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, 1998, or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT of 1934 for the transition period from to .
Commission file number 1-12259
TIME WARNER INC.
(Exact name of registrant as specified in its charter)
Delaware 13-3527249
(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 registrant's principal executive offices)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes x No
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Common Stock - $.01 par value 556,423,784
Series LMCN-V Common Stock - $.01 par value 57,061,942
- ------------------------------------------- ----------
Description of Class Shares Outstanding
as of October 31, 1998
TIME WARNER INC. AND
TIME WARNER ENTERTAINMENT COMPANY, L.P.
INDEX TO FORM 10-Q
Page
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Time
Warner TWE
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PART I. FINANCIAL INFORMATION
Management's discussion and analysis of results of operations
and financial condition................................... 1 47
Consolidated balance sheets at September 30, 1998 and
December 31, 1997......................................... 21 58
Consolidated statements of operations for the three and
nine months ended September 30, 1998 and 1997............. 22 59
Consolidated statements of cash flows for the nine
months ended September 30, 1998 and 1997.................. 23 60
Consolidated statement of shareholders' equity and
partnership capital for the nine
months ended September 30, 1998 and 1997.................. 24 61
Notes to consolidated financial statements................... 25 62
Supplementary information.................................... 39
PART II. OTHER INFORMATION...................................... 70
TIME WARNER INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
Time Warner Inc. ("Time Warner" or the "Company") classifies its business
interests into four fundamental areas: Entertainment, consisting principally of
interests in recorded music and music publishing, filmed entertainment,
television production and television broadcasting; Cable Networks, consisting
principally of interests in cable television programming; Publishing, consisting
principally of interests in magazine publishing, book publishing and direct
marketing; and Cable, consisting principally of interests in cable television
systems. A majority of Time Warner's interests in filmed entertainment,
television production, television broadcasting and cable television systems, and
a portion of its interests in cable television programming, are held through
Time Warner Entertainment Company, L.P. ("TWE"). 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 senior priority capital ("Senior Capital") and junior
priority capital ("Series B Capital"). The remaining 25.51% limited partnership
interests in the Series A Capital and Residual Capital of TWE are held by a
subsidiary of MediaOne Group, Inc. ("MediaOne"), formerly U S WEST, Inc. Time
Warner does not consolidate TWE and certain related companies (the
"Entertainment Group") for financial reporting purposes because of certain
limited partnership rights related to TWE's interest in certain cable television
systems. Capitalized terms are as defined and described in the accompanying
consolidated financial statements, or elsewhere herein.
Use of EBITA
Time Warner evaluates operating performance based on several factors, of
which the primary financial measure is operating income before noncash
amortization of intangible assets ("EBITA"). Consistent with management's
financial focus on controlling capital spending, EBITA measures operating
performance after charges for depreciation. In addition, EBITA eliminates the
uneven effect across all business segments of considerable amounts of noncash
amortization of intangible assets recognized in business combinations accounted
for by the purchase method, including the $14 billion acquisition of Warner
Communications Inc. in 1989, the $6.2 billion acquisition of Turner Broadcasting
System, Inc. in 1996 and the $2.3 billion of cable acquisitions in 1996 and
1995. The exclusion of noncash amortization charges is also consistent with
management's belief that Time Warner's intangible assets, such as cable
television and sports franchises, music catalogues and copyrights, film and
television libraries and the goodwill associated with its brands, are generally
increasing in value and importance to Time Warner's business objective of
creating, extending and distributing recognizable brands and copyrights
throughout the world. As such, the following comparative discussion of the
results of operations of Time Warner and the Entertainment Group includes, among
other factors, an analysis of changes in business segment EBITA. However, EBITA
should be considered in addition to, not as a substitute for, operating income,
net income and other measures of financial performance reported in accordance
with generally accepted accounting principles.
RESULTS OF OPERATIONS
As more fully described herein, Time Warner's and the Entertainment
Group's 1998 operating results have been affected by certain cable-related
transactions, including (i) the transfer of cable television systems (or
interests therein) serving approximately 650,000 subscribers that were formerly
owned by subsidiaries of Time Warner to the TWE-Advance/Newhouse Partnership
("TWE-A/N"), subject to approximately $1 billion of debt, in exchange for common
and preferred partnership interests therein, as well as certain related
transactions (collectively, the "TWE-A/N Transfers"), (ii) the transfer of TWE's
and TWE-A/N's direct broadcast satellite operations and related assets to
Primestar, Inc., a separate holding company (the "Primestar Roll-up
Transaction"), (iii) the reorganization
of Time Warner Cable's business telephony operations (the "Business Telephony
Reorganization"), (iv) the formation of a joint venture to operate and expand
Time Warner Cable's and MediaOne's existing high-speed Internet access
businesses (the "Road Runner Joint Venture") and (v) the sale or exchange of
certain cable television systems. The effects of these transactions are
described elsewhere herein.
EBITA and operating income for Time Warner and the Entertainment Group for
the three and nine months ended September 30, 1998 and 1997 are as follows:
Three Months Ended September 30, Nine Months Ended September 30,
-------------------------------- -------------------------------
EBITA Operating Income EBITA Operating Income
----- ---------------- ----- ----------------
1998 1997 1998 1997 1998 1997 1998 1997
---- ---- ---- ---- ---- ---- ---- ----
(millions)
Time Warner:
Publishing $ 112 $ 98 $ 102 $ 87 $ 373 $ 331 $ 346 $ 303
Music 99 90 30 17 288 314 80 99
Cable Networks-TBS 154 128 104 83 505 407 355 267
Filmed Entertainment-TBS 71 68 47 42 94 103 30 36
Cable 81 107 33 38 229 316 79 108
Intersegment elimination (1) (4) (1) (4) (21) (11) (21) (11)
------- ------- ------- ------- ------- ------- ------- -------
Total $ 516 $ 487 $ 315 $263 $1,468 $1,460 $ 869 $ 802
======= ======= ====== ======= ======= ======= ======= =======
Entertainment Group:
Filmed Entertainment-Warner Bros $ 162 $ 106 $ 129 $ 75 $ 403 $ 320 $ 304 $ 229
Broadcasting-The WB Network (17) (21) (17) (21) (78) (60) (80) (60)
Cable Networks-HBO 117 102 117 102 339 291 339 291
Cable (a) 336 257 240 179 1,017 759 731 530
------- ------- ------- ------- ------- ------- ------- -------
Total $ 598 $ 444 $ 469 $335 $1,681 $ 1,311 $1,294 $ 990
======= ======= ======= ======= ======= ======== ======= =======
- -------
(a)Includes net pretax gains recognized in connection with the sale or exchange
of certain cable television systems of approximately $6 million and $16
million for the three months ended September 30, 1998 and 1997, respectively,
and approximately $90 million and $40 million for the nine months ended
September 30, 1998 and 1997, respectively.
Three Months Ended September 30, 1998 Compared to Three Months Ended
September 30, 1997
Time Warner had revenues of $3.578 billion and net income of $39 million
($.06 loss per common share after preferred dividend requirements) for the three
months ended September 30, 1998, compared to revenues of $3.231 billion, a loss
of $28 million before an extraordinary loss on the retirement of debt ($.19 loss
per common share after preferred dividend requirements) and a net loss of $35
million ($.20 loss per common share) for the three months ended September 30,
1997. Time Warner's equity in the pretax income of the Entertainment Group was
$164 million for the three months ended September 30, 1998, compared to $96
million for the three months ended September 30, 1997.
Time Warner's net income increased to $39 million for the three months
ended September 30, 1998, compared to a net loss of $35 million for the three
months ended September 30, 1997. As discussed more fully below, this increase
principally resulted from an overall increase in business segment operating
income, higher income from Time Warner's equity in the pretax income of the
Entertainment Group, lower interest expense associated with Time
Warner's debt reduction efforts and the TWE-A/N Transfers, and the absence of a
$7 million extraordinary loss on the retirement of debt recognized in 1997. The
positive effect of these increases was offset in part by higher losses from
certain investments accounted for under the equity method of accounting and
lower gains on foreign exchange contracts.
The Entertainment Group had revenues of $3.222 billion and net income of
$173 million for the three months ended September 30, 1998, compared to revenues
of $2.857 billion and net income of $80 million for the three months ended
September 30, 1997. As discussed more fully below, the Entertainment Group's net
income increased in 1998 as compared to 1997 principally due to an overall
increase in operating income generated by its business segments (including the
positive effect of the TWE-A/N Transfers), offset in part by an increase in
interest expense associated with the TWE-A/N Transfers, higher losses from
certain investments accounted for under the equity method of accounting and
lower gains on foreign exchange contracts.
The relationship between income before income taxes and income tax expense
of Time Warner 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 of Time Warner includes all income taxes
related to its allocable share of partnership income and its equity in the
income tax expense of corporate subsidiaries of the Entertainment Group.
Time Warner
Publishing. Revenues increased to $1.076 billion, compared to $1.027
billion in the third quarter of 1997. EBITA increased to $112 million from $98
million. Operating income increased to $102 million from $87 million. Revenues
benefited primarily from significant increases in magazine advertising revenues,
as well as increases in magazine circulation revenues. Contributing to the
revenue gains were increases achieved by People, Sports Illustrated, Fortune and
In Style. EBITA and operating income increased principally as a result of the
revenue gains, cost savings and gains on the sale of certain assets, offset in
part by lower results from direct marketing operations.
Music. Revenues increased to $938 million, compared to $880 million in the
third quarter of 1997. EBITA increased to $99 million from $90 million.
Operating income increased to $30 million from $17 million. Revenues benefited
from an increase in domestic and international recorded music sales principally
relating to higher compact disc sales of a broad range of popular releases from
new and established artists and movie soundtracks, as well as lower returns of
product. At the end of September 1998, the Music division had a leading domestic
market share of 20%, as measured by SoundScan. EBITA and operating income
increased principally as a result of the revenue gains, offset in part by lower
results from direct marketing operations.
Cable Networks-TBS. Revenues increased to $825 million, compared to $748
million in the third quarter of 1997. EBITA increased to $154 million from $128
million. Operating income increased to $104 million from $83 million. Revenues
benefited from an increase in subscription and advertising revenues. The
increase in subscription revenues principally related to the conversion of TBS
Superstation from an advertiser-supported broadcast superstation to a
copyright-paid, cable television service, which allows TBS Superstation to
charge cable operators for the right to carry its cable television programming.
Subscription revenues also increased as a result of an increase in
subscriptions, primarily at CNN, Cartoon Network, TNT/Cartoon Europe and Turner
Classic
Movies, and higher rates. The increase in advertising revenues was due to a
strong overall advertising market for most of the division's networks, including
Cartoon Network, TNT/Cartoon Europe and CNN Headline News. These advertising and
subscription revenue increases more than offset reductions attributable to the
absence of National Football League programming on TNT. EBITA and operating
income increased principally as a result of the revenue gains and lower
programming costs at TNT, offset in part by higher programming costs at CNN and
losses associated with the Goodwill Games.
Filmed Entertainment-TBS. Revenues increased to $543 million, compared to
$363 million in the third quarter of 1997. EBITA increased to $71 million from
$68 million. Operating income increased to $47 million from $42 million.
Revenues benefited from a significant increase in syndication sales resulting
from the renewal by existing television station customers of second-cycle
broadcasting rights for Seinfeld, as well as an increase in worldwide theatrical
and home video revenues at New Line Cinema. EBITA and operating income increased
principally as a result of the revenue gains, offset in part by higher
participation costs payable to creative talent.
Cable. Revenues decreased to $236 million, compared to $248 million in the
third quarter of 1997. EBITA decreased to $81 million from $107 million.
Operating income decreased to $33 million from $38 million. The Cable division's
1998 operating results were reduced by the aggregate net impact of the TWE-A/N
Transfers and the deconsolidation of certain of its operations in connection
with each of the Primestar Roll-up Transaction, the Business Telephony
Reorganization and the formation of the Road Runner Joint Venture. Excluding the
effect of these transactions, revenues increased principally as a result of an
increase in basic cable subscribers, increases in regulated cable rates as
permitted under Time Warner Cable's "social contract" with the Federal
Communications Commission ("FCC") and an increase in advertising revenues.
Similarly excluding the effect of these transactions, EBITA and operating income
increased principally as a result of the revenue gains, offset in part by higher
depreciation related to capital spending.
Interest and Other, Net. Interest and other, net, increased to $311
million in the third quarter of 1998, compared to $309 million in the third
quarter of 1997. Interest expense decreased to $214 million, compared to $258
million in the third quarter of 1997, principally due to lower average debt
levels associated with the Company's debt reduction efforts and the TWE-A/N
Transfers. Other expense, net, increased to $97 million in the third quarter of
1998 from $51 million in the third quarter of 1997, principally because of
higher losses from certain investments accounted for under the equity method of
accounting and lower gains on foreign exchange contracts.
Entertainment Group
Filmed Entertainment-Warner Bros. Revenues increased to $1.729 billion,
compared to $1.399 billion in the third quarter of 1997. EBITA increased to $162
million from $106 million. Operating income increased to $129 million from $75
million. Revenues benefited from a significant increase in television production
and distribution operations principally relating to the initial off-network
domestic syndication availability of Friends and the initial off-network basic
cable availability of ER. EBITA and operating income benefited principally from
the revenue gains, offset in part by lower international syndication sales of
library product and film write-offs relating to disappointing results for
certain theatrical releases.
Broadcasting - The WB Network. Revenues increased to $64 million, compared
to $31 million in the third quarter of 1997. EBITA and operating income improved
to a loss of $17 million from a loss of $21 million. Revenues increased as a
result of higher advertising sales relating to improved television ratings and
the addition of a fourth night of prime-time programming in January 1998 and a
fifth night in September 1998. Operating losses improved principally as a result
of the revenue gains, offset in part by higher programming costs associated with
the expanded programming schedule and a lower allocation of losses to a minority
partner in the network. Due to the start-up nature of this national broadcast
operation, losses are expected to continue.
Cable Networks-HBO. Revenues increased to $505 million, compared to $482
million in the third quarter of 1997. EBITA and operating income increased to
$117 million from $102 million. Revenues benefited primarily from an increase in
subscriptions. EBITA and operating income increased principally as a result of
the revenue gains and, to a lesser extent, cost savings and higher income from
Comedy Central, a 50%-owned equity investee.
Cable. Revenues decreased to $1.052 billion, compared to $1.060 billion in
the third quarter of 1997. EBITA increased to $336 million from $257 million.
Operating income increased to $240 million from $179 million. The Cable
division's 1998 operating results were positively affected by the aggregate net
impact of the TWE-A/N Transfers and the deconsolidation of certain of its
operations in connection with each of the Primestar Roll-up Transaction, the
Business Telephony Reorganization and the formation of the Road Runner Joint
Venture. Excluding the effect of these transactions, revenues increased
principally as a result of an increase in basic cable subscribers, increases in
regulated cable rates as permitted under Time Warner Cable's "social contract"
with the FCC and an increase in advertising revenues. Similarly excluding the
effect of these transactions, EBITA and operating income increased principally
as a result of the revenue gains, offset in part by lower net gains relating to
the sale or exchange of certain cable television systems and higher depreciation
related to capital spending.
Interest and Other, Net. Interest and other, net, was $203 million in the
third quarter of 1998, compared to $146 million in the third quarter of 1997.
Interest expense increased to $145 million, compared to $124 million in the
third quarter of 1997, principally due to higher average debt levels associated
with the TWE-A/N Transfers. There was other expense, net, of $58 million in the
third quarter of 1998, compared to $22 million in the third quarter of 1997,
principally due to higher losses from certain investments accounted for under
the equity method of accounting, lower gains on foreign exchange contracts and
higher losses associated with TWE's asset securitization program.
Nine Months Ended September 30, 1998 Compared to Nine Months Ended September
30, 1997
Time Warner had revenues of $10.387 billion and net income of $78 million
($.27 loss per common share after preferred dividend requirements) for the nine
months ended September 30, 1998, compared to revenues of $9.458 billion, income
of $54 million before an extraordinary loss on the retirement of debt ($.33 loss
per common share) and net income of $30 million ($.37 loss per common share) for
the nine months ended September 30, 1997. Time Warner's equity in the pretax
income of the Entertainment Group was $437 million for the nine months ended
September 30, 1998, compared to $522 million for the nine months ended September
30, 1997.
Time Warner's net income increased to $78 million for the nine months
ended September 30, 1998, compared to net income of $30 million for the nine
months ended September 30, 1997. As discussed more fully below,
net income increased despite significantly lower aggregate, net pretax gains
recognized by TWE in connection with the sale or exchange of certain cable
television systems in each year and the 1997 sale of TWE's interest in E!
Entertainment Television, Inc. ("E! Entertainment"). These pretax gains amounted
to approximately $90 million in 1998 ($.07 per common share) and $290 million
($.30 per common share) in 1997. The negative effect of these gains on operating
trends, as well as higher losses from certain investments accounted for under
the equity method of accounting and lower gains on foreign exchange contracts,
was more than offset by an overall increase in business segment operating
income, lower interest expense associated with Time Warner's debt reduction
efforts and the TWE-A/N Transfers, and the absence of a $24 million
extraordinary loss on the retirement of debt recognized in 1997.
The Entertainment Group had revenues of $8.987 billion and net income of
$437 million for the nine months ended September 30, 1998, compared to revenues
of $8.190 billion and net income of $487 million for the nine months ended
September 30, 1997. As discussed more fully below and as previously described
above, the Entertainment Group's net income decreased in 1998 as compared to
1997 principally due to significantly lower aggregate, net pretax gains
recognized in connection with the sale or exchange of certain cable television
systems in each year and the 1997 sale of TWE's interest in E! Entertainment.
Excluding the effect of these transactions, the Entertainment Group's net income
increased in 1998 principally as a result of an overall increase in operating
income generated by its business segments (including the positive effect of the
TWE-A/N Transfers), offset in part by an increase in interest expense associated
with the TWE-A/N Transfers, higher losses from certain investments accounted for
under the equity method of accounting and lower gains on foreign exchange
contracts.
The relationship between income before income taxes and income tax expense
of Time Warner 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 of Time Warner includes all income taxes
related to its allocable share of partnership income and its equity in the
income tax expense of corporate subsidiaries of the Entertainment Group.
Time Warner
Publishing. Revenues increased to $3.160 billion, compared to $3.004
billion in the first nine months of 1997. EBITA increased to $373 million from
$331 million. Operating income increased to $346 million from $303 million.
Revenues benefited primarily from significant increases in magazine advertising
revenues, as well as increases in magazine circulation revenues. Contributing to
the revenue gains were increases achieved by People, Time, Fortune and In Style.
EBITA and operating income increased principally as a result of the revenue
gains and cost savings, offset in part by lower results from direct marketing
operations.
Music. Revenues increased to $2.731 billion, compared to $2.635 billion in
the first nine months of 1997. EBITA decreased to $288 million from $314
million. Operating income decreased to $80 million from $99 million. Revenues
benefited from an increase in domestic and international recorded music sales
principally relating to higher compact disc sales of a broad range of popular
releases from new and established artists and movie soundtracks, as well as
lower returns of product. At the end of September 1998, the Music division had a
leading domestic market share of 20%, as measured by SoundScan. Despite the
revenue increase, EBITA and operating income declined principally as a result of
lower results from direct marketing operations, the negative effect of changes
in
foreign currency exchange rates on international recorded music operations and
the absence of certain one-time gains recognized in 1997.
Cable Networks-TBS. Revenues increased to $2.459 billion, compared to
$2.092 billion in the first nine months of 1997. EBITA increased to $505 million
from $407 million. Operating income increased to $355 million from $267 million.
Revenues benefited from an increase in subscription and advertising revenues.
The increase in subscription revenues principally related to the conversion of
TBS Superstation from an advertiser-supported broadcast superstation to a
copyright-paid, cable television service, which allows TBS Superstation to
charge cable operators for the right to carry its cable television programming.
Subscription revenues also increased as a result of an increase in
subscriptions, primarily at CNN, Cartoon Network, TNT/Cartoon Europe and Turner
Classic Movies, and higher rates. The increase in advertising revenues was
principally due to a strong overall advertising market for most of the
division's networks, including TNT, Cartoon Network, CNN International and CNN
Headline News. EBITA and operating income increased principally as a result of
the revenue gains and lower programming costs at TNT, offset in part by higher
programming costs at CNN and losses associated with the Goodwill Games.
Filmed Entertainment-TBS. Revenues increased to $1.419 billion, compared
to $1.097 billion in the first nine months of 1997. EBITA decreased to $94
million from $103 million. Operating income decreased to $30 million from $36
million. Revenues benefited from a significant increase in syndication sales
resulting from the renewal by existing television station customers of
second-cycle broadcasting rights for Seinfeld, as well as an increase in
worldwide theatrical and home video revenues at New Line Cinema. Despite the
revenue increase, EBITA and operating income decreased principally as a result
of film write-offs relating to disappointing results for theatrical releases of
Castle Rock Entertainment.
Cable. Revenues decreased to $726 million, compared to $740 million in the
first nine months of 1997. EBITA decreased to $229 million from $316 million.
Operating income decreased to $79 million from $108 million. The Cable
division's 1998 operating results were negatively affected by the aggregate net
impact of the TWE-A/N Transfers and the deconsolidation of certain of its
operations in connection with each of the Primestar Roll-up Transaction, the
Business Telephony Reorganization and the formation of the Road Runner Joint
Venture. Excluding the effect of these transactions, revenues increased
principally as a result of an increase in basic cable subscribers, increases in
regulated cable rates as permitted under Time Warner Cable's "social contract"
with the FCC and an increase in advertising revenues. Similarly excluding the
effect of these transactions, EBITA and operating income increased principally
as a result of the revenue gains, offset in part by higher depreciation related
to capital spending and the absence of a gain on the sale of an investment
recognized in 1997.
Interest and Other, Net. Interest and other, net, decreased to $877
million in the first nine months of 1998, compared to $904 million in the first
nine months of 1997. Interest expense decreased to $669 million, compared to
$792 million in the first nine months of 1997, principally due to lower average
debt levels associated with the Company's debt reduction efforts and the TWE-A/N
Transfers. Other expense, net, increased to $208 million in the first nine
months of 1998 from $112 million in the first nine months of 1997, principally
because of losses from certain investments accounted for under the equity method
of accounting, lower gains on foreign exchange contracts and higher losses
associated with the Company's asset securitization program.
Entertainment Group
Filmed Entertainment-Warner Bros. Revenues increased to $4.371 billion,
compared to $3.830 billion in the first nine months of 1997. EBITA increased to
$403 million from $321 million. Operating income increased to $304 million from
$229 million. Revenues benefited from a significant increase in television
production and distribution operations principally relating to the initial
off-network domestic syndication availability of Friends and the initial
off-network basic cable availability of ER, as well as an increase in revenues
from consumer products licensing operations. EBITA and operating income
benefited principally from the revenue gains, offset in part by lower
international syndication sales of library product and film write-offs relating
to disappointing results for certain theatrical releases. In addition, EBITA and
operating income for each period included certain one-time gains on the sale of
assets that were comparable in amount and therefore, did not have any
significant effect on operating trends.
Broadcasting - The WB Network. Revenues increased to $170 million,
compared to $84 million in the first nine months of 1997. EBITA decreased to a
loss of $78 million from a loss of $60 million. Operating losses increased to
$80 million from $60 million. Revenues increased as a result of higher
advertising sales relating to improved television ratings and the addition of a
fourth night of prime-time programming in January 1998 and a fifth night in
September 1998. Despite the revenue increase, operating losses increased because
of a lower allocation of losses to a minority partner in the network. However,
excluding this minority interest effect, operating losses improved principally
as a result of the revenue gains, which outweighed higher programming costs
associated with the expanded programming schedule. Due to the start-up nature of
this national broadcast operation, losses are expected to continue.
Cable Networks-HBO. Revenues increased to $1.526 billion, compared to
$1.452 billion in the first nine months of 1997. EBITA and operating income
increased to $339 million from $291 million. Revenues benefited primarily from
an increase in subscriptions. EBITA and operating income increased principally
as a result of the revenue gains and, to a lesser extent, cost savings and
higher income from Comedy Central, a 50%-owned equity investee.
Cable. Revenues increased to $3.289 billion, compared to $3.146 billion in
the first nine months of 1997. EBITA increased to $1.017 billion from $759
million. Operating income increased to $731 million from $530 million. The Cable
division's 1998 operating results were positively affected by the aggregate net
impact of the TWE-A/N Transfers and the deconsolidation of certain of its
operations in connection with each of the Primestar Roll-up Transaction, the
Business Telephony Reorganization and the formation of the Road Runner Joint
Venture. Excluding the effect of these transactions, revenues increased
principally as a result of an increase in basic cable subscribers, increases in
regulated cable rates as permitted under Time Warner Cable's "social contract"
with the FCC and an increase in advertising revenues. Similarly excluding the
effect of these transactions, EBITA and operating income increased principally
as a result of the revenue gains and higher net gains relating to the sale or
exchange of certain cable television systems, offset in part by higher
depreciation related to capital spending.
Interest and Other, Net. Interest and other, net, increased to $550
million in the first nine months of 1998, compared to $157 million in the first
nine months of 1997. Interest expense increased to $418 million, compared to
$360 million in the first nine months of 1997, principally due to higher average
debt levels associated with the TWE-A/N Transfers. There was other expense, net,
of $132 million in the first nine months of 1998, compared
to other income, net, of $203 million in the first nine months of 1997,
principally due to the absence of an approximate $250 million pretax gain on the
sale of an interest in E! Entertainment recognized in 1997, higher losses from
certain investments accounted for under the equity method of accounting, lower
gains on foreign exchange contracts and higher losses associated with TWE's
asset securitization program.
FINANCIAL CONDITION AND LIQUIDITY
September 30, 1998
Time Warner
Financial Condition
At September 30, 1998, Time Warner had $9.1 billion of debt, $393 million
of cash and equivalents (net debt of $8.7 billion), $1.015 billion of borrowings
against future stock option proceeds, $575 million of mandatorily redeemable
preferred securities of a subsidiary, $1.9 billion of Series M exchangeable
preferred stock (see "Planned Redemption of Series M Preferred Stock"
hereinafter) and $9.1 billion of shareholders' equity, compared to $11.8 billion
of debt, $645 million of cash and equivalents (net debt of $11.2 billion), $533
million of borrowings against future stock option proceeds, $575 million of
mandatorily redeemable preferred securities of a subsidiary, $1.9 billion of
Series M exchangeable preferred stock and $9.4 billion of shareholders' equity
at December 31, 1997. Net debt decreased principally as a result of the TWE-A/N
Transfers, the use of cash distributions from TWE to reduce debt and other debt
reduction efforts.
Investment in TWE
Time Warner's investment in TWE at September 30, 1998 consisted of
interests in 74.49% of the Series A Capital and Residual Capital of TWE, and
100% of the Senior Capital and Series B Capital of TWE. Such priority capital
interests provide Time Warner (and with respect to the Series A Capital only,
MediaOne) with certain priority claims to the net partnership income of TWE and
distributions of TWE partnership capital, including certain priority
distributions of partnership capital in the event of liquidation or dissolution
of TWE. Each level of priority capital interest provides for an annual rate of
return equal to or exceeding 8%, including an above-market 13.25% annual rate of
return (11.25% to the extent concurrently distributed) related to Time Warner's
Series B Capital interest, which, when taken together with Time Warner's
contributed capital, represented a cumulative priority Series B Capital interest
of $6.6 billion at September 30, 1998.
While the TWE partnership agreement contemplates the reinvestment of
significant partnership cash flows in the form of capital expenditures and
otherwise provides for certain other restrictions that are expected to limit
cash distributions on partnership interests for the foreseeable future, TWE
borrowed $579 million under its bank credit agreement in July 1998 and paid a
distribution to Time Warner relating to its Senior Capital interest. Time Warner
used the $579 million of proceeds to reduce bank debt. Time Warner's remaining
$591 million Senior Capital interest and any future undistributed partnership
income allocated thereto (based on an 8% annual rate of return) is required to
be distributed to Time Warner on July 1, 1999.
Debt Transactions
During the second quarter of 1998, Time Warner issued $600 million
principal amount of 6.875% debentures due 2018 and borrowed $550 million under
its bank credit agreement, which together offset the debt reduction associated
with the conversion of $1.15 billion accreted amount of zero-coupon convertible
notes due 2013 (the "Zero-Coupon Convertible Notes") into 18.7 million shares of
Time Warner common stock. The net proceeds therefrom have been used to
repurchase common stock, including the repurchase of 9.1 million shares of
common stock in connection with the settlement of a forward purchase contract to
acquire such shares (see "Common Stock Repurchase Program" hereinafter). These
share repurchases partially offset the dilution resulting from the conversion of
the Zero-Coupon Convertible Notes.
In April 1998, Time Warner and TWE consummated three previously announced
transactions, consisting of the sale of TWE's 49% interest in Six Flags
Entertainment Corporation, the Primestar Roll-up Transaction and the sale of
certain cable television systems. As a result of these transactions, Time Warner
and TWE reduced debt by approximately $700 million in the aggregate, of which
$160 million relates to Time Warner and $540 million relates to TWE.
In February 1998, Time Warner Companies, Inc. ("TW Companies"), a wholly
owned subsidiary of Time Warner, repaid all of its $500 million principal amount
of 7.45% notes due February 1, 1998 at their maturity using proceeds raised from
the issuance of $500 million principal amount of 6.95% debentures due January
15, 2028.
In early 1998, Time Warner transferred approximately $1 billion of debt to
TWE-A/N in connection with the TWE-A/N Transfers. The debt assumed by TWE-A/N
has been guaranteed by TWI Cable Inc., a wholly owned subsidiary of Time Warner,
and certain of its subsidiaries.
An extraordinary loss of $24 million was recognized in the nine months
ended September 30, 1997 in connection with certain debt refinancings.
Planned Redemption of Series M Preferred Stock
In July 1998, Time Warner announced its intention to redeem its outstanding
shares of 10 1/4% Series M exchangeable preferred stock ("Series M Preferred
Stock") on December 30, 1998, at a price equal to 110% of its $1.9 billion
liquidation preference plus accumulated and accrued and unpaid dividends,
intending, based on current borrowing rates, to replace it with lower-cost bank
or public debt (the "Series M Refinancing"). Based on an anticipated 300 to 400
basis point reduction in the interest rate of the debt to be issued in
comparison to the dividend rate of the Series M Preferred Stock, and including a
reduction in taxes associated with the tax-deductible nature of the interest
payments on the debt, Time Warner expects to realize approximately $100 to $125
million of annual cash savings as a result of the Series M Refinancing. As
required pursuant to the terms of the Series M Preferred Stock, Time Warner's
principal credit rating agencies have confirmed that there will be no impact on
Time Warner's current credit ratings or ratings outlook as a result of this
refinancing. In connection with the Series M Refinancing, Time Warner expects to
record an estimated one-time reduction in earnings per common share of
approximately $.39 in the fourth quarter of 1998. This reduction will not have
any impact on net income and primarily results from treating the redemption
premium to be paid on the Series M Preferred Stock similarly to a preferred
dividend.
Common Stock Repurchase Program
During 1998, Time Warner issued approximately 26.3 million shares of
common stock in connection with the conversion of 12.6 million shares of
convertible preferred stock (consisting of approximately 5.0 million shares of
Series G preferred stock, 6.3 million shares of Series I preferred stock and 1.3
million shares of Series J preferred stock). These conversions are expected to
result in approximately $50 million of cash dividend savings in the aggregate
for Time Warner through the end of 1999.
As previously described, in order to offset partially the dilutive effect
relating to the conversion of the Zero-Coupon Convertible Notes, Time Warner
exercised its option under a forward purchase contract in June 1998 and
repurchased 9.1 million shares of its common stock at an aggregate cost of $632
million, or $69.12 per common share.
In connection with these transactions and the conversion of the
Zero-Coupon Convertible Notes, Time Warner's Board of Directors authorized in
1998 an 18.7 million share increase in the Company's existing common stock
repurchase program that, along with previous authorizations, allows the Company
to repurchase, from time to time, up to 53.7 million shares of common stock. The
common stock repurchased under the program is expected to continue to be used to
satisfy a portion of the future share issuances related to the exercise of
existing employee stock options and the potential conversion of certain
convertible securities. Actual repurchases in any period will be subject to
market conditions. As of September 30, 1998, Time Warner had acquired 26.4
million shares of its common stock in 1998 at an aggregate cost of $1.944
billion. In addition, in October 1998, Time Warner acquired another 3.2 million
shares of common stock at an aggregate cost of $258 million, thereby increasing
the cumulative shares purchased under this program to approximately 47.2 million
shares at an aggregate cost of approximately $3 billion. Except for repurchases
of common stock using $1.1 billion of borrowings in the second quarter of 1998
that offset a like-amount of debt reduction associated with the conversion of
the Zero-Coupon Convertible Notes into common stock, these repurchases have been
and are expected to continue to be funded with stock option exercise proceeds
and borrowings under Time Warner's Stock Option Proceeds Credit Facility, as
described more fully below.
In early 1998, Time Warner entered into a new five-year, $1.3 billion
revolving credit facility (the "Stock Option Proceeds Credit Facility"), which
replaced its previously existing facility. Borrowings under the Stock Option
Proceeds Credit Facility are principally used to fund stock repurchases and
future preferred dividend requirements on Time Warner's Series G, H, I and J
convertible preferred stock. At September 30, 1998 and December 31, 1997, Time
Warner had outstanding borrowings against future stock option proceeds of $1.015
billion and $533 million, respectively.
Cash Flows
During the first nine months of 1998, Time Warner's cash provided by
operations amounted to $1.194 billion and reflected $1.468 billion of EBITA from
its Publishing, Music, Cable Networks-TBS, Filmed Entertainment-TBS and Cable
businesses, $285 million of noncash depreciation expense, $102 million of
proceeds from Time Warner's asset securitization program and $605 million of
distributions from TWE (excluding $455 million representing the return of a
portion of the Time Warner General Partners' Senior Capital interests that has
been classified as a source of cash from investing activities), less $708
million of interest payments, $143 million of income taxes, $58 million of
corporate expenses and $357 million related to an aggregate increase in working
capital requirements, other balance sheet accounts and noncash items. Cash
provided by operations of $639 million for the first nine months of 1997
reflected $1.460 billion of business segment EBITA, $277 million of noncash
depreciation expense and $354 million of distributions from TWE (similarly
excluding $455 million representing the return of a portion of the Time Warner
General Partners' Senior Capital interests that has been classified as a source
of cash from investing activities), less $822 million of interest payments, $182
million of income taxes, $60 million of corporate expenses and $388 million
related to an aggregate increase in working capital requirements, other balance
sheet accounts and noncash items.
Cash provided by investing activities was $479 million in the first nine
months of 1998, compared to $89 million in the first nine months of 1997,
principally as a result of lower capital expenditures, an increase in investment
proceeds and a decrease in cash used for investments and acquisitions. Cash used
for investments and acquisitions in 1998 was offset in part by the effect of
consolidating approximately $200 million of cash of Paragon Communications
("Paragon") in connection with the TWE-A/N Transfers. Capital expenditures
decreased to $348 million in the first nine months of 1998, compared to $424
million in the first nine months of 1997.
Cash used by financing activities was $1.925 billion in the first nine
months of 1998, compared to $481 million in the first nine months of 1997.
During the first nine months of 1998, excluding additional borrowings that
offset the noncash reduction of $1.15 billion of debt relating to the conversion
of the Zero-Coupon Convertible Notes into common stock, Time Warner reduced debt
by approximately $1.8 billion. Time Warner used proceeds from the borrowings
associated with the conversion of the Zero-Coupon Convertible Notes, together
with most of the $599 million of proceeds received from the exercise of employee
stock options and $482 million of net borrowings against future stock option
proceeds, to repurchase approximately 26.4 million shares of Time Warner common
stock at an aggregate cost of $1.944 billion. Time Warner also paid $394 million
of dividends in the first nine months of 1998, compared to $253 million in the
first nine months of 1997, reflecting its election in 1998 to pay dividends on
its Series M Preferred Stock in cash rather than in-kind. Cash used by financing
activities in 1997 principally resulted from approximately $300 million of debt
reduction, the repayment of $185 million of borrowings against future stock
option proceeds, the repurchase of approximately 974 thousand shares of Time
Warner common stock at an aggregate cost of $37 million and the payment of $253
million of dividends, offset in part by $328 million of proceeds received from
the exercise of employee stock options.
The assets and cash flows of TWE are restricted by certain borrowing and
partnership agreements and are unavailable to Time Warner except through the
payment of certain fees, reimbursements, cash distributions and loans, which are
subject to limitations. Under its bank credit agreement, TWE is permitted to
incur additional indebtedness to make loans, advances, distributions and other
cash payments to Time Warner, subject to its individual compliance with the cash
flow coverage and leverage ratio covenants contained therein.
Management believes that Time Warner's operating cash flow, cash and
equivalents and additional borrowing capacity are sufficient to fund its capital
and liquidity needs for the foreseeable future without distributions and loans
from TWE above those permitted by existing agreements.
Entertainment Group
Financial Condition
The Entertainment Group had $7.4 billion of debt, $125 million of cash and
equivalents (net debt of $7.3 billion), $221 million of preferred stock of a
subsidiary, $591 million of Time Warner General Partners' Senior Capital and
$5.9 billion of partners' capital at September 30, 1998, compared to $6.0
billion of debt, $322 million of cash and equivalents (net debt of $5.7
billion), $233 million of preferred stock of a subsidiary, $1.1 billion of Time
Warner General Partners' Senior Capital and $6.4 billion of partners' capital at
December 31, 1997. Net debt of the Entertainment Group increased principally as
a result of the TWE-A/N Transfers and cash distributions paid to Time Warner.
Cash Flows
During the first nine months of 1998, the Entertainment Group's cash
provided by operations amounted to $1.273 billion and reflected $1.681 billion
of EBITA from its Filmed Entertainment-Warner Bros., Broadcasting-The WB
Network, Cable Networks-HBO and Cable businesses, $698 million of noncash
depreciation expense and $131 million of proceeds from TWE's asset
securitization program, less $419 million of interest payments, $57 million of
income taxes, $54 million of corporate expenses and $707 million related to an
aggregate increase in working capital requirements, other balance sheet accounts
and noncash items. Cash provided by operations of $918 million in the first nine
months of 1997 reflected $1.311 billion of business segment EBITA and $706
million of noncash depreciation expense, less $394 million of interest payments,
$55 million of income taxes, $54 million of corporate expenses and $596 million
related to an aggregate increase in working capital requirements, other balance
sheet accounts and noncash items.
Cash used by investing activities was $887 million in the first nine
months of 1998, compared to $777 million in the first nine months of 1997,
principally as a result of the effect of deconsolidating approximately $200
million of Paragon's cash in connection with the TWE-A/N Transfers that has been
included as a reduction of cash flows from investments and acquisitions, offset
in part by a $96 million increase in proceeds from the sale of investments.
Capital expenditures were $1.092 billion in the first nine months of 1998 and
$1.117 billion in the first nine months of 1997.
Cash used by financing activities was $583 million in the first nine
months of 1998, compared to $61 million in the first nine months of 1997,
principally as a result of the absence of $243 million of aggregate net proceeds
from the issuance of preferred stock of a subsidiary in the first quarter of
1997 and a $251 million increase in distributions paid to Time Warner, offset in
part by an increase in debt used to fund cash distributions to Time Warner.
Management believes that the Entertainment Group's operating cash flow,
cash and equivalents and additional borrowing capacity are sufficient to fund
its capital and liquidity needs for the foreseeable future.
Cable Capital Spending
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 it believes will position the business for sustained, long-term
growth. Capital spending by Time Warner Cable, including the cable operations of
both Time Warner and TWE, amounted to $1.149 billion in the nine months ended
September 30, 1998, compared to $1.221 billion in the nine months ended
September 30, 1997. For the full year of 1998, cable capital spending is
expected to be comparable to 1997 levels, with approximately $450 million
budgeted for the remainder of 1998. Capital spending by Time Warner Cable is
expected to continue to be funded by cable operating cash flow. In exchange for
certain flexibility in establishing cable rate pricing structures for regulated
services that went into effect on January 1, 1996 and consistent with Time
Warner Cable's long-term strategic plan, Time Warner Cable agreed with the FCC
to invest a total of $4 billion in capital costs in connection with the upgrade
of its cable infrastructure, which is expected to be substantially completed
over a five-year period ending December 31, 2000. The agreement with the FCC
covers all of the cable operations of Time Warner Cable, including the owned or
managed cable television systems of Time Warner, TWE and TWE-A/N. Management
expects to continue to finance such level of investment through cable operating
cash flow and the development of new revenue streams from expanded programming
options, high-speed Internet access and other services.
Cable Financing Strategy
Time Warner's and TWE's cable financing strategy is to continue to use
cable operating cash flow to finance the level of capital spending necessary to
upgrade the technological capability of its cable television systems and develop
new services, while pursuing opportunities to reduce either existing debt and/or
their share of future funding requirements related to the cable television
business and related ancillary businesses. Consistent with this strategy, Time
Warner, TWE and TWE-A/N have completed a series of transactions in 1998, as
discussed more fully below.
Business Telephony Reorganization
In July 1998, Time Warner, TWE and TWE-A/N completed the Business
Telephony Reorganization by combining their business telephony operations into a
single entity that is intended to be self-financing. This entity, named Time
Warner Telecom LLC ("TW Telecom"), is a competitive local exchange carrier
(CLEC) in selected metropolitan areas across the United States where it offers a
wide range of telephony services to business customers. Time Warner, MediaOne
and the Advance/Newhouse Partnership ("Advance/Newhouse"), a partner in TWE-A/N,
own interests in TW Telecom of 61.95%, 18.88% and 19.17%, respectively. Time
Warner's interest in TW Telecom is being accounted for under the equity method
of accounting because of certain rights held by MediaOne and Advance/Newhouse.
Following the Business Telephony Reorganization, TW Telecom raised
approximately $400 million of cash in July 1998 through the issuance of public
notes that mature in 2008. Such notes are non-recourse to Time Warner and the
proceeds therefrom are expected to be used by TW Telecom to continue to expand
and develop its telephony networks and services. Due to recent stock market
volatility, TW Telecom has postponed indefinitely its planned initial public
offering of a minority interest of common stock.
Road Runner Joint Venture
In June 1998, Time Warner, TWE, TWE-A/N, MediaOne, Microsoft Corp.
("Microsoft") and Compaq Computer Corp. ("Compaq") formed the Road Runner Joint
Venture to operate and expand Time Warner Cable's and MediaOne's existing
high-speed Internet access businesses. In exchange for contributing their
existing high-speed Internet access businesses, Time Warner received an 11.25%
common equity interest in the Road Runner Joint Venture, TWE received a 25%
interest, TWE-A/N received a 32.5% interest and MediaOne received a 31.25%
interest. In exchange for Microsoft and Compaq each contributing $212.5 million
of cash to the Road Runner Joint Venture, Microsoft and Compaq each received a
preferred equity interest therein that is convertible into a 10% common equity
interest. Accordingly, on a fully diluted basis, the Road Runner Joint Venture
is owned 9% by Time Warner, 20% by TWE, 26% by TWE-A/N, 25% by MediaOne, 10% by
Microsoft and 10% by Compaq. Each of Time Warner's, TWE's and TWE-A/N's interest
in the Road Runner Joint Venture is being accounted for under the equity method
of accounting.
The aggregate $425 million of capital contributed by Microsoft and Compaq
is expected to be used by the Road Runner Joint Venture to continue to expand
the roll out of high-speed Internet access services. In addition, as a result of
Time Warner Cable being a retailer of the Road Runner business in its franchise
areas whereby Time Warner Cable's technologically advanced, high-capacity cable
architecture will be used to provide these high-speed Internet access services,
Time Warner Cable will initially retain 70% of the subscription revenues and 30%
of the national advertising and transactional revenues generated from the
delivery of these on-line services to its cable subscribers. Time Warner Cable's
share of these revenues is expected to change periodically to 75% of
subscription revenues and 25% of national advertising and transactional revenues
by 2006.
Primestar Roll-up Transaction
In April 1998, TWE and Advance/Newhouse transferred the direct broadcast
satellite operations conducted by TWE and TWE-A/N (the "DBS Operations") and the
31% partnership interest in Primestar Partners, L.P. held by TWE-A/N
("Primestar" and collectively, the "Primestar Assets") to Primestar, Inc. ("New
Primestar"), a separate holding company. New Primestar owns the DBS Operations
and Primestar partnership interests formerly owned by TCI Satellite
Entertainment, Inc. and other previously existing partners of Primestar. In
exchange for contributing its interests in the Primestar Assets, TWE received
approximately 48 million shares of common stock of New Primestar (representing
an approximate 24% equity interest) and realized approximately $240 million of
debt reduction. TWE deconsolidated the DBS Operations effective as of April 1,
1998 and the equity interest in New Primestar received in this transaction is
being accounted for under the equity method of accounting.
TWE-A/N Transfers
In early 1998, Time Warner (through a wholly owned subsidiary) contributed
cable television systems (or interests therein) serving approximately 650,000
subscribers to TWE-A/N, subject to approximately $1 billion of debt, in exchange
for common and preferred partnership interests therein, and completed certain
related transactions. The debt assumed by TWE-A/N has been guaranteed by TWI
Cable and certain of its subsidiaries. TWE-A/N is now owned 65.3% by TWE, 33.3%
by Advance/Newhouse and 1.4% indirectly by Time Warner.
Filmed Entertainment Backlog
Backlog represents the amount of future revenue not yet recorded from cash
contracts for the licensing of theatrical and television product for pay cable,
basic cable, network and syndicated television exhibition. Backlog of Warner
Bros. amounted to $2.054 billion at September 30, 1998 compared to $2.126
billion at December 31, 1997 (including amounts relating to the licensing of
film product to Time Warner's and TWE's cable television networks, collectively,
of $711 million and $719 million, respectively).
Because backlog generally relates to contracts for the licensing of
theatrical and television product which have already been produced, the
recognition of revenue for such completed product is principally only dependent
upon the commencement of the availability period for telecast under the terms of
the related licensing agreement. Cash licensing fees are collected periodically
over the term of the related licensing agreements or on an accelerated basis
using a $600 million securitization facility. The portion of backlog for which
cash has not already been received has significant off-balance sheet asset value
as a source of future funding. The backlog excludes advertising barter
contracts, which are also expected to result in the future realization of
revenues and cash through the sale of advertising spots received under such
contracts.
Year 2000 Technology Preparedness
Time Warner, together with its Entertainment Group and like most large
companies, depends on many different computer systems and other chip-based
devices for the continuing conduct of its business. Older computer programs,
computer hardware and chip-based devices may fail to recognize dates beginning
on January 1, 2000 as being valid dates, and as a result may fail to operate or
may operate improperly when such dates are introduced.
Time Warner's exposure to potential Year 2000 problems exists in two
general areas: technological operations in the sole control of the Company and
technological operations dependent in some way on one or more third parties.
These technological operations include information technology ("IT") systems and
non-IT systems, including those with embedded technology, hardware and software.
Most of Time Warner's potential Year 2000 exposures are in the area of
technological operations dependent on one or more third parties. Failure to
achieve high levels of Year 2000 compliance in either area could have a material
adverse impact on Time Warner and its financial statements.
The Company's Year 2000 initiative is being conducted at the operational
level by divisional project managers and senior technology executives overseen
by senior divisional executives, with assistance internally as well as from
outside professionals. The progress of each division through the different
phases of remediation - inventorying, assessment, remediation planning,
implementation and final testing - is actively overseen and reviewed on a
regular basis by an executive oversight group that reports through the Company's
Chief Financial Officer to the Audit Committee of the Board of Directors.
The Company has generally completed the process of identifying potential
Year 2000 difficulties in its technological operations, including IT
applications, IT technology and support, desktop hardware and software, non-IT
systems and important third party operations, and distinguishing those that are
"mission critical" from those that are not. An item is considered "mission
critical" if its Year 2000-related failure would significantly impair the
ability of one of the Company's major business units to (1) produce, market and
distribute the products or services that generate significant revenues for
that business, (2) meet its obligations to pay its employees, artists, vendors
and other obligations or (3) meet its obligations under regulatory requirements
and internal accounting controls. The Company and its divisions, including the
Entertainment Group, have identified approximately 1,000 worldwide, "mission
critical" potential exposures. Of these, as of September 30, 1998, approximately
10% have been identified by the divisions as in the assessment stage,
approximately 30% as in the remediation planning stage, and almost 60% as in the
process of implementation or testing or as Year 2000 compliant. The Company
currently expects that the assessment phase for these potential exposures should
be completed by the end of 1998 and that remediation with respect to
technological operations in the sole control of the Company will be
substantially completed in all material respects by the end of the second
quarter of 1999.
In the area of "mission critical" technological operations dependent in
some way on one or more third parties, the situation is much less in Time
Warner's ability to predict or control. In addition, the Company's business is
heavily dependent on third parties that are themselves heavily dependent on
technology. In some cases, the Company's third party dependence is on vendors of
technology who are themselves working towards solutions to Year 2000 problems.
For example, in a situation endemic to the cable industry, much of the Company's
headend equipment that controls cable set-top boxes is currently not Year 2000
compliant. The box manufacturers are working with cable industry groups and have
recently developed solutions that the Company is beginning to install in its
headend equipment. It is currently expected that these solutions will be
substantially implemented by the end of the second quarter of 1999. In other
cases, the Company's third party dependence is on suppliers of products or
services that are themselves computer-intensive. For example, if a television
broadcaster or cable programmer encounters Year 2000 problems that impede its
ability to deliver its programming, the Company will be unable to provide that
programming to its cable customers. Similarly, because the Company is also a
programming supplier, third-party signal delivery problems could affect its
ability to deliver its programming to its customers. The Company has attempted
to include in its "mission critical" inventory significant service providers,
vendors, suppliers, customers and governmental entities that are believed to be
critical to business operations and is in various stages of attempting to
ascertain their state of Year 2000 readiness through questionnaires, interviews,
on-site visits, industry group participation and other available means.
Moreover, Time Warner is dependent, like all large companies, on the continued
functioning, domestically and internationally, of basic, heavily computerized
services such as banking telephony, and power, and various distribution
mechanisms ranging from the mail, railroads and trucking to high-speed data
transmission. Time Warner is taking steps to attempt to ensure that the third
parties on which it is heavily reliant are Year 2000 compliant, but cannot
predict the likelihood of such compliance nor the direct or indirect costs to
the Company of non-compliance by those third parties or of securing such
services from alternate compliant third parties.
The Company, including the Entertainment Group, currently estimates that
the aggregate cost of its Year 2000 remediation program, which started in 1996,
will be approximately $125 to $175 million, of which an estimated 40% to 50% has
been incurred through September 30, 1998. These costs include estimates of the
costs of assessment, replacement, repair and upgrade, both planned and
unplanned, of certain IT and non-IT systems and their implementation and
testing. These expenditures have been and are expected to continue to be funded
from the Company's operating cash flow and have not and are not expected to
impact materially the Company's financial statements.
Management believes that it has established an effective program to resolve
all significant Year 2000 issues in its sole control in a timely manner. As
noted above, however, the Company has not yet completed all phases of its
program and is dependent on third parties whose progress is not within its
control. In the event that the Company did not complete any of its currently
planned additional remediation prior to the Year 2000, management believes that
the Company could experience significant difficulty in producing and delivering
its products and services and conducting its business in the Year 2000 as it has
in the past. In addition, disruptions experienced by third parties with which
the Company does business as well as by the economy generally could also
materially adversely affect the Company. The amount of potential liability and
lost revenue cannot be reasonably estimated at this time.
The Company has been focusing its efforts on identification and
remediation of its Year 2000 exposures and has not yet developed significant
contingency plans in the event it does not successfully complete all phases of
its Year 2000 program. The Company intends to examine its status at the end of
1998, and periodically thereafter, to determine whether such plans are
necessary.
Euro Conversion
Effective January 1, 1999, the "euro" will be established as the common
legal currency of more than two-thirds of the member countries of the European
Union. These member countries will then have a three-year transitional period to
convert their existing sovereign currencies to the euro. By July 1, 2002, all
participating member countries must eliminate their sovereign currencies and
replace their legal tender with euro-denominated bills and coins.
Notwithstanding this transitional period, many commercial transactions are
expected to become euro-denominated well before the July 2002 deadline.
Accordingly, Time Warner is in the process of evaluating the short-term and
long-term effects of the euro conversion on its businesses, principally
consisting of its international publishing, music and filmed entertainment
operations.
Time Warner believes that its most significant short-term impact relating
to the euro conversion is the need to modify its accounting and information
systems to handle transactions during the transitional period in both the euro
and the existing sovereign currencies of the participating member countries.
Time Warner is in the process of identifying the accounting and information
systems in need of modification and, based on these findings, will formulate an
action plan to address the nature and timing of remediation efforts. Based on
preliminary information, costs to modify its accounting and information systems
are not expected to be material.
Time Warner believes that its most significant long-term business risk
relating to the euro conversion may be increased pricing pressures for its
products and services brought about by heightened consumer awareness of possible
cross-border price differences. However, Time Warner believes that these
business risks may be offset to some extent by lower production costs, other
cost savings and marketing opportunities. Notwithstanding such risks, management
does not believe at this time that the euro conversion will have a material
effect on Time Warner's financial position, results of operations or cash flows
in future periods.
Caution Concerning Forward-Looking Statements
The Securities and Exchange Commission encourages companies to disclose
forward-looking information so that investors can better understand a company's
future prospects and make informed investment decisions. This filing, together
with management's public commentary related thereto, contains such
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995, particularly statements anticipating future
growth in revenues, EBITA and cash flow and forecasting ongoing debt reduction.
Words such as "anticipate", "estimate", "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 management's
present expectations of future events. As with any projection or forecast, they
are inherently susceptible to changes in circumstances, and the Company is under
no obligation to (and expressly disclaims any such obligation to) update or
alter its forward-looking statements despite such changes.
Time Warner 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 and
(particularly in view of technological changes) protection of their intellectual
property rights. Time Warner's actual results could differ materially from
management's expectations because of changes in such factors. Some of the other
factors that also could cause actual results to differ from those contained in
the forward-looking statements include those identified in Time Warner's other
filings and:
* For Time Warner's cable business, more aggressive than expected
competition from new technologies and other types of video programming
distributors, including DBS; increases in government regulation of cable
or equipment rates (or any failure to reduce rate regulation as is
presently mandated by statute) or other terms of service (such as
"digital must-carry") or opposition to franchise renewals; the failure of
new equipment (such as digital set-top boxes) or services to function
properly, to appeal to enough consumers or to be delivered in a timely
fashion; and greater than expected increases in programming or other
costs.
* For Time Warner's cable programming and television businesses, greater
than expected programming or production costs; public and cable operator
resistance to price increases to offset higher programming costs (and the
negative impact on premium programmers of increases in basic cable
rates); the sensitivity of advertising to economic cyclicality; and
greater than expected fragmentation of consumer viewership due to an
increased number of programming services or the increased popularity of
alternatives to television.
* For Time Warner's film and television businesses, their ability to continue
to attract and select desirable talent and scripts at manageable costs;
increases in production costs generally; 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 such as DVD and the Internet.
* For Time Warner's music business, its ability to continue to attract and
select desirable talent at manageable costs; the timely completion of albums
by major artists; the popular demand for particular artists and albums; and
the overall strength of global music sales.
* For Time Warner's print media and publishing businesses, increases in paper
and distribution costs; the introduction and increased popularity of
alternative technologies for the provision of news and information, such as
the Internet; and fluctuations in advertiser and consumer spending.
* The ability of the Company and its key service providers, vendors,
suppliers, customers and governmental entities to replace, modify or upgrade
computer systems in ways that adequately address the Year 2000 issue,
including their ability to identify and correct all relevant computer codes
and embedded chips, unanticipated difficulties or delays in the
implementation of the Company's remediation plans and the ability of third
parties to adequately address their own Year 2000 issues.
In addition, Time Warner's overall financial strategy, including improved
financial ratios and a strengthened balance sheet, could be adversely affected
by increased interest rates, failure to meet earnings expectations, consequences
of the euro conversion and changes in Time Warner's plans, strategies and
intentions.
TIME WARNER INC.
CONSOLIDATED BALANCE SHEET
(Unaudited)
September 30, December 31,
1998 1997
---- ----
(millions, except
per share amounts)
ASSETS
Current assets
Cash and equivalents ..................................... $ 393 $ 645
Receivables, less allowances of $926 and $991 million .... 2,240 2,447
Inventories .............................................. 862 830
Prepaid expenses ......................................... 1,208 1,089
-------- --------
Total current assets ..................................... 4,703 5,011
Noncurrent inventories ................................... 1,902 1,766
Investments in and amounts due to and from
Entertainment Group .................................... 5,360 5,549
Other investments ........................................ 791 1,495
Property, plant and equipment ............................ 2,010 2,089
Music catalogues, contracts and copyrights ............... 867 928
Cable television and sports franchises ................... 3,127 3,982
Goodwill ................................................. 12,023 12,572
Other assets ............................................. 905 771
-------- --------
Total assets.......................................... ... $31,688 $ 34,163
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Accounts payable ......................................... $ 843 $ 912
Participations, royalties and programming costs payable .. 1,112 1,072
Debt due within one year ................................. 19 8
Other current liabilities ................................ 2,259 2,379
-------- --------
Total current liabilities ................................ 4,233 4,371
Long-term debt ........................................... 9,064 11,833
Borrowings against future stock option proceeds .......... 1,015 533
Deferred income taxes .................................... 3,609 3,960
Unearned portion of paid subscriptions ................... 720 672
Other liabilities ........................................ 1,473 1,006
Company-obligated mandatorily redeemable preferred
securities of a subsidiary holding solely subordinated
debentures of a subsidiary of the Company .............. 575 575
Series M exchangeable preferred stock, $.10 par value,
1.9 million shares outstanding and $1.903 billion
liquidation preference ................................. 1,859 1,857
Shareholders' equity
Preferred stock, $.10 par value, 27.3 and 35.4 million
shares outstanding, $2.730 and $3.539 billion liquidation
preference ............................................. 3 4
Series LMCN-V Common Stock, $.01 par value, 57.1 million
shares outstanding ..................................... 1 1
Common stock, $.01 par value, 547.9 and 519.0 million
shares outstanding (excluding 10.4 and 39.4 million
treasury shares) ....................................... 5 5
Paid-in capital .......................................... 12,878 12,680
Accumulated deficit ...................................... (3,747) (3,334)
-------- --------
Total shareholders' equity ............................... 9,140 9,356
-------- --------
Total liabilities and shareholders' equity................ $31,688 $ 34,163
======== ========
See accompanying notes.
TIME WARNER INC.
CONSOLIDATED STATEMENT OF OPERATIONS
(Unaudited)
Three Months Nine Months
Ended September 30, Ended September 30,
------------------- -------------------
1998 1997 1998 1997
---- ---- ---- ----
(millions, except per share amounts)
Revenues (a) ................................ $ 3,578 $3,231 $10,387 $ 9,458
------- ------ ------- -------
Cost of revenues (a)(b) ..................... 2,052 1,964 6,016 5,417
Selling, general and administrative (a)(b) .. 1,211 1,004 3,502 3,239
----- ----- ----- -----
Operating expenses .......................... 3,263 2,968 9,518 8,656
----- ----- ----- -----
Business segment operating income ........... 315 263 869 802
Equity in pretax income of Entertainment
Group (a) ................................. 164 96 437 522
Interest and other, net (a) ................. (311) (309) (877) (904)
Corporate expenses (a) ...................... (20) (17) (58) (60)
----- ----- ----- -----
Income before income taxes .................. 148 33 371 360
Income tax provision ........................ (109) (61) (293) (306)
----- ----- ----- -----
Income (loss) before extraordinary item ..... 39 (28) 78 54
Extraordinary loss on retirement of debt,
net of $5 million and $16 million income
tax benefits in 1997 ..................... - (7) - (24)
----- ----- ----- -----
Net income (loss) ........................... 39 (35) 78 30
Preferred dividend requirements ............. (76) (81) (236) (238)
----- ----- ----- -----
Net loss applicable to common shares......... $ (37) $ (116) $ (158) $ (208)
===== ======= ======= =======
Basic and diluted loss per common share:
Loss before extraordinary item............... $(.06) $ (.19) $ (.27) $ (.33)
===== ======= ======= =======
Net loss..................................... $(.06) $ (.20) $ (.27) $ (.37)
===== ======= ======= =======
Average common shares ..................... 601.3 573.3 592.0 564.4
===== ======= ======= =======
(a) Includes the following income (expenses) resulting from transactions with
the Entertainment Group and other related companies for the three and nine
months ended September 30, 1998, respectively, and for the corresponding
periods in the prior year: revenues-$120 million and $334 million in 1998,
$94 million and $241 million in 1997; cost of revenues-$(70) million and
$(207) million in 1998, $(67) million and $(188) million in 1997; selling,
general and administrative-$(8) million and $(28) million in 1998, $12
million and $20 million in 1997; equity in pretax income of Entertainment
Group-$72 million and $52 million in 1998, $11 million and $35 million in
1997; interest and other, net-$(2) million and $(8) million in 1998, $(9)
million and $(30) million in 1997; and corporate expenses-$18 million and
$54 million in 1998, $18 million and $54 million in 1997.
(b) Includes depreciation and amortization
expense of: $295 $320 $884 $935
==== ==== ==== ====
See accompanying notes.
TIME WARNER INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited)
Nine Months
Ended September 30,
-------------------
1998 1997
---- ----
(millions)
OPERATIONS
Net income................................................. $ 78 $ 30
Adjustments for noncash and nonoperating items:
Extraordinary loss on retirement of debt................... - 24
Depreciation and amortization.............................. 884 935
Noncash interest expense................................... 29 75
Excess (deficiency) of distributions over equity in
pretax income of Entertainment Group..................... 168 (168)
Changes in operating assets and liabilities................ 35 (257)
----- -----
Cash provided by operations................................ 1,194 639
----- -----
INVESTING ACTIVITIES
Investments and acquisitions............................... (86) (98)
Capital expenditures....................................... (348) (424)
Investment proceeds........................................ 458 156
Proceeds received from distribution of Senior
Capital contributed to TWE 455 455
----- -----
Cash provided by investing activities...................... 479 89
----- -----
FINANCING ACTIVITIES
Borrowings................................................. 1,669 1,945
Debt repayments............................................(2,300) (2,243)
Borrowings against future stock option proceeds............ 1,015 -
Repayments of borrowings against future stock
option proceeds ......................................... (533) (185)
Repurchases of Time Warner common stock....................(1,944) (37)
Dividends paid............................................. (394) (253)
Proceeds received from stock option and dividend
reinvestment plans ...................................... 599 328
Other, principally financing costs......................... (37) (36)
----- -----
Cash used by financing activities..........................(1,925) (481)
------ -----
INCREASE (DECREASE) IN CASH AND EQUIVALENTS................ (252) 247
CASH AND EQUIVALENTS AT BEGINNING OF PERIOD (a)............ 645 514
----- -----
CASH AND EQUIVALENTS AT END OF PERIOD...................... $393 $761
===== =====
- ---------------
(a) Includes current and noncurrent cash and equivalents at December 31, 1996.
See accompanying notes.
TIME WARNER INC.
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(Unaudited)
Nine Months
Ended September 30,
-------------------
1998 1997
---- ----
(millions)
BALANCE AT BEGINNING OF YEAR................................ $9,356 $9,502
Net income.................................................. 78 30
Decrease in unrealized gains on securities, net of
$6 million tax benefit ................................... - (9)
Foreign currency translation adjustments.................... (18) (70)
Increase in realized and unrealized losses on derivative
financial instruments, net of $28 million tax benefit..... (41) -
Cumulative effect of change in accounting for derivative
financial instruments, net of $3 million tax benefit...... (18) -
----- -----
Comprehensive income (loss)(a).............................. 1 (49)
Common stock dividends...................................... (161) (152)
Preferred stock dividends................................... (236) (238)
Repurchases of Time Warner common stock..................... (1,944) (37)
Issuance of common stock in connection with the conversion
of the zero-coupon convertible notes due 2013............. 1,150 -
Issuance of common stock in connection with the acquisition
of Turner Broadcasting System, Inc....................... - 67
Other, principally shares issued pursuant to stock option,
dividend reinvestment and benefit plans................... 974 437
------ ------
BALANCE AT SEPTEMBER 30,.......................................$9,140 $9,530
====== ======
- ---------------
(a) Comprehensive loss for the three months ended September 30, 1998 and 1997
was $16 million and $55 million, respectively. Comprehensive loss for the
three-month period ended September 30, 1998 has been increased by an $18
million cumulative effect of a change in accounting for derivative financial
instruments.
See accompanying notes.
TIME WARNER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION
Description of Business
Time Warner Inc. ("Time Warner" or the "Company") is the world's leading
media and entertainment company, whose principal business objective is to create
and distribute branded information and entertainment copyrights throughout the
world. Time Warner classifies its business interests into four fundamental
areas: Entertainment, consisting principally of interests in recorded music and
music publishing, filmed entertainment, television production and television
broadcasting; Cable Networks, consisting principally of interests in cable
television programming; Publishing, consisting principally of interests in
magazine publishing, book publishing and direct marketing; and Cable, consisting
principally of interests in cable television systems. A majority of Time
Warner's interests in filmed entertainment, television production, television
broadcasting and cable television systems, and a portion of its interests in
cable television programming, are held through Time Warner Entertainment
Company, L.P. ("TWE"). 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
senior priority capital ("Senior Capital") and junior priority capital ("Series
B Capital"). The remaining 25.51% limited partnership interests in the Series A
Capital and Residual Capital of TWE are held by a subsidiary of MediaOne Group,
Inc. ("MediaOne"), formerly U S WEST, Inc. Time Warner does not consolidate TWE
and certain related companies (the "Entertainment Group") for financial
reporting purposes because of certain limited partnership rights related to
TWE's interest in certain cable television systems.
The operating results of Time Warner's various business interests are
presented herein as an indication of financial performance (Note 10). Except for
start-up losses incurred in connection with The WB Network, Time Warner's
principal business interests generate significant operating income and cash flow
from operations. The cash flow from operations generated by such business
interests is considerably greater than their operating income due to significant
amounts of noncash amortization of intangible assets recognized in various
acquisitions accounted for by the purchase method of accounting. Noncash
amortization of intangible assets recorded by Time Warner's business interests,
including the unconsolidated business interests of the Entertainment Group,
amounted to $330 million and $333 million for the three months ended September
30, 1998 and 1997, respectively, and $986 million and $979 million for the nine
months ended September 30, 1998 and 1997, respectively.
Basis of Presentation
The accompanying 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 financial statements should be read in conjunction
with the audited consolidated financial statements of Time Warner for the year
ended December 31, 1997. Certain reclassifications have been made to the prior
year's financial statements to conform to the 1998 presentation.
Effective July 1, 1998, Time Warner adopted Financial Accounting Standards
Board Statement No. 133, "Accounting for Derivative Instruments and Hedging
Activities" ("FAS 133"). FAS 133 requires that all derivative financial
instruments, such as interest rate swap contracts, interest rate lock agreements
and foreign exchange
contracts, be recognized in the financial statements and measured at fair value
regardless of the purpose or intent for holding them. The adoption of FAS 133
did not have a material effect on Time Warner's primary financial statements,
but did reduce comprehensive income by $18 million in the accompanying
consolidated statement of shareholders' equity.
2. CABLE TRANSACTIONS
In addition to continuing to use cable operating cash flow to finance the
level of capital spending necessary to upgrade the technological capability of
their cable television systems and develop new services, Time Warner, TWE and
the TWE-Advance/Newhouse Partnership ("TWE-A/N") have completed a series of
transactions in 1998 related to the cable television business and related
ancillary businesses that either reduced existing debt and/or Time Warner's and
TWE's share of future funding requirements for such businesses. These
transactions are discussed more fully below.
Business Telephony Reorganization
In July 1998, in an effort to combine their business telephony operations
into a single entity that is intended to be self-financing, Time Warner, TWE and
TWE-A/N completed a reorganization of their business telephony operations (the
"Business Telephony Reorganization"), whereby (i) the operations conducted by
Time Warner, TWE and TWE-A/N were each contributed to a new holding company
named Time Warner Telecom LLC ("TW Telecom"), and then (ii) TWE's and TWE-A/N's
interests in TW Telecom were distributed to their partners, Time Warner,
MediaOne and the Advance/Newhouse Partnership ("Advance/Newhouse"). As a result
of the Business Telephony Reorganization, Time Warner, MediaOne and
Advance/Newhouse own interests in TW Telecom of 61.95%, 18.88% and 19.17%,
respectively. Time Warner's interest in TW Telecom is being accounted for under
the equity method of accounting because of certain rights held by MediaOne and
Advance/Newhouse.
TW Telecom is a competitive local exchange carrier (CLEC) in selected
metropolitan areas across the United States where it offers a wide range of
telephony services to business customers. Following the Business Telephony
Reorganization, TW Telecom raised approximately $400 million of cash in July
1998 through the issuance of public notes that mature in 2008. Such notes are
non-recourse to Time Warner and the proceeds therefrom are expected to be used
by TW Telecom to continue to expand and develop its telephony networks and
services.
Road Runner Joint Venture
In June 1998, Time Warner, TWE, TWE-A/N, MediaOne, Microsoft Corp.
("Microsoft") and Compaq Computer Corp. ("Compaq") formed a joint venture to
operate and expand Time Warner Cable's and MediaOne's existing high-speed
Internet access businesses (the "Road Runner Joint Venture"). In exchange for
contributing their existing high-speed Internet access businesses, Time Warner
received a common equity interest in the Road Runner Joint Venture of 11.25%,
TWE received a 25% interest, TWE-A/N received a 32.5% interest and MediaOne
received a 31.25% interest. In exchange for Microsoft and Compaq each
contributing $212.5 million of cash to the Road Runner Joint Venture, Microsoft
and Compaq each received a preferred equity interest therein that is convertible
into a 10% common equity interest. Accordingly, on a fully diluted basis, the
Road Runner Joint Venture is owned 9% by Time Warner, 20% by TWE, 26% by
TWE-A/N, 25% by MediaOne, 10% by Microsoft
and 10% by Compaq. Each of Time Warner's, TWE's and TWE-A/N's interest in the
Road Runner Joint Venture is being accounted for under the equity method of
accounting.
Primestar
In April 1998, TWE and Advance/Newhouse, a limited partner in TWE-A/N,
transferred the direct broadcast satellite operations conducted by TWE and
TWE-A/N (the "DBS Operations") and the 31% partnership interest in Primestar
Partners, L.P. held by TWE-A/N ("Primestar" and collectively, the "Primestar
Assets") to Primestar, Inc. ("New Primestar"), a separate holding company. New
Primestar owns the DBS Operations and Primestar partnership interests formerly
owned by TCI Satellite Entertainment, Inc. and other previously existing
partners of Primestar. In exchange for contributing its interests in the
Primestar Assets, TWE received approximately 48 million shares of common stock
of New Primestar (representing an approximate 24% equity interest) and realized
approximately $240 million of debt reduction. In partial consideration for
contributing its indirect interest in certain of the Primestar Assets,
Advance/Newhouse received an approximate 6% equity interest in New Primestar. As
a result of this transaction, effective as of April 1, 1998, TWE deconsolidated
the DBS Operations and the 24% equity interest in New Primestar received in the
transaction is being accounted for under the equity method of accounting. This
transaction is referred to herein as the "Primestar Roll-up Transaction."
In a related transaction, Primestar also entered into an agreement in June
1997 with The News Corporation Limited ("News Corp."), MCI WorldCom, Inc.
("MCI") and American Sky Broadcasting LLC ("ASkyB"), pursuant to which New
Primestar would acquire certain assets relating to the high-power, direct
broadcast satellite business of ASkyB (the "Primestar ASkyB Transaction"). In
May 1998, the U.S. Department of Justice brought a civil action against
Primestar, each of its cable owners, including TWE, and News Corp. and MCI, to
enjoin on antitrust grounds the Primestar ASkyB Transaction. Although the
parties had discussions with the U.S. Department of Justice in an attempt to
restructure the transaction, no resolution was reached and the parties
terminated their agreement in October 1998.
TWE-A/N Transfers
In early 1998, Time Warner (through a wholly owned subsidiary) contributed
cable television systems (or interests therein) serving approximately 650,000
subscribers to TWE-A/N, subject to approximately $1 billion of debt, in exchange
for common and preferred partnership interests therein, and completed certain
related transactions (collectively, the "TWE-A/N Transfers"). The cable
television systems transferred to TWE-A/N were formerly owned by TWI Cable Inc.
("TWI Cable"), a wholly owned subsidiary of Time Warner, and Paragon
Communications ("Paragon"), a partnership formerly owning cable television
systems serving approximately 1 million subscribers that was wholly owned by
subsidiaries of Time Warner, with 50% beneficially owned in the aggregate by TWE
and TWE-A/N. The debt assumed by TWE-A/N has been guaranteed by TWI Cable and
certain of its subsidiaries, including Paragon.
As part of the TWE-A/N Transfers, TWE and TWE-A/N exchanged substantially
all of their respective beneficial interests in Paragon for an equivalent share
of Paragon's cable television systems (or interests therein) serving
approximately 500,000 subscribers, resulting in wholly owned subsidiaries of
Time Warner owning 100% of the restructured Paragon entity, with less than 1%
beneficially held for TWE. Accordingly, effective as of
January 1, 1998, Time Warner has consolidated Paragon. Because this transaction
represented an exchange of TWE's and TWE-A/N's beneficial interests in Paragon
for an equivalent amount of its cable television systems, it did not have a
significant economic impact on Time Warner, TWE or TWE-A/N.
In connection with the TWE-A/N Transfers, Advance/Newhouse made a capital
contribution to TWE-A/N in order to maintain its 33.3% common partnership
interest therein. Accordingly, TWE-A/N is now owned 65.3% by TWE, 33.3% by
Advance/Newhouse and 1.4% indirectly by Time Warner. The TWE-A/N Transfers were
accounted for effective as of January 1, 1998. Time Warner did not recognize a
gain or loss on the TWE-A/N Transfers. TWE has continued to consolidate TWE-A/N
and Time Warner has accounted for its interest in TWE-A/N under the equity
method of accounting.
On a pro forma basis, giving effect to the TWE-A/N Transfers as if they
had occurred at the beginning of 1997, Time Warner would have reported for the
three and nine months ended September 30, 1997, respectively, revenues of $3.217
billion and $9.414 billion, depreciation expense of $95 million and $273
million, operating income before noncash amortization of intangible assets of
$458 million and $1.372 billion, operating income of $251 million and $763
million, equity in the pretax income of the Entertainment Group of $94 million
and $518 million, income (loss) before extraordinary item of $(26) million and
$59 million ($.19 and $.32 loss per common share) and net income (loss) of $(33)
million and $35 million ($.20 and $.36 loss per common share).
3. ENTERTAINMENT GROUP
Time Warner's investment in and amounts due to and from the Entertainment
Group at September 30, 1998 and December 31, 1997 consists of the following:
September 30, December 31,
1998 1997
---- ----
(millions)
Investment in TWE....................................... $4,491 $5,577
Stock option related distributions due from TWE......... 682 417
Credit agreement debt due to TWE........................ (400) (400)
Other net liabilities due to TWE, principally
related to home video distribution.................... (132) (141)
------ ------
Investment in and amounts due to and from TWE........... 4,641 5,453
Investment in TWE-A/N and other Entertainment Group
companies ............................................ 719 96
------ ------
Total................................................... $5,360 $5,549
====== ======
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 subsidiaries
of Time Warner. Time Warner, through its wholly owned subsidiaries, collectively
owns general and limited partnership interests in TWE consisting of 74.49% of
the Series A Capital and Residual Capital and 100% of the Senior Capital and
Series B Capital. The remaining 25.51% limited partnership interests in the
Series A Capital and Residual Capital of TWE are owned by MediaOne. Certain Time
Warner subsidiaries are the general partners of TWE (the "Time Warner General
Partners").
The TWE partnership agreement provides for special allocations of income,
loss and distributions of partnership capital, including priority distributions
in the event of liquidation. TWE reported net income of $435 million and $483
million in the nine months ended September 30, 1998 and 1997, respectively, no
portion of which was allocated to the limited partnership interests.
Summarized Financial Information of the Entertainment Group
Set forth below is summarized financial information of the Entertainment
Group, which reflects the TWE-A/N Transfers effective as of January 1, 1998, the
Primestar Roll-up Transaction effective as of April 1, 1998, the formation of
the Road Runner Joint Venture effective as of June 30, 1998 and the Business
Telephony Reorganization effective as of July 1, 1998.
Three Months Nine Months
Ended September 30, Ended September 30,
------------------- -------------------
1998 1997 1998 1997
---- ---- ---- ----
(millions)
Operating Statement Information
Revenues................................. $3,222 $2,857 $8,987 $8,190
Depreciation and amortization............ (358) (366) (1,085) (1,027)
Business segment operating income(1)..... 469 335 1,294 990
Interest and other, net(2) .............. (203) (146) (550) (157)
Minority interest........................ (52) (64) (198) (228)
Income before income taxes .............. 196 107 492 551
Net income............................... 173 80 437 487
- ------------------
(1) Includes net pretax gains recognized in connection with the sale or exchange
of certain cable television systems of approximately $6 million and $16
million for the three months ended September 30, 1998 and 1997,
respectively, and approximately $90 million and $40 million for the nine
months ended September 30, 1998 and 1997, respectively.
(2) Includes a pretax gain of approximately $250 million recognized in the first
quarter of 1997 related to the sale of an interest in E!
Entertainment Television, Inc.
Nine Months
Ended September 30,
-------------------
1998 1997
---- ----
(millions)
Cash Flow Information
Cash provided by operations............................... $1,273 $ 918
Capital expenditures...................................... (1,092) (1,117)
Investments and acquisitions.............................. (335) (104)
Investment proceeds....................................... 540 444
Borrowings................................................ 1,515 905
Debt repayments........................................... (840) (323)
Issuance of preferred stock of subsidiary................. - 243
Capital distributions..................................... (1,060) (809)
Other financing activities, net........................... (198) (77)
Increase (decrease) in cash and equivalents............... (197) 80
September 30, December 31,
1998 1997
---- ----
(millions)
Balance Sheet Information
Cash and equivalents................................ $ 125 $ 322
Total current assets................................ 4,050 3,623
Total assets........................................ 22,417 20,739
Total current liabilities........................... 4,310 3,976
Long-term debt...................................... 7,435 5,990
Minority interests.................................. 1,440 1,210
Preferred stock of subsidiary....................... 221 233
Time Warner General Partners' Senior Capital........ 591 1,118
Partners' capital .................................. 5,854 6,430
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, 1998 and December 31, 1997, the Time
Warner General Partners had recorded $682 million and $417 million,
respectively, of stock option related distributions due from TWE, based on
closing prices of Time Warner common stock of $87.56 and $62.00, respectively.
Time Warner is paid when the options are exercised. The Time Warner General
Partners also receive tax-related distributions from TWE on a current basis.
During the nine months ended September 30, 1998, the Time Warner General
Partners received cash distributions from TWE in the amount of $1.060 billion,
consisting of $579 million of Senior Capital distributions (representing the
return of $455 million of contributed capital and the distribution of $124
million of priority capital return), $264 million of tax-related distributions
and $217 million of stock option related distributions. During the nine months
ended September 30, 1997, the Time Warner General Partners received cash
distributions from TWE in the amount of $809 million, consisting of $535 million
of Senior Capital distributions (representing the return of $455 million of
contributed capital and the distribution of $80 million of priority capital
return), $232 million of tax-related distributions and $42 million of stock
option related distributions.
In addition, in connection with the Business Telephony Reorganization, TWE
recorded a $193 million noncash distribution to its partners, of which certain
wholly owned subsidiaries of Time Warner received an interest in TW Telecom
valued at $144 million based on TWE's historical cost of the net assets (Note
2).
Six Flags
In April 1998, TWE sold its remaining 49% interest in Six Flags
Entertainment Corporation ("Six Flags") to Premier Parks Inc. ("Premier"), a
regional theme park operator, for approximately $475 million of cash. TWE used
the net, after-tax proceeds from this transaction to reduce debt by
approximately $300 million. As part of the transaction, TWE will continue to
license its animated cartoon and comic book characters to Six Flags's theme
parks and will similarly license such rights to Premier's theme parks in the
United States and Canada under a long-term agreement covering an aggregate of
twenty-five existing and all future locations. A substantial portion of the gain
on this transaction has been deferred by TWE, principally as a result of its
continuing guarantees of certain significant long-term obligations of Six Flags
relating to the Six Flags Over Texas and Six Flags Over Georgia theme parks.
4. INVENTORIES Inventories consist of:
September 30, 1998 December 31, 1997
------------------ -----------------
Current Noncurrent Current Noncurrent
------- -------- ------- ----------
(millions)
Film costs:
Released, less amortization........... $ 86 $ 290 $ 68 $ 228
Completed and not released............ 11 2 88 48
In process and other.................. 4 184 - 141
Library, less amortization............ - 1,021 - 1,064
Programming costs, less amortization..... 315 405 293 285
Magazines, books and recorded music...... 446 - 381 -
----- ----- ----- -----
Total.................................... $862 $1,902 $830 $1,766
==== ====== ==== ======
5. LONG-TERM DEBT
In July 1998, Time Warner reduced bank debt by $579 million using the
proceeds received from a distribution by TWE relating to its Senior Capital
interest.
During the second quarter of 1998, Time Warner issued $600 million
principal amount of 6.875% debentures due 2018 and borrowed $550 million under
its bank credit agreement, which together offset the debt reduction associated
with the conversion of $1.15 billion accreted amount of zero-coupon convertible
notes due 2013 (the "Zero-Coupon Convertible Notes") into 18.7 million shares of
Time Warner common stock. The net proceeds therefrom have been used to
repurchase common stock, including the repurchase of 9.1 million shares of
common stock in connection with the settlement of a forward purchase contract to
acquire such shares (Note 8). These share repurchases partially offset the
dilution resulting from the conversion of the Zero-Coupon Convertible Notes.
In February 1998, Time Warner Companies, Inc. ("TW Companies"), a wholly
owned subsidiary of Time Warner, repaid all of its $500 million principal amount
of 7.45% notes due February 1, 1998 at their maturity using proceeds raised from
the issuance of $500 million principal amount of 6.95% debentures due January
15, 2028.
In early 1998, Time Warner reduced debt by approximately $1 billion in
connection with the TWE-A/N Transfers (see Note 2). The debt assumed by TWE-A/N
has been guaranteed by TWI Cable and certain of its subsidiaries, including
Paragon.
An extraordinary loss of $24 million was recognized in the nine months
ended September 30, 1997 in connection with certain debt refinancings, of which
$7 million was recognized in the third quarter.
6. BORROWINGS AGAINST FUTURE STOCK OPTION PROCEEDS
In connection with Time Warner's common stock repurchase program, Time
Warner entered into a new five-year, $1.3 billion revolving credit facility (the
"Stock Option Proceeds Credit Facility") in early 1998, which replaced its
previously existing facility. Borrowings under the Stock Option Proceeds Credit
Facility are principally used to fund stock repurchases and future preferred
dividend requirements on Time Warner's Series G, H, I and
J Preferred Stock. At September 30, 1998 and December 31, 1997, Time Warner had
outstanding borrowings against future stock option proceeds of $1.015 billion
and $533 million, respectively.
7. MANDATORILY REDEEMABLE PREFERRED SECURITIES
In December 1995, TW Companies issued approximately 23 million
Company-obligated mandatorily redeemable preferred securities of a wholly owned
subsidiary ("Preferred Trust Securities") for aggregate gross proceeds of $575
million. The sole assets of the subsidiary that is the obligor on the Preferred
Trust Securities are $592 million principal amount of 8 7/8% subordinated
debentures of TW Companies due December 31, 2025. Cumulative cash distributions
are payable on the Preferred Trust Securities at an annual rate of 8 7/8%. The
Preferred Trust Securities are mandatorily redeemable for cash on December 31,
2025, and TW Companies has the right to redeem the Preferred Trust Securities,
in whole or in part, on or after December 31, 2000, or in other certain
circumstances, in each case at an amount per Preferred Trust Security equal to
$25 plus accrued and unpaid distributions thereon.
Time Warner has certain obligations relating to the Preferred Trust
Securities which amount to a full and unconditional guaranty (on a subordinated
basis) of its subsidiary's obligations with respect thereto.
8. SHAREHOLDERS' EQUITY
During 1998, Time Warner issued approximately 26.3 million shares of
common stock in connection with the conversion of 12.6 million shares of
convertible preferred stock (consisting of approximately 5 million shares of
Series G preferred stock, 6.3 million shares of Series I preferred stock and 1.3
million shares of Series J preferred stock). These conversions are expected to
result in approximately $50 million of cash dividend savings in the aggregate
for Time Warner through the end of 1999.
In June 1998, in order to offset partially the dilutive effect relating to
the conversion of the Zero-Coupon Convertible Notes (Note 5), Time Warner
exercised its option under a forward purchase contract and repurchased 9.1
million shares of its common stock at an aggregate cost of $632 million, or
$69.12 per common share.
In connection with these transactions and the conversion of the
Zero-Coupon Convertible Notes, Time Warner's Board of Directors authorized in
1998 an 18.7 million share increase in the Company's existing common stock
repurchase program that, along with previous authorizations, allows the Company
to repurchase, from time to time, up to 53.7 million shares of common stock. The
common stock repurchased under the program is expected to continue to be used to
satisfy a portion of the future share issuances related to the exercise of
existing employee stock options and the potential conversion of certain
convertible securities. Actual repurchases in any period will be subject to
market conditions. As of September 30, 1998, Time Warner had acquired 26.4
million shares of its common stock in 1998 at an aggregate cost of $1.944
billion. In addition, in October 1998, Time Warner acquired another 3.2 million
shares of common stock at an aggregate cost of $258 million, thereby increasing
the cumulative shares purchased under this program to approximately 47.2 million
shares at an aggregate cost of approximately $3 billion. Except for repurchases
of common stock using $1.1 billion of borrowings in the second quarter of 1998
that offset a like-amount of debt reduction associated with the conversion of
the Zero-Coupon Convertible Notes into common stock, these repurchases have been
and are expected to continue to be funded with stock option
exercise proceeds and borrowings under Time Warner's Stock Option Proceeds
Credit Facility, as described more fully above.
9. DERIVATIVE FINANCIAL INSTRUMENTS
Time Warner uses derivative financial instruments principally to manage
the risk that changes in interest rates will affect either the fair value of its
debt obligations or the amount of its future interest payments and, with regard
to foreign currency exchange rates, to manage the risk that changes in exchange
rates will affect the amount of unremitted or future royalties and license fees
to be received from the sale of U.S. copyrighted products abroad. The following
is a summary of Time Warner's risk management strategies and the effect of these
strategies on Time Warner's consolidated financial statements.
Interest Rate Risk Management
Interest Rate Swap Contracts
Interest rate swap contracts are used to adjust the proportion of total
debt that is subject to variable and fixed interest rates. Under an interest
rate swap contract, Time Warner either agrees to pay an amount equal to a
specified variable-rate of interest times a notional principal amount, and to
receive in return an amount equal to a specified fixed-rate of interest times
the same notional principal amount or, vice versa, to receive a variable-rate
amount and to pay a fixed-rate amount. The notional amounts of the contract are
not exchanged. No other cash payments are made unless the contract is terminated
prior to maturity, in which case the amount paid or received in settlement is
established by agreement at the time of termination, and usually represents the
net present value, at current rates of interest, of the remaining obligations to
exchange payments under the terms of the contract. Interest rate swap contracts
are entered into with a number of major financial institutions in order to
minimize credit risk.
Time Warner accounts for its interest rate swap contracts differently
based on whether it has agreed to pay an amount based on a variable-rate or
fixed-rate of interest. For interest rate swap contracts under which Time Warner
agrees to pay variable-rates of interest, these contracts are considered to be a
hedge against changes in the fair value of Time Warner's fixed-rate debt
obligations. Accordingly, the interest rate swap contracts are reflected at fair
value in Time Warner's consolidated balance sheet and the related portion of
fixed-rate debt being hedged is reflected at an amount equal to the sum of its
carrying value plus an adjustment representing the change in fair value of the
debt obligations attributable to the interest rate risk being hedged. In turn,
changes during any accounting period in the fair value of these interest rate
swap contracts, as well as offsetting changes in the adjusted carrying value of
the related portion of fixed-rate debt being hedged, are recognized as
adjustments to interest expense in Time Warner's consolidated statement of
operations. The net effect of this accounting on Time Warner's operating results
is that interest expense on the portion of fixed-rate debt being hedged is
generally recorded based on variable interest rates.
For interest rate swap contracts under which Time Warner agrees to pay
fixed-rates of interest, these contracts are considered to be a hedge against
changes in the amount of future cash flows associated with Time Warner's
interest payments. Accordingly, the interest rate swap contracts are reflected
at fair value in Time
Warner's consolidated balance sheet and the related gains or losses on these
contracts are deferred in shareholders' equity (as a component of comprehensive
income). These deferred gains and losses are then amortized as an adjustment to
interest expense over the same period in which the related interest payments
being hedged are recognized in income. However, to the extent that any of these
contracts are not considered to be perfectly effective in offsetting the change
in the value of the interest payments being hedged, any changes in fair value
relating to the ineffective portion of these contracts are immediately
recognized in income. The net effect of this accounting on Time Warner's
operating results is that interest expense on the portion of variable-rate debt
being hedged is generally recorded based on fixed interest rates.
At September 30, 1998, Time Warner had interest rate swap contracts to pay
variable-rates of interest (average six-month LIBOR rate of 5.75%) and receive
fixed-rates of interest (average rate of 5.51%) on $1.6 billion notional amount
of indebtedness, which resulted in approximately 34.7% of Time Warner's
underlying debt, and 41% of Time Warner's and the Entertainment Group's combined
debt, being subject to variable interest rates. At December 31, 1997, Time
Warner had interest rate swap contracts on $2.3 billion notional amount of
indebtedness. The net gain or loss on the ineffective portion of these interest
rate swap contracts was not material in any period.
Interest Rate Lock Agreements
Interest rate lock agreements are used to hedge the risk that the cost of
a future issuance of debt may be adversely affected by changes in interest
rates. Under an interest rate lock agreement, Time Warner agrees to pay or
receive an amount equal to the difference between the net present value of the
cash flows for a notional principal amount of indebtedness based on the existing
yield of a U.S. treasury bond at the date when the hedge is established and the
existing yield of a U.S. treasury bond at the date when the hedge is settled,
typically when Time Warner issues new debt. The notional amounts of the
agreement are not exchanged. Interest rate lock agreements are entered into with
a number of major financial institutions in order to minimize credit risk.
Interest rate lock agreements are reflected at fair value in Time Warner's
consolidated balance sheet and the related gains or losses on these agreements
are deferred in shareholders' equity (as a component of comprehensive income).
These deferred gains and losses are then amortized as an adjustment to interest
expense over the same period in which the related interest costs on the new debt
issuances are recognized in income.
At September 30, 1998, Time Warner had interest rate lock agreements on
$1.015 billion notional amount of indebtedness, which are principally being used
to hedge future debt issuances in connection with the planned redemption of Time
Warner's Series M Preferred Stock on December 30, 1998. Time Warner had deferred
approximately $55 million of net losses on interest rate lock agreements at
September 30, 1998, of which approximately $4 million is expected to be
recognized in income over the next twelve months.
Foreign Currency Risk Management
Foreign exchange contracts are used primarily by Time Warner to hedge the
risk that unremitted or future royalties and license fees owed to Time Warner or
TWE domestic companies for the sale or anticipated sale of U.S. copyrighted
products abroad may be adversely affected by changes in foreign currency
exchange rates. As part of its overall strategy to manage the level of exposure
to the risk of foreign currency exchange rate fluctuations, Time
Warner hedges a portion of its and TWE's combined foreign currency exposures
anticipated over the ensuing twelve month period. At September 30, 1998, Time
Warner had effectively hedged approximately half of the combined estimated
foreign currency exposures that principally relate to anticipated cash flows to
be remitted to the U.S. over the ensuing twelve month period, using foreign
exchange contracts that generally have maturities of three months or less, which
generally are rolled over to provide continuing coverage throughout the year.
Time Warner often closes foreign exchange sale contracts by purchasing an
offsetting purchase contract. Time Warner reimburses or is reimbursed by TWE for
contract gains and losses related to TWE's foreign currency exposure. Foreign
exchange contracts are placed with a number of major financial institutions in
order to minimize credit risk.
Time Warner records these foreign exchange contracts at fair value in its
consolidated balance sheet and the related gains or losses on these contracts
are deferred in shareholders' equity (as a component of comprehensive income).
These deferred gains and losses are recognized in income in the period in which
the related royalties and license fees being hedged are received and recognized
in income. However, to the extent that any of these contracts are not considered
to be perfectly effective in offsetting the change in the value of the royalties
and license fees being hedged, any changes in fair value relating to the
ineffective portion of these contracts are immediately recognized in income.
Gains and losses on foreign exchange contracts are generally included as a
component of interest and other, net, in Time Warner's consolidated statement of
operations.
At September 30, 1998, Time Warner had contracts for the sale of $608
million and the purchase of $267 million of foreign currencies at fixed rates,
primarily Japanese yen (39% of contract value), German marks (42%) and French
francs (16%), compared to contracts for the sale of $507 million and the
purchase of $139 million of foreign currencies at December 31, 1997. Time Warner
had deferred approximately $4 million of net losses on foreign exchange
contracts at September 30, 1998, which is all expected to be recognized in
income over the next twelve months.
10. SEGMENT INFORMATION
Time Warner classifies its businesses into four fundamental areas:
Entertainment, consisting principally of interests in recorded music and music
publishing, filmed entertainment, television production and television
broadcasting; Cable Networks, consisting principally of interests in cable
television programming; Publishing, consisting principally of interests in
magazine publishing, book publishing and direct marketing; and Cable, consisting
principally of interests in cable television systems. A majority of Time
Warner's interests in filmed entertainment, television production, television
broadcasting and cable television systems, and a portion of its interests in
cable television programming are held by the Entertainment Group. The
Entertainment Group is not consolidated for financial reporting purposes.
Information as to the operations of Time Warner and the Entertainment
Group in different business segments is set forth below based on the nature of
the products and services offered. Time Warner evaluates performance based on
several factors, of which the primary financial measure is business segment
operating income before noncash amortization of intangible assets ("EBITA"). The
operating results of Time Warner's and the Entertainment Group's cable segments
reflect the TWE-A/N Transfers effective as of January 1, 1998, the Primestar
Roll-up Transaction effective as of April 1, 1998, the formation of the Road
Runner Joint Venture effective as of June 30, 1998 and the Business Telephony
Reorganization effective as of July 1, 1998.
Three Months Nine Months
Ended September 30, Ended September 30,
------------------- -------------------
1998 1997 1998 1997
---- ---- ---- ----
(millions)
Revenues
Time Warner:
Publishing .................................. $1,076 $ 1,027 $ 3,160 $ 3,004
Music ....................................... 938 880 2,731 2,635
Cable Networks-TBS .......................... 825 748 2,459 2,092
Filmed Entertainment-TBS .................... 543 363 1,419 1,097
Cable ....................................... 236 248 726 740
Intersegment elimination .................... (40) (35) (108) (110)
------ ------ ------- -------
Total........................................ $3,578 $3,231 $10,387 $ 9,458
====== ====== ======= =======
Entertainment Group:
Filmed Entertainment-Warner Bros............ $1,729 $ 1,399 $ 4,371 $ 3,830
Broadcasting-The WB Network ................ 64 31 170 84
Cable Networks-HBO ......................... 505 482 1,526 1,452
Cable....................................... 1,052 1,060 3,289 3,146
Intersegment elimination ................... (128) (115) (369) (322)
------ ------ ------- -------
Total....................................... $3,222 $ 2,857 $ 8,987 $ 8,190
====== ======= ======= =======
Three Months Nine Months
Ended September 30, Ended September 30,
------------------- -------------------
1998 1997 1998 1997
---- ---- ---- ----
(millions)
EBITA(1)
Time Warner:
Publishing ................................. $ 112 $ 98 $ 373 $ 331
Music ...................................... 99 90 288 314
Cable Networks-TBS ......................... 154 128 505 407
Filmed Entertainment-TBS ................... 71 68 94 103
Cable ...................................... 81 107 229 316
Intersegment elimination ................... (1) (4) (21) (11)
------- ------- ------- -------
Total ...................................... $ 516 $ 487 $ 1,468 $ 1,460
======= ======= ======= =======
Entertainment Group:
Filmed Entertainment-Warner Bros ........... $ 162 $ 106 $ 403 $ 321
Broadcasting-The WB Network ................ (17) (21) (78) (60)
Cable Networks-HBO ......................... 117 102 339 291
Cable(2) ................................... 336 257 1,017 759
------- ------- ------- -------
Total ...................................... $ 598 $ 444 $ 1,681 $ 1,311
======= ======= ======= =======
- ---------------
(1)EBITA represents business segment operating income before noncash
amortization of intangible assets. After deducting amortization of intangible
assets, Time Warner's business segment operating income for the three and
nine months ended September 30, 1998, respectively, and for the corresponding
periods in the prior year was $315 million and $869 million in 1998, and $263
million and $802 million in 1997. Similarly, business segment operating
income of the Entertainment Group for the three and nine months ended
September 30, 1998, respectively, and for the corresponding periods in the
prior year was $469 million and $1.294 billion in 1998, and $335 million and
$990 million in 1997.
(2)Includes net pretax gains recognized in connection with the sale or exchange
of certain cable television systems of approximately $6 million and $16
million for the three months ended September 30, 1998 and 1997, respectively,
and $90 million and $40 million for the nine months ended September 30, 1998
and 1997, respectively.
Three Months Nine Months
Ended September 30, Ended September 30,
------------------- -------------------
1998 1997 1998 1997
---- ---- ---- ----
(millions)
Depreciation of Property, Plant and Equipment
Time Warner:
Publishing..................................... $ 20 $ 16 $ 58 $ 49
Music.......................................... 16 21 54 62
Cable Networks-TBS............................. 25 23 72 65
Filmed Entertainment-TBS....................... 1 2 4 5
Cable.......................................... 32 34 97 96
---- ---- ---- ----
Total.......................................... $ 94 $ 96 $285 $277
==== ==== ==== ====
Entertainment Group:
Filmed Entertainment-Warner Bros............... $ 48 $ 55 $126 $145
Broadcasting-The WB Network.................... 1 - 1 1
Cable Networks-HBO............................. 6 5 16 15
Cable.......................................... 174 197 555 545
---- ---- ---- ----
Total.......................................... $229 $257 $698 $706
==== ==== ==== ====
Three Months Nine Months
Ended September 30, Ended September 30,
------------------- -------------------
1998 1997 1998 1997
---- ---- ---- ----
(millions)
Amortization of Intangible Assets(1)
Time Warner:
Publishing..................................... $ 10 $ 11 $ 27 $ 28
Music.......................................... 69 73 208 215
Cable Networks-TBS............................. 50 45 150 140
Filmed Entertainment-TBS....................... 24 26 64 67
Cable.......................................... 48 69 150 208
---- ---- ---- ----
Total.......................................... $201 $224 $599 $658
==== ==== ==== ====
Entertainment Group:
Filmed Entertainment-Warner Bros............... $ 33 $ 31 $ 99 $ 92
Broadcasting-The WB Network.................... - - 2 -
Cable Networks-HBO............................. - - - -
Cable.......................................... 96 78 286 229
---- ---- ---- ----
Total.......................................... $129 $109 $387 $321
==== ==== ==== ====
(1)Amortization includes amortization relating to all business combinations
accounted for by the purchase method, including the $14 billion acquisition
of Warner Communications Inc. in 1989, the $6.2 billion acquisition of Turner
Broadcasting System, Inc. in 1996 and the $2.3 billion of cable acquisitions
in 1996 and 1995.
11. COMMITMENTS AND CONTINGENCIES
Pending legal proceedings are substantially limited to litigation
incidental to the businesses of Time Warner and alleged damages in connection
with class action lawsuits. In the opinion of management, the ultimate
resolution of these matters will not have a material effect on the consolidated
financial statements of Time Warner.
12. ADDITIONAL FINANCIAL INFORMATION
Additional financial information with respect to cash flows is as follows:
Nine Months
Ended September 30,
-------------------
1998 1997
---- ----
(millions)
Interest expense..................................... $669 $792
Cash payments made for interest...................... 708 822
Cash payments made for income taxes.................. 191 225
Tax-related distributions received from TWE.......... 264 232
Income tax refunds received.......................... 48 43
Noncash investing activities in the first nine months of 1998 included the
Business Telephony Reorganization, the formation of the Road Runner Joint
Venture and the TWE-A/N Transfers (Note 2). Noncash financing activities
included the conversion of $1.15 billion accreted amount of Zero Coupon
Convertible Notes into 18.7 million shares of common stock in the first nine
months of 1998 (Note 5), the conversion of 12.6 million shares of convertible
preferred stock into approximately 26.3 million shares of common stock (Note 8)
and the payment of $137 million of noncash dividends on the Series M Preferred
Stock in the first nine months of 1997. During the nine months ended September
30, 1998, Time Warner received $102 million of proceeds under its asset
securitization program.
TIME WARNER INC.
SUPPLEMENTARY INFORMATION
CONDENSED CONSOLIDATING FINANCIAL STATEMENTS
(unaudited)
Time Warner Companies, Inc. ("TW Companies") and Turner Broadcasting
System, Inc. ("TBS" and, together with TW Companies, the "Guarantor
Subsidiaries") are wholly owned subsidiaries of Time Warner Inc. ("Time
Warner"). Time Warner, TW Companies and TBS have fully and unconditionally
guaranteed all of the outstanding publicly traded indebtedness of each other.
Set forth below are condensed consolidating financial statements of Time Warner,
including each of the Guarantor Subsidiaries, presented for the information of
each company's public debtholders. Separate financial statements and other
disclosures relating to the Guarantor Subsidiaries have not been presented
because management has determined that this information would not be material to
such debtholders. The following condensed consolidating financial statements
present the results of operations, financial position and cash flows of (i) Time
Warner, TW Companies and TBS (in each case, reflecting investments in its
consolidated subsidiaries under the equity method of accounting), (ii) the
direct and indirect non-guarantor subsidiaries of Time Warner and (iii) the
eliminations necessary to arrive at the information for Time Warner on a
consolidated basis. These condensed consolidating financial statements should be
read in conjunction with the accompanying consolidated financial statements of
Time Warner.
Consolidating Statement of Operations
For The Three Months Ended September 30, 1998
(unaudited)
Non- Time
Time TW Guarantor Elimina- Warner
Warner Companies TBS Subsidiaries tions Consolidated
------ --------- --- ------------ ----- ------------
(millions)
Revenues ........................................ $ - $ - $ 176 $ 3,418 $ (16) $ 3,578
------ ------ ----- ------- ----- -------
Cost of revenues (1) ............................ - - 83 1,985 (16) 2,052
Selling, general and administrative (1) ......... - - 45 1,166 - 1,211
------ ------ ----- ------- ----- -------
Operating expenses .............................. - - 128 3,151 (16) 3,263
------ ------ ----- ------- ----- -------
Business segment operating income ............... - - 48 267 - 315
Equity in pretax income of consolidated
subsidiaries .................................. 203 335 87 - (625) -
Equity in pretax income of Entertainment Group .. - - - 196 (32) 164
Interest and other, net ......................... (35) (183) (37) (40) (16) (311)
Corporate expenses .............................. (20) (14) (3) (15) 32 (20)
------ ------ ----- ------- ----- -------
Income before income taxes ...................... 148 138 95 408 (641) 148
Income tax provision ............................ (109) (102) (54) (232) 388 (109)
------ ------ ----- ------- ----- -------
Net income ...................................... $ 39 $ 36 $ 41 $ 176 $(253) $ 39
====== ====== ===== ======= ===== =======
(1) Includes depreciation and amortization
expense of: ............................... $ - $ - $ 2 $ 293 $ - $ 295
====== ====== ===== ======= ===== =======
Consolidating Statement of Operations
For The Three Months Ended September 30, 1997
(unaudited)
Non- Time
Time TW Guarantor Elimina- Warner
Warner Companies TBS Subsidiaries tions Consolidated
------ --------- --- ------------ ----- ------------
(millions)
Revenues ......................................... $ - $ - $ 121 $ 3,110 $ - $ 3,231
------ ------ ------ ------- ----- -------
Cost of revenues (1) ............................. - - 67 1,897 - 1,964
Selling, general and administrative (1) .......... - - 35 969 - 1,004
------ ------ ------ ------- ----- -------
Operating expenses ............................... - - 102 2,866 - 2,968
------ ------ ------ ------- ----- -------
Business segment operating income ................ - - 19 244 - 263
Equity in pretax income of consolidated
subsidiaries ................................... 43 173 124 - (340) -
Equity in pretax income of Entertainment Group ... - - - 107 (11) 96
Interest and other, net .......................... 7 (187) (60) (53) (16) (309)
Corporate expenses ............................... (17) (10) (2) (11) 23 (17)
------ ------ ------ ------- ----- -------
Income (loss) before income taxes ................ 33 (24) 81 287 (344) 33
Income tax provision ............................. (61) (24) (41) (161) 226 (61)
------ ------ ------ ------- ----- -------
Income (loss) before extraordinary item .......... (28) (48) 40 126 (118) (28)
Extraordinary loss on retirement of
debt, net of tax ............................... (7) (7) - (7) 14 (7)
------ ------ ------ ------- ----- -------
Net income (loss) ................................ $ (35) $ (55) $ 40 $ 119 $(104) $ (35)
====== ====== ====== ======= ===== =======
(1) Includes depreciation and amortization
expense of: ................................ $ - $ - $ 5 $ 315 $ - $ 320
====== ====== ====== ======= ===== =======
Consolidating Statement of Operations
For The Nine Months Ended September 30, 1998
(unaudited)
Non- Time
Time TW Guarantor Elimina- Warner
Warner Companies TBS Subsidiaries tions Consolidated
------ --------- --- ------------ ----- ------------
(millions)
Revenues ......................................... $ - $ - $ 542 $ 9,861 $ (16) $10,387
------ ------ ----- ------- ------- -------
Cost of revenues (1) ............................. - - 244 5,788 (16) 6,016
Selling, general and administrative (1) .......... - - 142 3,360 - 3,502
------ ------ ----- ------- ------- -------
Operating expenses ............................... - - 386 9,148 (16) 9,518
------ ------ ----- ------- ------- -------
Business segment operating income ................ - - 156 713 - 869
Equity in pretax income of consolidated
subsidiaries ................................... 486 949 165 - (1,600) -
Equity in pretax income of Entertainment Group ... - - - 492 (55) 437
Interest and other, net .......................... (57) (570) (121) (91) (38) (877)
Corporate expenses ............................... (58) (40) (11) (46) 97 (58)
------ ------ ----- ------- ------- -------
Income before income taxes ....................... 371 339 189 1,068 (1,596) 371
Income tax provision ............................. (293) (237) (127) (599) 963 (293)
------ ------ ----- ------- ------- -------
Net income ...................................... $ 78 $ 102 $ 62 $ 469 $ (633) $ 78
====== ====== ====== ======= ======= =======
(1) Includes depreciation and amortization
expense of: ................................ $ - $ - $ 6 $ 878 $ - $ 884
====== ======= ====== ======= ======= =======
Consolidating Statement of Operations
For The Nine Months Ended September 30, 1997
(unaudited)
Non- Time
Time TW Guarantor Elimina- Warner
Warner Companies TBS Subsidiaries tions Consolidated
------ --------- --- ------------ ----- ------------
(millions)
Revenues ......................................... $ - $ - $ 387 $ 9,071 $ - $ 9,458
------ ------ ----- ------- ------- -------
Cost of revenues (1) ............................. - - 192 5,225 - 5,417
Selling, general and administrative (1) .......... - - 126 3,113 - 3,239
------ ------ ----- ------- ------- -------
Operating expenses ............................... - - 318 8,338 - 8,656
------ ------ ----- ------- ------- -------
Business segment operating income ................ - - 69 733 - 802
Equity in pretax income of consolidated
subsidiaries ................................... 402 871 238 - (1,511) -
Equity in pretax income of Entertainment Group ... - - - 551 (29) 522
Interest and other, net .......................... 18 (564) (155) (174) (29) (904)
Corporate expenses ............................... (60) (38) (10) (43) 91 (60)
------ ------ ----- ------- ------- -------
Income before income taxes ....................... 360 269 142 1,067 (1,478) 360
Income tax provision ............................. (306) (211) (104) (594) 909 (306)
------ ------ ----- ------- ------- -------
Income before extraordinary item ................. 54 58 38 473 (569) 54
Extraordinary loss on retirement of debt,
net of tax ..................................... (24) (20) (4) (20) 44 (24)
------ ------ ----- ------- ------- -------
Net income ....................................... $ 30 $ 38 $ 34 $ 453 $ (525) $ 30
====== ====== ===== ======= ======= =======
(1) Includes depreciation and amortization
expense of: ................................ $ - $ - $ 16 $ 919 $ - $ 935
====== ======= ===== ======= ===== =======
Consolidating Balance Sheet
September 30, 1998
(unaudited)
Non- Time
Time TW Guarantor Elimina- Warner
Warner Companies TBS Subsidiaries tions Consolidated
------ --------- --- ------------ ----- ------------
(millions)
ASSETS
Current assets
Cash and equivalents ............................. $ - $ 8 $ 11 $ 374 $ - $ 393
Receivables, net ................................. 5 52 77 2,109 (3) 2,240
Inventories ...................................... - - 75 787 - 862
Prepaid expenses ................................. 17 - 2 1,192 (3) 1,208
------ ------ ----- ------- ------- -------
Total current assets ............................. 22 60 165 4,462 (6) 4,703
Noncurrent inventories ........................... - - 181 1,721 - 1,902
Investments in and amounts due to and from
consolidated subsidiaries ...................... 16,616 14,024 9,800 - (40,440) -
Investments in and amounts due to and
from Entertainment Group ....................... - 944 - 4,513 (97) 5,360
Other investments ................................ 170 12 24 1,211 (626) 791
Property, plant and equipment, net ............... 56 - 44 1,910 - 2,010
Music catalogues, contracts and copyrights ....... - - - 867 - 867
Cable television and sports franchises ........... - - - 3,127 - 3,127
Goodwill ......................................... - - - 12,023 - 12,023
Other assets ..................................... 58 116 119 619 (7) 905
------ ------ ----- ------- ------- -------
Total assets ..................................... $16,922 $15,156 $10,333 $30,453 $(41,176) $ 31,688
======= ======= ======= ======= ======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Accounts payable ................................. $ 3 $ - $ 13 $ 827 $ - $ 843
Participations, royalties and programming costs
payable ........................................ - - 30 1,082 - 1,112
Debt due within one year ......................... - - - 19 - 19
Other current liabilities ........................ 319 187 131 1,622 - 2,259
------ ------ ----- ------- ------- -------
Total current liabilities ........................ 322 187 174 3,550 - 4,233
Long-term debt ................................... 594 7,357 747 367 - 9,065
Debt due to affiliates ........................... - - 1,647 158 (1,805) -
Borrowings against future stock option proceeds .. 1,015 - - - - 1,015
Deferred income taxes ............................ 3,609 3,443 245 3,689 (7,377) 3,609
Unearned portion of paid subscriptions ........... - - - 720 - 720
Other liabilities ................................ 383 - 117 972 - 1,472
TW Companies-obligated mandatorily redeemable
preferred securities of a subsidiary holding
solely subordinated debentures of TW Companies . - - - 575 - 575
Series M exchangeable preferred stock ............ 1,859 - - - - 1,859
Shareholders' equity
Due to (from) Time Warner and subsidiaries ....... - (2,102) - (853) 2,955 -
Other shareholders' equity ....................... 9,140 6,271 7,403 21,275 (34,949) 9,140
------ ------ ----- ------- ------- -------
Total shareholders' equity ....................... 9,140 4,169 7,403 20,422 (31,994) 9,140
------ ------ ----- ------- ------- -------
Total liabilities and shareholders' equity ....... $16,922 $15,156 $10,333 $30,453 $(41,176) $ 31,688
======= ======= ======= ======= ======== ========
Consolidating Balance Sheet
December 31, 1997
(unaudited)
Non- Time
Time TW Guarantor Elimina- Warner
Warner Companies TBS Subsidiaries tions Consolidated
------ --------- --- ------------ ----- ------------
(millions)
ASSETS
Current assets
Cash and equivalents ............................. $ - $ 372 $ 9 $ 264 $ - $ 645
Receivables, net ................................. 34 82 9 2,350 (28) 2,447
Inventories ...................................... - - 112 718 - 830
Prepaid expenses ................................. 21 14 5 1,063 (14) 1,089
------ ------ ----- ------- ------- -------
Total current assets ............................. 55 468 135 4,395 (42) 5,011
Noncurrent inventories ........................... - - 123 1,643 - 1,766
Investments in and amounts due to and from
consolidated subsidiaries ...................... 16,189 14,995 9,950 - (41,134) -
Investments in and amounts due to and
from Entertainment Group ....................... - 970 - 4,620 (41) 5,549
Other investments ................................ 106 1 24 1,957 (593) 1,495
Property, plant and equipment, net ............... 68 - 48 1,973 - 2,089
Music catalogues, contracts and copyrights ....... - - - 928 - 928
Cable television and sports franchises ........... - - - 3,982 - 3,982
Goodwill ......................................... - - - 12,572 - 12,572
Other assets ..................................... 54 124 118 483 (8) 771
------ ------ ----- ------- ------- -------
Total assets ..................................... $16,472 $16,558 $10,398 $32,553 $(41,818) $ 34,163
======= ======= ======= ======= ======== =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Accounts payable........................ ......... $ 24 $ - $ 11 $ 877 $ - $ 912
Participations, royalties and programming costs
payable ........................................ - - 10 1,062 - 1,072
Debt due within one year ......................... - - - 8 - 8
Other current liabilities ........................ 442 284 234 1,371 48 2,379
------ ------ ----- ------- ------- -------
Total current liabilities ........................ 466 284 255 3,318 48 4,371
Long-term debt ................................... - 8,462 747 2,624 - 11,833
Debt due to affiliates ........................... - - 1,722 158 (1,880) -
Borrowings against future stock option proceeds .. 533 - - - - 533
Deferred income taxes ............................ 3,960 3,797 243 4,040 (8,080) 3,960
Unearned portion of paid subscriptions ........... - - - 672 - 672
Other liabilities ................................ 300 20 90 596 - 1,006
TW Companies-obligated mandatorily redeemable
preferred securities of a subsidiary holding
solely subordinated debentures of TW Companies.. - - - 575 - 575
Series M exchangeable preferred stock ............ 1,857 - - - - 1,857
Shareholders' equity
Due to (from) Time Warner and subsidiaries ....... - (2,195) - (256) 2,451 -
Other shareholders' equity ....................... 9,356 6,190 7,341 20,826 (34,357) 9,356
------ ------ ----- ------- ------- -------
Total shareholders' equity ....................... 9,356 3,995 7,341 20,570 (31,906) 9,356
------ ------ ----- ------- ------- -------
Total liabilities and shareholders' equity ....... $16,472 $16,558 $10,398 $32,553 $(41,818) $ 34,163
======= ======= ======= ======= ======== =======
Consolidating Statement of Cash Flows
For The Nine Months Ended September 30, 1998
(unaudited)
Non- Time
Time TW Guarantor Elimina- Warner
Warner Companies TBS Subsidiaries tions Consolidated
------ --------- --- ------------ ----- ------------
(millions)
OPERATIONS
Net income............................... ........ $ 78 $ 102 $ 62 $ 469 $ (633) $ 78
Adjustments for noncash and nonoperating items:
Depreciation and amortization .................... - - 6 878 - 884
Noncash interest expense ......................... - 29 - - - 29
Excess (deficiency) of distributions over equity in
pretax income of consolidated subsidiaries ..... 1,140 (467) 335 - (1,008) -
Excess of equity in pretax income of
Entertainment Group over distributions ......... - - - 113 55 168
Changes in operating assets and liabilities ...... 472 5 (125) (233) (84) 35
------ ------ ------ ------- ------- -------
Cash provided (used) by operations ............... 1,690 (331) 278 1,227 (1,670) 1,194
------ ------ ------ ------- ------- -------
INVESTING ACTIVITIES
Investments and acquisitions ..................... (213) - - 127 - (86)
Advances to parents and consolidated subsidiaries . (873) (187) - (39) 1,099 -
Repayment of advances from consolidated subsidiaries 75 360 - - (435) -
Capital expenditures ............................. - - (9) (339) - (348)
Investment proceeds .............................. - - - 458 - 458
Proceeds received from distribution of Senior
Capital contributed to TWE ..................... - - - 455 - 455
------ ------ ------ ------- ------- -------
Cash provided (used) by investing activities ..... (1,011) 173 (9) 662 664 479
------ ------ ------ ------- ------- -------
FINANCING ACTIVITIES
Borrowings ....................................... 601 496 - 579 (7) 1,669
Debt repayments .................................. - (500) (75) (1,800) 75 (2,300)
Change in due to/from parent ..................... - (188) (192) (558) 938 -
Borrowings against future stock option proceeds .. 1,015 - - - - 1,015
Repayments of borrowings against future stock
option proceeds ................................ (533) - - - - (533)
Repurchases of Time Warner common stock........... (1,944) - - - - -
Dividends paid ................................... (394) - - - - (394)
Proceeds received from stock options and
dividend reinvestment plans..................... 599 - - - - 599
Other ............................................ (23) (14) - - - (37)
------ ------ ------ ------- ------- -------
Cash used by financing activities ................ (679) (206) (267) (1,779) 1,006 (1,925)
------ ------ ------ ------- ------- -------
INCREASE (DECREASE) IN CASH AND
EQUIVALENTS .................................... - (364) 2 110 - (252)
------ ------ ------ ------- ------- -------
CASH AND EQUIVALENTS AT
BEGINNING OF PERIOD ............................ - 372 9 264 - 645
------ ------ ------ ------- ------- -------
CASH AND EQUIVALENTS AT END OF PERIOD............. $ - $ 8 $ 11 $ 374 $ - $ 393
====== ====== ====== ======= ======= =======
Consolidating Statement of Cash Flows
For The Nine Months Ended September 30, 1997
(unaudited)
Non- Time
Time TW Guarantor Elimina- Warner
Warner Companies TBS Subsidiaries tions Consolidated
------ --------- --- ------------ ----- ------------
(millions)
OPERATIONS
Net income ......................................... $ 30 $ 38 $ 34 $ 453 $ (525) $ 30
Adjustments for noncash and nonoperating items:
Extraordinary loss on retirement of debt ........... 24 20 4 20 (44) 24
Depreciation and amortization ...................... - - 16 919 - 935
Noncash interest expense ........................... - 73 2 - - 75
Excess of distributions over equity in pretax
income of consolidated subsidiaries .............. 490 597 272 - (1,359) -
Excess (deficiency) of equity in pretax income of
Entertainment Group over distributions ........... - - - (197) 29 (168)
Changes in operating assets and liabilities ........ 225 (293) (118) 482 (553) (257)
----- ------ ----- ------- ------- -------
Cash provided by operations ........................ 769 435 210 1,677 (2,452) 639
----- ------ ----- ------- ------- -------
INVESTING ACTIVITIES
Investments and acquisitions ....................... (17) - - (81) - (98)
Advance to parents and consolidated subsidiaries ... (778) (134) - - 912 -
Capital expenditures ............................... - - (8) (416) - (424)
Investment proceeds ................................ - - - 156 - 156
Proceeds received from distribution of Senior
Capital contributed to TWE ....................... - - - 455 - 455
----- ------ ----- ------- ------- -------
Cash provided (used) by investing activities ....... (795) (134) (8) 114 912 89
----- ------ ----- ------- ------- -------
FINANCING ACTIVITIES
Borrowings ......................................... - 1,575 762 370 (762) 1,945
Debt repayments .................................... - (833) (964) (446) - (2,243)
Change in due to/from parent ....................... 111 (785) - (1,628) 2,302 -
Repayments of borrowings against
future stock option proceeds ..................... (185) - - - - (185)
Repurchases of Time Warner common stock ............ (37) - - - - (37)
Dividends paid ..................................... (253) - - - - (253)
Proceeds received from stock option and dividend
reinvestment plans ............................... 328 - - - - 328
Other .............................................. - (6) - (30) - (36)
----- ------ ----- ------- ------- -------
Cash used by financing activities .................. (36) (49) (202) (1,734) 1,540 (481)
----- ------ ----- ------- ------- -------
INCREASE (DECREASE) IN CASH AND EQUIVALENTS ....... (62) 252 - 57 - 247
CASH AND EQUIVALENTS AT
BEGINNING OF PERIOD ............................. 62 137 - 315 - 514
----- ------ ----- ------- ------- -------
CASH AND EQUIVALENTS AT END OF PERIOD ............. $ - $ 389 $ - $ 372 $ - $ $761
===== ====== ===== ======= ======= =======
TIME WARNER ENTERTAINMENT COMPANY, L.P.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
Time Warner Entertainment Company, L.P. ("TWE" or the "Company")
classifies its business interests into three fundamental areas: Entertainment,
consisting principally of interests in filmed entertainment, television
production and television broadcasting; Cable Networks, consisting principally
of interests in cable television programming; and Cable, consisting principally
of interests in cable television systems. TWE also manages the cable properties
owned by Time Warner and the combined cable television operations are conducted
under the name of Time Warner Cable. Capitalized terms are as defined and
described in the accompanying consolidated financial statements, or elsewhere
herein.
Use of EBITA
TWE evaluates operating performance based on several factors, of which the
primary financial measure is operating income before noncash amortization of
intangible assets ("EBITA"). Consistent with management's financial focus on
controlling capital spending, EBITA measures operating performance after charges
for depreciation. In addition, EBITA eliminates the uneven effect across all
business segments of considerable amounts of noncash amortization of intangible
assets recognized in business combinations accounted for by the purchase method,
including Time Warner's $14 billion acquisition of Warner Communications Inc. in
1989 and $1.3 billion acquisition of the minority interest in American
Television and Communications Corporation in 1992. The exclusion of noncash
amortization charges is also consistent with management's belief that TWE's
intangible assets, such as cable television franchises, film and television
libraries and the goodwill associated with its brands, are generally increasing
in value and importance to TWE's business objective of creating, extending and
distributing recognizable brands and copyrights throughout the world. As such,
the following comparative discussion of the results of operations of TWE
includes, among other factors, an analysis of changes in business segment EBITA.
However, EBITA should be considered in addition to, not as a substitute for,
operating income, net income and other measures of financial performance
reported in accordance with generally accepted accounting principles.
RESULTS OF OPERATIONS
As more fully described herein, TWE's 1998 operating results have been
affected by certain cable-related transactions, including (i) the transfer of
cable television systems (or interests therein) serving approximately 650,000
subscribers that were formerly owned by subsidiaries of Time Warner to the
TWE-Advance/Newhouse Partnership ("TWE-A/N"), subject to approximately $1
billion of debt, in exchange for common and preferred partnership interests
therein, as well as certain related transactions (collectively, the "TWE-A/N
Transfers"), (ii) the transfer of TWE's and TWE-A/N's direct broadcast satellite
operations and related assets to Primestar, Inc., a separate holding company
(the "Primestar Roll-up Transaction"), (iii) the reorganization of Time Warner
Cable's business telephony operations (the "Business Telephony Reorganization"),
(iv) the formation of a joint venture to operate and expand Time Warner Cable's
and MediaOne's existing high-speed Internet access businesses (the "Road Runner
Joint Venture") and (v) the sale or exchange of certain cable television
systems. The effects of these transactions are described elsewhere herein.
EBITA and operating income for TWE for the three and nine months ended
September 30, 1998 and 1997 are as follows:
Three Months Ended September 30, Nine Months Ended September 30,
-------------------------------- -------------------------------
Operating Operating
EBITA Income EBITA Income
----- ------ ----- ------
1998 1997 1998 1997 1998 1997 1998 1997
---- ---- ---- ---- ---- ---- ---- ----
(millions)
Filmed Entertainment-Warner Bros $161 $106 $128 $ 75 $ 401 $ 315 $ 302 $223
Broadcasting-The WB Network (17) (21) (17) (21) (78) (60) (80) (60)
Cable Networks-HBO 117 102 117 102 339 291 339 291
Cable(a) 336 257 240 179 1,017 759 731 530
--- --- --- --- ----- --- --- ---
Total $597 $444 $468 $335 $1,679 $1,305 $1,292 $984
==== ==== ==== ==== ====== ====== ====== ====
- ---------------
(a) Includes net pretax gains recognized in connection with the sale or exchange
of certain cable television systems of approximately $6 million and $16
million for the three months ended September 30, 1998 and 1997,
respectively, and approximately $90 million and $40 million for the nine
months ended September 30, 1998 and 1997, respectively.
Three Months Ended September 30, 1998 Compared to the Three Months Ended
September 30, 1997
TWE had revenues of $3.220 billion and net income of $172 million for the
three months ended September 30, 1998, compared to revenues of $2.855 billion
and net income of $81 million for the three months ended September 30, 1997. As
discussed more fully below, TWE's net income increased in 1998 as compared to
1997 principally due to an overall increase in operating income generated by its
business segments (including the positive effect of the TWE-A/N Transfers),
offset in part by an increase in interest expense associated with the TWE-A/N
Transfers, higher losses from certain investments accounted for under the equity
method of accounting and lower gains on foreign exchange contracts.
As a U.S. partnership, TWE is not subject to U.S. federal and state income
taxation. Income and withholding taxes of $23 million and $27 million for the
three months ended September 30, 1998 and 1997, respectively, have been provided
for the operations of TWE's domestic and foreign subsidiary corporations.
Filmed Entertainment-Warner Bros. Revenues increased to $1.727 billion,
compared to $1.397 billion in the third quarter of 1997. EBITA increased to $161
million from $106 million. Operating income increased to $128 million from $75
million. Revenues benefited from a significant increase in television production
and distribution operations principally relating to the initial off-network
domestic syndication availability of Friends and the initial off-network basic
cable availability of ER. EBITA and operating income benefited principally from
the revenue gains, offset in part by lower international syndication sales of
library product and film write-offs relating to disappointing results for
certain theatrical releases.
Broadcasting - The WB Network. Revenues increased to $64 million, compared
to $31 million in the third quarter of 1997. EBITA and operating income improved
to a loss of $17 million from a loss of $21 million. Revenues increased as a
result of higher advertising sales relating to improved television ratings and
the addition of a fourth night of prime-time programming in January 1998 and a
fifth night in September 1998. Operating losses improved principally as a result
of the revenue gains, offset in part by higher programming costs associated with
the expanded programming schedule and a lower allocation of losses to a minority
partner in the network. Due to the start-up nature of this national broadcast
operation, losses are expected to continue.
Cable Networks-HBO. Revenues increased to $505 million, compared to $482
million in the third quarter of 1997. EBITA and operating income increased to
$117 million from $102 million. Revenues benefited primarily from an increase in
subscriptions. EBITA and operating income increased principally as a result of
the revenue gains, and, to a lesser extent, cost savings and higher income from
Comedy Central, a 50%-owned equity investee.
Cable. Revenues decreased to $1.052 billion, compared to $1.060 billion in
the third quarter of 1997. EBITA increased to $336 million from $257 million.
Operating income increased to $240 million from $179 million. The Cable
division's 1998 operating results were positively affected by the aggregate net
impact of the TWE-A/N Transfers and the deconsolidation of certain of its
operations in connection with each of the Primestar Roll-up Transaction, the
Business Telephony Reorganization and the formation of the Road Runner Joint
Venture. Excluding the effect of these transactions, revenues increased
principally as a result of an increase in basic cable subscribers, increases in
regulated cable rates as permitted under Time Warner Cable's "social contract"
with the Federal Communications Commission ("FCC") and an increase in
advertising revenues. Similarly excluding the effect of these transactions,
EBITA and operating income increased principally as a result of the revenue
gains, offset in part by lower net gains relating to the sale or exchange of
certain cable television systems and higher depreciation related to capital
spending.
Interest and Other, Net. Interest and other, net, was $203 million in the
third quarter of 1998, compared to $145 million in the third quarter of 1997.
Interest expense increased to $145 million, compared to $123 million in the
third quarter of 1997, principally due to higher average debt levels associated
with the TWE-A/N Transfers. There was other expense, net, of $58 million in the
third quarter of 1998, compared to $22 million in the third quarter of 1997,
principally due to higher losses from certain investments accounted for under
the equity method of accounting, lower gains on foreign exchange contracts and
higher losses associated with TWE's asset securitization program.
Nine Months Ended September 30, 1998 Compared to the Nine Months Ended
September 30, 1997
TWE had revenues of $8.980 billion and net income of $435 million for the
nine months ended September 30, 1998, compared to revenues of $8.183 billion and
net income of $483 million for the nine months ended September 30, 1997. As
discussed more fully below and as previously described above, TWE's net income
decreased in 1998 as compared to 1997 principally due to significantly lower
aggregate, net pretax gains recognized in connection with the sale or exchange
of certain cable television systems in each year and the 1997 sale of TWE's
interest in E! Entertainment Television, Inc. ("E! Entertainment"). Excluding
the effect of these transactions, TWE's net income increased in 1998 principally
as a result of an overall increase in operating income generated by its business
segments (including the positive effect of the TWE-A/N Transfers), offset in
part by an increase in interest expense associated with the TWE-A/N Transfers,
higher losses from certain investments accounted for under the equity method of
accounting and lower gains on foreign exchange contracts.
As a U.S. partnership, TWE is not subject to U.S. federal and state income
taxation. Income and withholding taxes of $55 million and $64 million for the
nine months ended September 30, 1998 and 1997, respectively, have been provided
for the operations of TWE's domestic and foreign subsidiary corporations.
Filmed Entertainment-Warner Bros. Revenues increased to $4.364 billion,
compared to $3.823 billion in the first nine months of 1997. EBITA increased to
$401 million from $315 million. Operating income increased to $302 million from
$223 million. Revenues benefited from a significant increase in television
production and distribution operations principally relating to the initial
off-network domestic syndication availability of Friends and the initial
off-network basic cable availability of ER, as well as an increase in revenues
from consumer products licensing operations. EBITA and operating income
benefited principally from the revenue gains, offset in part by lower
international syndication sales of library product and film write-offs relating
to disappointing results for certain theatrical releases. In addition, EBITA and
operating income for each period included certain one-time gains on the sale of
assets that were comparable in amount and therefore, did not have any
significant effect on operating trends.
Broadcasting - The WB Network. Revenues increased to $170 million,
compared to $84 million in the first nine months of 1997. EBITA decreased to a
loss of $78 million from a loss of $60 million. Operating losses increased to
$80 million from $60 million. Revenues increased as a result of higher
advertising sales relating to improved television ratings and the addition of a
fourth night of prime-time programming in January 1998 and a fifth night in
September 1998. Despite the revenue increase, operating losses increased because
of a lower allocation of losses to a minority partner in the network. However,
excluding this minority interest effect, operating losses improved principally
as a result of the revenue gains, which outweighed higher programming costs
associated with the expanded programming schedule. Due to the start-up nature of
this national broadcast operation, losses are expected to continue.
Cable Networks-HBO. Revenues increased to $1.526 billion, compared to
$1.452 billion in the first nine months of 1997. EBITA and operating income
increased to $339 million from $291 million. Revenues benefited primarily from
an increase in subscriptions. EBITA and operating income increased principally
as a result of the revenue gains, and, to a lesser extent, cost savings and
higher income from Comedy Central, a 50%-owned equity investee.
Cable. Revenues increased to $3.289 billion, compared to $3.146 billion in
the first nine months of 1997. EBITA increased to $1.017 billion from $759
million. Operating income increased to $731 million from $530 million. The Cable
division's 1998 operating results were positively affected by the aggregate net
impact of the TWE-A/N Transfers and the deconsolidation of certain of its
operations in connection with each of the Primestar Roll-up Transaction, the
Business Telephony Reorganization and the formation of the Road Runner Joint
Venture. Excluding the effect of these transactions, revenues increased
principally as a result of an increase in basic cable subscribers, increases in
regulated cable rates as permitted under Time Warner Cable's "social contract"
with the FCC and an increase in advertising revenues. Similarly excluding the
effect of these transactions, EBITA and operating income increased principally
as a result of the revenue gains and higher net gains relating to the sale or
exchange of certain cable television systems, offset in part by higher
depreciation related to capital spending.
Interest and Other, Net. Interest and other, net, was $550 million in the
first nine months of 1998, compared to $155 million in the first nine months of
1997. Interest expense increased to $418 million, compared to $358 million in
1997, principally due to higher average debt levels associated with the TWE-A/N
Transfers. There was other expense, net, of $132 million in the first nine
months of 1998, compared to other income, net, of $203 million in the first nine
months of 1997, principally due to the absence of an approximate $250 million
pretax gain on the sale of an interest in E! Entertainment recognized in 1997,
higher losses from certain investments accounted for under the equity method of
accounting, lower gains on foreign exchange contracts and higher losses
associated with TWE's asset securitization program.
FINANCIAL CONDITION AND LIQUIDITY
September 30, 1998
Financial Condition
TWE had $7.4 billion of debt, $125 million of cash and equivalents (net
debt of $7.3 billion), $221 million of preferred stock of a subsidiary, $591
million of Time Warner General Partners' Senior Capital and $5.8 billion of
partners' capital at September 30, 1998, compared to $6.0 billion of debt, $322
million of cash and equivalents (net debt of $5.7 billion), $233 million of
preferred stock of a subsidiary, $1.1 billion of Time Warner General Partners'
Senior Capital and $6.3 billion of partners' capital at December 31, 1997. Net
debt increased principally as a result of the TWE-A/N Transfers and cash
distributions paid to Time Warner.
Debt Transactions
In July 1998, TWE borrowed $579 million under its bank credit agreement
and paid a distribution to the Time Warner General Partners relating to their
Senior Capital interests.
In April 1998, TWE consummated two previously announced transactions,
consisting of the sale of TWE's 49% interest in Six Flags Entertainment
Corporation and the Primestar Roll-up Transaction. As a result of these
transactions, TWE reduced debt by approximately $540 million.
In early 1998, TWE-A/N assumed approximately $1 billion of debt from TWI
Cable Inc. ("TWI Cable"), a wholly owned subsidiary of Time Warner, in
connection with the TWE-A/N Transfers. The debt assumed by TWE-A/N has been
guaranteed by TWI Cable and certain of its subsidiaries.
Cash Flows
During the first nine months of 1998, TWE's cash provided by operations
amounted to $1.273 billion and reflected $1.679 billion of EBITA from its Filmed
Entertainment-Warner Bros., Broadcasting-The WB Network, Cable Networks-HBO and
Cable businesses, $698 million of noncash depreciation expense and $131 million
of proceeds from TWE's asset securitization program, less $419 million of
interest payments, $57 million of income taxes, $54 million of corporate
expenses, and $705 million related to an aggregate increase in working capital
requirements, other balance sheet accounts and noncash items. Cash provided by
operations of $918 million in the first nine
months of 1997 reflected $1.305 billion of business segment EBITA and $692
million of noncash depreciation expense, less $394 million of interest payments,
$55 million of income taxes, $54 million of corporate expenses and $576 million
related to an aggregate increase in working capital requirements, other balance
sheet accounts and noncash items.
Cash used by investing activities was $887 million in the first nine
months of 1998, compared to $777 million in the first nine months of 1997,
principally as a result of the effect of deconsolidating approximately $200
million of cash of Paragon Communications in connection with the TWE-A/N
Transfers that has been included as a reduction of cash flows from investments
and acquisitions, offset in part by a $96 million increase in proceeds from the
sale of investments. Capital expenditures were $1.092 billion in the first nine
months of 1998 and $1.117 billion in the first nine months of 1997.
Cash used by financing activities was $583 million in the first nine
months of 1998, compared to $61 million in the first nine months of 1997,
principally as a result of the absence of $243 million of aggregate net proceeds
from the issuance of preferred stock of a subsidiary in the first quarter of
1997 and a $251 million increase in distributions paid to Time Warner, offset in
part by an increase in debt used to fund cash distributions to Time Warner.
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.
Cable Capital Spending
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 it believes will position the business for sustained, long-term
growth. Capital spending by TWE's Cable division amounted to $991 million in the
nine months ended September 30, 1998, compared to $1.013 billion in the nine
months ended September 30, 1997. For the full year of 1998, cable capital
spending is expected to be comparable to 1997 levels, with approximately $400
million budgeted for the remainder of 1998. Capital spending by TWE's Cable
division is expected to continue to be funded by cable operating cash flow. In
exchange for certain flexibility in establishing cable rate pricing structures
for regulated services that went into effect on January 1, 1996 and consistent
with Time Warner Cable's long-term strategic plan, Time Warner Cable agreed with
the FCC to invest a total of $4 billion in capital costs in connection with the
upgrade of its cable infrastructure, which is expected to be substantially
completed over a five-year period ending December 31, 2000. The agreement with
the FCC covers all of the cable operations of Time Warner Cable, including the
owned or managed cable television systems of TWE, TWE-A/N and Time Warner.
Management expects to continue to finance such level of investment through cable
operating cash flow and the development of new revenue streams from expanded
programming options, high-speed Internet access and other services.
Cable Financing Strategy
Time Warner's and TWE's cable financing strategy is to continue to use
cable operating cash flow to finance the level of capital spending necessary to
upgrade the technological capability of its cable television systems and develop
new services, while pursuing opportunities to reduce either existing debt and/or
their share of future
funding requirements related to the cable television business and related
ancillary businesses. Consistent with this strategy, Time Warner, TWE and
TWE-A/N have completed a series of transactions in 1998, as discussed more fully
below.
Business Telephony Reorganization
In July 1998, Time Warner, TWE and TWE-A/N completed a reorganization of
their business telephony operations (the "Business Telephony Reorganization") by
combining such operations into a single entity that is intended to be
self-financing. This entity, named Time Warner Telecom LLC ("TW Telecom"), is a
competitive local exchange carrier (CLEC) in selected metropolitan areas across
the United States where it offers a wide range of telephony services to business
customers. Time Warner, MediaOne Group, Inc. ("MediaOne," formerly U S WEST,
Inc.) and the Advance/Newhouse Partnership ("Advance/Newhouse"), a limited
partner in TWE-A/N, own interests in TW Telecom of 61.95%, 18.88% and 19.17%,
respectively. As a result of the Business Telephony Reorganization, TWE and
TWE-A/N do not have continuing equity interests in these business telephony
operations.
Road Runner Joint Venture
In June 1998, Time Warner, TWE, TWE-A/N, MediaOne, Microsoft Corp.
("Microsoft") and Compaq Computer Corp. ("Compaq") formed a joint venture to
operate and expand Time Warner Cable's and MediaOne's existing high-speed
Internet access businesses (the "Road Runner Joint Venture"). In exchange for
contributing their existing high-speed Internet access businesses, Time Warner
received an 11.25% common equity interest in the Road Runner Joint Venture, TWE
received a 25% interest, TWE-A/N received a 32.5% interest and MediaOne received
a 31.25% interest. In exchange for Microsoft and Compaq each contributing $212.5
million of cash to the Road Runner Joint Venture, Microsoft and Compaq each
received a preferred equity interest therein that is convertible into a 10%
common equity interest. Accordingly, on a fully diluted basis, the Road Runner
Joint Venture is owned 9% by Time Warner, 20% by TWE, 26% by TWE-A/N, 25% by
MediaOne, 10% by Microsoft and 10% by Compaq. As a result of this transaction,
effective as of June 30, 1998, TWE and TWE-A/N deconsolidated their high-speed
Internet access operations and each of TWE's and TWE-A/N's interest in the Road
Runner Joint Venture is being accounted for under the equity method of
accounting.
The aggregate $425 million of capital contributed by Microsoft and Compaq
is expected to be used by the Road Runner Joint Venture to continue to expand
the roll out of high-speed Internet access services. In addition, as a result of
Time Warner Cable being a retailer of the Road Runner business in its franchise
areas whereby Time Warner Cable's technologically advanced, high-capacity cable
architecture will be used to provide these high-speed Internet access services,
Time Warner Cable will initially retain 70% of the subscription revenues and 30%
of the national advertising and transactional revenues generated from the
delivery of these on-line services to its cable subscribers. Time Warner Cable's
share of these revenues is expected to change periodically to 75% of
subscription revenues and 25% of national advertising and transactional revenues
by 2006.
Primestar Roll-up Transaction
In April 1998, TWE and Advance/Newhouse transferred the direct broadcast
satellite operations conducted by TWE and TWE-A/N (the "DBS Operations") and the
31% partnership interest in Primestar Partners, L.P. held
by TWE-A/N ("Primestar" and collectively, the "Primestar Assets") to Primestar,
Inc. ("New Primestar"), a separate holding company. New Primestar owns the DBS
Operations and Primestar partnership interests formerly owned by TCI Satellite
Entertainment, Inc. and other previously existing partners of Primestar. In
exchange for contributing its interests in the Primestar Assets, TWE received
approximately 48 million shares of common stock of New Primestar (representing
an approximate 24% equity interest) and realized approximately $240 million of
debt reduction. TWE deconsolidated the DBS Operations effective as of April 1,
1998 and the equity interest in New Primestar received in this transaction is
being accounted for under the equity method of accounting.
TWE-A/N Transfers
In early 1998, Time Warner (through a wholly owned subsidiary) contributed
cable television systems (or interests therein) serving approximately 650,000
subscribers to TWE-A/N, subject to approximately $1 billion of debt, in exchange
for common and preferred partnership interests therein, and completed certain
related transactions. The debt assumed by TWE-A/N has been guaranteed by TWI
Cable and certain of its subsidiaries. TWE-A/N is now owned 65.3% by TWE, 33.3%
by Advance/Newhouse and 1.4% indirectly by Time Warner.
Warner Bros. Backlog
Warner Bros.' backlog, representing the amount of future revenue not yet
recorded from cash contracts for the licensing of theatrical and television
product for pay cable, basic cable, network and syndicated television
exhibition, amounted to $2.054 billion at September 30, 1998, compared to $2.126
billion at December 31, 1997 (including amounts relating to TWE's cable
television networks of $211 million and $238 million, respectively, and to Time
Warner's cable television networks of $500 million and $481 million,
respectively).
Because backlog generally relates to contracts for the licensing of
theatrical and television product which have already been produced, the
recognition of revenue for such completed product is principally only dependent
upon the commencement of the availability period for telecast under the terms of
the related licensing agreement. Cash licensing fees are collected periodically
over the term of the related licensing agreements or on an accelerated basis
using a $600 million securitization facility. The portion of backlog for which
cash has not already been received has significant off-balance sheet asset value
as a source of future funding. The backlog excludes advertising barter
contracts, which are also expected to result in the future realization of
revenues and cash through the sale of advertising spots received under such
contracts.
Year 2000 Technology Preparedness
TWE, like most large companies, depends on many different computer systems
and other chip-based devices for the continuing conduct of its business. Older
computer programs, computer hardware and chip-based devices may fail to
recognize dates beginning on January 1, 2000 as being valid dates, and as a
result may fail to operate or may operate improperly when such dates are
introduced.
TWE's exposure to potential Year 2000 problems exists in two general
areas: technological operations in the sole control of the Company and
technological operations dependent in some way on one or more third parties.
These technological operations include information technology ("IT") systems and
non-IT systems, including those
with embedded technology, hardware and software. Most of TWE's potential Year
2000 exposures are in the area of technological operations dependent on one or
more third parties. Failure to achieve high levels of Year 2000 compliance in
either area could have a material adverse impact on TWE and its financial
statements.
The Company's Year 2000 initiative is being conducted at the operational
level by divisional project managers and senior technology executives overseen
by senior divisional executives, with assistance internally as well as from
outside professionals. The progress of each division through the different
phases of remediation - inventorying, assessment, remediation planning,
implementation and final testing - is actively overseen and reviewed on a
regular basis by an executive oversight group.
The Company has generally completed the process of identifying potential
Year 2000 difficulties in its technological operations, including IT
applications, IT technology and support, desktop hardware and software, non-IT
systems and important third party operations, and distinguishing those that are
"mission critical" from those that are not. An item is considered "mission
critical" if its Year 2000-related failure would significantly impair the
ability of one of the Company's major business units to (1) produce, market and
distribute the products or services that generate significant revenues for that
business, (2) meet its obligations to pay its employees, artists, vendors and
other obligations or (3) meet its obligations under regulatory requirements and
internal accounting controls. The Company and its divisions have identified
approximately 600 worldwide, "mission critical" potential exposures. Of these,
as of September 30, 1998, approximately 10% have been identified by the
divisions as in the assessment stage, approximately 40% as in the remediation
planning stage, and almost 50% as in the process of implementation or testing or
as Year 2000 compliant. The Company currently expects that the assessment phase
for these potential exposures should be completed by the end of 1998 and that
remediation with respect to technological operations in the sole control of the
Company will be substantially completed in all material respects by the end of
the second quarter of 1999.
In the area of "mission critical" technological operations dependent in
some way on one or more third parties, the situation is much less in TWE's
ability to predict or control. In addition, the Company's business is heavily
dependent on third parties that are themselves heavily dependent on technology.
In some cases, the Company's third party dependence is on vendors of technology
who are themselves working towards solutions to Year 2000 problems. For example,
in a situation endemic to the cable industry, much of the Company's headend
equipment that controls cable set-top boxes is currently not Year 2000
compliant. The box manufacturers are working with cable industry groups and have
recently developed solutions that the Company is beginning to install in its
headend equipment. It is currently expected that these solutions will be
substantially implemented by the end of the second quarter of 1999. In other
cases, the Company's third party dependence is on suppliers of products or
services that are themselves computer-intensive. For example, if a television
broadcaster or cable programmer encounters Year 2000 problems that impede its
ability to deliver its programming, the Company will be unable to provide that
programming to its cable customers. Similarly, because the Company is also a
programming supplier, third-party signal delivery problems could affect its
ability to deliver its programming to its customers. The Company has attempted
to include in its "mission critical" inventory significant service providers,
vendors, suppliers, customers and governmental entities that are believed to be
critical to business operations and is in various stages of attempting to
ascertain their state of Year 2000 readiness through questionnaires, interviews,
on-site visits, industry group participation and other available means.
Moreover, TWE is dependent, like all large companies, on the continued
functioning, domestically and internationally, of basic, heavily computerized
services such as banking, telephony and power, and various distribution
mechanisms ranging from the mail, railroads and trucking to high-speed data
transmission. TWE is taking steps to attempt to ensure that the third parties on
which it is heavily reliant are Year 2000 compliant, but cannot predict the
likelihood of such compliance nor the direct or indirect costs to the Company of
non-compliance by those third parties or of securing such services from
alternate compliant third parties.
The Company currently estimates that the aggregate cost of its Year 2000
remediation program, which started in 1996, will be approximately $50 to $85
million, of which an estimated 40% to 50% has been incurred through September
30, 1998. These costs include estimates of the costs of assessment, replacement,
repair and upgrade, both planned and unplanned, of certain IT and non-IT systems
and their implementation and testing. These expenditures have been and are
expected to continue to be funded from the Company's operating cash flow and
have not and are not expected to impact materially the Company's financial
statements.
Management believes that it has established an effective program to
resolve all significant Year 2000 issues in its sole control in a timely manner.
As noted above, however, the Company has not yet completed all phases of its
program and is dependent on third parties whose progress is not within its
control. In the event that the Company did not complete any of its currently
planned additional remediation prior to the Year 2000, management believes that
the Company could experience significant difficulty in producing and delivering
its products and services and conducting its business in the Year 2000 as it has
in the past. In addition, disruptions experienced by third parties with which
the Company does business as well as by the economy generally could also
materially adversely affect the Company. The amount of potential liability and
lost revenue cannot be reasonably estimated at this time.
The Company has been focusing its efforts on identification and
remediation of its Year 2000 exposures and has not yet developed significant
contingency plans in the event it does not successfully complete all phases of
its Year 2000 program. The Company intends to examine its status at the end of
1998, and periodically thereafter, to determine whether such plans are
necessary.
Euro Conversion
Effective January 1, 1999, the "euro" will be established as the common
legal currency of more than two-thirds of the member countries of the European
Union. These member countries will then have a three-year transitional period to
convert their existing sovereign currencies to the euro. By July 1, 2002, all
participating member countries must eliminate their sovereign currencies and
replace their legal tender with euro-denominated bills and coins.
Notwithstanding this transitional period, many commercial transactions are
expected to become euro-denominated well before the July 2002 deadline.
Accordingly, TWE is in the process of evaluating the short-term and long-term
effects of the euro conversion on its businesses, principally consisting of its
international filmed entertainment operations.
TWE believes that its most significant short-term impact relating to the
euro conversion is the need to modify its accounting and information systems to
handle transactions during the transitional period in both the euro and the
existing sovereign currencies of the participating member countries. TWE is in
the process of identifying
the accounting and information systems in need of modification and, based on
these findings, will formulate an action plan to address the nature and timing
of remediation efforts. Based on preliminary information, costs to modify its
accounting and information systems are not expected to be material.
TWE believes that its most significant long-term business risk relating to
the euro conversion may be increased pricing pressures for its products and
services brought about by heightened consumer awareness of possible cross-border
price differences. However, TWE believes that these business risks may be offset
to some extent by lower production costs, other cost savings and marketing
opportunities. Notwithstanding such risks, management does not believe at this
time that the euro conversion will have a material effect on TWE's financial
position, results of operations or cash flows in future periods.
Caution Concerning Forward-Looking Statements
The Securities and Exchange Commission encourages companies to disclose
forward-looking information so that investors can better understand a company's
future prospects and make informed investment decisions. This filing, together
with management's public commentary related thereto, contains such
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995, particularly statements anticipating future
growth in revenues, EBITA and cash flow and forecasting ongoing debt reduction.
Words such as "anticipate", "estimate", "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 management's
present expectations of future events. As with any projection or forecast, they
are inherently susceptible to changes in circumstances, and TWE is under no
obligation to (and expressly disclaims any such obligation to) update or alter
its forward-looking statements despite such changes.
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 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. Some of the other factors that also could
cause actual results to differ from those contained in the forward-looking
statements include those identified in TWE's other filings and:
* For TWE's cable business, more aggressive than expected competition from
new technologies and other types of video programming distributors,
including DBS; increases in government regulation of cable or equipment
rates (or any failure to reduce rate regulation as is presently mandated
by statute) or other terms of service (such as "digital must-carry") or
opposition to franchise renewals; the failure of new equipment (such as
digital set-top boxes) or services to function properly, to appeal to
enough consumers or to be delivered in a timely fashion; and greater than
expected increases in programming or other costs.
* For TWE's cable programming and television businesses, greater than expected
programming or production costs; public and cable operator resistance to
price increases to offset higher programming costs (and the negative impact
on premium programmers of increases in basic cable rates); the sensitivity
of advertising to
economic cyclicality; and greater than expected fragmentation of consumer
viewership due to an increased number of programming services or the
increased popularity of alternatives to television.
* For TWE's film and television businesses, their ability to continue to
attract and select desirable talent and scripts at manageable costs;
increases in production costs generally; 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 such as DVD and the Internet.
* The ability of the Company and its key service providers, vendors,
suppliers, customers and governmental entities to replace, modify or upgrade
computer systems in ways that adequately address the Year 2000 issue,
including their ability to identify and correct all relevant computer codes
and embedded chips, unanticipated difficulties or delays in the
implementation of the Company's remediation plans and the ability of third
parties to adequately address their own Year 2000 issues.
In addition, TWE's overall financial strategy, including improved
financial ratios and a strengthened balance sheet, could be adversely affected
by increased interest rates, failure to meet earnings expectations, consequences
of the euro conversion and changes in TWE's plans, strategies and intentions.
TIME WARNER ENTERTAINMENT COMPANY, L.P.
CONSOLIDATED BALANCE SHEET
(Unaudited)
September 30, December 31,
1998 1997
---- ----
(millions)
ASSETS
Current assets
Cash and equivalents................................ $ 125 $ 322
Receivables, including $485 and $385 million due
from Time Warner, less allowances of $407 and
$424 million ...................................... 2,438 1,914
Inventories.......................................... 1,310 1,204
Prepaid expenses..................................... 173 182
-------- -------
Total current assets................................. 4,046 3,622
Noncurrent inventories............................... 2,281 2,254
Loan receivable from Time Warner..................... 400 400
Investments.......................................... 724 315
Property, plant and equipment........................ 6,050 6,557
Cable television franchises.......................... 4,000 3,063
Goodwill............................................. 4,080 3,859
Other assets......................................... 826 661
-------- -------
Total assets.........................................$ 22,407 $20,731
======== =======
LIABILITIES AND PARTNERS' CAPITAL
Current liabilities
Accounts payable..................................... $ 1,077 $ 1,123
Participations and programming costs payable......... 1,393 1,176
Debt due within one year............................. 7 8
Other current liabilities, including $353 and
$184 million due to Time Warner ................... 1,828 1,667
-------- -------
Total current liabilities............................ 4,305 3,974
Long-term debt....................................... 7,435 5,990
Other long-term liabilities, including $682 and
$477 million due to Time Warner.................... 2,659 1,873
Minority interests................................... 1,440 1,210
Preferred stock of subsidiary holding solely a
mortgage note of its parent ....................... 221 233
Time Warner General Partners' Senior Capital......... 591 1,118
Partners' capital
Contributed capital.................................. 7,344 7,537
Undistributed partnership earnings (deficit)......... (1,588) (1,204)
-------- -------
Total partners' capital.............................. 5,756 6,333
-------- -------
Total liabilities and partners' capital..............$ 22,407 $20,731
======== =======
See accompanying notes.
TIME WARNER ENTERTAINMENT COMPANY, L.P.
CONSOLIDATED STATEMENT OF OPERATIONS
(Unaudited)
Three Months Nine Months
Ended September 30, Ended September 30,
------------------- -------------------
1998 1997 1998 1997
---- ---- ---- ----
(millions)
Revenues (a)..................................... $3,220 $ 2,855 $ 8,980 $ 8,183
------ ------- ------- -------
Cost of revenues (a)(b) ......................... 2,175 1,905 5,927 5,352
Selling, general and administrative (a)(b) ...... 577 615 1,761 1,847
------ ------- ------- -------
Operating expenses .............................. 2,752 2,520 7,688 7,199
------ ------- ------- -------
Business segment operating income ............... 468 335 1,292 984
Interest and other, net (a) ..................... (203) (145) (550) (155)
Minority interest ............................... (52) (64) (198) (228)
Corporate services (a) .......................... (18) (18) (54) (54)
------ ------- ------- -------
Income before income taxes ...................... 195 108 490 547
Income taxes .................................... (23) (27) (55) (64)
------ ------- ------- -------
Net income....................................... $ 172 $ 81 $ 435 $ 483
====== ======= ======= =======
- -------
(a) Includes the following income (expenses) resulting from transactions with
the partners of TWE and other related companies for the three and nine months
ended September 30, 1998, respectively, and for the corresponding periods
in the prior year: revenues-$227 million and $474 million in 1998, $103 million and
$224 million in 1997; cost of revenues-$(49) million and $(142) million in 1998,
$ (11) million and $(47) million in 1997; selling, general and
administrative-$(14) million and $(16) million in 1998, $20 million and $60
million in 1997; interest and other, net-$1 million and $6 million in 1998, $8
million and $25 million in 1997; and corporate services-$(18) million and $(54)
million in 1998, $(18) million and $(54) million in 1997
(b) Includes depreciation and amortization
expense of:................................. $ 358 $ 361 $ 1,085 $ 1,013
====== ======= ======= =======
See accompanying notes.
TIME WARNER ENTERTAINMENT COMPANY, L.P.
CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited)
Nine Months
Ended September 30,
-------------------
1998 1997
---- ----
(millions)
OPERATIONS
Net income...................................................$ 435 $ 483
Adjustments for noncash and nonoperating items:
Depreciation and amortization................................ 1,085 1,013
Changes in operating assets and liabilities.................. (247) (578)
------ -------
Cash provided by operations.................................. 1,273 918
------ -------
INVESTING ACTIVITIES
Investments and acquisitions................................. (335) (104)
Capital expenditures.........................................(1,092) (1,117)
Investment proceeds.......................................... 540 444
------ -------
Cash used by investing activities............................ (887) (777)
------ -------
FINANCING ACTIVITIES
Borrowings................................................... 1,515 905
Debt repayments.............................................. (840) (323)
Issuance of preferred stock of subsidiary.................... - 243
Capital distributions........................................(1,060) (809)
Other........................................................ (198) (77)
------ -------
Cash used by financing activities............................ (583) (61)
------ -------
INCREASE (DECREASE) IN CASH AND EQUIVALENTS.................. (197) 80
CASH AND EQUIVALENTS AT BEGINNING OF PERIOD.................. 322 216
------ -------
CASH AND EQUIVALENTS AT END OF PERIOD........................$ 125 $ 296
====== =======
See accompanying notes.
TIME WARNER ENTERTAINMENT COMPANY, L.P.
CONSOLIDATED STATEMENT OF PARTNERSHIP CAPITAL
(Unaudited)
Nine Months
Ended September 30,
-------------------
1998 1997
---- ----
(millions)
BALANCE AT BEGINNING OF YEAR.................................$6,333 $6,574
Net income................................................... 435 483
Increase (decrease) in unrealized gains on securities........ (2) 5
Foreign currency translation adjustments..................... (18) (28)
Increase in realized and unrealized losses on
derivative financial instruments .......................... (1) -
------ ------
Comprehensive income(a)...................................... 414 460
Stock option and tax-related distributions................... (746) (586)
Distribution of business telephony interests................. (193) -
Allocation of income to Time Warner General Partners'
Senior Capital ........................................... (52) (88)
------ ------
BALANCE AT SEPTEMBER 30,.................................... $5,756 $6,360
====== ======
- ---------------
(a) Comprehensive income for the three months ended September 30, 1998 and 1997
was $167 million and $72 million, respectively.
See accompanying notes.
TIME WARNER ENTERTAINMENT COMPANY, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION
Description of Business
Time Warner Entertainment Company, L.P., a Delaware limited partnership
("TWE"), classifies its businesses into three fundamental areas: Entertainment,
consisting principally of interests in filmed entertainment, television
production and television broadcasting; Cable Networks, consisting principally
of interests in cable television programming; and Cable, consisting principally
of interests in cable television systems.
The operating results of TWE's various business interests are presented
herein as an indication of financial performance (Note 6). Except for start-up
losses incurred in connection with The WB Network, TWE's principal business
interests generate significant operating income and cash flow from operations.
The cash flow from operations generated by such business interests is
considerably greater than their operating income due to significant amounts of
noncash amortization of intangible assets recognized principally in Time Warner
Companies, Inc.'s ("Time Warner") $14 billion acquisition of Warner
Communications Inc. ("WCI") in 1989 and $1.3 billion acquisition of the minority
interest in American Television and Communications Corporation ("ATC") in 1992,
a portion of which cost was allocated to TWE upon the capitalization of the
partnership. Noncash amortization of intangible assets recorded by TWE's
businesses amounted to $129 million and $109 million for the three months ended
September 30, 1998 and 1997, respectively, and $387 million and $321 million for
the nine months ended September 30, 1998 and 1997, respectively.
Time Warner and certain of its wholly owned subsidiaries collectively own
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 senior priority capital ("Senior Capital")
and junior priority capital ("Series B Capital"). The remaining 25.51% limited
partnership interests in the Series A Capital and Residual Capital of TWE are
held by a subsidiary of MediaOne Group, Inc. ("MediaOne"), formerly U S WEST,
Inc. Certain of Time Warner's subsidiaries are the general partners of TWE
("Time Warner General Partners").
Basis of Presentation
The accompanying 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 financial statements should be read in conjunction
with the audited consolidated financial statements of TWE for the year ended
December 31, 1997. Certain reclassifications have been made to the prior year's
financial statements to conform to the 1998 presentation.
Effective July 1, 1998, TWE adopted Financial Accounting Standards Board
Statement No. 133, "Accounting for Derivative Instruments and Hedging
Activities" ("FAS 133"). FAS 133 requires that all derivative financial
instruments, such as foreign exchange contracts, be recognized in the financial
statements and measured at fair value regardless of the purpose or intent for
holding them. The adoption of FAS 133 did not have a material effect on TWE's
financial statements.
2. ACQUISITIONS AND DISPOSITIONS
Cable Transactions
In addition to continuing to use cable operating cash flow to finance the
level of capital spending necessary to upgrade the technological capability of
their cable television systems and develop new services, Time Warner, TWE and
the TWE-Advance/Newhouse Partnership ("TWE-A/N") have completed a series of
transactions in 1998 related to the cable television business and related
ancillary businesses that either reduced existing debt and/or TWE's share of
future funding requirements for such businesses. These transactions are
discussed more fully below.
Business Telephony Reorganization
In July 1998, in an effort to combine their business telephony operations
into a single entity that is intended to be self-financing, Time Warner, TWE and
TWE-A/N completed a reorganization of their business telephony operations (the
"Business Telephony Reorganization"), whereby (i) the operations conducted by
Time Warner, TWE and TWE-A/N were each contributed to a new holding company
named Time Warner Telecom LLC ("TW Telecom"), and then (ii) TWE's and TWE-A/N's
interests in TW Telecom were distributed to their partners, Time Warner,
MediaOne and Advance/Newhouse. TW Telecom is a competitive local exchange
carrier (CLEC) in selected metropolitan areas across the United States where it
offers a wide range of telephony services to business customers. As a result of
the Business Telephony Reorganization, Time Warner, MediaOne and
Advance/Newhouse own interests in TW Telecom of 61.95%, 18.88% and 19.17%,
respectively. TWE and TWE-A/N do not have continuing equity interests in these
business telephony operations. TWE and TWE-A/N recorded the distribution of
their business telephony operations to their respective partners based on the
$244 million historical cost of the net assets, of which $193 million was
recorded as a reduction in partners' capital and $51 million was recorded as a
reduction in minority interest in TWE's consolidated balance sheet.
Road Runner Joint Venture
In June 1998, Time Warner, TWE, TWE-A/N, MediaOne, Microsoft Corp.
("Microsoft") and Compaq Computer Corp. ("Compaq") formed a joint venture to
operate and expand Time Warner Cable's and MediaOne's existing high-speed
Internet access businesses (the "Road Runner Joint Venture"). In exchange for
contributing their existing high-speed Internet access businesses, Time Warner
received a common equity interest in the Road Runner Joint Venture of 11.25%,
TWE received a 25% interest, TWE-A/N received a 32.5% interest and MediaOne
received a 31.25% interest. In exchange for Microsoft and Compaq each
contributing $212.5 million of cash to the Road Runner Joint Venture, Microsoft
and Compaq each received a preferred equity interest therein that is convertible
into a 10% common equity interest. Accordingly, on a fully diluted basis, the
Road Runner Joint Venture is owned 9% by Time Warner, 20% by TWE, 26% by
TWE-A/N, 25% by MediaOne, 10% by Microsoft and 10% by Compaq. As a result of
this transaction, effective as of June 30, 1998, TWE and TWE-A/N deconsolidated
their high-speed Internet access operations and each of TWE's and TWE-A/N's
interest in the Road Runner Joint Venture is being accounted for under the
equity method of accounting.
Primestar
In April 1998, TWE and Advance/Newhouse, a limited partner in TWE-A/N,
transferred the direct broadcast satellite operations conducted by TWE and
TWE-A/N (the "DBS Operations") and the 31% partnership interest in Primestar
Partners, L.P. held by TWE-A/N ("Primestar" and collectively, the "Primestar
Assets") to Primestar, Inc. ("New Primestar"), a separate holding company. New
Primestar owns the DBS Operations and Primestar partnership interests formerly
owned by TCI Satellite Entertainment, Inc. and other previously existing
partners of Primestar. In exchange for contributing its interests in the
Primestar Assets, TWE received approximately 48 million shares of common stock
of New Primestar (representing an approximate 24% equity interest) and realized
approximately $240 million of debt reduction. In partial consideration for
contributing its indirect interest in certain of the Primestar Assets,
Advance/Newhouse received an approximate 6% equity interest in New Primestar. As
a result of this transaction, effective as of April 1, 1998, TWE deconsolidated
the DBS Operations and the 24% equity interest in New Primestar received in the
transaction is being accounted for under the equity method of accounting. This
transaction is referred to herein as the "Primestar Roll-up Transaction."
In a related transaction, Primestar also entered into an agreement in June
1997 with The News Corporation Limited ("News Corp."), MCI WorldCom, Inc.
("MCI") and American Sky Broadcasting LLC ("ASkyB"), pursuant to which New
Primestar would acquire certain assets relating to the high-power, direct
broadcast satellite business of ASkyB (the "Primestar ASkyB Transaction"). In
May 1998, the U.S. Department of Justice brought a civil action against
Primestar, each of its cable owners, including TWE, and News Corp. and MCI, to
enjoin on antitrust grounds the Primestar ASkyB Transaction. Although the
parties had discussions with the U.S. Department of Justice in an attempt to
restructure the transaction, no resolution was reached and the parties
terminated their agreement in October 1998.
TWE-A/N Transfers
In early 1998, Time Warner (through a wholly owned subsidiary) contributed
cable television systems (or interests therein) serving approximately 650,000
subscribers to TWE-A/N, subject to approximately $1 billion of debt, in exchange
for common and preferred partnership interests therein, and completed certain
related transactions (collectively, the "TWE-A/N Transfers"). The cable
television systems transferred to TWE-A/N were formerly owned by TWI Cable Inc.
("TWI Cable"), a wholly owned subsidiary of Time Warner, and Paragon
Communications ("Paragon"), a partnership formerly owning cable television
systems serving approximately 1 million subscribers that was wholly owned by
subsidiaries of Time Warner, with 50% beneficially owned in the aggregate by TWE
and TWE-A/N. The debt assumed by TWE-A/N has been guaranteed by TWI Cable and
certain of its subsidiaries, including Paragon.
As part of the TWE-A/N Transfers, TWE and TWE-A/N exchanged substantially
all of their respective beneficial interests in Paragon for an equivalent share
of Paragon's cable television systems (or interests therein) serving
approximately 500,000 subscribers, resulting in wholly owned subsidiaries of
Time Warner owning 100% of the restructured Paragon entity, with less than 1%
beneficially held for TWE. Accordingly, effective as of January 1, 1998, Time
Warner has consolidated Paragon. Because this transaction represented an
exchange of TWE's and TWE-A/N's beneficial interests in Paragon for an
equivalent amount of its cable television systems, it did not have a significant
economic impact on Time Warner, TWE or TWE-A/N.
In connection with the TWE-A/N Transfers, Advance/Newhouse made a capital
contribution to TWE-A/N in order to maintain its 33.3% common partnership
interest therein. Accordingly, TWE-A/N is now owned 65.3% by TWE, 33.3% by
Advance/Newhouse and 1.4% indirectly by Time Warner. The TWE-A/N Transfers were
accounted for effective as of January 1, 1998. Time Warner did not recognize a
gain or loss on the TWE-A/N Transfers. TWE has continued to consolidate TWE-A/N
and Time Warner has accounted for its interest in TWE-A/N under the equity
method of accounting.
On a pro forma basis, giving effect to the TWE-A/N Transfers as if they
had occurred at the beginning of 1997, TWE would have reported for the three and
nine months ended September 30, 1997, respectively, revenues of $2.869 billion
and $8.227 billion, depreciation expense of $253 million and $696 million,
operating income before noncash amortization of intangible assets of $473
million and $1.393 billion, operating income of $347 million and $1.023 billion,
and net income of $79 million and $479 million.
Sale or Exchange of Cable Television Systems
In 1998 and 1997, in an effort to enhance their geographic clustering of
cable television properties, TWE sold or exchanged various cable television
systems. As a result of these transactions, TWE recognized net pretax gains of
approximately $6 million and $16 million for the three months ended September
30, 1998 and 1997, respectively, and approximately $90 million and $40 million
for the nine months ended September 30, 1998 and 1997, respectively. Such
amounts have been included in operating income in the accompanying consolidated
statement of operations.
Six Flags
In April 1998, TWE sold its remaining 49% interest in Six Flags
Entertainment Corporation ("Six Flags") to Premier Parks Inc. ("Premier"), a
regional theme park operator, for approximately $475 million of cash. TWE used
the net, after-tax proceeds from this transaction to reduce debt by
approximately $300 million. As part of the transaction, TWE will continue to
license its animated cartoon and comic book characters to Six Flags's theme
parks and will similarly license such rights to Premier's theme parks in the
United States and Canada under a long-term agreement covering an aggregate of
twenty-five existing and all future locations. A substantial portion of the gain
on this transaction has been deferred principally as a result of TWE's
continuing guarantees of certain significant long-term obligations of Six Flags
relating to the Six Flags Over Texas and Six Flags Over Georgia theme parks.
E! Entertainment Television, Inc.
In March 1997, TWE sold its 58% interest in E! Entertainment Television,
Inc. A pretax gain of approximately $250 million relating to this sale has been
included in the accompanying consolidated statement of operations for the nine
months ended September 30, 1997.
3. INVENTORIES
TWE's inventories consist of:
September 30, 1998 December 31, 1997
------------------ -----------------
Current Noncurrent Current Noncurrent
------- ---------- ------- ----------
(millions)
Film costs:
Released, less amortization............$ 555 $ 662 $ 545 $ 658
Completed and not released............. 263 93 170 50
In process and other................... 51 600 27 595
Library, less amortization............. - 573 - 612
Programming costs, less amortization...... 352 353 382 339
Merchandise............................... 89 - 80 -
------ ------ ------ ------
Total.....................................$1,310 $2,281 $1,204 $2,254
====== ====== ====== ======
4. 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 Time Warner for stock options granted to employees of TWE based on
the amount by which the market price of Time Warner Inc. common stock exceeds
the option exercise price on the exercise date or, with respect to options
granted prior to the TWE capitalization on September 30, 1992, the greater of
the exercise price and the $27.75 market price of Time Warner Inc. common stock
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 Time Warner Inc. common stock increases during the accounting
period, and reverses previously accrued stock option distributions and the
corresponding liability when the market price of Time Warner Inc. common stock
declines.
During the nine months ended September 30, 1998, TWE accrued $264 million
of tax-related distributions and $482 million of stock option distributions,
based on closing prices of Time Warner common stock of $87.56 at September 30,
1998 and $62.00 at December 31, 1997. During the nine months ended September 30,
1997, TWE accrued $232 million of tax-related distributions and $354 million of
stock option distributions as a result of an increase at that time in the market
price of Time Warner Inc. common stock. In the nine months ended September 30,
1998, TWE paid cash distributions to the Time Warner General Partners in the
amount of $1.060 billion, consisting of $264 million of tax-related
distributions, $217 million of stock option related distributions and a $579
million distribution to the Time Warner General Partners relating to their
Senior Capital interests. In the nine months ended September 30, 1997, TWE paid
the Time Warner General Partners cash distributions in the amount of $809
million, consisting of $232 million of tax-related distributions, $42 million of
stock option related distributions and a $535 million distribution to the Time
Warner General Partners relating to their Senior Capital interests.
In addition, in connection with the Business Telephony Reorganization, TWE
recorded a $193 million noncash distribution to its partners based on the
historical cost of the net assets (Note 2).
5. DERIVATIVE FINANCIAL INSTRUMENTS
TWE uses derivative financial instruments principally to manage the risk
that changes in exchange rates will affect the amount of unremitted or future
license fees to be received from the sale of U.S. copyrighted products abroad.
The following is a summary of TWE's foreign currency risk management strategy
and the effect of this strategy on TWE's consolidated financial statements.
Foreign Currency Risk Management
Foreign exchange contracts are used primarily by Time Warner to hedge the
risk that unremitted or future license fees owed to TWE domestic companies for
the sale or anticipated sale of U.S. copyrighted products abroad may be
adversely affected by changes in foreign currency exchange rates. As part of its
overall strategy to manage the level of exposure to the risk of foreign currency
exchange rate fluctuations, Time Warner hedges a portion of its foreign currency
exposures anticipated over the ensuing twelve month period, including those
related to TWE. At September 30, 1998, Time Warner had effectively hedged
approximately half of TWE's estimated foreign currency exposures that
principally relate to anticipated cash flows to be remitted to the U.S. over the
ensuing twelve month period, using foreign exchange contracts that generally
have maturities of three months or less, which generally are rolled over to
provide continuing coverage throughout the year. Time Warner often closes
foreign exchange sale contracts by purchasing an offsetting purchase contract.
Time Warner reimburses or is reimbursed by TWE for contract gains and losses
related to TWE's foreign currency exposure. Foreign exchange contracts are
placed with a number of major financial institutions in order to minimize credit
risk.
TWE records these foreign exchange contracts at fair value in its
consolidated balance sheet and the related gains or losses on these contracts
are deferred in partners' capital (as a component of comprehensive income).
These deferred gains and losses are recognized in income in the period in which
the related license fees being hedged are received and recognized in income.
However, to the extent that any of these contracts are not considered to be
perfectly effective in offsetting the change in the value of the license fees
being hedged, any changes in fair value relating to the ineffective portion of
these contracts are immediately recognized in income. Gains and losses on
foreign exchange contracts are generally included as a component of interest and
other, net, in TWE's consolidated statement of operations.
At September 30, 1998, Time Warner had contracts for the sale of $608
million and the purchase of $267 million of foreign currencies at fixed rates.
Of Time Warner's $341 million net sale contract position, none of foreign
exchange purchase contracts and $96 million of the foreign exchange sale
contracts related to TWE's foreign currencies exposure, primarily Japanese yen
(32% of net contract position related to TWE), English pounds (5%), German marks
(13%), Canadian dollars (7%) and French francs (9%), compared to a net sale
contract position of $105 million of foreign currencies at December 31, 1997.
TWE had deferred approximately $1 million of net losses on foreign exchange
contracts at September 30, 1998, which is all expected to be recognized in
income over the next twelve months.
6. SEGMENT INFORMATION
TWE classifies its businesses into three fundamental areas: Entertainment,
consisting principally of interests in filmed entertainment, television
production and television broadcasting; Cable Networks, consisting principally
of interests in cable television programming; and Cable, consisting principally
of interests in cable television systems.
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 business segment operating income before noncash amortization of
intangible assets ("EBITA"). The operating results of TWE's cable segment
reflect the TWE-A/N Transfers effective as of January 1, 1998, the Primestar
Roll-up Transaction effective as of April 1, 1998, the formation of the Road
Runner Joint Venture effective as of June 30, 1998 and the Business Telephony
Reorganization effective as of July 1, 1998.
Information as to the operations of TWE in different business segments is
set forth below.
Three Months Nine Months
Ended September 30, Ended September 30,
------------------- -------------------
1998 1997 1998 1997
---- ---- ---- ----
(millions)
Revenues
Filmed Entertainment-Warner Bros......... $1,727 $1,397 $4,364 $3,823
Broadcasting-The WB Network.............. 64 31 170 84
Cable Networks-HBO....................... 505 482 1,526 1,452
Cable.................................... 1,052 1,060 3,289 3,146
Intersegment elimination................. (128) (115) (369) (322)
------ ------ ------ ------
Total.................................... $3,220 $2,855 $8,980 $8,183
====== ====== ====== ======
Three Months Nine Months
Ended September 30, Ended September 30,
------------------- -------------------
1998 1997 1998 1997
---- ---- ---- ----
(millions)
EBITA(1)
Filmed Entertainment-Warner Bros......... $ 161 $ 106 $ 401 $ 315
Broadcasting-The WB Network.............. (17) (21) (78) (60)
Cable Networks-HBO....................... 117 102 339 291
Cable(2)................................. 336 257 1,017 759
----- ------ ------ ------
Total.................................... $ 597 $ 444 $1,679 $1,305
===== ====== ====== ======
- ---------------
(1)EBITA represents business segment operating income before noncash
amortization of intangible assets. After deducting amortization of intangible
assets, TWE's business segment operating income for the three and nine months
ended September 30, 1998, respectively, and for the corresponding periods in
the prior year was $468 million and $1.292 billion in 1998, and $335 million
and $984 million in 1997.
(2)Includes net pretax gains recognized in connection with the sale or exchange
of certain cable television systems of approximately $6 million and $16
million for the three months ended September 30, 1998 and 1997, respectively,
and approximately $90 million and $40 million for the nine months ended
September 30, 1998 and 1997, respectively.
Three Months Nine Months
Ended September 30, Ended September 30,
------------------- -------------------
1998 1997 1998 1997
---- ---- ---- ----
(millions)
Depreciation of Property, Plant and Equipment
Filmed Entertainment-Warner Bros......... $ 48 $ 50 $126 $131
Broadcasting-The WB Network.............. 1 - 1 1
Cable Networks-HBO....................... 6 5 16 15
Cable.................................... 174 197 555 545
---- ---- ---- ----
Total.................................... $229 $252 $698 $692
==== ==== ==== ====
Three Months Nine Months
Ended September 30, Ended September 30,
------------------- -------------------
1998 1997 1998 1997
---- ---- ---- ----
(millions)
Amortization of Intangible Assets (1)
Filmed Entertainment-Warner Bros.......... $ 33 $ 31 $ 99 $ 92
Broadcasting-The WB Network............... - - 2 -
Cable Networks-HBO........................ - - - -
Cable..................................... 96 78 286 229
---- ---- ---- ----
Total..................................... $129 $109 $387 $321
==== ==== ==== ====
- ---------------
(1)Amortization includes amortization relating to all business combinations
accounted for by the purchase method, including Time Warner's $14 billion
acquisition of WCI in 1989 and $1.3 billion acquisition of the minority
interest in ATC in 1992.
7. COMMITMENTS AND CONTINGENCIES
Pending legal proceedings are substantially limited to litigation
incidental to the businesses of TWE. In the opinion of management, the ultimate
resolution of these matters will not have a material effect on the consolidated
financial statements of TWE.
8. ADDITIONAL FINANCIAL INFORMATION
Additional financial information with respect to cash flows is as follows:
Nine Months
Ended September 30,
-------------------
1998 1997
---- ----
(millions)
Interest expense....................................... $418 $358
Cash payments made for interest........................ 419 394
Cash payments made for income taxes, net............... 57 55
Noncash capital distributions.......................... 675 354
Noncash investing and financing activities in the first nine months of
1998 included the Business Telephony Reorganization, the TWE-A/N Transfers, the
Primestar Roll-up Transaction and the exchange of certain cable television
systems (Note 2). During the nine months ended September 30, 1998, TWE received
$131 million of proceeds under its asset securitization program.
Part II. Other Information
Item 1. Legal Proceedings.
Reference is made to the litigation entitled Six Flags Over Georgia, Inc.,
et al. v. Six Flags Fund, Ltd., et al. commenced in Superior Court in Gwinnett
County, Georgia in connection with the management of the Six Flags Over Georgia
Theme Park described on pages I-28 and I-29 of TWE's Annual Report on Form 10-K
for the year ended December 31, 1997. TWE and its former 51% partner in Six
Flags retained financial responsibility for this litigation following completion
of the sale of Six Flags. Discovery has now concluded, although a number of
motions relating to discovery and discovery-related practices are still pending.
Plaintiffs in the action moved on October 22, 1998 to amend their complaint so
as to drop their claim for fraud and to modify their claim for breach of
contract. Trial on the remaining claims seeking damages in excess of $250
million is scheduled to commence November 16, 1998.
Reference is made to the civil action brought by the U.S. Department of
Justice in the United States District Court for the District of Columbia against
Primestar, Inc. ("Primestar") to enjoin on antitrust grounds Primestar's
proposed acquisition of certain assets described on page 62 of Time Warner's
Quarterly Report on Form 10-Q for the quarter ended June 30, 1998 (the "June 30,
1998 Form 10-Q"). Abandonment of the proposed acquisition was announced on
October 15, 1998 and it is expected that such abandonment will moot the
litigation.
Reference is made to the litigation entitled Coppola v. Warner Bros.
described on page 62 of the June 30, 1998 Form 10-Q. On October 15, 1998, the
Court vacated the jury award against Warner Bros. for $60 million in punitive
damages but affirmed the award of $20 million in compensatory damages and denied
Warner Bros.' motion for a new trial. Both sides have stated they will appeal
the Court's ruling.
Reference is made to the litigation entitled Samuel D. Moore, et al. v.
American Federation of Television and Radio Artists, et al., described on pages
I-36 and I-37 of Time Warner's Annual Report on Form 10-K for the year ended
December 31, 1997 and on page 62 of the June 30, 1998 Form 10-Q. By Order dated
October 6, 1998, the 11th Circuit Court of Appeals has accepted interlocutory
review of the District Court's Order dated June 22, 1998, denying class
certification. This appeal will now proceed to briefing and argument.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits.
The exhibits listed on the accompanying Exhibit Index are filed or
incorporated by reference as a part of this report and such Exhibit Index is
incorporated herein by reference.
(b) Reports on Form 8-K.
No Current Report on Form 8-K was filed by Time Warner during the quarter
ended September 30, 1998.
TIME WARNER INC.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Time Warner Inc.
(Registrant)
By: /s/ Richard J. Bressler
Name: Richard J. Bressler
Title: Executive Vice President and
Chief Financial Officer
Dated: November 12, 1998
EXHIBIT INDEX
Pursuant to Item 601 of Regulations S-K
Exhibit No. Description of Exhibit
27 Financial Data Schedule.