in subscribers in France and Germany.

     For the three months ended June 30, 2004 the increase in Advertising revenues reflects an increase in third party advertising reflecting increased revenue from domestic paid-search advertising contracts (from $41 million to $72 million) as well as increases in current period traditional online advertising. For the six months ended June 30, 2004, the increase in Advertising revenues reflects increased revenue from domestic paid-search advertising contracts (from $88 million to $146 million) as well as increases in current period traditional online advertising. 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 the comparable period in 2003 (from $35 million to $5 million). The Company expects advertising revenue to continue to increase during the remainder of 2004 due to expected growth in both paid-search and traditional online advertising. In addition, the acquisition of Advertising.com in the third quarter is expected to contribute incremental growth.

     Other revenues primarily include merchandising revenue, software licensing revenue and revenue from providing the Cable segment access to the AOL Transit Data Network for high-speed access to the Internet. Other revenues for the three months ended June 30, 2004 were essentially flat. The decrease in Other revenues for the first six months of 2004 was due primarily to the Company’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.

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

     For the three months ended June 30, 2004, costs of revenues decreased 7% and, as a percentage of revenues, decreased to 49% in 2004 from 53% in 2003. For the six months ended June 30, 2004, costs of revenues decreased 8% and, as a percentage of revenues, decreased to 49% in 2004 from 53% in 2003. For the three and six months, the declines related primarily to lower network-related expenses. Network-related expenses decreased 23% to $496 million and 21% to $1.023 billion for the three and six months, respectively, principally attributable to improved pricing and decreased levels of service commitments as well as increased amounts of network assets under capital leases versus operating leases. These factors are expected to result in continued declines in network expenses for the remainder of 2004. These declines were offset partially by additional costs associated with the consolidation of AOL Japan and AOLA during 2004.

     The increase in selling, general and administrative expenses for the three and six months ended June 30, 2004 primarily related to an increase in marketing costs and additional costs resulting from the consolidation of AOL Japan and AOLA. The increase in marketing costs resulted from higher spending on member acquisition activities, partially offset by a decline in brand advertising and an approximate $25 million adjustment to reduce excess marketing accruals made in prior years, primarily related to AOL’s European operations. Management does not believe that the understatement of prior-years’ results was material to any of the year’s financial statements. Similarly, management does not believe that the adjustment made is material to the current period results. The overall increase in marketing costs for the six months was partially offset by the previously discussed change in the treatment of intercompany advertising barter transactions (refer to page 73 of the Company’s 2003 Form 10-K). Also, included in the six month results for 2004 and 2003 are $15 million and $20 million, respectively, of benefits related to favorable rulings on certain state sales tax matters. In addition, AOL’s three and six month results for 2004 were impacted by the provision of certain state sales tax reserves related to the November 2003 expiration of the federal moratorium on Internet sales taxes. Both the U.S. Senate and U.S. House of Representatives have passed legislation that would retroactively reinstate the federal moratorium on Internet sales taxes. As of June 30, 2004, AOL has accrued a $40 million liability for such sales taxes. Depending upon the legislation ultimately passed, if any, all or some portion of this accrued liability may be reversed, positively impacting AOL’s future results of operations. However, until such legislation is passed, AOL continues to accrue for such sales taxes.

     As previously discussed under “Significant Transactions and Other Items Affecting Comparability,” the three months ended June 30, 2004 includes a $10 million impairment charge related to the pending sale of a building, which is expected to close in the third quarter of 2004. The three and six months ended June 30, 2004 includes a $2 million reversal of previously established restructuring accruals, reflecting changes in estimates. The six months ended June 30, 2003 included $4 million of restructuring charges.

     The increases in Operating Income before Depreciation and Amortization and Operating Income for the three and six months are due primarily to an increase in overall revenues and lower costs of revenues, offset in part by higher selling, general and administrative expenses.

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

     Cable. Revenues, Operating Income before Depreciation and Amortization and Operating Income of the Cable segment for the three and six months ended June 30, 2004 and 2003 are as follows:

     For the three and six months ended June 30, 2004, Subscription revenues increased due to the continued penetration of new services (primarily high-speed data and advanced digital video services) and higher basic cable rates. High-speed data subscription revenues increased to $433 million for the three months ended June 30, 2004 from $347 million for the three months ended June 30, 2003 and to $847 million for the six months ended June 30, 2004 from $661 million for the six months ended June 30, 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 Internet service, as well as other Internet services offered by TWC Inc. At June 30, 2004, as compared to June 30, 2003, basic cable subscribers declined by 0.3% and totaled 10.909 million (including 1.581 million subscribers of unconsolidated investees, which are managed by TWC Inc.), digital video subscribers increased by 13% to 4.610 million (including 738,000 subscribers of unconsolidated investees, which are managed by TWC Inc.), residential high-speed data subscribers increased by 24% to 3.548 million (including 498,000 subscribers of unconsolidated investees, which are managed by TWC Inc.) and commercial high-speed data subscribers increased by 43% to 149,000 (including 17,000 subscribers of unconsolidated investees, which are managed by TWC Inc.).

     The increase in Advertising revenues for the three and six months ended June 30, 2004 was attributable to an increase in the volume of advertising spots sold and, to a lesser extent, higher rates.

     For the three and six months ended June 30, 2004, costs of revenues increased 11% and, as a percentage of revenues, remained flat at 44% for all periods. The increase in costs of revenues is primarily related to increases in video programming costs and higher employee costs. Video programming cost increases of 12% to $467 million and 11% to $919 for the three and six months ended June 30, 2004, respectively, were attributable to contractual rate increases across TWC Inc.’s programming line-up (including sports programming). Video programming costs are expected to continue to rise for the remainder of 2004 at rates slightly higher than the rate of increase experienced during the first six months, reflecting the expansion of service offerings and timing of industry-wide programming cost increases (including sports programming) related to both inflation-indexed and negotiated license fee increases. Employee costs increased for the three and six months ended June 30, 2004 primarily due to merit increases and higher headcount resulting from the rollout of new services.

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

     The increase in selling, general and administrative expenses for the three and six months ended June 30, 2004 is the result of higher marketing and general operating costs, due in part to the rollout of new services. These increases also include costs of $7 million and $34 million for the three and six months, respectively, incurred in connection with a previously noted Urban Cable dispute settled in the second quarter of 2004.

     Operating Income before Depreciation and Amortization increased for the three and six months ended June 30, 2004, principally as a result of Subscription revenue gains, offset in part by higher costs of revenues and higher selling, general and administrative expenses.

     Included in Operating Income before Depreciation and Amortization for the three and six months ended June 30, 2004 are costs associated with the rollout of Digital Phone service, which are expected to increase as the service is deployed in each of TWC Inc.’s divisions prior to the 2004 year end. At June 30, 2004, Digital Phone service was commercially available in 15 divisions.

     For the three and six months ended June 30, 2004, 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 due to the cumulative investment in customer premise equipment, which generally has a significantly shorter useful life compared to the mix of assets previously purchased. Amortization expense increased $17 million and $33 million for the three and six months ended June 30, 2004, respectively, primarily as a result of amortization of franchise-related customer relationships that were established in connection with the TWE Restructuring in 2003, whose valuation was finalized in the fourth quarter of 2003.

     Filmed Entertainment. Revenues, Operating Income before Depreciation and Amortization and Operating Income of the Filmed Entertainment segment for the three and six months ended June 30, 2004 and 2003 are as follows:

     For the three and six months ended June 30, 2004, Content revenues increased primarily as a result of improvements from both theatrical and television product. For the three months, revenue from theatrical product included $74 million of increased worldwide theatrical film revenues, an increase of $85 million in worldwide home video sales and an $82 million increase in made for theatrical television license fees. For the three months, the increase in revenues from television product is attributable to a $63 million increase in home video sales and an increase in worldwide license fees of $21 million. For the six months, the increase in revenues was led by television product revenue, which is attributable to an increase in worldwide license fees of $523 million and a $164 million

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

increase in home video sales. For the six months, revenue from theatrical product included an increase of $165 million in worldwide home video sales, $61 million of higher worldwide theatrical film rentals and a $32 million increase in made for theatrical television license fees.

     For the three and six months ended June 30, 2004, the increase in worldwide theatrical film revenues was attributable primarily to international overages associated with The Lord of the Rings: The Return of the King and the success of Harry Potter and the Prisoner of Azkaban and Troy. For the three and six months, the increase in theatrical home video sales is primarily attributable to key second quarter releases, including The Lord of the Rings: The Return of the King, The Matrix Revolutions and The Last Samurai. In addition, the six-month period benefited from a strong first quarter home video release slate at New Line, which included Freddy vs. Jason and The Texas Chainsaw Massacre. Additionally, theatrical revenues increased for the three and six months due primarily to the network television availability of Harry Potter and the Sorcerer’s Stone during the second quarter of 2004. For the three and six months ended June 30, 2004, the increase in made for television home video sales was attributable to an increased number of series now sold in this format, including such television properties as Friends, Babylon 5 and Smallville. The increase in television worldwide license fees for the six months ended June 30, 2004 was primarily attributable to the third cycle syndication continuance license arrangements for Seinfeld, an increase in the number of television episodes produced and delivered and increased network fees associated with two long-running series.

     Other revenues increased primarily due to the consolidation of the results of Warner Village in 2004 as previously discussed, which contributed $21 million and $55 million of Other revenues during the three and six months, respectively. The Company’s U.K. cinema interests, which were sold in the second quarter of 2003, contributed Other revenues of $17 million and $46 million, respectively, for the three and six months ended June 30, 2003.

     The increase in costs of revenues was primarily related to increased film costs ($1.524 billion and $3.052 billion for the three and six months ended June 30, 2004 compared to $1.261 billion and $2.496 billion for the three and six months ended June 30, 2003, respectively) as well as higher marketing and distribution costs. The increase in film costs for the three months resulted primarily from the quantity and mix of films released in the quarter, including the home video release of The Lord of the Rings: The Return of the King and the theatrical releases of Harry Potter and the Prisoner of Azkaban and Troy, partially offset by lower valuation adjustments. In addition to the above, the increase for the six months reflects increased production of new episodic television series (new series are generally produced at a cost in excess of their network license fees). Marketing and distribution costs increased for the three and six months due to the quantity and mix of films released during the periods. Costs of revenues as a percentage of revenues decreased to 75% for the three months ended June 30, 2004 from 76% for the three months ended June 30, 2003, and to 74% for the six months ended June 30, 2004 compared to 77% for the six months ended June 30, 2003, reflecting improved contributions from theatrical and television products.

     For the three months ended June 30, 2004, selling, general and administrative costs increased due to additional headcount and merit increases. In addition, there were additional costs resulting from the consolidation of Warner Village. For the six months ended June 30, 2004, the increase in selling, general and administrative expenses also reflects additional distribution fees associated with the off-network television syndication of Seinfeld and the items described above.

     As previously discussed under “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 includes increased total 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. Included in Operating Income before Depreciation and Amortization for the three and six months of 2004 is $2 million and $12 million, respectively, resulting from the consolidation of Warner Village.

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

     The increase in Operating Income was due primarily to the aforementioned changes in Operating Income before Depreciation and Amortization described above.

     The Company anticipates the rate of growth in both Operating Income before Depreciation and Amortization and Operating Income will be slower during the remainder of 2004 in comparison to that experienced in the first-half of 2004 due to difficult comparisons in theatrical results, including the home video release of The Lord of the Rings: The Two Towers, which occurred in the third quarter of 2003 compared to the second quarter of 2004 release of The Lord of the Rings: The Return of the King.

     Networks. Revenues, Operating Income before Depreciation and Amortization and Operating Income of the Networks segment for the three and six months ended June 30, 2004 and 2003 are as follows:

     The increase in Subscription revenues for the three and six months ended June 30, 2004 was due primarily to higher subscription rates and an increase in the number of subscribers at both Turner and HBO. In addition, due to the favorable resolution of certain contractual agreements at both Turner and HBO, approximately $50 million of previously deferred revenues were recognized when the fees became fixed and determinable in the second quarter of 2004.

     The increase in Advertising revenues for the three and six months ended June 30, 2004 was driven primarily by higher CPMs and sellouts at Turner’s entertainment networks.

     The increase in Content revenues for the three months ended June 30, 2004 was primarily due to higher ancillary sales of HBO’s original programming. This increase was partially offset by the absence of revenues from the winter sports teams, which were sold at the end of the first quarter of 2004. The winter sports teams contributed $11 million of Content revenues for the three months ended June 30, 2003. For the six months ended June 30, 2004, the 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 the second quarter winter sports teams’ Content revenues, partially offset by higher 2004 ancillary sales of HBO’s original programming and higher license fees and syndication revenues from Everybody Loves Raymond.

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

     Other revenues declined for the three and six months ended June 30, 2004 due to the sale of the winter sports teams in the first quarter of 2004.

     Costs of revenues increased 7% and as a percentage of revenues was 54% and 56% for the three months ended June 30, 2004 and 2003, respectively. Costs of revenues increased 1% and as a percentage of revenues was 53% and 57% for the six months ended June 30, 2004 and 2003, respectively. Programming costs increased to $967 million for the three months ended June 30, 2004 as compared to $867 million for the three months ended June 30, 2003 and to $1.708 billion for the six months ended June 30, 2004 from $1.631 billion for the six months ended June 30, 2003. The increase in programming expenses for the three and six months is primarily due to an increase in sports programming costs at Turner, principally NBA rights costs, and higher theatrical film and original series costs at HBO. Costs of revenues for the quarter ended June 30, 2004 benefited from the sale of the winter sports teams in March 2004 and a reduction in player payroll at the Atlanta Braves. For the six months, costs of revenues reflected lower distribution costs associated with the decrease in HBO’s Content revenues noted above, a significant reduction in the costs associated with the war in Iraq at Turner’s news networks and a reduction in player payroll at the Atlanta Braves.

     Selling, general and administrative costs increased for the three months ended June 30, 2004, primarily due to higher marketing and promotion expenses to support new programming initiatives and network branding at Turner’s domestic entertainment networks and higher general and administrative costs across the networks, partially offset by a decline in marketing expenses at HBO and a $41 million reduction of bad debt expense. For the six months ended June 30, 2004, the decrease in selling, general and administrative expenses is primarily related to a $101 million decrease in bad debt expense, partially offset by higher general and administrative costs, which included in 2003 a favorable litigation settlement at Turner. The reduction of bad debt expense reflects the 2004 reversal of approximately $14 million and $75 million for the three and six months, respectively, of bad debt reserves at Turner and HBO on receivables from Adelphia Communications (“Adelphia”), a major cable operator that declared bankruptcy in 2002, and incremental second quarter 2003 bad debt charges at Turner related to certain cable operators. During the second quarter of 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 previously discussed under “Significant Transactions and Other Items Affecting Comparability,” the six months ended June 30, 2004 include a $7 million pretax loss on the sale of the winter sports teams, and the three and six months ended June 30, 2003 included a $178 million impairment charge at Turner related to the writedown of intangible assets of the winter sports teams. The six months ended June 30, 2003 also included $8 million of restructuring costs at Turner.

     Operating Income before Depreciation and Amortization improved for the three and six months ended June 30, 2004 due to the increased revenues and changes in costs, including the 2003 impairment charge, as described above.

     For the three and six months ended June 30, 2004, Operating Income increased primarily due to the changes in Operating Income before Depreciation and Amortization.

     The previously announced sale of the winter sports teams was completed on March 31, 2004. The winter sports teams had revenues of $66 million, an Operating Loss before Depreciation and Amortization of $8 million and an Operating Loss of $8 million for the three and six months ended June 30, 2004 compared to $25 million of revenues, an Operating Loss before Depreciation and Amortization of $7 million and an Operating Loss of $8 million for the three months ended June 30, 2003 and $94 million of revenues, an Operating Loss before Depreciation and Amortization of $16 million and an Operating Loss of $18 million for the six months ended June 30, 2003. For the full year of 2003, the winter sports teams contributed approximately $160 million of revenues, an Operating Loss before Depreciation and Amortization of $35 million and an Operating Loss of $37 million.

     The Company anticipates that for the remainder of 2004, the rate of growth in both Operating Income before Depreciation and Amortization and Operating Income, excluding the impact of the $219 million non-cash impairment charge incurred in 2003 related to the winter sports teams, will be lower than that experienced in the first six months. The lower rate of growth results from the absence of the approximate $75 million reversal of bad

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

debt reserves on receivables from Adelphia and the approximate $50 million benefit from the favorable resolution of certain contractual agreements as previously discussed, as well as the absence of an approximate $45 million benefit from the favorable resolution of certain contractual agreements recognized in the third quarter of 2003. In addition, the Company anticipates an increase in programming and marketing expenses, higher newsgathering costs associated with the political conventions and elections and more difficult advertising revenue comparisons to the second half of 2003.

     Publishing. Revenues, Operating Income before Depreciation and Amortization and Operating Income of the Publishing segment for the three and six months ended June 30, 2004 and 2003 are as follows:

     For the three and six months ended June 30, 2004, Subscription revenues increased 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.

     For the three and six months ended June 30, 2004, Advertising revenues increased due to growth at several publications including Fortune, In Style, Real Simple, Sports Illustrated, and Time. The Company anticipates that the recent recovery in Advertising revenues will continue into the second half of 2004.

     Content and Other revenues declined primarily due to the sale of Time Life at the end of 2003, which contributed $10 million and $20 million, respectively, of Content revenues and $77 million and $153 million, respectively, of Other revenues for the three and six months ended June 30, 2003. Excluding Time Life, Content and Other revenues increased due to growth at the other direct marketing businesses.

     The sale of Time Life will continue to negatively impact Content and Other revenues in 2004, as Time Life contributed total Content revenues of $40 million and Other revenues of $312 million in 2003.

     Costs of revenues declined for the three and six months ended June 30, 2004 primarily as a result of the sale of Time Life in 2003, which had $35 million and $74 million of costs for the three and six months, respectively. Excluding Time Life, costs of revenues increased 6% for both the three and six months, and, as a percentage of

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

revenues, was 38% and 39% for the three months of 2004 and 2003, respectively, and 42% for both the six months of 2004 and 2003, respectively. Costs of revenues for the magazine publishing business include manufacturing (paper, printing and distribution) and editorial-related costs, which together increased 10% to $448 million and 6% to $835 million for the three and six months ended June 30, 2004, respectively, due primarily to an increase in ad pages, the effects of foreign currency exchange rates and magazine launch-related costs. This increase was partially offset by a decline in costs at the Time Warner Book Group.

     Selling, general and administrative expenses included $64 million and $128 million of costs associated with Time Life for the three and six months ended June 30, 2003, respectively. Excluding Time Life, selling, general and administrative expenses increased 21% and 12% for the three and six months, respectively, primarily due to the timing of consumer promotions and magazine launch-related costs. The second quarter of 2003 also benefited from the reversal of a $12 million reserve for health and welfare plans and the reversal of a $12 million accrual that was no longer required for an outstanding legal matter.

     As previously discussed under “Significant Transactions and Other Items Affecting Comparability,” the six-months of 2004 results reflect an $8 million pretax gain on the sale of a building and the three and six months ended June 30, 2003 results included a $99 million impairment charge related to goodwill and intangible assets at the Time Warner Book Group and $6 million and $18 million, respectively, 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 and restructuring charges in 2003, Operating Income before Depreciation and Amortization increased $10 million for the three months ended June 30, 2004 and decreased $5 million for the six months ended June 30, 2004 and Operating Income increased $6 million for the three months ended June 30, 2004 and decreased $12 million for the six months ended June 30, 2004. The increase in the three months primarily reflects an increase in overall revenues and the favorable effects of foreign currency exchange rates, partially offset by a $7 million increase in magazine launch-related costs associated with the launch of one new magazine and the development of three others and the effects of the 2003 accrual reversals totaling $24 million described above. The decrease for the six months reflects magazine launch-related costs of $17 million and the effects of the 2003 accrual reversals totaling $24 million described above, partially offset by an increase in overall revenues.

FINANCIAL CONDITION AND LIQUIDITY

Current Financial Condition

     At June 30, 2004, Time Warner had $24.3 billion of debt, $6.2 billion of cash and equivalents (net debt of $18.1 billion, defined as total debt less cash and equivalents) and $58.1 billion of shareholders’ equity, compared to $25.7 billion of debt, $3.0 billion of cash and equivalents (net debt of $22.7 billion) and $56.0 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.

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

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.

     The following table shows the change in net debt from December 31, 2003 to June 30, 2004 (in millions):

     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.

     As previously discussed, the Company has agreed to (i) purchase Advertising.com for $435 million (net of cash acquired), (ii) purchase the 60% of Urban Cable it currently does not own for $53 million plus the assumption of $58 million in debt, and (iii) sell its 30.6% ownership stake in VIVA and its 49% stake in VIVA Plus to Viacom for approximately 109 million Euros (approximately $132 million) in cash. The purchase of Advertising.com closed on August 2, 2004 and the remaining transactions are expected to close in the third quarter of 2004.

     The Company employs a disciplined approach to pursuing investment opportunities. Depending upon the timing and magnitude of future incremental investments, the Company’s net debt may continue to decline due to the prospective generation of Free Cash Flow.

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

Cash Flows

     Cash and equivalents increased to $6.226 billion as of June 30, 2004 from $3.040 billion as of December 31, 2003. See below for a discussion of the change.

Operating Activities

     Sources of cash provided by operations are as follows:

     Cash provided by operations decreased to $3.306 billion in 2004 compared to $3.795 billion in 2003. The decrease in cash provided by operations is related primarily to 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 2003, partially offset by higher Operating Income before Depreciation and Amortization and a reduction in domestic qualified pension plan contributions and merger and restructuring payments. 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 sales proceeds and similar items. The reduction in working capital included higher collections in 2003 and the timing of billings in 2004 of accounts receivable at the Filmed Entertainment segment.

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

Investing Activities

     Sources of cash provided by investing activities are as follows:

     Cash provided by investing activities increased to $1.118 billion in 2004 from $637 million in 2003. The increase in cash provided by investing activities is due primarily to the net proceeds received from the sale of WMG in 2004, partially offset by $783 million of cash proceeds related to the sale of the Company’s investment in Hughes and $1.225 billion of cash proceeds related to the sale of the Company’s investment in Comedy Central during 2003 and an increase in capital expenditures and product development costs during 2004.

Financing Activities

     Sources of cash used by financing activities are as follows:

     Cash used by financing activities was $1.238 billion in 2004 compared to $4.088 billion in 2003. The decrease in cash used by financing activities was due principally to incremental debt repayments in 2003 as part of the

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

Company’s debt reduction program and the 2003 redemption of mandatorily redeemable preferred securities of a subsidiary.

     In the first six months of 2004, the Company purchased and retired $136 million (approximately $219 million face value) of AOL Zero-Coupon Convertible Subordinated Notes, (“Zero-Coupon Notes”), repaid $250 million of 7.4% senior notes that were due in 2004 and exercised the call option on $200 million of 8.4% senior debentures due in 2024.

     Included in debt due within one year is approximately $1.2 billion of Zero-Coupon Notes. The holders of the Zero-Coupon Notes can require the Company to purchase the Zero-Coupon Notes on December 6, 2004. On or after December 6, 2004, the Company has the right to redeem all or a portion of the Zero-Coupon Notes at any time. Management currently expects a significant portion of holders will exercise their right to redeem the Zero-Coupon Notes.

Free Cash Flow

     Time Warner evaluates operating performance based on several measures, including Free Cash Flow. Free Cash Flow is cash provided (used) by operations (as defined by accounting principles generally accepted in the United States) less cash provided by discontinued operations, capital expenditures and product development costs, principal payments on capital leases, dividends paid and partnership distributions, if any. Free Cash Flow is considered to be an important indicator of the Company’s ability to reduce debt and make strategic investments. 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 accounting principles generally accepted in the United States.

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

Long-Term Debt and Other Financing Arrangements

Time Warner Credit Agreements

     On June 30, 2004, Time Warner amended and restated its existing $6.0 billion unsecured revolving credit facility and terminated its $1.5 billion 364-day revolving credit facility. The Company now has a $7.0 billion 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 obligations of both Time Warner and Time Warner Finance Ireland are directly or indirectly guaranteed by America Online, Historic TW, Turner Broadcasting System, Inc., and Time Warner Companies, Inc. The obligations of Time Warner Finance Ireland are guaranteed by Time Warner.

     Borrowings under the TW Facility bear interest at rates determined by the credit rating of Time Warner, which interest 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 the aggregate outstanding loans and other extensions of credit exceed 50% of the aggregate committed amounts thereunder.

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

     The TW Facility provides same-day funding and multi-currency capability. 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 ratios and related financial metrics are defined in the agreement. At June 30, 2004, the Company was in compliance with all of these covenants. The TW Facility does not contain any credit ratings-based defaults or covenants, nor 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, including issuances of letters of credit, and unused credit is available to support commercial paper borrowings.

As of June 30, 2004, there were no borrowings outstanding under the TW Facility.

Commercial Paper Program

     In the second quarter of 2004, TWC Inc. established a $2.0 billion unsecured commercial paper program. Time Warner Entertainment Company, L.P. (“TWE”). 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”) may not exceed $3.0 billion. 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 other unsecured senior indebtedness.

Capital Expenditures and Product Development Costs

     Time Warner’s total capital expenditures and product development costs were $1.341 billion for the six months ended June 30, 2004 compared to $1.263 billion for the six months ended June 30, 2003. Capital expenditures and product development costs principally relate to the Company’s Cable segment, which had capital expenditures of $718 million in the six months ended June 30, 2004 and $773 million in the six months ended June 30, 2003.

     The Cable segment’s capital expenditures are comprised of the following categories:

     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 a digital TV signal) and cable modems used in the delivery of high-speed data 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 provided generally 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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Filmed Entertainment Backlog

     Backlog represents the amount of future revenue not yet recorded from cash contracts for the licensing of theatrical and television product for pay cable, basic cable, network and syndicated television exhibition. Backlog for all of Time Warner’s Filmed Entertainment companies was approximately $3.7 billion at June 30, 2004 and $3.9 billion at December 31, 2003, including amounts relating to the licensing of film product to Time Warner’s Networks segment of approximately $783 million at June 30, 2004 and $740 million at December 31, 2003.

Selected Investment Information

Cable Joint Ventures

     On May 1, 2004, the Company completed the previously announced restructuring of two joint ventures that it manages, Kansas City Cable Partners (“KCCP”), a 50-50 joint venture between Comcast and TWE serving approximately 299,000 basic video subscribers as of June 30, 2004, and Texas Cable Partners, L.P. (“TCP”), a 50-50 joint venture between Comcast and the TWE-Advance/Newhouse Partnership (“TWE-A/N”) serving approximately 1.2 million basic video subscribers as of June 30, 2004. The Company accounts for its investment in these joint ventures using the equity method. Under the restructuring, KCCP was merged into TCP, which was renamed “Texas and Kansas City Cable Partners, L.P.” Following the restructuring, the combined partnership is owned 50% by Comcast and 50% collectively by TWE and TWE-A/N. Beginning any time after June 1, 2006, either TWC Inc. or Comcast can trigger a 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 south Texas systems — with an arrangement to distribute the partnership’s debt between the two pools. The party triggering the dissolution would own the remaining pool of systems and any debt associated with that pool.

Google Inc.

     As previously reported, America Online holds approximately 7.4 million shares of Series D Preferred Stock of Google Inc. that it received through the exercise of a warrant for approximately $22 million. Each share will convert automatically into a share of Class B Common Stock upon Google’s completion of an initial public offering that generates at least a specified amount. Google has filed a registration statement for an initial public offering that would generate more than the specified amount based on Google’s anticipated per share offering price range. Google is permitting America Online and certain other investors to include a portion of their holdings in the shares anticipated to be sold in the offering and, in its amended registration statement filed on July 26, 2004, Google listed America Online as a selling stockholder of up to 743,745 shares, and up to an additional 867,149 shares if the underwriters’ full overallotment option is exercised. The Company cannot predict when Google’s proposed initial public offering will be completed. Assuming the offering is completed, America Online will be subject to restrictions on transfer of further shares pursuant to lock-up arrangements in connection with the offering. In addition, America Online will be subject to restrictions on any further transfers in the future under applicable securities laws unless sales are made either pursuant to a registration statement or under exemptions from registration.

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RISK FACTORS AND CAUTION CONCERNING FORWARD-LOOKING STATEMENTS

Risk Factors

     If the events discussed in these risk factors occur, the Company’s business, financial condition, results of operations or cash flows could be materially adversely affected. In such case, the market price of the Company’s common stock could decline.

     The Company’s America Online business faces substantial competition in maintaining and growing its subscriber base, in developing compelling products and services, and in increasing revenues from sources other than fees for the AOL service, and if America Online is unable to meet its competitive challenges, the Company’s financial results could be adversely affected. During the last several years, the online services industry has been changing from one in which the only way for a household to access the Internet was through narrowband (i.e., telephone “dial-up”) Internet access provided by Internet service providers to one in which households can access the Internet through a variety of connection methods, such as cable modems, DSL or wireless connections offered by a number of different providers, including Internet service providers, cable companies and telephone and other telecommunications companies. As a result, significant price and service competition exists. Due to this increased competition, maintaining and growing the AOL service subscriber base and the fees charged to subscribers have become increasingly difficult. America Online has incurred losses in subscribers throughout 2003 and in the first six months of 2004. The losses were due to a number of factors, which include the maturing of the narrowband Internet access business and the significant competition America Online faces for subscribers both in the narrowband and broadband arenas, as well as actions taken to remove non-paying subscribers pursuant to America Online’s strategy of focusing on member profitability.

     Since late 2002, America Online’s strategy has focused on improving and expanding its Internet products and services, including enhancement or upgrade to the content and features provided through the flagship AOL service, and introducing premium services, as well as reducing costs. The success of this strategy will depend on a number of factors, including sustained management focus, accurate forecasting of consumer preferences, and the ability to anticipate and keep up with technological developments. If America Online is unsuccessful, Time Warner’s financial condition, results of operations and cash flows could be adversely affected.

     With respect to “dial-up” narrowband Internet access, America Online faces significant competition from other Internet service providers, particularly those with low-price offerings. To meet this competition through ways other than price reductions, America Online has focused on improving the quality of features and content provided on its flagship AOL service to seek, to attract and retain narrowband Internet users, including introducing customized services targeted for kids (KOL) and teens (RED). America Online also operates lower-priced Internet services to compete with the low-price ISPs. It is too early to determine whether these actions will be successful in retaining existing and attracting new narrowband subscribers.

     During 2003, America Online actively marketed its AOL for Broadband price plans. For subscribers with a broadband connection, AOL provides specialized content and features. With the exception of an insignificant number of test plans, the one feature unique to AOL for Broadband price plans is simultaneous usage of the AOL service under multiple screen names. America Online initially focused on offering a “bundled” service that combined the AOL service with high-speed Internet access provided by third-party broadband Internet access providers such as cable companies and telephone companies. Due primarily to lower prices charged by other broadband Internet access providers, as well as to address geographic areas in which it did not have arrangements with broadband Internet access providers, America Online has changed its strategy to a “BYOA” strategy, offering various bring-your-own-broadband-access plans. Under this strategy, members purchase broadband Internet access through another service provider and then subscribe to the AOL service at a monthly subscription fee that includes unlimited access to the AOL service via the third-party broadband connection and, depending on the price plan, either a limited or an unlimited amount of narrowband Internet access provided by AOL. For this BYOA strategy to be successful in maintaining and increasing subscribers, the AOL for Broadband product must be compelling enough that users (whether they are existing AOL members who are moving from narrowband to broadband Internet

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service or new members) are willing to pay an additional fee on top of their third-party broadband Internet access cost for the AOL for Broadband product. While America Online has experienced a positive initial reaction to its BYOA broadband product, it believes it will need to continue to enhance the broadband product to differentiate it from and compete with the offerings from other broadband online services, and provide enough value and quality to attract and retain subscribers, and there is no assurance that America Online will be successful in doing so or will be able to do so at the current price levels.

     America Online expects to experience further declines in the number of subscribers and may experience increased volatility in its subscriber base. Each year, a significant portion of AOL members cancel their membership or are terminated by America Online either for non-payment of account charges or violation of one of the terms of service that apply to members (for example, sending spam e-mails or violating community guidelines in chat rooms). In addition, maintaining and growing the subscriber base is difficult because the larger the subscriber base, the greater the number of new subscribers required to offset those subscribers who cancel or are terminated. Before 2003, America Online had been able to attract sufficient new members to more than offset cancellations and terminations. In 2003 and into 2004, however, America Online did not register new members in numbers sufficient to replace the subscribers who cancel or are terminated. It expects the decline in subscribers to continue. America Online continues to test new price plans, service offerings and payment methods to identify effective ways to attract and retain members.

     It is relatively early in the process of introducing the AOL for Broadband product and the BYOA pricing plans, and although the initial reaction has been positive, it may not be indicative of longer-term response rates. In addition, as AOL members test broadband Internet products and pricing plans, AOL may see subscriber shifts among various price plans. This movement could result in increases or decreases in the number of subscribers to various pricing plans, as well as change the relative mix of members in narrowband and broadband plans. For example, during the first six months of 2004, most of the net additions to the BYOA pricing plans were to a relatively new $24.95 premium BYOA price plan that includes unlimited third-party broadband or narrowband Internet access as well as unlimited narrowband Internet access provided by AOL. Most of the additional subscribers to this BYOA plan have migrated from AOL’s narrowband service. Because AOL classifies its broadband and narrowband members on the basis of the price plan marketed by AOL and selected by the member, rather than the connection speed or method, a member’s classification may not reflect the member’s actual connection method.

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     America Online will need to develop other sources of revenues to offset the lower revenues from service fees expected to result from the decline in subscribers and the offering of the lower-priced Internet services to compete against other narrowband ISPs. America Online identified a number of methods to do this and has made progress on several objectives, although it needs to continue to make progress in a number of these, including the following:

     •      increasing AOL Europe’s profitability in 2004;

     •      continuing to reduce costs throughout its operations, especially those costs that relate to the size of the subscriber base such as network service costs; and

     •      continuing to introduce and expand use of existing premium services that provide incremental revenues from members, such as the AOL Call Alert feature, AOL Voicemail, the subscription music service MusicNet, and the computer virus prevention service offered through McAfee.

     Each of these objectives will require continued efforts to extend their success. America Online also must continue to focus on establishing, expanding and renewing relationships with advertisers and improving its advertising business. There have been management changes in that area in recent years, which have had some adverse impacts on its ability to achieve its goals of improving its online advertising business.

     In addition, since many of the premium services are offered via broadband, success with the premium services may depend on how successful the AOL for Broadband product is in the longer term. Revenues from premium services may be adversely affected by pressure to reduce prices for the services or to incorporate them into the standard AOL service offering rather than offering them separately as premium services due to competitors who may offer similar services over time at lower prices or at no additional charge as part of their standard offerings.

     America Online faces risks relating to the expiration of the Internet Tax Freedom Act and other tax risks related to changes in or interpretations of federal, state and local laws and regulations. The taxation of online and Internet access service providers is currently unsettled in many respects. In that regard, a number of proposals have been made at the federal, state and local levels that could impose taxes on Internet access. It is also possible that new interpretations of existing statutes could occur as taxing authorities consider these proposals. Further, the Internet Tax Freedom Act, which placed a moratorium on new state and local taxes on Internet access, expired in November 2003. At present, both the House of Representatives and Senate have passed bills that would extend the moratorium with retroactive effect to November 1, 2003. However, the legislation has not yet made it through conference committee. If the legislation is not passed ultimately or if the provisions of this new legislation allow for increased levels of state taxing authority, America Online’s results of operations could be adversely impacted. In addition, future state and local tax laws or interpretations of existing laws imposing taxes on Internet access could also adversely impact America Online’s results of operations.

     The Company’s Cable segment has begun providing voice services over its cable systems and faces risks inherent to entering into a new line of business, from competition, and from regulatory actions or requirements. TWC Inc. intends to rollout its Digital Phone service in all of its operating divisions during 2004. Coordinating the rollout of a product with which it has only limited operating experience may present significant challenges. First, although TWC Inc. has introduced the service in a number of operating areas, it remains a relatively new technology. Furthermore, the Digital Phone service depends upon interconnection and related services provided by certain third parties. TWC Inc. may encounter unforeseen difficulties as it introduces the product in new operating areas or increases the scale of its offering in areas in which it has launched. Second, TWC Inc. will face heightened customer expectations for the reliability of voice services as compared with video and high-speed data services. TWC Inc. will need to undertake significant training of customer service representatives and technicians. If the service is not sufficiently reliable or TWC Inc. otherwise fails to meet customer expectations, the Digital Phone business could be impacted adversely. Third, the competitive landscape for voice services is expected to be intense, with TWC Inc. facing competition from other providers of VoIP services, as well as regional incumbent telephone companies, cellular telephone service providers, and others, including established long distance companies. The regional incumbent telephone companies have substantial capital and other resources, as well as longstanding customer relationships. Some of these companies have entered into co-marketing arrangements with direct-to-home

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satellite service providers to offer video services (and, in the future, could offer video services on their own) together with their telephone and DSL offerings. Such bundled offerings by telephone companies may compete with TWC Inc.’s offerings and could adversely impact TWC Inc. Finally, the Company expects advances in communications technology, as well as changes in the marketplace and the regulatory and legislative environment. Consequently, the Company is unable to predict the effect that ongoing or future developments in these areas might have on the Cable segment’s voice business and operations.

     The voice services business may also present additional regulatory risks. It is unclear whether and to what extent traditional state and federal telephone regulations will apply to telephony services provided using VoIP technology. In addition, regulators could allow utility pole owners to charge cable operators offering voice services higher rates for pole rental than is allowed for cable and high-speed services. The FCC recently initiated a rulemaking proceeding examining the proper regulatory approach to voice services utilizing VoIP technology, Congress is considering enacting new laws to govern those services, there are court cases addressing the proper regulatory treatment for the service, and there are rulemakings and various other proceedings underway at the state level. In view of these various activities at the state and federal level, the Company cannot be certain what impact regulation will have on the Digital Phone business.

     Ongoing investigations by the Securities and Exchange Commission and the Department of Justice and pending shareholder litigation could affect Time Warner’s operations. The SEC and the DOJ are investigating the Company’s financial reporting and disclosure practices. As of August 4, 2004, there were 41 putative class action and shareholder derivative lawsuits alleging violations of federal and state securities laws as well as purported breaches of fiduciary duties pending against Time Warner, certain of its current and former executives, past and present members of its Board of Directors and, in certain instances, America Online. There is also a consolidated action making allegations of ERISA violations. The complaints purport to be made on behalf of certain of the Company’s shareholders and allege, among other things, that Time Warner made material misrepresentations and/or omissions of material facts 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. There are also actions filed by individual shareholders pending in federal and state courts. The Company is unable to predict the outcome of the SEC and DOJ investigations and the pending shareholder litigation. The Company is incurring expenses as a result of the SEC and DOJ investigations and the shareholder litigation pending against the Company, and any costs associated with judgments in or settlements of these matters could adversely affect its financial condition and results of operations. See “Other Key 2004 Developments — SEC and DOJ Investigations.”

     Technological developments may adversely affect the Company’s competitive position and limit its ability to protect its valuable intellectual property rights. Time Warner’s businesses operate in the highly competitive, consumer-driven and rapidly changing media and entertainment industries. These businesses, as well as the industries generally, are to a large extent dependent on technological developments, including access to and selection and viability of new technologies, and are subject to potential pressure from competitors as a result of their technological developments. For example:

     •     The Company’s cable business may be adversely affected by more aggressive than expected competition from alternate technologies such as satellite and DSL; by the failure to choose technologies appropriately; by the failure of new equipment, such as digital set-top boxes or digital video recorders, or services, such as digital cable, high-speed data services, voice over Internet protocol and video-on-demand, to appeal to enough consumers or to be available at prices consumers are willing to pay, to function as expected and to be delivered in a timely fashion;

     •     The Company’s America Online business may be adversely affected by competitors’ abilities to more quickly develop new technologies, including more compelling features/functionalities and premium services for Internet users, and by the uncertainty of the costs for obtaining rights under patents that may cover technologies and methods used to deliver new services; and

     •     The Company’s filmed entertainment and television network businesses may be adversely affected by the fragmentation of consumer leisure and entertainment time caused by a greater number of choices resulting from technological developments, the impact of digital video recorders or other technologies that change the nature of the

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advertising and other markets for television products, technological developments that facilitate the theft and unlawful distribution of the Company’s copyrighted works in digital form, including via the Internet, and by legal and practical limitations on the ability to enforce the Company’s intellectual property rights.

Caution Regarding Forward-Looking Statements

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

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

     For Time Warner’s AOL business:

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     For Time Warner’s cable business:

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     For Time Warner’s filmed entertainment businesses:

     For Time Warner’s network businesses:

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     For Time Warner’s publishing businesses:

     For Time Warner generally, the overall financial strategy, including growth in operations, maintaining financial ratios and a strong balance sheet, could be adversely affected by decreased liquidity in the capital markets, including any reduction in the ability to access either the capital markets for debt securities or bank financings, failure to meet earnings expectations, significant acquisitions or other transactions, economic slowdowns, the impact of terrorist acts and hostilities in Iraq and elsewhere in the world, increased expenses as a result of the SEC and DOJ investigations and the shareholder litigation pending against Time Warner, as well as the risk of costs associated with judgments in or settlements of such matters, and changes in the Company’s plans, strategies and intentions. In addition, lower than expected valuations associated with the cash flows and revenues at its segments may result in its inability to realize the value of recorded intangibles and goodwill at those segments.

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Item 4. 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 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 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 in this report, the Company began consolidating the financial results of AOLA effective March 31, 2004 pursuant to the requirements of FIN 46. 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.

     There have not been any changes in the Company’s internal control over financial reporting during the quarter ended June 30, 2004 that have materially affected, or are reasonably likely to materially affect, its internal control over financial reporting.

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CONSOLIDATED BALANCE SHEET
(Unaudited)