SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT of 1934 for the quarterly period ended September 30, 2001, or
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[ ] 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 001-12878
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TIME WARNER ENTERTAINMENT COMPANY, L.P.
(Exact name of registrant as specified in its charter)
Delaware 13-3666692
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
American Television and Communications Corporation Delaware 13-2922502
Warner Communications Inc. Delaware 13-2696809
(Exact name of registrant as specified in its charter) (State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
75 Rockefeller Plaza
New York, New York 10019
(212) 484-8000
(Address, including zip code, and telephone number, including
area code, of each 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
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TIME WARNER ENTERTAINMENT COMPANY L.P.
AND TWE GENERAL PARTNERS
INDEX TO FORM 10-Q
Page
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TWE
General
TWE Partners
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PART I. FINANCIAL INFORMATION
Management's discussion and analysis of results of operations and financial condition............. 1 25
Consolidated balance sheets at September 30, 2001 and December 31, 2000........................... 10 30
Consolidated statements of operations for the three and nine months ended September 30, 2001
and 2000....................................................................................... 11 31
Consolidated statements of cash flows for the nine months ended September 30, 2001
and 2000....................................................................................... 12 33
Consolidated statements of partnership capital and shareholders' equity for the
nine months ended September 30, 2001 and 2000.................................................. 13 34
Notes to consolidated financial statements........................................................ 14 35
PART II. OTHER INFORMATION........................................................................ 45
TIME WARNER ENTERTAINMENT COMPANY, L.P.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
Description of Business
AOL Time Warner Inc. ("AOL Time Warner") is the world's first
Internet-powered media and communications company. The Company was formed in
connection with the merger of America Online, Inc. ("America Online") and Time
Warner Inc. ("Time Warner"), which was consummated on January 11, 2001 (the
"Merger"). As a result of the Merger, America Online and Time Warner each became
a wholly owned subsidiary of AOL Time Warner.
A majority of AOL Time Warner's interests in the Filmed Entertainment
and Cable segments, and a portion of its interests in the Networks segment, are
held through Time Warner Entertainment Company, L.P. ("TWE"). AOL Time Warner
owns general and limited partnership interests in TWE consisting of 74.49% of
the pro rata priority capital ("Series A Capital") and residual equity capital
("Residual Capital"), and 100% of the junior priority capital. The remaining
25.51% limited partnership interests in the Series A Capital and Residual
Capital of TWE are held by MediaOne TWE Holdings, Inc., a subsidiary of AT&T
Corp. ("AT&T").
As part of the integration of TWE's businesses into AOL Time Warner's
operating structure, management is pursuing various initiatives to enhance
efficiencies. Such initiatives, some of which have already been implemented,
include the consolidation of certain duplicative administrative and operational
functions and the restructuring of certain under-performing assets. For
additional information on the Merger and TWE's restructuring initiatives, see
Notes 1 and 2, respectively, to the accompanying consolidated financial
statements.
TWE classifies its business interests into three fundamental areas:
Cable, consisting principally of interests in cable television systems; Filmed
Entertainment, consisting principally of interests in filmed entertainment and
television production; and Networks, consisting principally of interests in
cable television and broadcast network programming. TWE also manages the cable
properties owned by AOL Time Warner and the combined cable television operations
are conducted under the name of Time Warner Cable.
AOL Time Warner and AT&T from time to time have engaged in discussions
regarding AT&T's interest in TWE. On February 28, 2001, AT&T delivered to AOL
Time Warner and TWE notice of its exercise of certain registration rights under
the TWE partnership agreement. Actions pursuant to the notice were then
suspended while discussions between AOL Time Warner and AT&T regarding AT&T's
interest in TWE continued. AT&T, AOL Time Warner and TWE have now resumed the
registration rights process that could result in the registration for public
sale or the purchase by TWE of some or all of AT&T's interest in TWE.
Use of EBITDA
TWE evaluates operating performance based on several factors, including
its primary financial measure of operating income (loss) before noncash
depreciation of tangible assets and amortization of goodwill and intangible
assets ("EBITDA"). TWE considers EBITDA an important indicator of the
operational strength and performance of its businesses, including the ability to
provide cash flows to service debt and fund capital expenditures. In addition,
EBITDA eliminates the uneven effect across all business segments of considerable
amounts of noncash depreciation of tangible assets and amortization of goodwill
and intangible assets recognized in business combinations accounted for by the
purchase method. As such, the following comparative discussion of the results of
operations of TWE includes, among other factors, an analysis of changes in
EBITDA. However, EBITDA should be considered in addition to, not as a
1
TIME WARNER ENTERTAINMENT COMPANY, L.P.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION--(Continued)
substitute for, operating income (loss), net income (loss) and other measures of
financial performance reported in accordance with generally accepted accounting
principles.
Transactions Affecting Comparability of Results of Operations
America Online-Time Warner Merger
The Merger was accounted for by AOL Time Warner as an acquisition of
Time Warner under the purchase method of accounting for business combinations.
Under the purchase method of accounting, the estimated cost of approximately
$147 billion to acquire Time Warner, including transaction costs, was allocated
to its underlying net assets, including the net assets of TWE to the extent
acquired, based on their respective estimated fair values. Any excess of the
purchase price over estimated fair values of the net assets acquired was
recorded as goodwill.
As a result of the Merger and the application of the purchase method of
accounting, the accompanying historical operating results and financial
condition are no longer comparable to 2001. Accordingly, in order to enhance
comparability and make an analysis of 2001 meaningful, the following discussion
of results of operations and changes in financial condition and liquidity is
based upon pro forma financial information for 2000 as if the Merger had
occurred on January 1, 2000. These results also reflect reclassifications of
historical operating results and segment information to conform to AOL Time
Warner's financial statement presentation, as follows:
o TWE's digital media results have been allocated to the business segments
now responsible for managing those operations and are no longer treated as
a separate reportable segment;
o Income and losses related to equity-method investments and gains and losses
on the sale of investments have been reclassified from operating income
(loss) to other income (expense), net; and
o Corporate expenses have been reclassified to selling, general and
administrative costs as a reduction of operating income (loss).
Other Significant Transactions and Nonrecurring Items
As more fully described herein, the comparability of TWE's operating
results has been affected by certain significant transactions and nonrecurring
items in 2000. The operating results for the first nine months of 2000, on both
a historical and pro forma basis, included (i) a pretax gain of $10 million in
the first quarter relating to the partial recognition of a deferred gain on the
1998 sale of Six Flags Entertainment Corporation ("Six Flags"), (ii) a $50
million pretax charge in the second quarter relating to the Six Flags
litigation, (iii) a pretax loss of $8 million in the second quarter relating to
the sale or exchange of certain cable systems and investments, (iv) a net pretax
investment-related gain of approximately $65 million recognized in the third
quarter, principally related to additional proceeds received in the third
quarter of 2000 in connection with the 1999 sale of an interest in
CanalSatellite, a satellite television platform servicing France and Monaco, and
(v) a noncash charge of $524 million in the first quarter shown separately in
the accompanying consolidated statement of operations related to the cumulative
effect of an accounting change in connection with the adoption of a new film
accounting standard.
In order to meaningfully assess underlying operating trends, management
believes that the results of operations for each period should be analyzed after
excluding the effects of significant and nonrecurring items. As such, the
following discussion and analysis focuses on amounts and trends adjusted to
exclude the impact of these unusual items.
2
TIME WARNER ENTERTAINMENT COMPANY, L.P.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION--(Continued)
However, unusual items may occur in any period. Accordingly, investors and other
financial statement users individually should consider the types of events and
transactions for which adjustments have been made.
RESULTS OF OPERATIONS
Revenues and EBITDA by business segment are as follows:
Three Months Ended September 30, Nine Months Ended September 30,
------------------------------------------- --------------------------------------------
Revenues EBITDA Revenues EBITDA
------------------------------------------- --------------------------------------------
2001 2000(a) 2001 2000(a) 2001 2000(a) 2001 2000(a)
Historical Pro Forma Historical Pro Forma Historical Pro Forma Historical Pro Forma
---------- --------- ---------- --------- ---------- --------- ---------- ---------
(millions)
Cable............................ $1,513 $1,288 $ 681 $ 614 $ 4,362 $ 3,799 $ 2,009 $ 1,782
Filmed Entertainment............. 1,689 1,688 204 157 4,882 4,710 465 459
Networks......................... 726 658 184 134 2,195 1,993 498 355
Corporate........................ - - (19) (19) - - (58) (56)
Intersegment elimination......... (125) (140) - - (466) (384) - -
------ ------ ------ ------ ------- ------- ------- -------
Total revenues and EBITDA........ $3,803 $3,494 $1,050 $ 886 $10,973 $10,118 $ 2,914 $ 2,540
Depreciation and amortization.... - - (957) (911) - - (2,810) (2,714)
------ ------ ------ ------ ------- ------- ------- -------
Total revenues and operating
income (loss)................. $3,803 $3,494 $ 93 $ (25) $10,973 $10,118 $ 104 $ (174)
====== ====== ===== ====== ======= ======= ======= =======
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(a) 2001 operating results reflect the impact of the America Online-Time Warner
merger. In order to enhance comparability, pro forma financial information
for 2000 is provided as if the Merger had occurred at the beginning of
2000, including certain reclassifications of TWE's historical operating
results to conform to AOL Time Warner's financial statement presentation.
TWE's historical EBITDA and operating income for the three months ended
September 30, 2000 were $889 million and $516 million, respectively. TWE's
historical EBITDA and operating income for the nine months ended September
30, 2000 were $2.548 billion and $1.454 billion, respectively.
Three Months Ended September 30, 2001 Compared to Three Months Ended September
30, 2000
Consolidated Results
TWE had revenues of $3.803 billion and a net loss of $241 million for
the three months ended September 30, 2001, compared to revenues of $3.494
billion on both a pro forma and historical basis and a net loss of $315 million
on a pro forma basis (net income of $248 million on a historical basis) for the
three months ended September 30, 2000.
As previously described, in addition to the consummation of the Merger,
the comparability of TWE's operating results for the third quarter of 2000, on
both a pro forma and historical basis, has been affected by the recognition of a
net pretax investment-related gain of approximately $65 million, principally
related to additional proceeds received in 2000 related to the 1999 sale of an
interest in CanalSatellite.
Revenues. TWE's revenues increased to $3.803 billion in 2001, compared
to $3.494 billion on both a pro forma and historical basis in 2000. This
increase was driven by an increase in subscription revenues of 13% to $1.863
billion, an increase in advertising and commerce revenues of 3% to $319 million
and an increase in content and other revenues of 6% to $1.621 billion.
As discussed more fully below, the increase in subscription revenues
was principally due to an increase in the number of subscribers and higher
subscription rates at both the Cable and Networks segments. The increase in
advertising and commerce revenues was principally due to increased advertising
at the Cable segment and at The WB Network. The
3
TIME WARNER ENTERTAINMENT COMPANY, L.P.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION--(Continued)
increase in content and other revenues was principally due to licensing
arrangements for the continuing second-cycle broadcasting rights and increased
first-cycle broadcasting rights for Friends at the Filmed Entertainment segment.
Net Income (Loss). TWE's net loss decreased by $74 million to $241
million in 2001, compared to $315 million on a pro forma basis in 2000 (net
income of $248 million on a historical basis). Excluding the effect of the
nonrecurring item referred to earlier, TWE's net loss decreased by $139 million
to $241 million in 2001 from $380 million on a pro forma basis in 2000. TWE's
net loss decreased due to higher EBITDA and lower interest expense, offset in
part by increases in depreciation expense and the absence in 2001 of a net
pretax investment-related gain of approximately $65 million related to
additional proceeds received in 2000 in connection with the 1999 sale of an
interest in CanalSatellite.
Depreciation and Amortization. Depreciation and amortization increased
to $957 million in 2001 from $911 million on a pro forma basis in 2000 ($373
million on a historical basis). This increase was due to an increase in
depreciation, primarily reflecting higher levels of capital spending at the
Cable segment related to the roll-out of digital services over the past three
years, offset in part by a decrease in amortization.
Interest Expense, Net. Interest expense, net decreased to $133 million
in 2001, compared to $160 million on both a pro forma and historical basis in
2000, principally as a result of lower market interest rates offset in part by
higher outstanding debt levels.
Other Expense (Income), Net. Other expense, net, increased to $101
million in 2001, compared to $11 million on a pro forma basis in 2000 (other
income of $11 million on a historical basis), primarily due to the absence in
2001 of a net pretax investment-related gain of approximately $65 million
recognized in 2000, principally related to additional proceeds received in 2000
in connection with the 1999 sale of an interest in CanalSatellite and higher
losses on certain investments accounted for under the equity method of
accounting.
Minority Interest Expense. Minority interest expense of $69 million in
2001, was comparable to the $62 million of minority interest expense on both a
pro forma and historical basis in 2000.
Income Tax Provision. As a U.S. partnership, TWE is not subject to U.S.
federal and state income taxation. Income and withholding taxes of $31 million
in 2001 and $57 million on both a pro forma and historical basis in 2000, have
been provided for the operations of TWE's domestic and foreign subsidiary
corporations.
Business Segment Results
Cable. Revenues increased to $1.513 billion in 2001, compared to $1.288
billion in 2000. EBITDA increased to $681 million in 2001 from $614 million on a
pro forma basis in 2000. Revenues increased due to a 15% increase in
subscription revenues and a 42% increase in advertising and commerce revenues.
The increase in subscription revenues was due to higher basic cable rates, an
increase in subscribers to high-speed online services, an increase in digital
cable subscribers and an increase in basic cable subscribers. The increase in
advertising and commerce revenues was primarily related to a general increase in
advertising sales, including advertising purchased by programming vendors to
promote their channel launches. EBITDA increased principally as a result of the
revenue growth, offset in part by higher programming costs related to the
roll-out of digital services and programming rate increases.
Filmed Entertainment-Warner Bros. Revenues increased to $1.689 billion
in 2001, compared to $1.688 billion in 2000. EBITDA increased to $204 million in
2001 from $157 million on a pro forma basis in 2000. Revenues benefited from the
licensing arrangements for continuing second-cycle broadcasting rights and
increased first-cycle
4
TIME WARNER ENTERTAINMENT COMPANY, L.P.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION--(Continued)
broadcasting rights for Friends and higher DVD sales. This benefit was offset
entirely from lower domestic theatrical revenues and lower revenues in the
retail operations, related to the closure of Warner Bros.' Studio Stores. EBITDA
benefited from the licensing of Friends, reduced losses from the closure of the
Studio Store operations and reduced expenses for online development.
Networks. Revenues increased to $726 million in 2001, compared to $658
million in 2000. EBITDA increased to $184 million in 2001 from $134 million on a
pro forma basis in 2000. Revenues grew primarily due to an increase in
subscription revenues at HBO and an increase in advertising and commerce
revenues at The WB Network. For HBO, subscription revenues benefited from an
increase in the number of subscribers and higher rates. For The WB Network, the
increase in advertising and commerce revenues was driven by increased
advertising rates and ratings in key demographic groups and the intercompany
sale of advertising to other business segments of TWE. EBITDA was higher due to
improved results at both HBO and The WB Network. For HBO, the increase in EBITDA
was principally due to the increase in revenues and increased cost savings from
HBO's overhead cost management program. For The WB Network, the EBITDA
improvement was principally due to the increase in advertising and commerce
revenues.
Nine Months Ended September 30, 2001 Compared to Nine Months Ended September 30,
2000
Consolidated Results
TWE had revenues of $10.973 billion and a net loss of $823 million for
the nine months ended September 30, 2001, compared to revenues of $10.118
billion on both a pro forma and historical basis and a loss before the
cumulative effect of an accounting change of $1.078 billion on a pro forma basis
(income before the cumulative effect of an accounting change of $617 million on
a historical basis) for the nine months ended September 30, 2000.
As previously described, in addition to the consummation of the Merger,
the comparability of TWE's operating results for the third quarter of 2000, on
both a pro forma and historical basis, has been affected by the recognition of
certain significant, nonrecurring items aggregating approximately $507 million
of net pretax losses.
Revenues. TWE's revenues increased to $10.973 billion in 2001, compared
to $10.118 billion in 2000. This increase was driven by an increase in
subscription revenues of 12% to $5.472 billion, an increase in advertising and
commerce revenues of 3% to $932 million and an increase in content and other
revenues of 6% to $4.569 billion.
As discussed more fully below, the increase in subscription revenues
was principally due to an increase in the number of subscribers and higher
subscription rates at both the Cable and Networks segments. The increase in
advertising and commerce revenues was principally due to increased advertising
at the Cable segment and at The WB Network. The increase in content and other
revenues was principally due to increased distribution of theatrical product at
the Filmed Entertainment segment.
Net Income (Loss.) TWE's net loss decreased by $779 million to $823
million in 2001, compared to $1.602 billion on a pro forma basis in 2000 (net
income of $93 million on a historical basis). Excluding the effect of the
nonrecurring items referred to earlier, TWE's net loss decreased by $272 million
to $823 million in 2001 from $1.095 billion on a pro forma basis in 2000. TWE's
net loss decreased due to higher EBITDA, lower amortization expense and lower
interest expense, offset in part by increases in depreciation expense and
minority interest.
Depreciation and Amortization. Depreciation and amortization increased
to $2.810 billion in 2001 from $2.714 billion on a pro forma basis in 2000
($1.094 billion on a historical basis). This increase was due to an increase in
5
TIME WARNER ENTERTAINMENT COMPANY, L.P.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION--(Continued)
depreciation, primarily reflecting higher capital spending at the Cable segment
related to the roll-out of digital services over the past three years, offset in
part by a decrease in amortization.
Interest Expense, Net. Interest expense, net decreased to $428 million
in 2001, compared to $461 million on both a pro forma and a historical basis in
2000, principally as a result of lower market interest rates and the absence in
2001 of additional interest expense recognized in the second quarter of 2000
related to the Six Flags litigation, offset in part by higher outstanding debt
levels.
Other Expense, Net. Other expense, net, increased to $188 million in
2001, compared to $180 million on a pro forma basis in 2000 ($113 million on a
historical basis), primarily due to the absence in 2001 of a net pretax
investment-related gain of approximately $65 million, principally related to
additional proceeds received in 2000 in connection with the 1999 sale of an
interest in CanalSatellite, offset in part by higher gains on the sale or
exchange of various unconsolidated cable television systems and investments,
lower losses from certain investments accounted for under the equity method of
accounting and lower losses on asset securitization programs.
Minority Interest Expense. Minority interest expense increased to $242
million in 2001, compared to $145 million on both a pro forma and a historical
basis in 2000. Minority interest expense increased principally due to pretax
gains in 2001 on the exchange of various unconsolidated cable television systems
at an equity investee of the TWE-Advance/Newhouse Partnership attributable to
the minority owners of TWE-A/N and a higher allocation of losses in 2000 to a
minority partner in The WB Network.
Income Tax Expense Provision. As a U.S. partnership, TWE is not subject
to U.S. federal and state income taxation. Income and withholding taxes of $69
million in 2001 and $118 million on both a pro forma and historical basis in
2000, have been provided for the operations of TWE's domestic and foreign
subsidiary corporations.
Business Segment Results
Cable. Revenues increased to $4.362 billion in 2001, compared to $3.799
billion in 2000. EBITDA increased to $2.009 billion in 2001 from $1.782 billion
on a pro forma basis in 2000. Revenues increased due to a 14% increase in
subscription revenues and a 26% increase in advertising and commerce revenues.
The increase in subscription revenues was due to higher basic cable rates, an
increase in subscribers to high-speed online services, an increase in digital
cable subscribers and an increase in basic cable subscribers. The increase in
advertising and commerce revenues was primarily related to a general increase in
advertising sales, including advertising purchased by programming vendors to
promote their channel launches. EBITDA increased principally as a result of the
revenue gains, offset in part by higher programming costs related to the
roll-out of digital services and programming rate increases.
Filmed Entertainment-Warner Bros. Revenues increased to $4.882 billion
in 2001, compared to $4.710 billion in 2000. EBITDA increased to $465 million in
2001 from $459 million on a pro forma basis in 2000. Revenues benefited from the
increased domestic distribution of theatrical product, principally due to higher
DVD sales, and licensing arrangements for continuing second-cycle broadcasting
rights and increased first-cycle broadcasting rights for Friends. This benefit
was offset in part by lower revenues in the retail operations related to the
closure of Warner Bros.' Studio Stores. EBITDA increased principally due to the
increased revenues, reduced losses from the closure of the Studio Store
operations and reduced expenses for online development, offset in part by higher
advertising and distribution costs because of an increase in the number and
timing of new theatrical releases in comparison to the prior year comparable
period.
6
TIME WARNER ENTERTAINMENT COMPANY, L.P.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION--(Continued)
Networks. Revenues increased to $2.195 billion in 2001, compared to
$1.993 billion in 2000. EBITDA increased to $498 million in 2001 from $355
million on a pro forma basis in 2000. Revenues grew primarily due to an increase
in subscription revenues at HBO and an increase in advertising and commerce
revenues at The WB Network. For HBO, subscription revenues benefited primarily
from an increase in the number of subscribers and higher rates. For The WB
Network, the increase in advertising and commerce revenues was driven by
increased advertising rates and ratings in key demographic groups and the
intercompany sale of advertising to other business segments of TWE. EBITDA was
higher due to improved results at both HBO and The WB Network. For HBO, the
increase in EBITDA was principally due to the increase in revenues and increased
cost savings from HBO's overhead cost management program. For The WB Network,
the EBITDA improvement was principally due to the increase in advertising and
commerce revenues.
FINANCIAL CONDITION AND LIQUIDITY
September 30, 2001
Financial Condition
At September 30, 2001, TWE had $8.1 billion of debt, $329 million of
cash and equivalents (net debt of $7.8 billion) and $65.5 billion of partners'
capital, compared to $7.1 billion of debt, $306 million of cash and equivalents
(net debt of $6.8 billion) and $66.4 billion of partners' capital on a pro forma
basis at December 31, 2000. On a historical basis, TWE had $7.1 billion of debt,
$306 million of cash and equivalents (net debt of $6.8 billion) and $6.9 billion
of partners' capital at December 31, 2000.
Cash Flows
During the first nine months of 2001, TWE's cash provided by operations
amounted to $1.997 billion and reflected $2.914 billion of EBITDA and $243
million of proceeds received under TWE's asset securitization program, less $416
million of net interest payments, $139 million of net income taxes paid and $605
million related to an increase in other working capital requirements. Cash
provided by operations of $2.172 billion in the first nine months of 2000
reflected $2.540 billion of pro forma EBITDA and $221 million of proceeds
received under TWE's asset securitization program, less $403 million of net
interest payments, $81 million of net income taxes paid and $105 million related
to an increase in other working capital requirements.
Cash used by investing activities was $2.242 billion in the nine months
of 2001, compared to $1.500 billion in 2000. The cash used by investing
activities in 2001 included $832 million in cash used for the acquisition of
investments and $1.442 billion of capital expenditures, offset in part by $32
million of proceeds received from the sale of investments. The cash used by
investing activities in 2000 included $275 million in cash used for the
acquisition of investments and $1.436 billion of capital expenditures, offset in
part by $211 million of proceeds received from the sale of investments.
Cash provided by financing activities was $268 million in the first
nine months of 2001, compared to cash used by financing activities of $927
million in 2000. Cash provided by financing activities in 2001 primarily related
to $744 million of net borrowings, offset in part by capital distributions of
$404 million. Cash used in financing activities in 2000 primarily related to
$168 million of net debt repayments and $684 million of capital distributions.
Management believes that TWE's operating cash flow, cash and
equivalents and additional borrowing capacity are sufficient to fund its capital
and liquidity needs for the foreseeable future.
7
TIME WARNER ENTERTAINMENT COMPANY, L.P.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION--(Continued)
Cable Capital Spending
TWE's capital spending primarily relates to spending at Time Warner
Cable. Over the past three years, Time Warner Cable has been engaged in a plan
to upgrade the technological capability and reliability of its cable television
systems and develop new services, which management believes will position the
business for sustained, long-term growth. Capital spending by TWE's Cable
division amounted to $1.362 billion in 2001, compared to $1.351 billion in 2000.
As more systems are upgraded, the fixed portion of Cable's capital spending is
replaced with spending that varies based on the number of new subscribers. At
September 30, 2001, TWE's Cable segment managed 2.861 million digital cable
subscribers, a 22.6% penetration of basic cable subscribers. This compares to
1.259 million digital cable subscribers, or a 10.0% penetration of basic cable
subscribers at September 30, 2000. Similarly, the number of high-speed online
customers grew to 1.661 million, or 9.1% of eligible homes, from 719 thousand,
or 5.8% of eligible homes at September 30, 2000. Such rapid growth of
subscribers to these digital services increased the variable capital spending
for digital cable boxes, high-speed modems and associated support equipment.
Cable capital spending for the remainder of 2001 is expected to remain at levels
comparable to 2000, reflecting spending on variable capital commensurate with
the roll-out of Time Warner Cable's popular digital services, including digital
cable and high-speed online services. Capital spending is expected to continue
to be funded by Time Warner Cable's operating cash flow.
Caution Concerning Forward-Looking Statements
The Securities and Exchange Commission (the "SEC") encourages companies
to disclose forward-looking information so that investors can better understand
a company's future prospects and make informed investment decisions. This
document contains such "forward-looking statements" within the meaning of the
Private Securities Litigation Reform Act of 1995, particularly statements
anticipating future growth in revenues, EBITDA and cash flow. Words such as
"anticipates," "estimates," "expects," "projects," "intends," "plans,"
"believes" and words and terms of similar substance used in connection with any
discussion of future operating or financial performance identify such
forward-looking statements. Those forward-looking statements are based on
management's present expectations about future events. As with any projection or
forecast, they are inherently susceptible to uncertainty and changes in
circumstances, and TWE is under no obligation to (and expressly disclaims any
such obligation to) update or alter its forward-looking statements whether as a
result of such changes, new information, future events or otherwise.
TWE operates in highly competitive, consumer-driven and rapidly
changing media and entertainment businesses that are dependent on government
regulation and economic, political and social conditions in the countries in
which they operate, consumer demand for their products and services,
technological developments and (particularly in view of technological changes)
protection of their intellectual property rights. TWE's actual results could
differ materially from management's expectations because of changes in such
factors. Other factors and risks could also cause actual results to differ from
those contained in the forward-looking statements, including those identified in
TWE's other filings with the SEC and the following:
o For TWE's cable business, more aggressive than expected competition from
new technologies and other types of video programming distributors,
including DBS and DSL; increases in government regulation of basic cable or
equipment rates or other terms of service (such as "digital must-carry,"
open access or common carrier requirements); government regulation of other
services, such as broadband cable modem service; increased difficulty in
obtaining franchise renewals; the failure of new equipment (such as digital
set-top boxes) or services (such as digital cable, high-speed online
services, telephony over cable or video on demand) to appeal to enough
consumers or to
8
TIME WARNER ENTERTAINMENT COMPANY, L.P.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION--(Continued)
be available at reasonable prices, to function as expected and to be
delivered in a timely fashion; fluctuations in spending levels by business
and consumers; and greater than expected increases in programming or other
costs.
o For TWE's cable and broadcast television network businesses, greater than
expected programming or production costs; public and cable operator
resistance to price increases (and the negative impact on premium
programmers of increases in basic cable rates); increased regulation of
distribution agreements; the sensitivity of advertising to economic
cyclicality; the development of new technologies that alter the role of
programming networks and services; and greater than expected fragmentation
of consumer viewership due to an increased number of programming services
or the increased popularity of alternatives to television.
o For TWE's film businesses, their ability to continue to attract and select
desirable talent and scripts at manageable costs; general increases in
production costs; fragmentation of consumer leisure and entertainment time
(and its possible negative effects on the broadcast and cable networks,
which are significant customers of these businesses); continued popularity
of merchandising; and the uncertain impact of technological developments.
In addition, TWE's overall financial strategy, including growth in
operations, maintaining its financial ratios and strengthened balance sheet,
could be adversely affected by increased interest rates, failure to meet
earnings expectations, significant acquisitions or other transactions, economic
slowdowns, consequences of the euro conversion and changes in TWE's plans,
strategies and intentions.
9
TIME WARNER ENTERTAINMENT COMPANY, L.P.
CONSOLIDATED BALANCE SHEET
(Unaudited)
September 30, December 31, December 31,
2001 2000 2000
Historical Pro Forma(a) Historical(a)
---------- ------------ -------------
(millions)
ASSETS
Current assets
Cash and equivalents....................................................... $ 329 $ 306 $ 306
Receivables, including $1.205, $1.556 and $1.556 billion due from AOL
Time Warner, less allowances of $754, $677 and $677 million............ 3,712 3,643 3,643
Inventories................................................................ 770 762 762
Prepaid expenses........................................................... 275 200 200
------- ------- -------
Total current assets....................................................... 5,086 4,911 4,911
Noncurrent inventories and film costs...................................... 4,696 3,938 2,579
Investments................................................................ 2,479 2,218 543
Property, plant and equipment.............................................. 8,238 7,468 7,493
Cable television franchises................................................ 20,200 23,100 5,329
Brands and trademarks...................................................... 2,105 2,500 -
Goodwill and other intangible assets....................................... 41,346 39,882 3,603
Other assets............................................................... 1,168 959 1,000
------- ------- -------
Total assets............................................................... $85,318 $84,976 $25,458
======= ======= =======
LIABILITIES AND PARTNERS' CAPITAL
Current liabilities
Accounts payable........................................................... $ 2,479 $ 2,272 $ 2,272
Participations payable..................................................... 990 969 969
Programming costs payable.................................................. 572 455 455
Debt due within one year................................................... 2 3 3
Other current liabilities, including $1.486, $1.223 and $1.223 billion due
to AOL Time Warner..................................................... 2,604 2,799 2,799
------- ------- -------
Total current liabilities.................................................. 6,647 6,498 6,498
Long-term debt, including $2.291 billion due to AOL Time Warner at
September 30, 2001..................................................... 8,106 7,108 7,108
Other long-term liabilities, including $476, $681 and $681 million
due to AOL Time Warner................................................. 3,016 3,045 3,045
Minority interests......................................................... 2,038 1,881 1,881
Partners' capital
Contributed capital........................................................ 66,879 66,793 7,349
Partnership deficit........................................................ (1,368) (349) (423)
------- ------- -------
Total partners' capital.................................................... 65,511 66,444 6,926
------- ------- -------
Total liabilities and partners' capital.................................... $85,318 $84,976 $25,458
======= ======= =======
- -------------------
(a) TWE's historical financial statements for the prior period represent the
financial results of TWE prior to the America Online-Time Warner merger. In
order to enhance comparability, pro forma financial statements for 2000 are
presented supplementally as if the merger of America Online and Time Warner
had occurred at the beginning of 2000 (Note 1).
See accompanying notes.
10
TIME WARNER ENTERTAINMENT COMPANY, L.P.
CONSOLIDATED STATEMENT OF OPERATIONS
(Unaudited)
Three Months Ended September 30, Nine Months Ended September 30,
------------------------------------- ------------------------------------
2001 2000 2000 2001 2000 2000
Historical Pro Forma(a) Historical(a) Historical Pro Forma(a) Historical(a)
---------- ------------ ------------- ---------- ------------ ------------
(millions)
Revenues:
Subscriptions................................... $ 1,863 $ 1,649 $ 1,649 $ 5,472 $ 4,892 $ 4,892
Advertising and commerce........................ 319 310 310 932 901 901
Content and other............................... 1,621 1,535 1,535 4,569 4,325 4,325
------- ------- ------- ------- ------- -------
Total revenues(b).................................. 3,803 3,494 3,494 10,973 10,118 10,118
Cost of revenues(b)................................ (2,429) (2,187) (2,199) (6,945) (6,266) (6,305)
Selling, general and administrative(b)............. (608) (639) (636) (1,904) (1,943) (1,935)
Amortization of goodwill and other intangible
assets......................................... (673) (693) (143) (2,020) (2,083) (424)
------- ------- ------- ------- ------- -------
Operating income (loss)............................ 93 (25) 516 104 (174) 1,454
Interest expense, net.............................. (133) (160) (160) (428) (461) (461)
Other income (expense), net(b)..................... (101) (11) 11 (188) (180) (113)
Minority interest.................................. (69) (62) (62) (242) (145) (145)
------- ------- ------- ------- ------- -------
Income (loss) before income taxes and cumulative
effect of accounting change..................... (210) (258) 305 (754) (960) 735
Income taxes....................................... (31) (57) (57) (69) (118) (118)
------- ------- ------- ------- ------- -------
Income (loss) before cumulative effect of
accounting change............................... (241) (315) 248 (823) (1,078) 617
Cumulative effect of accounting change............. - - - - (524) (524)
------- ------- ------- ------- ------- -------
Net income (loss).................................. $ (241) $ (315) $ 248 $ (823) $(1,602) $ 93
======= ======= ======= ======= ======= =======
- --------------
(a) TWE's historical financial statements for prior periods represent the
financial results of TWE prior to the America Online-Time Warner merger. In
order to enhance comparability, pro forma financial statements for 2000 are
presented supplementally as if the merger of America Online and Time Warner
had occurred at the beginning of 2000, including certain reclassifications
of TWE's historical operating results to conform to AOL Time Warner's
financial statement presentation (Note 1).
(b) Includes the following income (expenses) resulting from transactions with
the partners of TWE and other related companies:
Revenues................................. $274 $224 $224 $715 $443 $443
Cost of revenues......................... (140) (111) (111) (395) (258) (258)
Selling, general and administrative...... (32) (25) (25) (113) (109) (109)
Other income (expense), net.............. 5 11 11 7 20 20
See accompanying notes.
11
TIME WARNER ENTERTAINMENT COMPANY, L.P.
CONSOLIDATED STATEMENT OF CASH FLOWS
Nine Months Ended September 30,
(Unaudited)
2001 2000 2000
Historical Pro Forma(a) Historical(a)
----------- --------- ----------
(millions)
OPERATIONS
Net income (loss) ........................................... $ (823) $(1,602) $ 93
Adjustments for noncash and nonoperating items:
Cumulative effect of accounting change ................... - 524 524
Depreciation and amortization ............................ 2,810 2,714 1,094
Amortization of film costs ............................... 1,322 1,160 1,160
Equity in losses of investee companies after distributions 235 242 164
Changes in operating assets and liabilities ................. (1,547) (866) (863)
------- ------- -------
Cash provided by operations ................................. 1,997 2,172 2,172
------- ------- -------
INVESTING ACTIVITIES
Investments and acquisitions ................................ (832) (275) (275)
Capital expenditures ........................................ (1,442) (1,436) (1,436)
Investment proceeds ......................................... 32 211 211
------- ------- -------
Cash used by investing activities ........................... (2,242) (1,500) (1,500)
------- ------- -------
FINANCING ACTIVITIES
Borrowings .................................................. 3,279 1,250 1,250
Debt repayments ............................................. (2,535) (1,418) (1,418)
Capital distributions ....................................... (404) (684) (684)
Other ....................................................... (72) (75) (75)
------- ------- -------
Cash provided (used) by financing activities ................ 268 (927) (927)
------- ------- -------
INCREASE (DECREASE) IN CASH AND EQUIVALENTS ................. 23 (255) (255)
CASH AND EQUIVALENTS AT BEGINNING OF PERIOD ................. 306 517 517
------- ------- -------
CASH AND EQUIVALENTS AT END OF PERIOD ....................... $ 329 $ 262 $ 262
======= ======= =======
- -------------------
(a) TWE's historical financial statements for prior periods represent the
financial results of TWE prior to the America Online-Time Warner merger. In
order to enhance comparability, pro forma financial statements for 2000,
are presented supplementally as if the merger of America Online and Time
Warner had occurred at the beginning of 2000, including certain
reclassifications of TWE's historical operating results to conform to AOL
Time Warner's financial statement presentation (Note 1).
See accompanying notes.
12
TIME WARNER ENTERTAINMENT COMPANY, L.P.
CONSOLIDATED STATEMENT OF PARTNERSHIP CAPITAL
Nine Months Ended September 30,
(Unaudited)
2001 2000
Historical Historical
---------- ----------
(millions)
BALANCE AT BEGINNING OF PERIOD ................................. $ 6,926 $ 7,149
Allocation of a portion of the purchase price in connection
with America Online-Time Warner merger to TWE ............... 59,518 -
-------- -------
Balance at beginning of period, adjusted to give effect to
the America Online-Time Warner merger ....................... 66,444 7,149
Net income (loss) .............................................. (823) 93
Other comprehensive income (loss) .............................. 2 (57)
-------- -------
Comprehensive income (loss)(a) ................................. (821) 36
Distributions .................................................. (199) (760)
Other .......................................................... 87 16
-------- -------
BALANCE AT END OF PERIOD ....................................... $ 65,511 $ 6,441
======== =======
- -------------------
(a) Comprehensive income (loss) was $(225) million for the three months ended
September 30, 2001 and $237 million for the three months ended September
30, 2000.
See accompanying notes.
13
TIME WARNER ENTERTAINMENT COMPANY, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of Business
AOL Time Warner Inc. ("AOL Time Warner") is the world's first fully
integrated Internet-powered media and communications company. The Company was
formed in connection with the merger of America Online, Inc. ("America Online")
and Time Warner Inc. ("Time Warner"), which was consummated on January 11, 2001
(the "Merger"). As a result of the Merger, America Online and Time Warner each
became a wholly owned subsidiary of AOL Time Warner.
A majority of AOL Time Warner's interests in the Filmed Entertainment and
Cable segments, and a portion of its interests in the Networks segment, are held
through Time Warner Entertainment Company, L.P. ("TWE"). AOL Time Warner owns
general and limited partnership interests in TWE consisting of 74.49% of the pro
rata priority capital ("Series A Capital") and residual equity capital
("Residual Capital"), and 100% of the junior priority capital. The remaining
25.51% limited partnership interests in the Series A Capital and Residual
Capital of TWE are held by MediaOne TWE Holdings, Inc., a subsidiary of AT&T
Corp.
TWE, a Delaware limited partnership, classifies its business interests into
three fundamental areas: Cable, consisting principally of interests in cable
television systems; Filmed Entertainment, consisting principally of interests in
filmed entertainment and television production; and Networks, consisting
principally of interests in cable television and broadcast network programming.
Each of the business interests within Cable, Filmed Entertainment and
Networks is important to TWE's objective of increasing partner value through the
creation, extension and distribution of recognizable brands and copyrights
throughout the world. Such brands and copyrights include (1) Time Warner Cable,
currently the second largest operator of cable television systems in the U.S.,
(2) the unique and extensive film, television and animation libraries of Warner
Bros. and trademarks such as the Looney Tunes characters and Batman, (3) leading
television networks, such as The WB Network, HBO and Cinemax.
The operating results of TWE's various business segments are presented
herein as an indication of financial performance (Note 6). TWE's business
segments generate significant cash flow from operations. The cash flow from
operations generated by such business segments is considerably greater than
their operating income due to significant amounts of noncash amortization of
goodwill and intangible assets recognized primarily in connection with the
America Online-Time Warner merger. Noncash amortization of goodwill and
intangible assets recorded by TWE's business segments amounted to $673 million
in the third quarter of 2001 and $693 million on a pro forma basis in the third
quarter of 2000 ($143 million on a historical basis). Noncash amortization of
intangible assets amounted to $2.020 billion for the first nine months of 2001
and $2.083 billion on a pro forma basis for the first nine months of 2000 ($424
million on a historical basis).
14
TIME WARNER ENTERTAINMENT COMPANY, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
Basis of Presentation
America Online-Time Warner Merger
The Merger has been accounted for by AOL Time Warner as an acquisition of
Time Warner under the purchase method of accounting for business combinations.
Under the purchase method of accounting, the cost of approximately $147 billion
to acquire Time Warner, including transaction costs, was allocated to its
underlying net assets, including the net assets of TWE to the extent acquired,
based on their respective estimated fair values. The excess of the purchase
price over the estimated fair values of the net assets acquired was recorded as
goodwill. This allocation includes intangible assets, such as film and
television libraries, cable television franchises and brands and trademarks. The
goodwill and identified intangible assets are being amortized on a straight-line
basis over the following weighted-average useful lives:
Weighted-Average
Useful Life
-----------
(Years)
Film and television libraries....................... 17
Cable television franchises......................... 25
Brands and trademarks............................... 34
Goodwill............................................ 25
The estimates of the fair values and weighted average useful lives of net
assets acquired, identified intangibles and goodwill are based upon a
preliminary estimate. Additional work needs to be completed to finalize the
allocation of the purchase price to net assets, identified intangibles and
goodwill acquired. TWE does not expect the final allocation of the purchase
price to differ materially from the amounts included in the accompanying
consolidated financial statements.
As discussed further below, the Financial Accounting Standards Board
("FASB") issued Statement of Financial Accounting Standards No. 142, "Goodwill
and Other Intangible Assets," which provides, among other things, for the
nonamortization of goodwill and intangible assets with indefinite useful lives.
Consequently, goodwill and some intangible assets recognized in connection with
the Merger will no longer be amortized, beginning in the first quarter of 2002.
Because the Merger was not consummated on or before December 31, 2000, the
accompanying consolidated financial statements and notes for 2000 reflect only
the financial results of TWE on a historical basis without the significant
amortization created by the Merger. However, in order to enhance comparability,
pro forma consolidated financial statements are presented supplementally to
illustrate the effects of the Merger on the historical financial position and
operating results of TWE. The pro forma financial statements for TWE are
presented as if the Merger between America Online and Time Warner had occurred
on January 1, 2000. These results also reflect reclassifications of TWE's
historical operating results and segment information to conform to the combined
AOL Time Warner's financial statement presentation, as follows:
o TWE's digital media results have been allocated to the business segments
now responsible for managing those operations and are no longer treated as
a separate reportable segment;
o Income and losses related to equity-method investments and gains and losses
on the sale of investments have been reclassified from operating income
(loss) to other income (expense), net; and
15
TIME WARNER ENTERTAINMENT COMPANY, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
o Corporate services have been reclassified to selling, general and
administrative costs as a reduction of operating income (loss).
Interim Financial Statements
The accompanying consolidated financial statements are unaudited but, in
the opinion of management, contain all of the adjustments (consisting of those
of a normal recurring nature) considered necessary to present fairly the
financial position and the results of operations and cash flows for the periods
presented in conformity with generally accepted accounting principles applicable
to interim periods. The accompanying consolidated financial statements should be
read in conjunction with the audited consolidated financial statements of TWE
included in AOL Time Warner's Current Report on Form 8-K/A dated January 11,
2001, filed February 9, 2001 (the "2000 Financial Statements").
Cumulative Effect of Change in Film Accounting Principle
In June 2000, TWE adopted Statement of Position 00-2, "Accounting by
Producers and Distributors of Films" ("SOP 00-2"). SOP 00-2 established new film
accounting standards, including changes in revenue recognition and accounting
for advertising, development and overhead costs. Specifically, SOP 00-2 requires
advertising costs for theatrical and television product to be expensed as
incurred. This compares to TWE's previous policy of first capitalizing and then
expensing advertising costs for theatrical product over the related revenue
streams. In addition, SOP 00-2 requires development costs for abandoned projects
and certain indirect overhead costs to be charged directly to expense, instead
of those costs being capitalized to film costs, which was required under the
previous accounting model. SOP 00-2 also requires all film costs to be
classified in the balance sheet as noncurrent assets.
TWE adopted the provisions of SOP 00-2, retroactively to the beginning of
2000. As a result, TWE's pro forma net loss in 2000 (net income on a historical
basis) includes a one-time, noncash charge of $524 million, primarily to reduce
the carrying value of its film inventory. This charge has been reflected as a
cumulative effect of an accounting change in the accompanying consolidated
statement of operations.
Revenue Classification Changes
In April 2001, the FASB's Emerging Issues Task Force ("EITF") reached a
final consensus on EITF Issue No. 00-25, "Vendor Income Statement
Characterization of Consideration Paid to a Reseller of the Vendor's Products"
("EITF 00-25"). EITF 00-25 will be effective for TWE in the first quarter of
2002. EITF 00-25 clarifies the income statement classification of costs incurred
by a vendor in connection with the reseller's purchase or promotion of the
vendor's products, resulting in certain cooperative advertising and product
placement costs previously classified as selling expenses to be reflected as a
reduction of revenues earned from that activity. TWE management does not believe
that the application of the provisions of EITF 00-25 will have a material impact
on TWE's consolidated financial statements.
16
TIME WARNER ENTERTAINMENT COMPANY, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
Impairment or Disposal of Long-Lived Assets
In August 2001, the FASB issued Statement of Financial Accounting Standards
No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("FAS
144"). FAS 144 clarifies the accounting for the impairment of long-lived assets
and for long-lived assets to be disposed of, including the disposal of business
segments and major lines of business. FAS 144 will be effective for TWE in the
first quarter of 2002. TWE management does not expect that the application of
the provisions of FAS 144 will have a material impact on TWE's consolidated
financial statements.
Asset Retirement Obligations
In July 2001, the FASB issued Statement of Financial Accounting Standards
No. 143, "Accounting for Asset Retirement Obligations" ("FAS 143"). FAS 143
addresses the accounting and reporting for obligations associated with the
retirement of tangible long-lived assets and the associated asset retirement
costs. FAS 143 will be effective for TWE in the first quarter of 2002. TWE
management does not expect that the application of the provisions of FAS 143
will have a material impact on TWE's consolidated financial statements.
Accounting for Business Combinations
In July 2001, the FASB issued Statements of Financial Accounting Standards
No. 141, "Business Combinations" ("FAS 141") and No. 142, "Goodwill and Other
Intangible Assets" ("FAS 142"). These standards change the accounting for
business combinations by, among other things, prohibiting the prospective use of
pooling-of-interests accounting and requiring companies to stop amortizing
goodwill and certain intangible assets with an indefinite useful life created by
business combinations accounted for using the purchase method of accounting.
Instead, goodwill and intangible assets deemed to have an indefinite useful life
will be subject to an annual review for impairment. The new standards generally
will be effective for TWE in the first quarter of 2002 and for purchase business
combinations consummated after June 30, 2001. TWE is in the process of
quantifying the anticipated impact of adopting the provisions of FAS 142, which
is expected to be significant.
Upon adoption, TWE will stop amortizing goodwill, including goodwill
included in the carrying value of certain investments accounted for under the
equity method of accounting. Based on the current levels of goodwill, this would
reduce annual amortization expense and, with respect to equity investees, it
would reduce other expense, net, by approximately $1.7 billion and $100 million,
respectively. The impact of stopping goodwill amortization and the amortization
of goodwill included in the carrying value of equity investees would be to
similarly increase TWE's annual net income by approximately $1.8 billion. In
addition, TWE is in the process of evaluating certain intangible assets to
determine whether they are deemed to have an indefinite useful life. As a result
of this process, TWE may stop amortizing an additional $20 billion to $25
billion of intangible assets. This could result in an additional reduction of
amortization by approximately $800 million to $1 billion, which will have a
corresponding increase in TWE's net income.
As noted above, goodwill and intangible assets deemed to have an indefinite
useful life will be subject to an annual review for impairment. TWE is in the
process of determining whether any such impairment would be recognized upon
adoption of the new accounting standard. If, however, TWE concludes that an
impairment charge for goodwill or intangible assets deemed to have an indefinite
useful life is necessary, such a charge would be non-operational in nature and
reflected as a cumulative effect of an accounting change.
17
TIME WARNER ENTERTAINMENT COMPANY, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities
In September 2000, FASB issued Statement of Financial Accounting Standards
No. 140, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities--a Replacement of FASB Statement No. 125" ("FAS
140"). FAS 140 revises the criteria for accounting for securitizations and other
transfers of financial assets and collateral. In addition, FAS 140 requires
certain additional disclosures. Except for the new disclosure provisions, which
were effective for the year ended December 31, 2000, FAS 140 was effective for
the transfer of financial assets occurring after March 31, 2001. The provisions
of FAS 140 did not have a significant effect on TWE's consolidated financial
statements.
Reclassifications
Certain reclassifications have been made to the prior year's financial
statements to conform to the 2001 presentation.
2. MERGER-RELATED COSTS
America Online-Time Warner Merger
In connection with the Merger, TWE has reviewed its operations and
implemented several plans to restructure its operations ("restructuring plans").
As part of the restructuring plans, TWE accrued an initial restructuring
liability of approximately $210 million during the first quarter of 2001. The
Company accrued an additional $32 million liability during the third quarter as
additional initiatives met the accounting criteria required for recognition. The
restructuring accruals relate to costs to exit and consolidate certain
activities at TWE, as well as costs to terminate employees across the various
business units. Such amounts were recognized as liabilities assumed in the
purchase business combination and included in the allocation of the cost to
acquire Time Warner. Accordingly, such amounts resulted in additional goodwill
being recorded in connection with the Merger.
Of the total restructuring accrual, $61 million related to work force
reductions and represented employee termination benefits. Because certain
employees can defer receipt of termination benefits for up to 24 months, cash
payments will continue after the employee has been terminated. Termination
payments of approximately $14 million were made in the first nine months of
2001, including approximately $4 million in the third quarter of 2001. As of
September 30, 2001, the remaining liability of $47 million was primarily
classified as a current liability in the accompanying consolidated balance
sheet.
The restructuring accrual also includes approximately $181 million
associated with exiting certain activities, primarily related to lease and
contract termination costs. Specifically, TWE plans to exit certain
under-performing operations, including the Studio Store operations included in
the Filmed Entertainment segment. The restructuring accrual associated with
other exiting activities specifically includes incremental costs and contractual
termination obligations for items such as leasehold termination payments and
other facility exit costs incurred as a direct result of these plans, which will
not have future benefits. Payments related to exiting activities were
approximately $45 million in the first nine months of 2001, including
approximately $25 million in the third quarter of 2001. As of September 30,
2001, the remaining liability of $136 million was primarily classified as a
current liability in the accompanying consolidated balance sheet.
18
TIME WARNER ENTERTAINMENT COMPANY, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
The restructuring liabilities recorded are based on TWE's restructuring
plans that have been committed to by management. These restructuring plans are
expected to be refined in the fourth quarter as management continues to evaluate
the integration of the combined companies and completes its purchase price
allocation.
Selected information relating to the restructuring plans follows (in
millions):
Employee Other
Termination Exit Costs Total
----------- ---------- -----
Initial accruals $61 $181 $242
Cash paid (14) (45) (59)
------- ------- -----
Restructuring liability as of September 30, 2001 $47 $136 $183
======= ======= =====
3. SIGNIFICANT TRANSACTIONS
Six Flags
In December 1998, a jury returned an adverse verdict in the Six Flags
Entertainment Corporation ("Six Flags") litigation awarding compensatory and
punitive damages totaling $454 million. TWE and its former 51% partner in Six
Flags were financially responsible for this judgment. TWE appealed the verdict,
but, in July 2000, an appellate court unexpectedly affirmed the jury's verdict.
As a result, TWE revised its estimate of its financial exposure and recorded a
one-time, pretax charge of $50 million in the second quarter of 2000 to cover
its additional financial exposure in excess of established reserves, which
consisted of the unrecognized portion of the deferred gain on the 1998 sale of
Six Flags and accrued interest. The $50 million charge is classified in two
components in the accompanying consolidated statement of operations on a pro
forma basis for the nine months ended September 30, 2000; $26 million of the
charge, representing an accrual for additional interest, is included in interest
expense, net, and the remaining $24 million is included in other income
(expense), net.
The Company has paid in full the compensatory damages portion of the award.
The punitive damages portion of the award and related accrued interest, which
were fully accrued at September 30, 2001, remains in litigation.
Filmed Entertainment Investment-Related Gains
During the third quarter of 2000, Warner Bros. recognized a net pretax
investment-related gain of approximately $65 million, principally relating to
additional proceeds received in the third quarter of 2000 in connection with the
1999 sale of an interest in CanalSatellite, a satellite television platform
servicing France and Monaco. This gain is included in other income (expense),
net, in the accompanying consolidated statement of operations on both a
pro forma and historical basis for the three and nine months ended September 30,
2000.
Loss on Sale or Exchange of Cable Television Systems and Investments
In 2000, largely in an ongoing effort to enhance its geographic clustering
of cable television properties, the Company sold or exchanged various cable
television systems and investments. In connection with the sale or exchange of
unconsolidated cable television systems, approximately $8 million of net pretax
losses were recognized in the second
19
TIME WARNER ENTERTAINMENT COMPANY, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
quarter of 2000 and are included in other income (expense), net, in the
accompanying consolidated statement of operations on both a pro forma and
historical basis for the nine months ended September 30, 2000.
4. INVENTORIES AND FILM COSTS
Inventories and film costs consist of:
September 30, 2001 December 31, 2000 December 31, 2000
Historical Pro Forma Historical
---------- --------- ----------
(millions)
Programming costs, less amortization.......................... $1,161 $1,029 $1,014
Film costs-Theatrical:
Released, less amortization................................ 600 711 711
Completed and not released................................. 557 113 113
In production.............................................. 323 386 386
Development and pre-production............................. 33 25 25
Film costs-Television:
Released, less amortization................................ 55 133 133
Completed and not released................................. 147 194 194
In production.............................................. 37 76 76
Development and pre-production............................. 2 5 5
Film costs-Library, less amortization......................... 2,414 1,800 456
Merchandise................................................... 137 228 228
------ ------ ------
Total inventories and film costs.............................. 5,466 4,700 3,341
Less current portion of inventory............................. 770 762 762
------ ------ ------
Total noncurrent inventories and film costs................... $4,696 $3,938 $2,579
====== ====== ======
5. PARTNERS' CAPITAL
TWE is required to make distributions to reimburse the partners for income
taxes at statutory rates based on their allocable share of taxable income, and
to reimburse AOL Time Warner for stock options granted to employees of TWE based
on the amount by which the market price of AOL Time Warner common stock exceeds
the option exercise price on the exercise date or, with respect to options
granted prior to the TWE capitalization on June 30, 1992, the greater of the
exercise price or the $9.25 market price of AOL Time Warner common stock
(adjusted for the Merger) at the time of the TWE capitalization. TWE accrues a
stock option distribution and a corresponding liability with respect to
unexercised options when the market price of AOL Time Warner common stock
increases during the accounting period, and reverses previously accrued stock
option distributions and the corresponding liability when the market price of
AOL Time Warner common stock declines.
During the nine months ended September 30, 2001, TWE accrued $50 million of
tax-related distributions and $149 million of stock option distributions, based
on closing prices of AOL Time Warner common stock of $33.10 at September 30,
2001 and $34.80 at December 31, 2000. During the nine months ended September 30,
2000, TWE accrued $471 million of tax-related distributions and $289 million of
stock option distributions as a result of an increase at that time in the market
price of AOL Time Warner common stock. During the nine months ended September
30, 2001, TWE paid distributions to the AOL Time Warner General Partners in the
amount of $404 million, consisting of $50 million of tax-related distributions
and $354 million of stock option related distributions. During the nine months
ended September 30, 2000, TWE paid the AOL Time Warner General Partners
distributions in the amount of $684 million, consisting of $471 million of
tax-related distributions and $213 million of stock option related
distributions.
20
TIME WARNER ENTERTAINMENT COMPANY, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
6. SEGMENT INFORMATION
As a result of the Merger, AOL Time Warner management assessed the manner
in which financial information of TWE is reviewed in making operating decisions
and assessing performance. In accordance with FASB's Statement of Financial
Accounting Standards No. 131 "Disclosures About Segments of an Enterprise and
Related Information," TWE reclassified its 2000 historical segment presentation
to conform to the current presentation.
TWE classifies its business interests into three fundamental areas: Cable,
consisting principally of interests in cable television systems; Filmed
Entertainment, consisting principally of interests in filmed entertainment and
television production; and Networks, consisting principally of interests in
cable television and broadcast network programming.
Information as to the operations of TWE in different business segments is
set forth below based on the nature of the products and services offered. TWE
evaluates performance based on several factors, of which the primary financial
measure is operating income (loss) before noncash depreciation of tangible
assets and amortization of goodwill and intangible assets ("EBITDA"). The
accounting policies of the business segments are the same as those described in
the summary of significant accounting policies under Note 1 in TWE's 2000
Financial Statements. Intersegment sales are accounted for at fair value as if
the sales were to third parties.
Three Months Ended September 30, Nine Months Ended September 30,
------------------------------------ ------------------------------------
2001 2000 2000 2001 2000 2000
Historical Pro Forma(a) Historical Historical Pro Forma(a) Historical
---------- --------- ---------- ---------- --------- ----------
(millions)
Revenues
Cable............................................ $1,513 $1,288 $1,288 $ 4,362 $ 3,799 $ 3,799
Filmed Entertainment-Warner Bros. ............... 1,689 1,688 1,688 4,882 4,710 4,710
Networks......................................... 726 658 658 2,195 1,993 1,993
Intersegment elimination......................... (125) (140) (140) (466) (384) (384)
------ ------ ------ ------- ------- -------
Total Revenues................................... $3,803 $3,494 $3,494 $10,973 $10,118 $10,118
====== ====== ====== ======= ======= =======
- -------------------
(a) Pro forma revenues for 2000 include certain reclassifications of each
segment's historical operating results to conform to AOL Time Warner's
financial statement presentation. On a pro forma basis, the Merger had no
impact on TWE's historical consolidated revenues for the nine months ended
September 30, 2000.
Three Months Ended September 30, Nine Months Ended September 30,
------------------------------------ ------------------------------------
2001 2000 2000 2001 2000 2000
Historical Pro Forma(a) Historical Historical Pro Forma(a) Historical
---------- --------- ---------- ---------- --------- ----------
(millions)
EBITDA(b)
Cable............................................ $ 681 $614 $615 $2,009 $1,782 $1,785
Filmed Entertainment-Warner Bros. ............... 204 157 158 465 459 462
Networks......................................... 184 134 135 498 355 357
Corporate........................................ (19) (19) (19) (58) (56) (56)
------ ---- ---- ------ ------ ------
Total EBITDA..................................... $1,050 $886 $889 $2,914 $2,540 $2,548
====== ==== ==== ====== ====== ======
- -------------------
(a) 2001 EBITDA reflects the impact of the America Online-Time Warner merger.
In order to enhance comparability, pro forma EBITDA for 2000 is provided as
if the Merger had occurred at the beginning of 2000, including certain
reclassifications of TWE's historical operating results to conform to AOL
Time Warner's financial statement presentation.
(b) EBITDA represents business segment operating income (loss) before
depreciation of tangible assets and amortization of goodwill and intangible
assets. After deducting depreciation and amortization, TWE reported
operating income (loss) for the third quarter of $93 million in 2001 and
$(25) million on a pro forma basis in 2000 (operating income of $516
million on a historical basis). TWE reported operating income (loss) for
the first nine months of $104 million in 2001 and $(174) million on a pro
forma basis in 2000 (operating income of $1.454 billion on a historical
basis).
21
TIME WARNER ENTERTAINMENT COMPANY, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
Three Months Ended September 30, Nine Months Ended September 30,
------------------------------------ ------------------------------------
2001 2000 2000 2001 2000 2000
Historical Pro Forma(a) Historical Historical Pro Forma(a) Historical
---------- --------- ---------- ---------- --------- ----------
(millions)
Depreciation of Property, Plant and Equipment
Cable............................................ $254 $187 $203 $700 $536 $580
Filmed Entertainment-Warner Bros. ............... 19 22 18 61 67 62
Networks......................................... 8 8 8 24 24 24
Corporate........................................ 3 1 1 5 4 4
---- ---- ---- ---- ---- ----
Total Depreciation............................... $284 $218 $230 $790 $631 $670
==== ==== ==== ==== ==== ====
- -------------------
(a) 2001 depreciation reflects the impact of the America Online-Time Warner
merger. In order to enhance comparability, pro forma depreciation for 2000
is provided as if the Merger had occurred at the beginning of 2000,
including certain reclassifications of TWE's historical operating results
to conform to AOL Time Warner's financial statement presentation.
Three Months Ended September 30, Nine Months Ended September 30,
------------------------------------ ------------------------------------
2001 2000 2000 2001 2000 2000
Historical Pro Forma(a) Historical Historical Pro Forma(a) Historical
---------- --------- ---------- ---------- --------- ----------
(millions)
Amortization of Intangible Assets(b)
Cable............................................ $483 $490 $111 $1,444 $1,471 $329
Filmed Entertainment-Warner Bros. ............... 97 104 30 292 309 91
Networks......................................... 93 99 2 284 303 4
---- ---- ---- ------ ------ ----
Total Amortization............................... $673 $693 $143 $2,020 $2,083 $424
==== ==== ==== ====== ====== ====
- --------------------
(a) 2001 amortization reflects the impact of the America Online-Time Warner
merger. In order to enhance comparability, pro forma amortization for 2000
is provided as if the Merger had occurred at the beginning of 2000,
including certain reclassifications of TWE's historical operating results
to conform to AOL Time Warner's financial statement presentation.
(b) Includes amortization relating to business combinations accounted for by
the purchase method, substantially all of which arose in the merger of
America Online and Time Warner in 2001.
TWE's assets have significantly increased since December 31, 2000 due to
the consummation of the Merger and the allocation of the $147 billion cost to
acquire Time Warner to the underlying net assets of Time Warner, including the
net assets of TWE to the extent acquired, based on their respective estimated
fair values. Any excess of the purchase price over estimated fair value of the
net assets acquired was recorded as goodwill and allocated among AOL Time
Warner's business segments, including the business segments of TWE. As such,
TWE's assets by business segment are as follows:
September 30, December 31,
2001 2000
Historical Pro Forma(a)
---------- ---------
(millions)
Assets
Cable.................................................. $56,440 $56,097
Filmed Entertainment-Warner Bros. ..................... 17,014 16,825
Networks............................................... 11,160 11,654
Corporate.............................................. 704 400
------- -------
Total assets........................................... $85,318 $84,976
======= =======
- -------------------
(a) 2001 assets reflect the impact of the America Online-Time Warner merger. In
order to enhance comparability, pro forma assets as of December 31, 2000
are provided as if the Merger had occurred at the beginning of 2000. TWE's
historical assets as of December 31, 2000 were $25.458 billion.
22
TIME WARNER ENTERTAINMENT COMPANY, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
7. COMMITMENTS AND CONTINGENCIES
In Six Flags Over Georgia LLC et al. v. Time Warner Entertainment Company
et al., following a trial in December 1998, the jury returned a verdict for
plaintiffs and against defendants, including TWE, on plaintiffs' claims for
breaches of fiduciary duty. The jury awarded plaintiffs approximately $197
million in compensatory damages and $257 million in punitive damages, and
interest has been accruing on those amounts at the Georgia annual statutory rate
of twelve percent. The Company has since paid the compensatory damages with
accrued interest. Payment of the punitive damages portion of the award with
accrued interest was stayed by the United States Supreme Court on March 1, 2001
pending the disposition of a certiorari petition with that Court, which was
filed by TWE on June 15, 2001. On October 1, 2001, the United States Supreme
Court granted TWE's petition, vacated the decision by the Georgia Court of
Appeals to affirm the punitive damages award, and remanded the matter to the
Georgia Court of Appeals for further consideration.
The costs and other effects of pending or future litigation, governmental
investigations, legal and administrative cases and proceedings (whether civil or
criminal), settlements, judgments and investigations, claims and changes in
those matters (including the matter described above), and developments or
assertions by or against TWE relating to intellectual property rights and
intellectual property licenses, could have a material adverse effect on TWE's
business, financial condition and operating results.
8. ADDITIONAL FINANCIAL INFORMATION
Cash Flows
Additional financial information with respect to cash flows is as follows:
Nine Months Ended September 30,
---------------------------------
2001 2000 2000
Historical Pro Forma Historical
---------- --------- ----------
(millions)
Cash payments made for interest, net............ $416 $403 $403
Cash payments made for income taxes, net........ 139 81 81
Noncash capital distributions................... - 76 76
Other Expense, Net
Other income (expense), net, consists of:
Three Months Ended September 30, Nine Months Ended September 30,
--------------------------------- ---------------------------------
2001 2000 2000 2001 2000 2000
Historical Pro Forma Historical Historical Pro Forma Historical
---------- --------- ---------- ---------- --------- ----------
(millions)
Investment gains (losses)........................ $ (23) $ 63 $ 63 $ 15 $ 54 $ 54
Losses on equity investees....................... (79) (72) (50) (190) (194) (127)
Losses on asset securitization programs.......... (7) (4) (4) (18) (35) (35)
Miscellaneous.................................... 8 2 2 5 (5) (5)
----- ---- ---- ----- ----- -----
Total other income (expense), net................ $(101) $(11) $ 11 $(188) $(180) $(113)
===== ==== ==== ===== ===== =====
23
TIME WARNER ENTERTAINMENT COMPANY, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
Other Current Liabilities
Other current liabilities consist of:
September 30, December 31, December 31,
2001 2000 2000
Historical Pro Forma Historical
---------- --------- ----------
Accrued expenses................. $1,949 $2,071 $2,071
Accrued compensation............. 267 352 352
Deferred revenues................ 355 297 297
Accrued income taxes............. 33 79 79
------ ------ ------
Total............................ $2,604 $2,799 $2,799
====== ====== ======
24
TWE GENERAL PARTNERS
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
On June 30, 1992, thirteen direct or indirect subsidiaries of Time
Warner Companies, Inc. ("TW Companies") contributed the assets and liabilities
or the rights to the cash flows of substantially all of TW Companies' Filmed
Entertainment-Warner Bros., Cable Networks-HBO and Cable businesses to Time
Warner Entertainment Company, L.P., a Delaware limited partnership ("TWE"), for
general partnership interests, and each general partner guaranteed a pro rata
portion of substantially all of TWE's debt and accrued interest based on the
relative fair value of the net assets each contributed to TWE (the "General
Partner Guarantees"). Since then, eleven of the thirteen original general
partners have been merged or dissolved into the other two. Warner Communications
Inc. ("WCI") and American Television and Communications Corporation ("ATC") are
the two remaining general partners of TWE (collectively, the "General
Partners"). They have succeeded to the general partnership interests and have
assumed the General Partner Guarantees of the eleven former general partners.
The General Partners in the aggregate hold 63.27% of the pro rata
priority capital ("Series A Capital") and residual equity capital ("Residual
Capital") of TWE and 100% of the junior priority capital ("Series B Capital") of
TWE. TW Companies holds, directly or indirectly, 11.22% of the Series A Capital
and Residual Capital limited partnership interests. The remaining 25.51% limited
partnership interests in the Series A Capital and Residual Capital of TWE are
held by MediaOne TWE Holdings, Inc., a subsidiary of AT&T Corp. ("AT&T").
AOL Time Warner Inc. ("AOL Time Warner") and AT&T from time to time
have engaged in discussions regarding AT&T's interest in TWE. On February 28,
2001, AT&T delivered to AOL Time Warner and TWE notice of its exercise of
certain registration rights under the TWE partnership agreement. Actions
pursuant to the notice were then suspended while discussions between AOL Time
Warner and AT&T regarding AT&T's interest in TWE continued. AT&T, AOL Time
Warner and TWE have now resumed the registration rights process that could
result in the registration for public sale or the purchase by TWE of some or all
of AT&T's interest in TWE.
On January 11, 2001, America Online, Inc. ("America Online") and Time
Warner Inc. ("Time Warner") merged to form AOL Time Warner, the world's
first Internet-powered media and communications company (the "Merger"). As a
result of the Merger, America Online and Time Warner each became a wholly owned
subsidiary of AOL Time Warner and WCI and ATC each became an indirect, wholly
owned, subsidiary of AOL Time Warner.
Set forth below is a discussion of the results of operations and
financial condition of WCI, the only General Partner with independent business
operations. WCI conducts substantially all of AOL Time Warner's music
operations, which include copyrighted music from many of the world's leading
recording artists that is produced and distributed by a family of established
record labels such as Warner Bros. Records, Atlantic Records, Elektra
Entertainment and Warner Music International. The financial position and results
of operations of ATC are principally derived from its investments in TWE, TW
Companies, Turner Broadcasting System, Inc. and Time Warner Telecom Inc., and
its revolving credit agreement with TW Companies. Capitalized terms are as
defined and described in the accompanying consolidated financial statements, or
elsewhere herein.
As part of the integration of WCI's businesses into AOL Time Warner's
operating structure, management is pursuing various initiatives to enhance
efficiencies. Such initiatives, some of which have already been implemented,
include the consolidation of certain duplicative administrative and operational
functions and the restructuring of certain under-performing assets. For
additional information on the Merger and WCI's restructuring initiatives, see
Notes 1 and 2, respectively, to the accompanying consolidated financial
statements.
25
TWE GENERAL PARTNERS
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION--(Continued)
Use of EBITDA
WCI evaluates operating performance based on several factors, including
its primary financial measure of operating income (loss) before noncash
depreciation of tangible assets and amortization of goodwill and intangible
assets ("EBITDA"). WCI considers EBITDA an important indicator of the
operational strength and performance of its businesses, including the ability to
provide cash flows to service debt and fund capital expenditures. As such, the
following comparative discussion of the results of operations of WCI includes,
among other factors, an analysis of changes in EBITDA. However, EBITDA should
be considered in addition to, not as a substitute for, operating income (loss),
net income (loss) and other measures of financial performance reported in
accordance with generally accepted accounting principles.
Transactions Affecting Comparability of Results of Operations
America Online-Time Warner Merger
The Merger was accounted for by AOL Time Warner as an acquisition of
Time Warner under the purchase method of accounting for business combinations.
Under the purchase method of accounting, the estimated cost of approximately
$147 billion to acquire Time Warner, including transaction costs, was allocated
to its underlying net assets, including the net assets of the General Partners
and the net assets of TWE to the extent acquired, based on their respective
estimated fair values. Any excess of the purchase price over estimated fair
values of the net assets acquired was recorded as goodwill.
As a result of the Merger, the accompanying historical operating
results and financial condition reflect reclassifications to conform to AOL Time
Warner's financial statement presentation, as follows:
o Digital media results have been allocated to the business segments now
responsible for managing those operations, including WCI's music
operations;
o Income and losses related to equity-method investments and gains and losses
on the sale of investments have been reclassified from operating income
(loss) to other income (expense), net; and
o Corporate expenses have been reclassified to selling, general and
administrative costs as a reduction of operating income (loss).
RESULTS OF OPERATIONS
Three Months Ended September 30, 2001 Compared to the Three Months Ended
September 30, 2000
WCI had revenues of $939 million and net loss of $355 million for the
three months ended September 30, 2001, compared to revenues of $949 million and
net income of $96 million for the three months ended September 30, 2000. EBITDA
decreased to $86 million in 2001 from $110 million in 2000. Operating income
decreased to a loss of $149 million in 2001 from operating income of $29 million
in 2000. Revenues decreased primarily due to the negative effect of changes in
foreign currency exchange rates on international music operations. Excluding the
negative impact of foreign currency exchange rates, revenues increased primarily
due to higher international recorded music sales, offset
26
TWE GENERAL PARTNERS
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION--(Continued)
in part by lower industry-wide domestic recorded music sales and higher product
returns. The decrease in EBITDA principally related to the reduction in
revenues, higher marketing costs, including the cost of promoting new artists,
and higher worldwide provisions for bad debts, offset in part by higher income
from DVD manufacturing operations and lower artist royalty costs. The revenue
decline relating to lower industry-wide domestic recorded music sales levels
could continue for the remainder of the year.
WCI's equity in the pretax income (loss) of TWE was $(107) million for
the three months ended September 30, 2001, compared to $181 million for the
three months ended September 30, 2000. TWE's pretax income decreased in 2001 as
compared to 2000 principally as a result of the Merger and the application of
the purchase method of accounting at TWE. This decrease was primarily as a
result of increased amortization of goodwill and other intangible assets
recorded in connection with the Merger, including the amortization of goodwill
included in the carrying value of investments accounted for under the equity
method, which is recorded in other expense, net.
Interest expense, net, was $8 million in 2001, compared to $1 million
in 2000. The reason for the increase was the recognition of interest associated
with a long-term liability for artist contracts, which was established as a
result of the Merger and the application of the purchase method of accounting.
There was other expense, net, of $48 million in 2001, compared to $36
million in 2000. The increase in other expense, net, was principally because of
higher losses from certain investments accounted for under the equity method of
accounting. Such losses primarily relate to the amortization of goodwill and
intangible assets associated with these investments recorded in connection with
the Merger.
The relationship between income before income taxes and income tax
expense for the General Partners is principally affected by the amortization of
goodwill and certain other financial statement expenses that are not deductible
for income tax purposes. Income tax expense for each of the General Partners
includes all income taxes related to its allocable share of partnership income
of TWE.
Nine Months Ended September 30, 2001 Compared to the Nine Months ended September
30, 2000
WCI had revenues of $2.715 billion and net loss of $1.132 billion for
the nine months ended September 30, 2001, compared to revenues of $2.884 billion
and net loss of $66 million for the nine months ended September 30, 2000. EBITDA
decreased to $267 million in 2001 from $342 million in 2000. Operating income
decreased to a loss of $429 million in 2001 from operating income of $99
million in 2000. Revenues decreased primarily due to the negative effect of
changes in foreign currency exchange rates on international music operations,
lower industry-wide recorded music sales and higher product returns. The
decrease in EBITDA principally related to the reduction in revenues, higher
marketing costs, including the cost of promoting new artists, and higher
worldwide provisions for bad debts, offset in part by higher income from DVD
manufacturing operations and lower artist royalty costs. The revenue decline
relating to lower industry-wide recorded music sales levels could continue for
the remainder of the year.
WCI's equity in the pretax income (loss) of TWE was $(334) million for
the nine months ended September 30, 2001, compared to $436 million for the nine
months ended September 30, 2000. TWE's pretax income decreased in 2001 as
compared to 2000 principally as a result of the Merger and the application of
the purchase method of accounting at TWE. This decrease was primarily as a
result of increased amortization of goodwill and other intangible assets
recorded in connection with the Merger, including the amortization of goodwill
included in the carrying value of investments accounted for under the equity
method, which is recorded in other expense, net.
27
TWE GENERAL PARTNERS
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION--(Continued)
Interest expense, net, was $19 million in 2001, compared to $2 million
in 2000. The reason for the increase was the recognition of interest associated
with a long-term liability for artist contracts, which was established as a
result of the Merger and the application of the purchase method of accounting.
There was other expense, net, of $276 million in 2001, compared to $207
million in 2000. The increase in other expense, net, was principally because of
higher losses from certain investments accounted for under the equity method of
accounting. Such losses primarily relate to the amortization of goodwill and
intangible assets associated with these investments recorded in connection with
the Merger. The higher losses were partially offset by the absence in 2001 of a
$115 million noncash pretax charge in 2000 to reduce the carrying value of
WCI's investment in Columbia House.
The relationship between income before income taxes and income tax
expense for the General Partners is principally affected by the amortization of
goodwill and certain other financial statement expenses that are not deductible
for income tax purposes. Income tax expense for each of the General Partners
includes all income taxes related to its allocable share of partnership income
of TWE.
FINANCIAL CONDITION AND LIQUIDITY
September 30, 2001
Financial Condition
WCI had $59.8 billion of equity at September 30, 2001, compared to $8.8
billion of equity at December 31, 2000. The increase in equity is primarily as a
result of the Merger and the application of the purchase method of accounting at
WCI. Cash and equivalents were zero at September 30, 2001, compared to $36
million at December 31, 2000. WCI had no borrowings outstanding to TW Companies
under its revolving credit agreement at the end of either period.
ATC had $29.3 billion of equity at September 30, 2001, compared to $2.1
billion at December 31, 2000. The increase is primarily as a result of the
Merger and the application of the purchase method of accounting at ATC. Although
ATC has no independent operations, it is expected that additional tax-related
and other distributions from TWE, as well as availability under ATC's revolving
credit agreement with TW Companies, will continue to be sufficient to satisfy
ATC's obligations with respect to its tax-sharing agreement with TW Companies
for the foreseeable future.
Cash Flows
In the first nine months of 2001, WCI's cash provided by operations
amounted to $219 million and reflected $267 million of EBITDA and $240 million
of distributions from TWE, less $148 million of proceeds repaid under WCI's
asset securitization program, $62 million of net income tax payments (net of $12
million received from TW Companies under a tax-sharing agreement), $5 million
of net interest payments and $73 million related to an increase in other working
capital requirements. In the first nine months of 2000, cash provided by WCI's
operations of $271 million reflected $342 million of EBITDA and $405 million of
distributions from TWE, less $37 million of proceeds repaid under WCI's asset
securitization program, $12 million of net income taxes ($68 million of which
was paid to TW Companies under a tax-sharing agreement), $10 million of interest
payments and $417 million related to an increase in other working capital
requirements.
Cash used by investing activities was $225 million in the first nine
months of 2001, compared to $132 million in the first nine months of 2000 as a
result of an increase in investments and acquisitions.
28
TWE GENERAL PARTNERS
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION--(Continued)
Cash used by financing activities was $30 million in the first nine
months of 2001, compared to $148 million in the first nine months of 2000 as a
result of decreased advances to TW Companies, offset in part by increased
dividend payments.
Management believes that WCI's operating cash flow and borrowing
availability under its revolving credit agreement with TW Companies are
sufficient to fund its capital and liquidity needs for the foreseeable future
without cash distributions from TWE above those permitted by existing
agreements.
WCI and ATC have no claims on the assets and cash flows of TWE except
through the payment of certain reimbursements and cash distributions. During the
nine months ended September 30, 2001, the General Partners received an aggregate
$404 million of distributions from TWE, consisting of $50 million of tax-related
distributions and $354 million of stock option related distributions. During the
nine months ended September 30, 2000, the General Partners received an aggregate
$684 million of distributions, consisting of $471 million of tax-related
distributions and $213 million of stock option related distributions. Of such
aggregate distributions, WCI received $240 million during the nine months ended
September 30, 2001 and $405 million in 2000 and ATC received $164 million during
the nine months ended September 30, 2001 and $279 million in 2000.
29
TWE GENERAL PARTNERS
CONSOLIDATED BALANCE SHEETS
(Unaudited)
WCI ATC
--------------------------- ----------------------------
September 30, December 31, September 30, December 31,
2001 2000 2001 2000
---- ---- ---- ----
(millions)
ASSETS
Current assets
Cash and equivalents.................................. $ - $ 36 $ - $ -
Receivables, less allowances of $269 and
$267 million....................................... 954 1,708 - -
Inventories........................................... 149 164 - -
Prepaid expenses...................................... 877 883 - -
------- ------- ------- ------
Total current assets.................................. 1,980 2,791 - -
Investments in and amounts due to and from TWE........ 37,434 2,060 25,715 1,852
Investments in TW Companies........................... 103 103 60 60
Other investments..................................... 6,476 1,361 3,732 457
Music catalogues and copyrights....................... 2,935 704 - -
Brands and trademarks................................. 1,636 - - -
Goodwill.............................................. 11,492 3,463 - -
Other assets, primarily property, plant and
equipment.......................................... 611 564 - -
------- ------- ------- ------
Total assets.......................................... $62,667 $11,046 $29,507 $2,369
======= ======= ======= ======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Accounts and royalties payable........................ $ 962 $ 1,097 $ - $ -
Other current liabilities............................. 597 515 - -
------- ------- ------- ------
Total current liabilities............................. 1,559 1,612 - -
Long-term liabilities, including $282, $403, $212 and
$294 million, respectively, due to TW Companies.... 1,273 658 212 294
Shareholders' equity
Common stock.......................................... 1 1 1 1
Preferred stock of WCI, $.01 par value, 90,000
shares outstanding and $90 million liquidation
preference......................................... - - - -
Paid-in capital....................................... 62,043 9,931 30,025 2,341
Retained earnings (deficit)........................... (909) 329 (89) 386
------- ------- ------- ------
61,135 10,261 29,937 2,728
Due from TW Companies, net............................ (714) (899) (306) (317)
Reciprocal interest in TW Companies stock............. (586) (586) (336) (336)
------- ------- ------- ------
Total shareholders' equity............................ 59,835 8,776 29,295 2,075
------- ------- ------- ------
Total liabilities and shareholders' equity............ $62,667 $11,046 $29,507 $2,369
======= ======= ======= ======
See accompanying notes.
30
TWE GENERAL PARTNERS
CONSOLIDATED STATEMENTS OF OPERATIONS
Three Months Ended September 30,
(Unaudited)
WCI ATC
---------------- -----------------
2001 2000 2001 2000
---- ---- ---- ----
(millions)
Content and other revenues(a)...................................... $ 939 $ 949 $ - $ -
----- ----- ------ -----
Cost of revenues(a)................................................ (465) (563) - -
Selling, general and administrative(a)............................. (412) (297) - -
Amortization of goodwill and other intangibles..................... (211) (60) - -
----- ----- ------ -----
Operating income (loss)............................................ (149) 29 - -
Equity in pretax income (loss) of TWE(a)........................... (107) 181 (75) 124
Interest expense, net.............................................. (8) (1) (1) -
Other income (expense), net(a)..................................... (48) (36) 14 8
----- ----- ------ -----
Income (loss) before income taxes.................................. (312) 173 (62) 132
Income tax expense(a).............................................. (43) (77) (41) (50)
----- ----- ------ -----
Net income (loss).................................................. $(355) $ 96 $ (103) $ 82
====== ===== ======= =====
- ------------------
(a) Includes the following income (expenses) resulting from transactions with
AOL Time Warner, TW Companies, TWE or equity investees of the General
Partners:
Revenues.................................................... $ 47 $ 46 $ - $ -
Cost of revenues............................................ (1) (3) - -
Selling, general and administrative......................... (5) (7) - -
Equity in pretax income (loss) of TWE....................... (19) (14) - -
Other income (expense), net................................. 1 (1) - -
Income tax expense.......................................... (27) (31) (7) (27)
See accompanying notes.
31
TWE GENERAL PARTNERS
CONSOLIDATED STATEMENTS OF OPERATIONS
Nine Months Ended September 30,
(Unaudited)
WCI ATC
---------------- ---------------
2001 2000 2001 2000
---- ---- ---- ----
(millions)
Content and other revenues(a) ............................. $ 2,715 $ 2,884 $ - $ -
------- ------- ------- -------
Cost of revenues(a) ....................................... (1,266) (1,560) - -
Selling, general and administrative(a) .................... (1,252) (1,044) - -
Amortization of goodwill and other intangibles ............ (626) (181) - -
------- ------- ------- -------
Operating income (loss) ................................... (429) 99 - -
Equity in pretax income (loss) of TWE(a) .................. (334) 436 (230) 299
Interest expense, net ..................................... (19) (2) (1) -
Other income (expense), net(a) ............................ (276) (207) (132) 29
------- ------- ------- -------
Income (loss) before income taxes and cumulative effect
of accounting change ................................. (1,058) 326 (363) 328
Income tax expense(a) ..................................... (74) (190) (56) (143)
------- ------- ------- -------
Income (loss) before cumulative effect of accounting
change................................................ (1,132) 136 (419) 185
Cumulative effect of accounting change, net of
$135 million income tax benefit for WCI and
$91 million income tax benefit for ATC ............... - (202) - (136)
------- ------- ------- -------
Net income (loss) ......................................... $(1,132) $ (66) $ (419) $ 49
======= ======= ======= =======
- ----------------------
(a) Includes the following income (expenses) resulting from transactions with
AOL Time Warner, TW Companies, TWE or equity investees of the General
Partners:
Revenues........................................... $158 $189 $ - $ -
Cost of revenues................................... (3) (8) - -
Selling, general and administrative................ (14) (12) - -
Equity in pretax income (loss) of TWE.............. (69) (72) - -
Other income (expense), net........................ 17 1 - -
Income tax benefit (expense)....................... 12 (68) 2 (95)
See accompanying notes.
32
TWE GENERAL PARTNERS
CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended September 30,
(Unaudited)
WCI ATC
---------------- ---------------
2001 2000 2001 2000
---- ---- ---- ----
(millions)
OPERATIONS
Net income (loss) ................................................ $(1,132) $ (66) $ (419) $ 49
Adjustments for noncash and nonoperating items:
Cumulative effect of accounting change ...................... - 202 - 136
Depreciation and amortization ............................... 696 243 - -
Excess of distributions over equity in pretax income of TWE.. 574 (31) 394 (20)
Equity in losses (income) of other investee companies after
distributions ............................................. 265 59 132 (13)
Changes in operating assets and liabilities ...................... (184) (136) 26 120
------- ------- ------- -------
Cash provided by operations ...................................... 219 271 133 272
------- ------- ------- -------
INVESTING ACTIVITIES
Investments and acquisitions ..................................... (109) (21) - -
Capital expenditures ............................................. (126) (111) - -
Proceeds from sale of investments/fixed assets ................... 10 - - -
------- ------- ------- -------
Cash used by investing activities ................................ (225) (132) - -
------- ------- ------- -------
FINANCING ACTIVITIES
Dividends ........................................................ (215) (131) (144) (87)
(Increase) decrease in amounts due from TW Companies, net ........ 185 (17) 11 (185)
------- ------- ------- -------
Cash used by financing activities ................................ (30) (148) (133) (272)
------- ------- ------- -------
DECREASE IN CASH AND EQUIVALENTS ................................. (36) (9) - -
CASH AND EQUIVALENTS AT BEGINNING OF PERIOD ...................... 36 107 - -
------- ------- ------- -------
CASH AND EQUIVALENTS AT END OF PERIOD ............................ $ - $ 98 $ - $ -
======= ======= ======= =======
See accompanying notes.
33
TWE GENERAL PARTNERS
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Nine Months Ended September 30,
(Unaudited)
WCI ATC
----------------- -----------------
2001 2000 2001 2000
---- ---- ---- ----
(millions)
BALANCE AT BEGINNING OF PERIOD..................................... $ 8,776 $8,737 $ 2,075 $2,137
Net income (loss).................................................. (1,132) (66) (419) 49
Other comprehensive loss........................................... (15) (42) 3 (17)
------- ------ ------- ------
Comprehensive loss................................................. (1,147) (108) (416) 32
Increase in stock option distribution liability to
TW Companies(a)................................................. (88) (171) (61) (118)
Dividends.......................................................... (5) (700) - -
Transfers to TW Companies, net..................................... 185 678 11 (185)
Allocation of a portion of the purchase price of the America
Online-Time Warner merger to WCI and ATC........................ 52,112 - 27,685 -
Other.............................................................. 2 6 1 5
------- ------ ------- ------
BALANCE AT END OF PERIOD........................................... $59,835 $8,442 $29,295 $1,871
======= ====== ======= ======
- ------------------
(a) The General Partners record distributions to TW Companies and a
corresponding receivable from TWE as a result of the stock option related
distribution provisions of the TWE partnership agreement. Stock option
distributions of $88 million and $171 million for WCI and $61 million and
$118 million for ATC were accrued in the first nine months of 2001 and
2000, respectively, because of an increase in the market price of AOL Time
Warner common stock (Note 4).
See accompanying notes.
34
TWE GENERAL PARTNERS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION
Description of Business
On June 30, 1992, thirteen direct or indirect subsidiaries of Time
Warner Companies, Inc. ("TW Companies") contributed the assets and liabilities
or the rights to the cash flows of substantially all of TW Companies' Filmed
Entertainment-Warner Bros., Cable Networks-HBO and Cable businesses to Time
Warner Entertainment Company, L.P., a Delaware limited partnership ("TWE"), for
general partnership interests, and each general partner guaranteed a pro rata
portion of substantially all of TWE's debt and accrued interest based on the
relative fair value of the net assets each contributed to TWE (the "General
Partner Guarantees," see Note 5). Since then, eleven of the thirteen original
general partners have been merged or dissolved into the other two. Warner
Communications Inc. ("WCI") and American Television and Communications
Corporation ("ATC") are the two remaining general partners of TWE. They have
succeeded to the general partnership interests and have assumed the General
Partner Guarantees of the eleven former general partners. WCI, ATC and, where
appropriate, the former general partners are referred to herein as the "General
Partners."
WCI conducts substantially all of TW Companies' music operations,
which include copyrighted music from many of the world's leading recording
artists that is produced and distributed by a family of established record
labels such as Warner Bros. Records, Atlantic Records, Elektra Entertainment and
Warner Music International. ATC does not conduct operations independent of its
ownership interests in TWE and certain other investments.
On January 11, 2001, America Online, Inc. ("America Online") and Time
Warner Inc. ("Time Warner") merged to form AOL Time Warner Inc. ("AOL Time
Warner"), the world's first Internet-powered media and communications company
(the "Merger"). As a result of the Merger, America Online and Time Warner each
became a wholly owned subsidiary of AOL Time Warner and WCI and ATC each became
an indirect, wholly owned subsidiary of AOL Time Warner.
Basis of Presentation
America Online-Time Warner Merger
The Merger has been accounted for by AOL Time Warner as an acquisition
of Time Warner under the purchase method of accounting for business
combinations. Under the purchase method of accounting, the cost of approximately
$147 billion to acquire Time Warner, including transaction costs, was allocated
to its underlying net assets, including the net assets of the General Partners,
based on their respective estimated fair values. The excess of the purchase
price over the estimated fair values of the net assets acquired was recorded as
goodwill. This allocation includes intangible assets for WCI, such as music
catalogues and music copyrights and brands and trademarks. The goodwill and
identified intangible assets are being amortized on a straight-line basis over
the following weighted-average useful lives:
35
TWE GENERAL PARTNERS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(Unaudited)
Weighted-Average
Useful Life
-----------
(Years)
Music catalogues and copyrights..................................... 20
Brands and trademarks............................................... 30
Goodwill............................................................ 20
The estimates of the fair values and weighted average useful lives of
net assets acquired, identified intangibles and goodwill are based upon a
preliminary estimate. Additional work needs to be completed to finalize the
allocation of the purchase price to net assets, identified intangibles and
goodwill acquired. WCI does not expect the final allocation of the purchase
price to differ materially from the amounts included in the accompanying
consolidated financial statements.
As discussed further below, the Financial Accounting Standards Board
("FASB") issued Statement of Financial Accounting Standards No. 142, "Goodwill
and Other Intangible Assets," which provides, among other things, for the
nonamortization of goodwill and intangible assets with indefinite useful lives.
Consequently, goodwill and some intangible assets recognized in connection with
the Merger will no longer be amortized, beginning in the first quarter of 2002.
As a result of the Merger, WCI's historical operating results reflect
reclassifications to conform to AOL Time Warner's financial statement
presentation, as follows:
o Digital media results have been allocated to the business segments now
responsible for managing those operations, including WCI's music
operations;
o Income and losses related to equity-method investments and gains and losses
on the sale of investments have been reclassified from operating income
(loss) to other income (expense), net; and
o Corporate services have been reclassified to selling, general and
administrative costs as a reduction of operating income (loss).
Interim Financial Statements
The accompanying consolidated financial statements are unaudited but,
in the opinion of management, contain all the adjustments (consisting of those
of a normal recurring nature) considered necessary to present fairly the
financial position and the results of operations and cash flows for the periods
presented in conformity with generally accepted accounting principles applicable
to interim periods. The accompanying consolidated financial statements should be
read in conjunction with the audited consolidated financial statements of the
General Partners included in AOL Time Warner's Current Report on Form 8-K/A
dated January 11, 2001, filed February 9, 2001 (the "2000 Financial
Statements").
Cumulative Effect of Change in Film Accounting Principle
In June 2000, Time Warner and TWE adopted Statement of Position 00-2,
"Accounting by Producers and Distributors of Films" ("SOP 00-2"). SOP 00-2
established new film accounting standards, including changes in revenue
recognition and accounting for advertising, development and overhead costs.
Specifically, SOP 00-2 requires advertising costs for theatrical and television
products to be expensed as incurred. This compares to Time Warner's and TWE's
36
TWE GENERAL PARTNERS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(Unaudited)
previous policy of first capitalizing and then expensing advertising costs for
theatrical products over the related revenue streams. In addition, SOP 00-2
requires development costs for abandoned projects and certain indirect overhead
costs to be charged directly to expense, instead of those costs being
capitalized to film costs, which was required under the previous accounting
model. SOP 00-2 also requires all film costs to be classified in the balance
sheet as noncurrent assets.
Time Warner and TWE adopted the provisions of SOP 00-2 retroactively to
the beginning of 2000. Because WCI and ATC have investments in TWE and other
Time Warner consolidated subsidiaries, which are accounted for under the equity
method, net income for the nine months ended September 30, 2000 includes a
one-time, noncash, after-tax charge of $202 million for WCI and $136 million for
ATC. These charges have been reflected as a cumulative effect of an accounting
change in the accompanying consolidated statement of operations for the nine
months ended September 30, 2000.
Revenue Classification Changes
Securities and Exchange Commission Staff Accounting Bulletin No. 101
- --------------------------------------------------------------------
In the fourth quarter of 2000, WCI adopted Securities and Exchange
Commission Staff Accounting Bulletin No. 101, "Revenue Recognition in
Financial Statements" ("SAB 101"). SAB 101 clarifies certain existing accounting
principles for the timing of revenue recognition and the classification of
revenues in financial statements. While WCI's existing revenue recognition
policies were consistent with the provisions of SAB 101, the new rules resulted
in changes as to how revenues from certain transactions are classified. As a
result of applying the provisions of SAB 101, WCI's revenues and costs were
increased by an equal amount of $11 million during the third quarter of 2000 and
$73 million during the nine months ended September 30, 2000.
Emerging Issues Task Force Issue No. 00-25
- ------------------------------------------
In April 2001, the FASB's Emerging Issues Task Force ("EITF") reached
a final consensus on EITF Issue No. 00-25 "Vendor Income Statement
Characterization of Consideration Paid to a Reseller of the Vendor's
Products" ("EITF 00-25"). EITF 00-25 will be effective for WCI and ATC in
the first quarter of 2002. EITF 00-25 clarifies the income statement
classification of costs that are incurred by a vendor in connection with
the reseller's purchase or promotion of the vendor's products, resulting in
certain cooperative advertising and product placement costs previously
classified as selling expenses to be reflected as a reduction of revenues
earned from that activity. Management does not believe that the application
of the provisions of EITF 00-25 will have a material impact on WCI's or ATC's
consolidated financial statements.
Impairment or Disposal of Long-Lived Assets
In August 2001, the FASB issued Statement of Financial Accounting
Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets" ("FAS 144"). FAS 144 clarifies the accounting for the impairment of
long-lived assets and for long-lived assets to be disposed of, including the
disposal of business segments and major lines of business. FAS 144 will be
effective for WCI and ATC in the first quarter of 2002. Management does not
expect that the application of the provisions of FAS 144 will have a material
impact on WCI's or ATC's consolidated financial statements.
37
TWE GENERAL PARTNERS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(Unaudited)
Asset Retirement Obligations
In July 2001, the FASB issued Statement of Financial Accounting
Standards No. 143, "Accounting for Asset Retirement Obligations" ("FAS 143").
FAS 143 addresses the accounting and reporting for obligations associated with
the retirement of tangible long-lived assets and the associated asset retirement
costs. FAS 143 will be effective for WCI and ATC in the first quarter of 2002.
Management does not expect that the application of the provisions of FAS 143
will have a material impact on WCI's or ATC's consolidated financial statements.
Accounting for Business Combinations
In July 2001, the FASB issued Statements of Financial Accounting
Standards No. 141, "Business Combinations" ("FAS 141") and No. 142, "Goodwill
and Other Intangible Assets" ("FAS 142"). These standards change the accounting
for business combinations by, among other things, prohibiting the prospective
use of pooling-of-interests accounting and requiring companies to stop
amortizing goodwill and certain intangible assets with an indefinite useful life
created by business combinations accounted for using the purchase method of
accounting. Instead, goodwill and intangible assets deemed to have an indefinite
useful life will be subject to an annual review for impairment. The new
standards generally will be effective for WCI and ATC in the first quarter of
2002 and for purchase business combinations consummated after June 30, 2001. WCI
and ATC are in the process of quantifying the anticipated impact of adopting the
provisions of FAS 142, which is expected to be significant.
Upon adoption, WCI and ATC will stop amortizing goodwill, including
goodwill included in the carrying value of certain investments accounted for
under the equity method of accounting. Based on current levels of goodwill, this
would reduce WCI's annual amortization expense by approximately $750 million,
equity in the pretax loss of TWE by approximately $800 million and other
expense, net, by approximately $300 million. The impact on ATC would be an
annual reduction in the equity in pretax loss of TWE by approximately $550
million and other expense, net, by approximately $225 million. Because goodwill
amortization is nondeductible for tax purposes, the impact of stopping goodwill
amortization and the amortization of goodwill included in the carrying value of
equity investees would be to increase WCI's and ATC's annual net income by
approximately $1.4 billion and $450 million, respectively.
In addition, WCI and TWE are in the process of evaluating certain
intangible assets to determine whether they are deemed to have an indefinite
useful life. As a result of this process, WCI and TWE may be prohibited from
amortizing certain intangible assets, which will serve to further increase both
WCI's and ATC's earnings. For WCI, annual pretax amortization could be further
reduced by up to $60 million, annual equity in the pretax loss of TWE could be
further reduced by approximately $350 million to $450 million and annual other
expense, net, could be further reduced by up to $15 million, all of which would
have a corresponding after-tax increase on WCI's net income of approximately
$200 million to $320 million. For ATC, annual equity in the pretax loss of TWE
could be further reduced by approximately $250 million to $300 million, which
would have a corresponding after-tax increase on ATC's net income of
approximately $150 million to $180 million.
As noted above, goodwill and intangible assets deemed to have an
indefinite useful life will be subject to an annual review for impairment.
Management is in the process of determining whether any such impairment would
be recognized upon adoption of the new accounting standard. If, however,
management concludes that an impairment
38
TWE GENERAL PARTNERS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(Unaudited)
charge for goodwill or intangible assets deemed to have an indefinite useful
life is necessary, such a charge would be non-operational in nature and
reflected as a cumulative effect of an accounting charge.
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities
In September 2000, the FASB issued Statement of Financial Accounting
Standards No. 140, "Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities--a Replacement of FASB Statement No. 125"
("FAS 140"). FAS 140 revises the criteria for accounting for securitizations and
other transfers of financial assets and collateral. In addition, FAS 140
requires certain additional disclosures. Except for the new disclosure
provisions, which were effective for the year ended December 31, 2000, FAS 140
is effective for the transfer of financial assets occurring after March 31,
2001. The provisions of FAS 140 did not have a significant effect on WCI or
ATC's consolidated financial statements.
Reclassifications
Certain reclassifications have been made to the prior year's financial
statements to conform to the 2001 presentation.
2. MERGER-RELATED COSTS
America Online-Time Warner Merger
In connection with the Merger, WCI has reviewed its operations and
implemented several plans to restructure its operations ("restructuring plans").
As part of the restructuring plans, WCI accrued an initial restructuring
liability of approximately $312 million during the first quarter of 2001. The
restructuring accruals relate to costs to exit and consolidate certain
activities at WCI, as well as costs to terminate employees of WCI. Such amounts
were recognized as liabilities assumed in the purchase business combination and,
accordingly, resulted in additional goodwill being recorded in connection with
the Merger.
Of the total restructuring accrual, $225 million related to work force
reductions and represented employee termination benefits. Because certain
employees can defer receipt of termination benefits for up to 24 months, cash
payments will continue after the employee has been terminated. Termination
payments of approximately $32 million were made in the first nine months of
2001, including approximately $17 million in the third quarter of 2001. As of
September 30, 2001, the remaining liability of approximately $193 million was
primarily classified as a current liability in WCI's accompanying consolidated
balance sheet.
The restructuring accrual also includes approximately $87 million
associated with exiting certain activities. The restructuring accrual associated
with exiting activities specifically includes incremental costs and contractual
obligations for items such as leasehold termination payments and other facility
exit costs incurred as a direct result of these plans, which will not have
future benefits. Payments related to exiting activities were approximately $7
million in the first nine months of 2001, including approximately $1 million
in the third quarter of 2001. As of September 30, 2001, the remaining liability
of $80 million was primarily classified as a long-term liability in WCI's
accompanying consolidated balance sheet.
39
TWE GENERAL PARTNERS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(Unaudited)
The restructuring liabilities recorded are based on WCI's restructuring
plans that have been committed to by management. These restructuring plans are
expected to be refined in the fourth quarter as management continues to evaluate
the integration of the combined companies and completes its purchase price
allocation.
Selected information relating to the restructuring plans follows (in
millions):
Employee Other
Termination Exit Costs Total
------------- ------------ ------------
Initial accruals $225 $87 $312
Incremental accruals - - -
Cash paid (32) (7) (39)
------------- ------------ ------------
Restructuring liability as of September 30, 2001 $193 $80 $273
============= ============ ============
3. COLUMBIA HOUSE INVESTMENT WRITE-DOWN
In March 2000, the proposed merger between CDNOW, Inc. and Columbia
House was terminated. In connection with the termination of the merger, the risk
associated with the timely execution of certain strategic alternatives for
Columbia House's operations and the transformation of Columbia House's
traditional business model to an online one increased. As a result, Time
Warner's management concluded that the decline in Columbia House's business was
likely to continue through the near term. As such, WCI recorded a $115 million
noncash pretax charge in the first quarter of 2000 to reduce the carrying value
of its investment in Columbia House to an estimate of its fair value. The charge
has been included in other income (expense), net, in the accompanying
consolidated statement of operations for the nine months ended September 30,
2000.
4. INVESTMENT in TWE
The General Partners' investment in and amounts due to and from TWE at
September 30, 2001 and December 31, 2000 consists of the following:
September 30, 2001 WCI ATC
------------------ --- ---
(millions)
Investment in TWE.................................................................. $37,090 $25,521
Stock option related distributions due from TWE.................................... 282 194
Other net receivables due from TWE................................................. 62 -
------- -------
Total.............................................................................. $37,434 $25,715
======= =======
December 31, 2000 WCI ATC
------------------ --- ---
(millions)
Investment in TWE.................................................................. $2,242 $1,575
Stock option related distributions due from TWE.................................... 404 277
Other net liabilities due to TWE, principally related to home video distribution... (586) -
------ ------
Total.............................................................................. $2,060 $1,852
====== ======
40
TWE GENERAL PARTNERS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(Unaudited)
Partnership Structure and Allocation of Income
TWE is a Delaware limited partnership that was capitalized on June
30, 1992 to own and operate substantially all of the Filmed Entertainment-Warner
Bros., Cable Networks-HBO and Cable businesses previously owned by the General
Partners. The General Partners in the aggregate hold 63.27% of the pro rata
priority capital ("Series A Capital") and residual equity capital ("Residual
Capital") of TWE and 100% of the junior priority capital of TWE. TW Companies,
directly or indirectly, holds 11.22% of the Series A Capital and Residual
Capital limited partnership interests. The remaining 25.51% limited partnership
interests in the Series A Capital and Residual Capital of TWE are held by
MediaOne TWE Holdings, Inc., a subsidiary of AT&T Corp.
The TWE partnership agreement provides for special allocations of
income, loss and distributions of partnership capital, including priority
distributions in the event of liquidation. A portion of TWE's net income has
been allocated to the limited partnership interests.
Summarized Financial Information of TWE
Set forth below is summarized financial information of TWE. The
comparability of TWE's summarized financial information has been affected by a
number of significant transactions and nonrecurring items. Specifically, for the
first nine months of 2000, the operating results include (i) a pretax gain of
$10 million in the first quarter relating to the partial recognition of a
deferred gain on the 1998 sale of Six Flags Entertainment Corporation
("Six Flags"), (ii) a $50 million pretax charge in the second quarter related
to the Six Flags litigation, (iii) a pretax loss of approximately $8 million in
the second quarter relating to the sale or exchange of various cable television
systems and investments, (iv) a net pretax investment-related gain of
approximately $65 million recognized in the third quarter, principally related
to additional proceeds received in the third quarter of 2000 in connection with
the 1999 sale of an interest in CanalSatellite, a satellite television platform
servicing France and Monaco, and (v) a noncash charge of $524 million in the
first quarter reflecting the cumulative effect of an accounting change in
connection with the adoption of a new film accounting standard. For a more
comprehensive description of the noncash charge from the cumulative effect of
an accounting change, see Note 1 to the accompanying TWE consolidated financial
statements. In addition, as a result of the Merger and the application of the
purchase method of accounting to TWE, the accompanying summarized historical
operating results and financial condition for TWE are no longer comparable to
2001. Accordingly, in order to enhance comparability and make an analysis of
2001 meaningful, pro forma financial information for 2000 has been provided
supplementally as if the Merger had occurred on January 1, 2000. For a more
comprehensive description of the impact of the Merger on TWE, see Notes 1 and 2
to the accompanying TWE consolidated financial statements.
41
TWE GENERAL PARTNERS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(Unaudited)
Three Months Nine Months
Ended September 30, Ended September 30,
------------------- -------------------
2001 2000 2000 2001 2000 2000
Historical Pro Forma Historical Historical Pro Forma Historical
---------- --------- ---------- ---------- --------- ----------
(millions)
Operating Statement Information
Revenues......................................... $3,803 $3,494 $3,494 $10,973 $10,118 $10,118
Operating income (loss).......................... 93 (25) 516 104 (174) 1,454
Interest expense, net............................ (133) (160) (160) (428) (461) (461)
Other income (expense), net...................... (101) (11) 11 (188) (180) (113)
Minority interest................................ (69) (62) (62) (242) (145) (145)
Income (loss) before income taxes and ...........
cumulative effect of an accounting change... (210) (258) 305 (754) (960) 735
Income (loss) before cumulative effect of an
accounting change........................... (241) (315) 248 (823) (1,078) 617
Net income (loss)................................ (241) (315) 248 (823) (1,602) 93
Nine Months Ended September 30,
-------------------------------
2001 2000 2000
Historical Pro Forma Historical
---------- --------- ----------
(millions)
Cash Flow Information
Cash provided by operations..................................................... $1,997 $2,172 $2,172
Investments and acquisitions.................................................... (832) (275) (275)
Capital expenditures............................................................ (1,442) (1,436) (1,436)
Investment proceeds............................................................. 32 211 211
Borrowings...................................................................... 3,279 1,250 1,250
Debt repayments................................................................. (2,535) (1,418) (1,418)
Capital distributions........................................................... (404) (684) (684)
Other........................................................................... (72) (75) (75)
Increase (decrease) in cash and equivalents..................................... 23 (255) (255)
September 30, December 31, December 31,
2001 2000 2000
Historical Pro Forma Historical
---------- --------- ----------
(millions)
Balance Sheet Information
Cash and equivalents............................................................ $ 329 $ 306 $ 306
Total current assets............................................................ 5,086 4,911 4,911
Total assets.................................................................... 85,318 84,976 25,458
Total current liabilities....................................................... 6,647 6,498 6,498
Long-term debt ................................................................. 8,106 7,108 7,108
Minority interests.............................................................. 2,038 1,881 1,881
Partners' capital............................................................... 65,511 66,444 6,926
Capital Distributions
The assets and cash flows of TWE are restricted by the TWE partnership
and credit agreements and are unavailable for use by the partners except through
the payment of certain fees, reimbursements, cash distributions and loans, which
are subject to limitations. At September 30, 2001 and December 31, 2000, the
General Partners had recorded $476 million and $681 million, respectively, of
stock option related distributions due from TWE, based on closing prices of AOL
Time Warner stock of $33.10 at September 30, 2001 and $34.80 as of December 31,
2000. The General Partners are paid when the options are exercised. The General
Partners also receive tax-related distributions from TWE on a current basis.
During the nine months ended September 30, 2001, the General Partners received
cash distributions from TWE in the amount of $404 million, consisting of $50
million of tax-related distributions and $354 million of stock
42
TWE GENERAL PARTNERS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(Unaudited)
option related distributions. During the nine months ended September 30, 2000,
the General Partners received cash distributions from TWE in the amount of
$684 million, consisting of $471 million of tax-related distributions and $213
million of stock option related distributions. Of such aggregate distributions,
WCI received $240 million during the first nine months of 2001 and $405 million
in 2000 and ATC received $164 million during the first nine months of 2001 and
$279 million in 2000.
5. GENERAL PARTNER GUARANTEES
Each General Partner has guaranteed a pro rata portion of approximately
$4.1 billion of TWE's debt and accrued interest at September 30, 2001, based on
the relative fair value of the net assets each General Partner (or its
predecessor) contributed to TWE. Such indebtedness is recourse to each General
Partner only to the extent of its guarantee. There are no restrictions on the
ability of the General Partner guarantors to transfer assets, other than TWE
assets, to parties that are not guarantors.
The portion of TWE debt and accrued interest at September 30, 2001 that
was guaranteed by each General Partner is set forth below:
Total Guaranteed by
Each General Partner
--------------------
General Partner % Amount
--------------- ------ ------
(dollars in millions)
WCI.............................................................................. 59.27 $2,419
ATC.............................................................................. 40.73 1,663
------ ------
Total............................................................................ 100.00 $4,082
====== ======
6. COMMITMENTS AND CONTINGENCIES
In Six Flags Over Georgia LLC et al. v. Time Warner Entertainment
Company et al., following a trial in December 1998, the jury returned a verdict
for plaintiffs and against defendants, including TWE, on plaintiffs' claims for
breaches of fiduciary duty. The jury awarded plaintiffs approximately $197
million in compensatory damages and $257 million in punitive damages, and
interest has been accruing on those amounts at the Georgia annual statutory rate
of twelve percent. The Company has since paid the compensatory damages with
accrued interest. Payment of the punitive damages portion of the award with
accrued interest was stayed by the United States Supreme Court on March 1, 2001
pending the disposition of a certiorari petition with that Court, which was
filed by TWE on June 15, 2001. On October 1, 2001, the United States Supreme
Court granted TWE's petition, vacated the decision by the Georgia Court of
Appeals to affirm the punitive damages award, and remanded the matter to the
Georgia Court of Appeals for further consideration.
WCI is subject to a number of state and federal class action lawsuits
as well as an action brought by a number of state Attorneys General alleging
unlawful horizontal and vertical agreements to fix the prices of compact discs
by the major record companies. Although WCI believes that, as to each of these
actions, the cases have no merit, adverse jury verdicts could result in a
material loss. WCI is unable to predict the outcomes of the litigation and
cannot reasonably estimate a range of possible loss given the current status of
the cases.
The costs and other effects of pending or future litigation,
governmental investigations, legal and administrative cases and proceedings
(whether civil or criminal), settlements, judgments and investigations, claims
and changes in those matters (including those matters described above), and
developments or assertions by or against WCI or TWE relating
43
TWE GENERAL PARTNERS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(Unaudited)
to intellectual property rights and intellectual property licenses, could have a
material adverse effect on WCI's business, financial condition and operating
results.
7. ADDITIONAL FINANCIAL INFORMATION
Additional financial information with respect to cash flows is as
follows:
Nine Months Ended September 30,
------------------------------------
2001 2000
--------------- ------------
WCI ATC WCI ATC
--- --- --- ----
(millions)
Cash payments made for interest................................. $ 12 $ - $ 10 $ -
Interest income received........................................ 7 - - -
Net cash payments (refunds) for income taxes.................... 62 27 12 95
Tax-related distributions received from TWE..................... 30 20 279 192
Noncash capital distributions................................... - - 45 31
Noncash financing activities in 2000 included the settlement of WCI's note
receivable from TW Companies through a WCI dividend in the amount of $695
million to TW Companies.
44
Part II. Other Information
Item 1. Legal Proceedings.
Reference is made to Six Flags Over Georgia LLC et al. v. Time Warner
Entertainment Company, L.P., described on pages I-20 and I-21 of TWE's Annual
Report on Form 10-K for the year ended December 31, 2000 (the "2000 Form 10-K")
and page 43 of TWE's Quarterly Report on Form 10-Q for the quarter ended June
30, 2001. On October 1, 2001, the U.S. Supreme Court granted TWE's petition for
certiorari and both vacated the opinion of the Georgia Court of Appeals as to
the punitive damages portion of the original jury award and remanded to such
court for further consideration.
On August 17, 2001, the European Commission formally suspended its
investigation of the vertical relationship between record companies and
retailers in certain EU member states, described on page I-21 of TWE's 2000
Form 10-K.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits.
None.
(b) Reports on Form 8-K.
No Current Report on Form 8-K was filed by TWE during the quarter ended
September 30, 2001.
45
TIME WARNER ENTERTAINMENT COMPANY, L.P.
AND TWE GENERAL PARTNERS
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
each of the registrants has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized.
TIME WARNER ENTERTAINMENT COMPANY, L.P.
By: Warner Communications Inc.,
as General Partner
By /s/ John LaBarca
-------------------------------------------
Name: John LaBarca
Title: Senior Vice President and
Controller
AMERICAN TELEVISION AND COMMUNICATIONS CORPORATION
WARNER COMMUNICATIONS INC.
By /s/ John LaBarca
-------------------------------------------
Name: John LaBarca
Title: Senior Vice President and
Controller
Date: November 14, 2001