Item 1. Business.
Time Warner Inc. (the "Company" or "Time Warner") is a leading media and
entertainment company. The Company was formed in connection with the merger of
America Online, Inc. ("America Online") and Time Warner Inc., now known as
Historic TW Inc. ("Historic TW"), which was consummated on January 11, 2001 (the
"Merger" or the "America Online-Historic TW Merger"). The Company changed its
name from AOL Time Warner Inc. to Time Warner Inc. on October 16, 2003.
The Company classifies its businesses into the following fundamental
areas:
America Online, consisting principally of interactive services;
Cable, consisting principally of interests in cable systems providing video
and high speed data services;
Filmed Entertainment, consisting principally of feature film, television and
home video production and distribution;
Networks, consisting principally of cable television and broadcast networks;
and
Publishing, consisting principally of magazine and book publishing.
At March 2, 2004, the Company had a total of approximately 80,000 active
employees.
For convenience, the terms the "Registrant," "Company" and "Time Warner"
are used in this report to refer to both the parent company and collectively to
the parent company and the subsidiaries through which its various businesses are
conducted, unless the context otherwise requires.
Asset Sales
In conjunction with the Company's debt reduction program announced in
January 2003, during 2003 and the first quarter of 2004, the Company sold
certain of its businesses and non-strategic assets, including all of the Warner
Music recorded music, music publishing and CD and DVD manufacturing businesses,
the Time Life Inc. direct marketing business, the Company's 50%-interest in
Comedy Central and its interest in Hughes Electronics Corporation. The Company
also expects to complete the sale of its winter sports teams prior to the end of
the first quarter of 2004.
TWE Restructuring
On March 31, 2003, the Company completed the restructuring (the "TWE
Restructuring") of Time Warner Entertainment Company, L.P. ("TWE"), a limited
partnership which formerly held a substantial portion of the Company's filmed
entertainment and cable television assets. Prior to the TWE Restructuring,
subsidiaries of Comcast Corporation ("Comcast") held a 27.64% limited
partnership interest in TWE.
As a result of the TWE Restructuring, Time Warner acquired complete
ownership of TWE's content businesses, including Warner Bros., Home Box Office
and TWE's interests in The WB Television Network and Courtroom Television
Network ("Court TV"). Additionally, all of Time Warner's interests in cable,
including those that were wholly owned and those that were held through TWE, are
now controlled by a new subsidiary of Time Warner called Time Warner Cable Inc.
("TWC Inc." or "TWC"). As part of the TWE Restructuring, Time Warner received a
79% economic interest in TWC Inc.'s cable systems and TWE, which continues to
own the cable system interests previously owned by it, became a subsidiary of
TWC Inc. In exchange for its previous stake in TWE, Comcast (i) received Time
Warner preferred stock which will be converted into $1.5 billion of Time Warner
common stock; (ii) received a 21.0% economic interest in TWC Inc.'s cable
systems; and (iii) was relieved of $2.1 billion of pre-existing debt which was
incurred by TWC Inc. as part of the TWE Restructuring. Comcast's 21.0% economic
interest in TWC Inc.'s cable business is held through a 17.9% direct common
ownership interest in TWC Inc. (representing a 10.7% voting interest) and a
limited partnership interest in TWE representing a 4.7% residual equity
interest. Time Warner's 79%
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economic interest in TWC Inc.'s cable business is held through an 82.1% common
ownership interest in TWC Inc. (representing an 89.3% voting interest) and a
partnership interest in TWE representing a 1% residual equity interest. Time
Warner also holds a $2.4 billion mandatorily redeemable preferred equity
interest in TWE. For additional information with respect to the TWE
Restructuring, see "Description of Certain Provisions of the TWE Partnership
Agreement" herein.
On December 29, 2003, TWC Inc. received a notice from Comcast requesting
that TWC Inc. start the registration process under the Securities Act of 1933
for the sale in a firm underwritten offering of Comcast's 17.9% common interest
in TWC Inc. The notice was delivered pursuant to a registration rights agreement
related to the TWC Inc. securities. The Company cannot predict the timing of an
effective registration in response to the notice. For additional information
with respect to TWC Inc., see "Description of Certain Provisions of Agreements
related to TWC Inc." herein.
Restructuring of TWE-Advance/Newhouse Partnership and Road Runner
During 2002, TWE and Advance/Newhouse Partnership ("Advance/Newhouse")
completed the restructuring of the general partnership known as the Time Warner
Entertainment-Advance/Newhouse Partnership ("TWE-A/N"). As a result of the
restructuring (the "TWE-A/ N Restructuring"), cable systems serving 2.1 million
basic video subscribers (the "A/N Systems"), primarily located in Florida, were
transferred to a subsidiary of TWE-A/N, and Advance/Newhouse's interest in
TWE-A/N was converted into an interest that tracks the economic performance of
these A/N Systems. Advance/Newhouse has authority for supervision of the
day-to-day operations of the A/N Systems. Time Warner has deconsolidated the
financial position and operating results of the A/N Systems for all periods.
Also, in connection with the TWE-A/N Restructuring, Time Warner
effectively acquired Advance/Newhouse's 17% interest in Road Runner, a high
speed cable modem Internet service provider, thereby increasing the Company's
ownership to approximately 82% on a fully attributed basis.
Caution Concerning Forward-Looking Statements
This Annual Report on Form 10-K includes certain "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995. These statements are based on management's current expectations and are
subject to uncertainty and changes in circumstances. Actual results may vary
materially from the expectations contained herein due to changes in economic,
business, competitive, technological and/or regulatory factors. More detailed
information about those factors is set forth in Management's Discussion and
Analysis of Results of Operations and Financial Condition in the financial pages
herein. Time Warner is under no obligation to (and expressly disclaims any such
obligation to) update or alter its forward-looking statements, whether as a
result of new information, subsequent events or otherwise.
Available Information and Website
The Company's annual reports on Form 10-K, quarterly reports on Form 10-Q,
current reports on Form 8-K and any amendments to such reports filed with or
furnished to the Securities and Exchange Commission (SEC) pursuant to
Sections 13(a) or 15(d) of the Securities Exchange Act are available free of
charge on the Company's website at www.timewarner.com as soon as reasonably
practicable after such reports are electronically filed with the SEC.
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AMERICA ONLINE
America Online, Inc., a wholly owned subsidiary of the Company based in
Dulles, Virginia, is the world's leader in interactive services. America
Online's operations include: the AOL service; the CompuServe service; the
Netscape Internet Service; the Wal-Mart Connect service; AOL for Broadband;
premium services such as MusicNet@AOL and AOL Call Alert; and America Online's
messaging and Web properties, such as AOL Instant Messenger, ICQ, Moviefone and
MapQuest.
The AOL Service
The core AOL service, a subscription-based service with over 24 million
members in the U.S. and 30.6 million members in the U.S. and Europe, combined,
at December 31, 2003, provides members with a global, interactive community
offering a wide variety of content, features and tools. The range of content,
features and tools offered on the AOL service includes the following:
Online Community - The AOL service promotes interactive community through
email services, instant messaging, public and private chat rooms,
interactive polling, AOL Talk Phone (allowing voice conversations) and AOL
Journals (AOL's "blog" feature).
Content - Content on the AOL service is both internally generated and
provided by diverse external sources, including other Time Warner divisions.
As part of its strategy, the AOL service is focusing, in part, on developing
exclusive content. During 2003, AOL launched new programming areas or
experiences targeting specific demographic groups, including: KOL, designed
for kids aged 6 to 12; AOL Black Focus, targeted to the African-American
community; and AOL Latino, a Spanish language Internet service for
U.S. Hispanics. Red, launched in early 2004, is an online experience
targeted toward teens. Content on the AOL service is organized in a variety
of ways for easy access by members, including channels, toolbar icons,
customization tools and Favorite Places, which allow members to mark
particular Web sites or AOL areas.
Customization and Control Features - Members can customize their experience
on the AOL service through features and tools, such as an interactive
calendar; My AOL Quickview, which allows additional customization of the
Welcome Screen; an alerts and reminders service; SuperBuddy icons; mail
controls, including anti-spam features; and parental controls which permit
parents to limit access to particular AOL areas, features or Web sites.
AOL 9.0 Optimized, introduced in 2003, offers personalized spam filters and
enhanced parental controls, among other things. AOL also launched AOL
Communicator in 2003, a sophisticated email offering targeted at tech-savvy
members.
AOL Music - AOL Music offers a variety of programming, products and services
that enable consumers to discover, listen to and buy music online. AOL
Music's properties include the AOL Music Channel; Radio@AOL, a built-in
radio service; Web music features, including Netscape Music and AIM Today;
the Winamp audio jukebox player and SHOUTcast, a streaming audio service and
Internet music directory. As of December 2003, AOL members are able to
access Apple's iTunes Music Store through AOL Music and pay for their
downloads through their AOL "wallet" or other payment options.
Shopping - The AOL Shopping channel allows members to shop for a wide
variety of products from various retailers while remaining in the AOL
service. AOL also offers members shopping opportunities throughout other
channels on the service. The channel's shopping tools and resources include
a search function, electronic shopping lists, and AOL's "wallet." AOL
provides a customer satisfaction guarantee for all merchandise purchased
through an AOL Certified Merchant on AOL Shopping.
Subscriber fees are charged to members of the AOL service based on the
level of service selected. The primary narrowband price plan for U.S. members is
an unlimited usage plan for $23.90 per month that includes dial-up telephone
access to both the AOL service and the Internet. Narrowband members may also
select from other pricing plans with lower rates, including limited usage plans
and an annual payment plan that
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allows members to pay for a year of the AOL service in advance at a reduced
rate. America Online continues to test new price plans and payment methods.
Members of AOL may cancel their membership at any time, for any reason, by
telephone, fax or mail. AOL utilizes a number of incentives and retention
programs to encourage members to continue as members, as well as to bring back
members who have recently canceled. In addition, AOL undertakes a wide range of
marketing campaigns and promotions to attract new members.
AOL for Broadband
The AOL for Broadband service is available to members connecting to the
AOL service through a high-speed broadband technology such as cable or digital
subscriber lines (DSL) and is marketed primarily as a "bring your own access"
(BYOA) product. AOL for Broadband provides these members with expanded
multimedia content, including streaming music, CD-quality radio and other audio,
full-motion video, streaming news clips, movie trailers, games and online
catalogue shopping features. As part of its business strategy, AOL has focused
on developing a broadband product with differentiated and exclusive content.
Under the broadband BYOA plan, members pay a monthly base fee of $14.95,
which allows unlimited time on the AOL service via a broadband connection not
provided by America Online, plus a limited number of hours each month of dial-up
access in the U.S. from America Online and the ability to have multiple
simultaneous log-ins for one account (MSL). AOL also provides bundled broadband
services to existing subscribers through a number of DSL and cable partners.
AOL Europe and Other International Operations
AOL International oversees the America Online services and operations
outside the United States. As of December 31, 2003, AOL Europe, a wholly owned
division of America Online, had nearly 6.4 million members in France, Germany,
the U.K. and other European countries. In each of these countries, local
language content, marketing and community are offered. America Online Latin
America, Inc. ("AOLA"), a publicly-traded joint venture, operates services in
Brazil, Mexico and Argentina, serves members of the AOL-branded service in
Puerto Rico, and had over 400,000 members as of December 31, 2003. The America
Online services are also offered through joint ventures or distribution
arrangements in Canada and Japan. For additional information with respect to
AOLA, see Note 7, "Investments, Including Available-for-Sale Securities - AOL
Latin America," to the Company's consolidated financial statements set forth in
the financial pages herein.
Premium and Other Services
America Online offers a variety of premium services to its members,
including AOLbyPhone, which allows members to access AOL services over the
telephone; AOL Call Alert, an online call waiting service that lets members
know, through a real-time alert on their computer screen, who is calling while
they are online; MusicNet@AOL, an online music subscription service; and AOL
Voicemail, a service that allows members to listen to voicemail messages on
their computer and e-mail messages on their phone. In April 2003, together with
McAfee Security, AOL launched a new premium service that provides protection
from computer viruses. These premium services are an element of AOL's overall
business strategy to offset reduced revenues due to fewer subscribers and lower
prices of BYOA price plans.
AOL Mobile services deliver a variety of the AOL service's features and
content to users of wireless devices, such as mobile phones, PDAs, and other
handheld devices. The content and services available include wireless access to
email, news, weather, sports and stock quotes, as well as content from America
Online's other properties. AOL Instant Messenger and ICQ, two of America
Online's messaging products, are also available on a variety of wireless
devices.
America Online also provides text entry solutions for wireless devices
through its subsidiary, Tegic Communications, Inc. Tegic's leading product, the
T9 Text Input software, enables individuals to send e-mail,
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short messaging services and instant messages, as well as perform other
text-based functions and access the Internet, using the standard telephone
keypad to enter words or sentences.
Other Internet Service Providers
The CompuServe service targets value-oriented Internet service consumers
in the U.S. and professional business-oriented consumers outside of the U.S.
Additionally, CompuServe seeks opportunities to develop and operate co-branded
and custom versions of the CompuServe service and offers private label Internet
solutions for strategic partners, such as Hewlett-Packard. Subscriber fees are
charged to CompuServe members based on the level of service selected, including
an unlimited usage plan, a lower monthly rate providing for a set number of
hours usage (with additional usage charged at an hourly rate) and a "bring your
own access" plan for members with Internet access from another provider.
In January 2004, America Online launched the Netscape Internet service, a
low-cost Internet service provider (ISP). The Netscape service costs $9.95 per
month for unlimited use. In addition to unlimited Internet access, the service
offers e-mail, a start page and Internet search powered by Google.
America Online operates the Wal-Mart Connect service for Wal-Mart. The
Wal-Mart Connect service is offered to consumers for $9.94 a month and offers
email, instant messaging and online content.
Web Properties and Messaging
America Online's Web properties serve as an online network of AOL brands
on the Internet, offering a variety of content and applications.
AOL Instant Messenger is an Internet-based communications service that
allows Internet users to know when other users of the service are online and to
send and receive instant messages in real time. ICQ Ltd. is an Internet-based
real-time communications service that utilizes the ICQ ("I seek you") instant
communications and chat technology with a constant desktop presence.
Approximately two-thirds of ICQ users reside outside the U.S.
Moviefone is one of the leading movie guide and ticketing services in the
U.S. Through its interactive telephone service (777-FILM), its online service
(Moviefone.com), and its wireless services, Moviefone provides moviegoers with a
weekly, free directory of movies, show times and theater locations, and also
provides the ability to purchase tickets remotely for a per-ticket service
charge.
MapQuest provides customized maps, destination information and driving
directions to consumers through its Web site (MapQuest.com) and its wireless
partners. Through licensing agreements, MapQuest helps businesses integrate maps
and driving directions into their Internet, intranet and call center
applications.
The Netscape portal (Netscape.com) offers a variety of products and
services, including search services, Web-based e-mail, instant messaging and
message boards, programming channels and opportunities for electronic commerce.
Netscape Netbusiness (netbusiness.netscape.com), an Internet site targeted to
owners of small businesses, offers customizable information resources,
productivity and communications tools. America Online continues to maintain the
Netscape browser, but no future development for the browser is currently
planned.
AOL.com offers members AOL content and features, including email, AOL
Instant Messenger, and personalized news and calendar services, when members are
able to access the Internet, but not their AOL service.
Technologies
America Online employs a multiple vendor strategy in designing,
structuring and operating the network services utilized in its interactive
online services. AOLnet, a transfer control protocol/Internet protocol (TCP/IP)
network of third-party network service providers, is used for the AOL service
and certain versions
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of the CompuServe service in North America. America Online anticipates
continuing to review its network services in order to align its network
capacity, provide members of its online services with higher speed access and
manage data network costs.
America Online also utilizes the AOL Transit Data Network (ATDN), the
domestic and international network that connects AOL, CompuServe 2000 and Time
Warner Cable high speed data customers to the Internet. The ATDN functions as
the conduit between all of Time Warner's content and the Internet, linking
together facilities on four continents, with its greatest capacity in the U.S.
and Europe. The ATDN Internet backbone is built from high-end routers and
high-bandwidth circuits purchased under long-term agreements from third party
carriers.
America Online enters into multiple-year data communications agreements to
support AOLnet. In connection with those agreements, America Online may commit
to purchase certain minimum data communications services or to pay a fixed cost
for the network services. Improving and maintaining AOLnet requires a
substantial investment in telecommunications equipment. In addition to making
cash purchases of telecommunications equipment, America Online also finances
purchases of this equipment by entering into capital leases for such equipment.
Advertising and Commerce
A component of America Online's business strategy is earning revenues from
advertising and commerce, including partnering with companies such as Google, as
well as from related sources such as transaction and licensing fees. America
Online offers its advertising and commerce partners a variety of customized
programs, which may include premier placement, sponsorship of particular content
offerings for designated time periods, or the opportunity to target users with
specified interests. America Online also sells selected merchants preferred
rights to market particular goods or services within one or more of the online
services and properties. In those arrangements, America Online provides its
advertising and commerce partners certain marketing and promotional
opportunities and in return receives cash payments, the opportunity for revenue
sharing, cross-promotion, competitive pricing and/or online conveniences for
subscribers.
Marketing
America Online utilizes a common marketing infrastructure for its multiple
brands of interactive services and Web properties. To support its goals of
attracting and retaining members or users, as applicable, and developing and
differentiating the family of brands, America Online markets its products,
services and brands through a broad array of programs and strategies, including
broadcast television and radio advertising campaigns, direct mail,
telemarketing, magazine inserts (including magazines published by the Company's
publishing segment) and print advertisements, retail distribution, bundling
agreements, Web advertising and alternate media. Other marketing strategies
include extensive online and offline cross-promotion and co-branding with a wide
variety of partners. Additionally, through multi-year bundling agreements, the
interactive online services and products are installed on a range of computers
made by personal computer manufacturers and are available to consumers by
clicking on an icon during the computer's initial setup process or on the
desktop. America Online also utilizes targeted or limited online and offline
promotions, marketing programs and pricing plans designed to appeal to
particular groups of potential users of its interactive online services and to
distinguish and develop its different brands, products and services.
Competition
America Online competes for subscription revenues with multiple companies
providing Internet services (ISPs), such as the Microsoft Network, EarthLink and
AT&T Worldnet, and discount ISPs such as NetZero. America Online also competes
with companies that provide Internet access via narrowband and broadband
technologies, such as Internet access providers, cable companies and telephone
companies. Like America Online, other companies, such as Microsoft and Yahoo,
offer broadband services to consumers, either as a bundled product or a BYOA
product. America Online also competes more broadly for subscription revenues
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and members' time with cable, information, entertainment and media companies.
America Online competes for advertising and commerce revenues with a wide range
of companies, including those that focus on the Internet, such as online
services, Internet access companies, Web-based portals, and individual Web sites
providing content, commerce, community and similar features, as well as media
companies, such as those with newspaper or magazine publications, radio stations
and broadcast stations or networks. Additionally, America Online faces the risk
that competition from other ISPs and other Internet companies may result in
reduced revenues for America Online from its premium services, should those
services be included as part of basic Internet service.
America Online faces competition in developing technologies, and risks
from potential new developments in distribution technologies and equipment in
Internet access. In particular, America Online faces competition from
developments in the following types of Internet access distribution technologies
or equipment: broadband distribution technologies used in cable Internet access
services; advanced personal computer-based access services offered through DSL
technologies offered by local telecommunications companies; other advanced
digital services offered by wireless companies; television-based interactive
services; personal digital assistants or handheld computers; enhanced mobile
phones; and other equipment offering functional equivalents to the AOL Mobile
services. America Online must keep pace with these developments and also ensure
that it either has comparable and compatible technology or access to
distribution technologies developed or owned by third parties.
CABLE
The Company's Cable business consists principally of interests in cable
systems that provide video programming and high speed data services to customers
under the name Time Warner Cable. As a result of the TWE Restructuring completed
on March 31, 2003, Time Warner Cable Inc. ("TWC Inc.") became an 82.1%-owned
subsidiary of the Company. Of the 10.9 million basic video subscribers served by
the Company at December 31, 2003, 1.6 million are in systems owned by TWC Inc.
directly or through wholly-owned subsidiaries and 9.3 million are in systems
that are owned or managed by TWC Inc.'s joint ventures and partnerships, which
include TWE and TWE-A/N, among others. As a result of the TWE Restructuring, TWE
became a 94.3%-owned subsidiary of TWC Inc. (with the Company holding a
partnership interest in TWE representing a 1% residual equity interest and a
$2.4 billion preferred component). All of these systems provide services under
the Time Warner Cable brand name.
As a result of the TWE-A/ N Restructuring in 2002, cable systems serving
2.1 million basic video subscribers (the "A/ N Systems"), primarily located in
Florida, were transferred to a subsidiary of TWE-A/N, and Advance/ Newhouse's
interest in TWE-A/ N was converted into an interest that tracks the economic
performance of these A/ N Systems. Advance/ Newhouse has authority for
supervision of the day-to-day operations of the A/ N Systems. Time Warner has
deconsolidated the financial position and operating results of the A/ N Systems
for all periods and has presented these as a part of discontinued operations.
On December 1, 2003, the Company announced that Time Warner Cable would
restructure two joint ventures that it manages, Kansas City Cable Partners, a
50-50 joint venture between Comcast and TWE serving approximately 304,000 basic
video subscribers as of December 31, 2003, and Texas Cable Partners, a 50-50
joint venture between Comcast and TWE-A/ N serving approximately 1.2 million
basic video subscribers as of December 31, 2003. The Company accounts for its
investment in these joint ventures using the equity method. Under the
restructuring, completion of which is subject to customary conditions (including
receipt of applicable regulatory approvals), Kansas City Cable Partners will be
merged into Texas Cable Partners and renamed "Texas and Kansas City Cable
Partners, L.P." Following the restructuring, the combined partnership will be
owned 50% by Comcast, and 50% by TWE and TWE-A/ N collectively. Beginning any
time after the later of June 1, 2006 and the two-year anniversary of the closing
of the restructuring, either Time Warner Cable or Comcast can trigger a
dissolution of the partnership. If a dissolution is triggered, the
non-triggering party has the right to choose and take full ownership of one of
two pools of the combined partnership's systems - one pool consisting of the
Houston systems and the other consisting of the Kansas City and south Texas
systems - with an arrangement to distribute the partnership's
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debt between the two pools. The party triggering the restructuring would own the
remaining pool of systems and any debt associated with that pool.
Systems Operations
Time Warner Cable is the second largest operator of cable systems in the
U.S. As of December 31, 2003, cable systems owned or managed by Time Warner
Cable passed approximately 18.8 million homes, provided basic video service to
10.9 million subscribers, over 4.3 million of whom also subscribe to Time Warner
Cable's digital video service, and provided high speed data services to nearly
3.4 million residential subscribers and commercial accounts. Time Warner Cable
plans to introduce its new Internet protocol-based voice service, known as
Digital Phone, in most, if not all, of its operating systems in 2004.
Time Warner Cable operates large clustered and technologically advanced
cable systems. As of December 31, 2003, over 75% of its subscribers were in 19
geographic clusters, each serving more than 300,000 subscribers, and over 99% of
its cable systems were capable of carrying two-way broadband services, with
approximately 99% having been upgraded to 750MHz or higher. Time Warner Cable's
systems are divided among 31 regional operating divisions, all but three of
which are focused on discrete geographic areas. Time Warner Cable is an industry
leader in developing and rolling-out new products and services, including video
on demand, subscription video on demand, high-definition television and set-top
boxes with integrated digital video recorders (DVRs). See "Video Services"
below.
Franchises
Cable systems are constructed and operated under non-exclusive franchises
granted by state or local governmental authorities. Franchises typically contain
many conditions, such as time limitations on commencement or completion of
construction; service requirements, including number of channels; provision of
free services to schools and other public institutions; and the maintenance of
insurance and indemnity bonds. Cable franchises are subject to various federal,
state and local regulations. See "Regulation and Legislation" below.
Video Services
Time Warner Cable's video subscribers are typically charged monthly
subscription fees based on the level of service selected and, in some cases,
equipment usage fees. Pay-per-view and video on demand movies and special events
are charged on a per view basis. During 2003, video service revenues accounted
for approximately 75% of Time Warner Cable's revenues.
Time Warner Cable's systems typically offer two levels of analog video
service - basic and standard, which together provide, on average, approximately
70 channels, including local broadcast signals. The basic and standard tiers are
available for a fixed monthly fee. Subscribers to Time Warner Cable's analog
video service may purchase premium channels for an additional monthly fee, with
discounts generally available for the purchase of packages of more than one
premium service. Analog video customers who lease a set top box from Time Warner
Cable also have access to pay-per-view movies and special events. The rates Time
Warner Cable can charge for its "basic" tier, as well as for equipment rentals
and installation services, are subject to regulation under federal law. For more
information, see "Regulation and Legislation" below.
In addition to analog video service, all of Time Warner Cable's divisions
also offer digital video services. As of December 31, 2003, nearly 40% of Time
Warner Cable's basic video subscribers also purchased digital services.
Subscribers to digital video service receive all the channels included in the
basic and standard tiers plus up to 60 additional digital cable networks, up to
45 CD-quality audio music services, more pay-per-view choices and other features
such as enhanced parental control options. Subscribers to digital video service
may also purchase mini tiers (e.g., sports tiers and Spanish language tiers) and
premium channels for an additional monthly fee, with discounts generally
available for the purchase of packages of more than one such service. In many
cases, subscribers who elect to purchase premium services receive multiplex
versions of these services at
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no additional charge. The digital set-top boxes that subscribers receive also
offer an interactive program guide and access to video on demand and
subscription video on demand.
Video on Demand and Subscription Video on Demand
As of December 31, 2003, Time Warner Cable offered video on demand and
subscription video on demand services in all of its 31 divisions. Video on
demand enables digital subscribers to instantaneously purchase movies and other
programming, and to utilize VCR-like functions (such as pause, rewind and
fast-forward) while watching these programs. Subscribers are charged for video
on demand on a per use basis. Subscription video on demand provides digital
customers the ability to view an array of content associated with a particular
content provider. Subscription video on demand uses the same technology and
offers the same features as video on demand, but subscriber access is charged on
a monthly rather than a per use basis. Subscription video on demand is currently
offered in connection with premium channels such as HBO and it is expected that
other programming will be available over time.
High Definition Television
Pursuant to FCC regulation, television broadcast stations have been
granted additional over-the-air spectrum to provide, under a prescribed rollout
schedule, high definition and digital television signals to the public. To date,
Time Warner Cable has agreed to carry the high definition television signals and
other digital signals broadcast by numerous local television stations, including
all stations owned and operated by the ABC, CBS, NBC and Fox networks and nearly
all public television stations in Time Warner Cable's operating areas. Time
Warner Cable is also carrying the HDTV offerings of HBO, Showtime, Discovery,
HDNet and iN DEMAND, as well as high-definition sports programming from Fox's
Regional Sports Networks and NBA-TV.
Digital Video Recorders
As of December 31, 2003, Time Warner Cable offered set-top boxes with
integrated DVRs in 30 of its 31 divisions. DVR users can record programming on a
hard drive built into the set-top box through the interactive program guide and
view the recorded programming using VCR-like functions such as pause, rewind and
fast-forward. DVR users can also record one show while watching another and have
the ability to pause even "live" television.
Programming Rights
Time Warner Cable generally obtains the right to carry video programming
services through negotiation of affiliation agreements with programmers. Most
programming services impose a monthly license fee per subscriber upon the cable
operator and these fees typically increase over time. Time Warner Cable's
programming costs have risen in recent years (See Management's Discussion and
Analysis of Results of Operations and Financial Condition, "Business Segment
Results - Cable" in the financial pages herein). Time Warner Cable obtains the
right to carry local broadcast television stations either through the stations'
exercise of their so-called "must carry" rights, or through negotiated
retransmission consent agreements. See "Regulation and Legislation -
Communications Act and FCC Regulation - Carriage of Broadcast Television
Stations and Other Programming Regulation" below. Time Warner Cable's existing
programming and retransmission consent agreements expire at various times. Time
Warner Cable cannot ensure that it will be able to renew any or all of its
existing agreements upon expiration or obtain the rights to any other
programming services or broadcast television stations on reasonable terms or at
all. It is not known whether the loss of any one popular programming supplier
would have a material adverse effect on Time Warner Cable's operations.
High Speed Data Services
As of December 31, 2003, Time Warner Cable had nearly 3.4 million high
speed data subscribers, consisting of 3.228 million residential subscribers and
128,000 commercial accounts. Subscribers pay a flat
9
monthly fee for high speed data service, which typically includes Internet
access and email. Due to their nature, commercial and bulk subscribers are
charged at different rates than residential subscribers. During 2003, high speed
data revenues accounted for approximately 19% of Time Warner Cable's revenues.
Time Warner Cable's residential customers can choose from a variety of
ISPs, including the Company's Road Runner and AOL for Broadband services. High
speed data customers connect their personal computers (PCs) to Time Warner
Cable's two-way hybrid fiber optic/coaxial plant using a cable modem. Time
Warner Cable also offers networking options that allow customers to connect
multiple PCs to a single cable modem.
Time Warner Cable offers its Road Runner branded, high speed data service
to both residential and commercial customers in all of Time Warner Cable's 31
divisions. In connection with the TWE-A/ N Restructuring, TWE and an affiliate
of the Company effectively acquired Advance/ Newhouse's 17% interest in Road
Runner, thereby increasing the Company's ownership to approximately 82% on a
fully attributed basis. As a result of the termination of Advance/ Newhouse's
minority rights in Road Runner, the Company consolidated Road Runner with its
results retroactive to January 1, 2002.
Time Warner Cable's provision of the AOL for Broadband service and its
obligation to make multiple ISP services available to its residential customers
are subject to compliance with the terms of the FTC Consent Decree and the FCC
Order entered in connection with the regulatory clearance of the America
Online-Historic TW Merger. (See "Regulation and Legislation" below, for a
description of these terms).
Voice Services
During 2003, Time Warner Cable launched its new Digital Phone service in
Portland, ME, and provided the service to selected customers in Rochester, NY,
Raleigh, NC and Kansas City, KS. Digital Phone utilizes voice over Internet
protocol or "VoIP" technology which enables subscribers to make and receive
calls using traditional telephone handsets connected to a cable modem through
their existing in-home telephone wiring. Digital Phone provides unlimited local,
in-state and domestic long distance calling, as well as call waiting, caller ID
and enhanced "911" services, for a fixed monthly fee. Subscribers switching to
Digital Phone can keep their existing landline phone numbers and retain their
directory listings.
Time Warner Cable intends to roll out Digital Phone service in most, if
not all, of its operating divisions during 2004. In December 2003, Time Warner
Cable announced that it had entered into multi-year agreements with each of MCI
and Sprint pursuant to which each will assist Time Warner Cable in the
provisioning of Digital Phone service to customers, termination of VoIP voice
traffic to the public switched network, delivery of enhanced "911" service,
local number portability and long distance traffic carriage.
Advertising
Time Warner Cable also generates revenue by selling advertising time to a
variety of national, regional and local businesses. During 2003, advertising
revenues accounted for approximately 6% of Time Warner Cable's revenues.
Cable operators receive an allocation of scheduled advertising time on
certain cable programming services into which the operator can insert
commercials. The clustering of Time Warner Cable's systems expands the share of
viewers that Time Warner Cable reaches within a local DMA (Designated Market
Area), which helps local ad sales personnel to compete more effectively with
broadcast and other media. In addition, in many locations, contiguous cable
system operators have formed advertising interconnects to deliver locally
inserted commercials across wider geographic areas, replicating the reach of
broadcast stations as much as possible. As of December 31, 2003, 13 of Time
Warner Cable's 31 divisions participated in local cable advertising
interconnects.
A portion of Time Warner Cable's advertising revenues come from sales to
other Time Warner segments and from sales to programming vendors in support of
their channel launches. During 2001 and 2002, these sales represented a
substantial portion of Time Warner Cable's total advertising revenues. However,
these advertising revenues decreased sharply during 2003 as the number of new
programming service launches declined and other Time Warner segments purchased
less advertising from Time Warner Cable. See
10
Management's Discussion and Analysis of Results of Operations and Financial
Condition, "Business Segment Results - Cable" in the financial pages herein.
Local News Channels
Time Warner Cable operates, alone or in partnerships, 24-hour local news
channels in New York City (NY1 News and NY1 Noticias), Albany, NY (Capital
News 9), Rochester, NY (R/ News), Syracuse, NY (News 10 Now), Charlotte and
Raleigh, NC (Carolina News 14), Austin, TX (News 8 Austin), San Antonio, TX
(News 9 San Antonio) and Houston, TX (News 24 Houston). These channels have
developed into attractive vehicles for local advertising and provide Time Warner
Cable with an important connection to the communities in which the channels
operate.
Competition
Time Warner Cable faces intense competition from a variety of alternative
information and entertainment delivery sources, principally from direct-to-home
satellite video providers and regional telephone companies offering DSL service.
Competition with regional telephone companies is likely to intensify as Time
Warner Cable introduces its Digital Phone service. Furthermore, in the future,
technological advances will most likely increase the number of alternatives
available to Time Warner Cable's customers. In general, Time Warner Cable also
faces competition from other media for advertising dollars.
DBS. Time Warner Cable's video services face competition from satellite
services, such as DirecTV and the Dish Network, which offer satellite-delivered
pre-packaged programming services that can be received by relatively small and
inexpensive receiving dishes. The video services provided by these satellite
providers are comparable, in many respects, with Time Warner Cable's analog and
digital video services. In many metropolitan areas, satellite services now also
include local broadcast signals. Some DBS providers have entered into
co-marketing arrangements with regional telephone companies in an effort to
provide customers with both video and DSL service from what appears to the
customer to be a single source.
"Online" Competition. Time Warner Cable's high speed data service faces
competition from a variety of companies that offer other forms of online
services, including DSL high speed data service provided by regional telephone
companies and dial-up services over ordinary telephone lines. DSL providers have
engaged in aggressive price competition in some of Time Warner Cable's operating
areas and some DSL providers have entered into co-marketing arrangements with
DBS operators in an effort to provide customers with both DSL and video service
from what appears to the customer to be a single source. Monthly prices of
dial-up services are typically less expensive than broadband services. Other
developing new technologies, such as Internet service via satellite or wireless
connections, also compete with cable and cable modem services.
Digital Phone Competition. Time Warner Cable intends to roll out its new
Digital Phone service in most, if not all, of its operating areas during 2004.
Digital Phone will compete directly with the local and long distance offerings
of the regional telephone companies which provide service in these areas, as
well as with wireless phone providers and national providers of VoIP products
such as Vonage. As a result, Time Warner Cable anticipates that the competitive
environment in which it operates will become increasingly intense, especially in
light of the fact that the regional telephone companies also offer online
services that compete with Time Warner Cable's high speed data service.
Overbuilds. Under the Cable Television Consumer Protection and Competition
Act of 1992, franchising authorities are prohibited from unreasonably refusing
to award additional franchises. As a result, from time to time, Time Warner
Cable faces competition from overlapping cable systems operating in its
franchise areas, including municipally-owned systems.
SMATV (Satellite master antenna television). Additional competition comes
from private cable television systems servicing condominiums, apartment
complexes and certain other multiple dwelling units, often on an exclusive
basis, with local broadcast signals and many of the same satellite-delivered
program services offered by franchised cable systems. Some SMATV operators now
offer voice and high speed data services.
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MMDS/ Wireless Cable (Multichannel microwave distribution services). Time
Warner Cable faces competition from wireless cable operators, including digital
wireless operators, who use terrestrial microwave technology to distribute video
programming. Some MMDS operators now offer voice and high speed Internet
services.
Telephone Companies. Time Warner Cable faces video competition from
telephone companies. Under the 1996 Telecommunications Act, telephone companies
are free to enter the retail video distribution business within their local
exchange service areas, including through satellite, MMDS and SMATV, as
traditional franchised cable system operators or as operators of "open video
systems" subject to local authorizations and local fees.
Consumer Electronics Manufacturers. To the extent that Time Warner Cable's
products and services converge with theirs, Time Warner Cable may compete with
the manufacturers of consumer electronics products.
Additional Competition. In addition to multichannel video providers, cable
systems compete with all other sources of news, information and entertainment,
including over-the-air television broadcast reception, live events, movie
theaters, home video products and the Internet.
FILMED ENTERTAINMENT
The Company's Filmed Entertainment businesses produce and distribute
theatrical motion pictures, television shows, animation and other programming,
distribute home video product and license rights to the Company's feature films,
television programming and characters. All of the foregoing businesses are
principally conducted by various subsidiaries and affiliates of Warner Bros.
Entertainment Inc., known collectively as the Warner Bros. Entertainment Group
("Warner Bros."), now wholly owned subsidiaries of the Company. The filmed
entertainment segment also includes New Line Cinema Corporation ("New Line"),
also a wholly owned subsidiary of the Company.
Feature Films
Warner Bros. Pictures
Warner Bros. produces feature films both wholly on its own and under
co-financing arrangements with others, and also distributes completed films
produced and financed by others. The terms of Warner Bros.' agreements with
independent producers and other entities are separately negotiated and vary
depending upon the production, the amount and type of financing by Warner Bros.,
the media and territories covered, the distribution term and other factors.
Warner Bros.' feature films are produced under both the Warner Bros. Pictures
and Castle Rock banners and, commencing in 2004, also by Warner Independent
Pictures.
Warner Bros.' strategy focuses on offering a diverse slate of films with a
mix of genres, talent and budgets that includes four to six "event" movies per
year. In response to the rising cost of producing theatrical films, Warner Bros.
has entered into certain joint venture agreements with other companies to
co-finance films, decreasing its financial risk while in most cases retaining
substantially all worldwide distribution rights. During 2003, Warner Bros.
released a total of 20 original motion pictures for theatrical exhibition, of
which 7 were wholly financed by Warner Bros. and 13 were financed with or by
others, including Mystic River, The Last Samurai, Matrix Reloaded and Matrix
Revolutions. A total of 25 motion pictures are currently slated to be released
during 2004, of which 7 are wholly financed by Warner Bros. and 18 are financed
with or by others.
Warner Bros.' joint venture arrangements include a joint venture with
Village Roadshow Pictures to co-finance the production of motion pictures and an
arrangement with Gaylord Entertainment ("Gaylord") to co-finance the production
of motion pictures with Gaylord and its wholly owned subsidiary, Pandora
Investments SARL, for which Warner Bros. acquires domestic distribution rights.
Warner Bros. has a distribution arrangement with Franchise Pictures LLC
under which, for certain motion pictures, it has domestic distribution rights
and foreign distribution rights in selected territories.
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Additionally, Warner Bros. Pictures has an exclusive distribution arrangement
with Alcon Entertainment ("Alcon") for distribution of all of Alcon's motion
pictures in domestic and certain international territories, and an exclusive
worldwide distribution arrangement with Shangri-La Entertainment, LLC.
Warner Independent Pictures, established in August 2003 with a Spring 2004
initial release target, will produce or acquire up to ten smaller budget and
alternative films a year for domestic and/or worldwide release.
Warner Bros. distributes feature films to more than 125 markets
internationally. In 2003, Warner Bros. distributed internationally 21 original
motion pictures produced by U.S. companies plus 14 "local language" productions
that it either produced or acquired.
New Line
Theatrical films are also produced and distributed by New Line, a leading
independent producer and distributor of theatrical motion pictures with two film
divisions, New Line Cinema and Fine Line Features. Included in its 13 films
released during 2003, New Line released the Oscar-award winning The Lord of the
Rings: The Return of the King, the third and final installment in The Lord of
the Rings trilogy, and Elf. A total of 15 motion pictures are currently slated
for theatrical release by New Line during 2004. Like Warner Bros., New Line
releases a diversified slate of films with an emphasis on building and
leveraging franchises. As part of its strategy for reducing financial risk and
dealing with the rising cost of film production, New Line typically pre-sells
the international rights to its releases on a territory by territory basis,
while still retaining a share of each film's potential profitability in those
foreign territories.
Home Video
Warner Home Video Inc. ("WHV") distributes for home video use DVDs and
videocassettes containing filmed entertainment product produced or otherwise
acquired by the Company's various content-producing subsidiaries and divisions,
including Warner Bros. Pictures, Warner Bros. Television, Castle Rock, New Line,
Home Box Office, Turner Broadcasting System and WarnerVision. WHV also
distributes other companies' product, including DVDs and videocassettes for BBC,
PBS and National Geographic, national sports leagues, and Leapfrog (a children's
learning toy company) in the U.S., and certain producers in Italy, the U.K.,
Australia and France.
WHV sells and/or licenses its product in the U.S. and in major
international territories to retailers and/or wholesalers through its own sales
force, with warehousing and fulfillment handled by third parties. In some
countries, WHV's product is distributed through licensees. DVD product is
replicated under long term contracts with third parties. Videocassette product
is manufactured under contracts with independent duplicators. Among WHV's 2003
DVD and videocassette releases, 17 film titles generated U.S. sales of more than
one million units each.
Since inception of the DVD format, WHV has released close to 2,000 DVD
titles in the U.S. and international markets, led by worldwide sales of Harry
Potter and the Sorcerer's Stone and Harry Potter and the Chamber of Secrets,
which have sold a total of over 40 million DVD units. DVD is the fastest selling
consumer electronics product of all time, with an installed base at December 31,
2003 of nearly 57 million households in the U.S. and over 100 million households
internationally (including approximately 25 million households in China).
Television
Warner Bros. is one of the world's leading suppliers of television
programming, distributing programming in more than 175 countries and in more
than 40 languages. Warner Bros. both develops and produces new television
series, made-for-television movies, mini-series, reality-based entertainment
shows and animation programs and also distributes television programming for
exhibition on all media. The distribution library
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owned or managed by Warner Bros. currently has more than 6,600 feature films,
approximately 39,000 television titles, and 14,000 animated titles (including
1,500 classic animated shorts).
Warner Bros.' television programming is primarily produced by Warner Bros.
Television Production Inc. ("WBTV"), which produces primetime dramatic and
comedy programming for the major networks, and Telepictures Productions Inc.
("Telepictures"), which specializes in reality-based and talk/variety series for
the syndication and primetime markets. For the 2003-04 season, WBTV is producing
hits such as Smallville and Gilmore Girls for The WB Television Network and ER,
Friends, The West Wing, George Lopez, Without a Trace, Cold Case, The O.C., Two
and a Half Men and Nip/ Tuck for third party networks. Telepictures has
primetime hits The Bachelor and The Bachelorette as well as first-run
syndication staples, such as Extra, and the new talk show, The Ellen DeGeneres
Show.
Warner Bros. Animation Inc. is responsible for the creation, development
and production of contemporary television and feature film animation, as well as
for the creative use and production of classic animated characters from Warner
Bros.' and DC Comics' libraries, including Looney Tunes and the Hanna-Barbera
libraries.
Backlog
Backlog represents the future revenue not yet recorded from cash contracts
for the licensing of theatrical and television programming for pay cable,
network (excluding certain license fees), basic cable and syndicated television
exhibition. Backlog for all of Time Warner's filmed entertainment companies
amounted to $3.9 billion at December 31, 2003, compared to $3.3 billion at
December 31, 2002 (including amounts relating to the intercompany licensing of
film product to the Company's cable television networks (including HBO) of
approximately $740 million and $850 million as of December 31, 2003 and
December 31, 2002, respectively). The backlog excludes advertising barter
contracts.
Other Entertainment Assets
Warner Bros. Consumer Products Inc. licenses rights in both domestic and
international markets to the names, likenesses, images, logos and other
representations of characters and copyrighted material from the films and
television series produced or distributed by Warner Bros. including the
superhero characters of DC Comics, Hanna-Barbera characters, classic films and
Harry Potter.
Through joint ventures, Warner Bros. International Cinemas Inc. ("WBIC")
owns interests in 77 multi-screen cinema complexes with 682 screens in Japan,
China, Italy, Spain and Taiwan. In early 2004, WBIC entered into agreements with
local partners in China under which WBIC will acquire a majority interest in
multiplexes in Nanjing and will manage certain others. WBIC sold its interest in
its cinema circuits in the U.K., Australia and Portugal during 2003.
DC Comics, wholly owned by the Company, publishes more than 50 regularly
issued comics magazines featuring such popular characters as Superman, Batman,
Wonder Woman and The Sandman. DC Comics also derives revenues from motion
pictures, television, product licensing and books. The Company also owns E.C.
Publications, Inc., the publisher of MAD magazine.
Competition
The production and distribution of theatrical motion pictures, television
and animation product and videocassettes/ DVDs are highly competitive
businesses, as each vies with the other, as well as with other forms of
entertainment and leisure time activities, including video games, the Internet
and other computer-related activities for consumers' attention. Furthermore,
there is increased competition in the television industry evidenced by the
increasing number and variety of broadcast networks and basic cable and pay
television services now available. Despite this increasing variety of networks
and services, access to primetime and syndicated television slots has actually
tightened as networks and owned and operated stations increasingly source
programming from content producers aligned with or owned by their parent
companies. There is active
14
competition among all production companies in these industries for the services
of producers, directors, writers, actors and others and for the acquisition of
literary properties. With respect to the distribution of television product,
there is significant competition from independent distributors as well as major
studios. Piracy and unauthorized recording, transmission and distribution of
digital content and physical products are increasing challenges due to advances
in compression technologies and proliferation of broadband access which make it
easier to copy and distribute large files as well as to transfer such files to
physical media. Additionally, the increase in usage of DVRs that allow consumers
to skip commercials could significantly impact the advertising markets that
drive the commercial television business. Revenues for filmed entertainment
product depend in part upon general economic conditions, but the competitive
position of a producer or distributor is still greatly affected by the quality
of, and public response to, the entertainment product it makes available to the
marketplace.
Warner Bros. also competes in its character merchandising and other
licensing activities with other licensors of character, brand and celebrity
names.
NETWORKS
The Company's Networks business consists principally of domestic and
international basic cable networks, pay television programming services, a
broadcast television network, and a sports franchise. The basic cable networks
(collectively, the "Turner Networks") owned by Turner Broadcasting System, Inc.
("TBS") constitute the principal component of the Company's basic cable
networks. Pay television programming consists of the multichannel HBO and
Cinemax pay television programming services (collectively, the "Home Box Office
Services") operated by Home Box Office Inc., now a wholly owned subsidiary of
the Company. The WB Television Network ("The WB"), a broadcast television
network, is operated as a limited partnership in which WB Communications, a
wholly owned subsidiary of the Company, holds a 77.5% interest and is the
network's managing general partner.
The Turner Networks and the Home Box Office Services (collectively, the
"Cable Networks") distribute their programming via cable and other distribution
technologies, including satellite distribution.
The Turner Networks generate their revenue principally from the sale of
advertising time (other than Turner Classic Movies, which sells advertising only
in certain European markets) and from receipt of monthly per subscriber fees
paid by cable system operators, DTH distribution companies, hotels and other
customers (known as affiliates) that have contracted to receive and distribute
such networks. Turner Classic Movies is commercial-free in most of its
distribution area and generates most of its revenue from the monthly fees paid
by affiliates, which are generally charged on a per subscriber basis. The Home
Box Office Services generate revenue principally from fees paid by affiliates
for the delivery of the Home Box Office Services to subscribers who are
generally free to cancel their subscriptions at any time. Home Box Office's
agreements with its affiliates are typically long-term arrangements that provide
for annual service fee increases and retail promotion activities and have fee
arrangements that are generally related to the number of subscribers served by
the affiliate. The Home Box Office Services and their affiliates engage in
ongoing marketing and promotional activities to retain existing subscribers and
acquire new subscribers. Home Box Office also derives revenues from its
successful original films and series through the sale of DVDs and
videocassettes, as well as, in recent years, from the syndication of Everybody
Loves Raymond.
Although the Cable Networks believe prospects of continued carriage and
marketing of their respective Networks by the larger affiliates are good, the
loss of one or more of them as distributors of any individual network or service
could have a material adverse effect on their respective businesses. In
addition, further consolidation of multiple-system cable operators could
adversely impact the Cable Networks' prospect for securing future carriage
agreements on favorable terms.
Advertising revenue on the basic cable networks and The WB consists of
consumer advertising, which is sold primarily on a national basis (The WB sells
time exclusively on a national basis, with local affiliates of The WB selling
local advertising). Advertising contracts generally have terms of one year or
less. Advertising revenue is generated from a wide variety of categories,
including financial and business services, food and
15
beverages, automotive, entertainment and office supplies and equipment.
Advertising revenue is a function of the size and demographics of the audience
delivered, the "CPM," which is the cost per thousand viewers delivered, and the
number of units of time sold. Units sold and CPMs are influenced by the
quantitative and qualitative characteristics of the audience of each network as
well as overall advertiser demand in the marketplace.
Turner Networks
Domestic Networks
TBS's entertainment networks include two general entertainment networks,
TBS Superstation, with approximately 87.9 million U.S. households as of
December 31, 2003, reported by Nielsen Media Research ("households"); and TNT,
with approximately 88.2 million households in the U.S. as of December 31, 2003;
as well as Cartoon Network, with approximately 85.7 million households in the
U.S. as of December 31, 2003; and Turner Classic Movies, a commercial-free
network presenting classic films from TBS's MGM, RKO and pre-1950 Warner Bros.
film libraries, among others, which had approximately 66.9 million households in
the U.S. as of December 31, 2003. Programming for these entertainment networks
is derived, in part, from the Company's film, made-for-television and animation
libraries as to which TBS or other divisions of the Company own the copyrights,
plus licensed programming, including sports, and special made-for-cable films
and series. Other networks include Turner South, a regional entertainment
network featuring movies and sitcoms from the Turner library and regional news
and sports events targeted to viewers in the Southeast, and Boomerang, a network
featuring classic cartoons.
TBS has licensed programming rights from the National Basketball
Association (the "NBA") to televise a certain number of regular season and
playoff games on TNT through the 2007-08 season. TBS Superstation and Turner
South televise Atlanta Braves baseball games, for which rights fee payments are
made to Major League Baseball's central fund for distribution to all Major
League Baseball clubs. Through a joint venture with NBC, TBS also has rights to
televise certain NASCAR Nextel Cup and Busch Series races through 2006.
TBS's CNN network, a 24-hour per day cable television news service, had
more than 88.2 million households in the U.S. as of December 31, 2003. Together
with CNN International ("CNNI"), CNN reached more than 200 countries and
territories as of December 31, 2003. CNN operates 38 news bureaus, of which 11
are located in the U.S. and 27 are located around the world. In addition to
Headline News, which provides updated half-hour newscasts throughout each day,
CNN has expanded its brand franchise to include CNNfn, featuring business and
consumer news. TBS also has a number of special market news networks.
International Networks
CNNI is distributed to multiple distribution platforms for delivery to
cable systems, satellite platforms, broadcasters, hotels and other viewers
around the world on a network of 11 regional satellites. CNN en Espa๑ol is a
separate Spanish language all-news network in Latin America. TBS also
distributes region-specific and languaged feeds or versions of TNT, Cartoon
Network, Turner Classic Movies and Boomerang on either a single channel or
combined channel basis in over 100 countries around the world. In the U.K.,
Turner also distributes Toonami, an all-action animation network.
In a number of regions, TBS has launched international versions of its
channels through joint ventures with local partners. These include CNN+, a
Spanish language 24-hour news network distributed in Spain and Andorra; CNN
Turk, a Turkish language 24-hour news network; and Cartoon Network Japan. TBS
also has a 30.6% interest in VIVA Media AG, a public company, which owns a
German television production company and television music channels in Germany,
The Netherlands, Poland, Hungary, Switzerland and Eastern Europe, and holds a
significant interest in n-tv, a German language news network currently reaching
over 48 million homes in Germany and contiguous countries in Europe, primarily
via cable and satellite.
16
Internet Sites
In addition to its cable networks, TBS manages various Internet sites that
generate revenue from commercial advertising and consumer subscription fees. The
CNN News Group has multiple sites, such as CNN.com and allpolitics.com, which
are operated by CNN Interactive. The CNN News Group also produces CNNMoney.com
together with Time Inc.'s Money Magazine. TBS also operates the NASCAR Web site,
NASCAR.com, pursuant to an agreement with NASCAR through 2006, and the PGA's Web
site, PGA.com, pursuant to an agreement with PGA through 2011.
CartoonNetwork.com is a popular advertiser-supported site for children ages two
to eleven.
Home Box Office
HBO, operated by the wholly owned subsidiary Home Box Office, Inc., is the
nation's most widely distributed pay television service. Together with its
sister service, Cinemax, HBO had approximately 38.8 million subscriptions as of
December 31, 2003. Both HBO and Cinemax are made available on a number of
multiplex channels and in high definition. Home Box Office continues to roll out
its subscription video on demand products, which enable digital cable
subscribers who subscribe to the Home Box Office Services to view programs at a
time of their choice with VCR-like functionality.
A major portion of the programming on HBO and Cinemax consists of recently
released, uncut and uncensored theatrical motion pictures. Home Box Office's
practice has been to negotiate licensing agreements of varying duration with
major motion picture studios and independent producers and distributors in order
to ensure continued access to such films. These agreements typically grant pay
television exhibition rights to recently released and certain older films owned
by the particular studio, producer or distributor in exchange for a negotiated
fee, which may be a function of, among other things, the box office performances
of the film.
HBO also defines itself by the exhibition of award-winning original
dramatic and comedy series, movies and mini-series such as The Sopranos, Six
Feet Under, Sex and the City and Angels in America, and boxing matches, sports
documentaries and sports news programs, as well as concerts, comedy specials,
family programming and documentaries. HBO won 7 Golden Globe Awards in January
2004, more than all other networks combined. In 2003, HBO also won 18 Emmysฎ -
the most of any network.
Home Box Office produces Everybody Loves Raymond, now in its eighth season
on CBS and its first syndication cycle. HBO Sports operates HBO Pay-Per-View, an
entity that distributes pay-per-view prizefights. HBO Video markets
videocassettes and DVDs of a variety of feature films including My Big Fat Greek
Wedding and a number of HBO's original movies, miniseries and dramatic and
comedy series, including Band of Brothers, The Sopranos and Sex and the City.
Home Box Office has also begun to syndicate some of its successful original
programs. Through various joint ventures, HBO-branded services are also
distributed in more than 50 countries in Latin America, Asia and Central Europe.
The WB Television Network
The WB provides a national group of affiliated television stations with
13 hours of prime time plus two additional hours of Sunday access programming
during six days of the week (Sunday through Friday). The WB's programming is
primarily aimed at adults 18-34. The network's line-up of programs includes
series such as 7th Heaven, Everwood, One Tree Hill, Charmed, Reba, Smallville,
Gilmore Girls and Steve Harvey's Big Time. As of December 31, 2003, Kids' WB!, a
programming service for young viewers, presented 14 hours of animated
programming per week, including Mucha Lucha, Yu-Gi-Oh!, What's New Scooby-Doo?
and Pokemon.
As of December 31, 2003, 84 primary and 9 secondary affiliates provide
coverage for The WB in the top 100 television markets. Additional coverage
reaching approximately 9 million homes in smaller markets is provided by The WB
100+ Station Group, a venture between The WB and local broadcasters under which
WB programming is disseminated over the facilities of local cable operators.
17
Tribune Broadcasting owns a 22.25% interest in The WB and the balance is
held by WB Communications Inc., a wholly owned subsidiary of the Company. The WB
is managed by the Warner Bros. Entertainment Group.
Other Network Interests
The Company and Liberty Media ("Liberty") each have a 50% interest in
Court TV, which was available in approximately 79 million homes as of
December 31, 2003. Court TV is an advertiser-supported basic cable television
service whose programming aims to provide an informative and entertaining view
of the American system of justice. Focusing on "investigative television,"
Court TV broadcasts trials by day and original programs such as Forensic Files
and popular off-network series such as NYPD Blue in the evening. Under the
Court TV Operating Agreement, beginning January 2006, Liberty may give written
notice to the Company requiring the Company to purchase all of Liberty's
interest in Court TV (the "Liberty Put"). The agreement further provides that as
of the same date, the Company may, by notice to Liberty, require Liberty to sell
all of its interest in Court TV to the Company (the "Time Warner Call"). The
price to be paid upon exercise of either the Liberty Put or the Time Warner Call
will be an amount equal to one half of the fair market value of Court TV,
determined by appraisal.
Through a wholly owned subsidiary, TBS owns the Atlanta Braves of Major
League Baseball. The Braves derive revenue from ticket receipts, advertising and
related sales, premium seating sales, concessions, local sponsorships and the
sale of local broadcasting rights, and share pro rata in proceeds from national
media contracts and licensing activities of Major League Baseball. TBS expects
to complete the sale of its professional basketball and hockey franchises during
the first quarter of 2004.
Competition
Each of the Networks competes with other television programming services
for marketing and distribution by cable and other distribution systems. All of
the Networks compete for viewers' attention and audience share with all other
forms of programming provided to viewers, including broadcast networks, local
over-the-air television stations, other pay and basic cable television services,
home video, pay-per-view and video on demand services, online activities and
other forms of news, information and entertainment. In addition, the Networks
face competition for programming with those same commercial television networks,
independent stations, and pay and basic cable television services, some of which
have exclusive contracts with motion picture studios and independent motion
picture distributors. The Turner Networks, The WB and TBS's Internet sites
compete for advertising with numerous direct competitors and other media.
The Cable Networks' production divisions compete with other producers and
distributors of programs for air time on broadcast networks, independent
commercial television stations, and pay and basic cable television networks.
PUBLISHING
The Company's magazine and book publishing businesses are conducted
primarily by Time Inc., a wholly owned subsidiary of the Company, either
directly or through its subsidiaries. Time Warner Book Group Inc., a Time Inc.
subsidiary, conducts Publishing's trade book publishing operations.
Magazines
General
As of March 1, 2004, Time Inc. published over 130 magazines worldwide,
including Time, People, Sports Illustrated, Entertainment Weekly, Southern
Living, In Style, Fortune, Money, Real Simple, Cooking Light and 77 magazines
published by IPC Group Limited in the U.K. and Australia. These magazines
generally appeal to the broad consumer market.
18
Time Inc. expands its core magazine businesses generally through the
development of product extensions and international editions. Product extensions
are generally managed by the individual magazines and involve, among other
things, new magazines, specialized editions aimed at particular audiences, and
publication of editorial content through different media, such as the Internet,
books and television.
Description of Magazines
Generally, each magazine published by Time Inc. in the U.S. has an
editorial staff under the supervision of a managing editor and a business staff
under the management of a president or publisher. Magazine production and
distribution activities are generally centralized. Fulfillment activities for
Time Inc.'s U.S. magazines are generally administered from a centralized
facility in Tampa, Florida.
Time Inc.'s major magazines and their areas of editorial focus are
summarized below:
Time is a weekly newsmagazine that summarizes the news and interprets the
week's events, both national and international. Time also has four weekly
English-language editions that circulate outside the United States. Time for
Kids is a current events newsmagazine for children, ages 5 to 13.
People is a weekly magazine that reports on celebrities and other notable
personalities. People has expanded its franchise in recent years to include
People en Espa๑ol, a Spanish-language magazine aimed primarily at Hispanic
readers in the U.S., and Teen People, aimed at teenage readers. Who Weekly is an
Australian version of People.
Sports Illustrated is a weekly magazine that covers sports. Sports
Illustrated for Kids is a sports magazine intended primarily for pre-teenagers.
Entertainment Weekly is a weekly magazine that includes reviews and
reports on movies, DVDs, video, television, music and books.
In Style is a monthly magazine that focuses on celebrity, lifestyle,
beauty and fashion. In recent years, In Style has expanded internationally by
launching in Australia and the U.K.; it is also published in Germany, Brazil,
South Korea and Greece under licensing agreements.
Fortune is a bi-weekly magazine that reports on worldwide economic and
business developments and compiles the annual Fortune 500 list of the largest
U.S. corporations. Money is a monthly magazine that reports primarily on
personal finance. Other business and financial magazines include FSB: Fortune
Small Business, which covers small business, and Business 2.0, a magazine that
reports on innovation in the worlds of business and technology.
Real Simple is a monthly magazine that focuses on life, home, body and
soul and provides practical solutions for simplifying various aspects of busy
lives.
Through Southern Progress Corporation, Time Inc. publishes several
regional magazines including Southern Living and Sunset, and several specialty
publishing titles, including Cooking Light and Health.
IPC Group Limited, the U.K.'s leading consumer magazine publisher,
publishes 77 magazines and numerous special issues and guides in the U.K. and
Australia. These publications are largely focused in the television, women's,
home and garden, leisure and men's lifestyle categories. Its titles include
What's on TV, TV Times, Woman, Marie Claire, Homes & Gardens and Horse & Hound.
Time4 Media publishes 21 popular participatory sport and outdoor
publications such as Golf, Ski, Skiing, Field & Stream, Outdoor Life, Transworld
Skateboarding, Transworld Snowboarding and Yachting, as well as Popular Science.
Through various subsidiaries, Time Inc. publishes Parenting magazine and
This Old House magazine and also produces several television series, including
This Old House and Ask This Old House.
Time Inc. also has management responsibility under a management contract
for the American Express Publishing Corporation's publishing operations,
including its lifestyle magazines Travel & Leisure, Food & Wine and Departures.
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Time Inc. has a 49% equity stake in Essence Communications Partners, the
publisher of Essence, the premier magazine for African-American women.
Advertising
Advertising carried in Time Inc.'s U.S. magazines is predominantly
consumer advertising, including domestic and foreign automobile manufacturers,
toiletries and cosmetics, media and entertainment, food, computers and
technology, pharmaceuticals, retail and department stores and financial
services. In 2003, Time Inc. magazines accounted for approximately 24.3% of the
total U.S. advertising revenue in consumer magazines, as measured by the
Publishers Information Bureau (PIB). People, Sports Illustrated and Time were
ranked 1, 3 and 4, respectively, by PIB, and Time Inc. had 7 of the 30 leading
magazines in terms of advertising dollars.
Circulation
Circulation drives the advertising rate base, which is the guaranteed
minimum average paid circulation level on which advertising rates are
determined. Most of Time Inc.'s magazines are primarily sold by subscription and
delivered to subscribers through the mail, other than IPC titles which are
primarily sold at newsstand. Subscriptions are sold primarily through direct
mail and online solicitation, subscription sales agents, marketing agreements
with other companies and insert cards in Time Inc. magazines and other
publications. Time Inc. owns in excess of 84% of Synapse Group, Inc.
("Synapse"), a leading magazine subscription agent in the U.S. Synapse sells
magazine subscriptions principally through marketing relationships with credit
card issuers, consumer catalog companies, commercial airlines with frequent
flier programs and Internet businesses.
Single copies of magazines, sales of which are reported as a component of
subscription revenues, are sold through retail outlets such as newsstands,
supermarkets, and convenience and drug stores, and may or may not result in
repeat purchases and revenues. The copies are supplied by wholesalers or
directly through a Time Inc. subsidiary. Time Distribution Services Inc. is
responsible for the distribution and marketing of single copies of Time Inc.
magazines and certain other publications in the U.S. and Canada. Warner
Publisher Services Inc. is a major distributor of books and other publishers'
magazines sold through wholesalers in the U.S. and Canada.
Paper and Printing
Paper constitutes a significant component of physical costs in the
production of magazines. During 2003, Time Inc. purchased over half a million
tons of paper principally from four independent manufacturers.
Printing and binding for Time Inc. magazines are performed primarily by
major domestic and international independent printing concerns in approximately
12 locations in the U.S. and in locations in 7 other countries. Magazine
printing contracts are either fixed-term or open-ended at fixed prices with, in
some cases, adjustments based on certain criteria.
Books
Time Inc.'s trade book publishing operations are conducted primarily by
the Time Warner Book Group Inc. (formerly Time Warner Trade Publishing Inc.)
through its three major publishing houses, Warner Books, Little, Brown and
Company, and Time Warner Book Group UK. During 2003, the Time Warner Book Group
placed 50 books on The New York Times bestseller lists, including The Lovely
Bones by Alice Sebold, Dude, Where's My Country? by Michael Moore, Flyboys by
James Bradley, and new releases from many of its major recurring bestselling
authors, such as James Patterson, Nicholas Sparks and David Baldacci.
The Time Warner Book Group handles book distribution for Little, Brown and
Warner Books, as well as Disney, Microsoft and other publishers, through its
distribution center in Indiana. The marketing of trade books is primarily to
retail stores, online outlets and wholesalers throughout the U.S., Canada and
the U.K. Through their combined U.S. and U.K. operations, the Time Warner Book
Group companies have the ability
20
to acquire English-language publishing rights for the distribution of hard and
soft-cover books throughout the world.
Oxmoor House, Inc., Leisure Arts, Inc. and Sunset Books publish and
distribute a variety of how-to books for the cooking, home repair, gardening,
craft, needlework, decorating and travel markets.
Direct Marketing
Through subsidiaries, Time Inc. conducts direct marketing businesses. In
addition to selling magazine subscriptions, Synapse is a direct marketer of
consumer products, including software, videos and other merchandise.
Southern Living at Home, the direct selling division of Southern Progress
Corporation, specializes in home d้cor products which are sold through
independent consultants at parties hosted in people's homes in the United
States.
Book-of-the-Month Club, Inc. ("BOMC") has a 50-50 joint venture with
Bertelsmann AG's Doubleday book clubs business to operate the U.S. book clubs of
BOMC and Doubleday jointly. The joint venture, named Bookspan, acquires the
rights to manufacture and sell books to consumers through clubs. Bookspan
operates its own fulfillment and warehousing operations in Pennsylvania. Under
the relevant agreements, beginning in June 2005, either Bertelsmann or the
Company may elect to terminate the venture by giving notice during specified
termination periods. If such an election is made, a confidential bid process
will take place pursuant to which the highest bidder will purchase the other
party's entire venture interest. The Company is unable to predict whether this
bid process will occur or the amount that may be paid out or received under it.
On December 31, 2003, Time Inc. sold its Time Life Inc. business, a direct
marketer of entertainment products such as music and videos.
Postal Rates
Postal costs represent a significant operating expense for the Company's
magazine and direct marketing activities. Time Inc. strives to minimize postal
expense through the use of certain cost-saving measures, including measures with
respect to address quality, mail preparation and delivery of products to postal
facilities. It has been the Company's practice generally in selling books and
other products by mail to include a separate charge for postage and handling,
which is adjusted from time to time to partially offset any increased postage or
handling costs.
Competition
Time Inc.'s magazine operations compete for circulation, audience and
advertising with numerous other publishers and retailers, as well as other
media. These magazine operations compete for advertising directed at the general
public and also advertising directed at more focused demographic groups.
Time Inc.'s direct marketing operations compete with other direct
marketers through all media for the consumer's attention. In addition to the
traditional media sources for product sales, the Internet has become a strong
vehicle in the direct marketing business and for subscription sales.
21
OTHER SIGNIFICANT ASSETS
The Company also has an aggregate equity interest in Time Warner Telecom
Inc. ("Time Warner Telecom") of approximately 44% and an aggregate voting
interest (consisting of high-voting common stock) of approximately 71%. Time
Warner Telecom is a fiber facilities-based integrated communications provider
that provides data, dedicated Internet access, and local and long distance voice
services to medium and large businesses in 44 metropolitan areas across the
United States. The Company's nominees to the Board of Directors of Time Warner
Telecom are limited to less than a majority by the terms of a stockholder
agreement and Time Warner Telecom is a separately-managed public company whose
stock is traded through Nasdaq. Its financial results are not consolidated with
those of the Company. The Company has determined that it does not consider its
interest in Time Warner Telecom to be strategic and has so advised Time Warner
Telecom.
INTELLECTUAL PROPERTY
Time Warner Inc. is one of the world's leading creators, owners and
distributors of intellectual property. The Company's vast intellectual property
assets include copyrights in motion pictures, books, magazines and software;
trademarks in names, logos and characters; patents or patent applications for
inventions related to its products and services; and licenses of intellectual
property rights of various kinds. These intellectual property assets, both in
the U.S. and in other countries around the world, are among the Company's most
valuable assets. The Company derives value from these assets through a range of
business models, including the theatrical release of films, the licensing of its
films and television programming to multiple domestic and international
television and cable networks and pay television services, and the sale of
products such as DVDs, videocassettes, books and magazines. It also derives
revenues related to its intellectual property through advertising in its
magazines, networks, cable systems and online services and from various types of
licensing activities, including licensing of its trademarks and characters. To
protect these assets, the Company relies upon a combination of copyright,
trademark, unfair competition, patent and trade secret laws and contract
provisions. The duration of the protection afforded to the Company's
intellectual property depends on the type of property in question and the laws
and regulations of the relevant jurisdiction; in the case of licenses, it also
depends on contractual and/or statutory provisions.
The Company vigorously pursues all appropriate avenues of protection for
its intellectual property. However, there can be no assurance of the degree to
which these measures will be successful in any given case. Policing unauthorized
use of the Company's products and services is often difficult and the steps
taken may not in every case prevent the misappropriation of the Company's
intellectual property. Piracy, particularly in the digital environment,
continues to present a threat to revenues from products and services based on
intellectual property. The Company seeks to limit that threat through a
combination of approaches, including offering legitimate market alternatives,
applying digital rights management technologies, pursuing legal sanctions for
infringement, promoting appropriate legislative initiatives, and enhancing
public awareness of the meaning and value of intellectual property. The Company
works with various cross-industry groups and trade associations, as well as with
strategic partners to develop and implement technological solutions to control
digital piracy.
Third parties may challenge the validity or scope of the Company's
intellectual property from time to time, and such challenges could result in the
limitation or loss of intellectual property rights. In addition, domestic and
international laws, statutes and regulations are constantly changing, and the
Company's assets may be either adversely or beneficially affected by such
changes. Moreover, effective intellectual property protection may be either
unavailable or limited in certain foreign territories. The Company therefore
engages in efforts to strengthen and update intellectual property protection
around the world, including efforts to ensure effective remedies for
infringement.
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REGULATION AND LEGISLATION
The Company's cable system, cable and broadcast television network and
original programming businesses are subject, in part, to regulation by the
Federal Communications Commission ("FCC"), and the cable system business is also
subject to regulation by some state governments and substantially all local
governments where the Company has cable systems. The Company's magazine, book
and other direct marketing activities are also subject to regulation. In
addition, in connection with regulatory clearance of the America Online-Historic
TW Merger, the Company's cable system and Internet businesses are subject to
compliance with the terms of the Consent Decree (the "Consent Decree") issued by
the Federal Trade Commission ("FTC"), the Order to Hold Separate issued by the
FTC, the Memorandum Opinion and Order ("Order") issued by the FCC, and the
Decision issued by the European Commission and the undertakings thereunder. The
Company is also subject to an FTC consent decree (the "Turner Consent Decree")
as a result of the FTC's approval of the acquisition of Turner Broadcasting
System, Inc. in 1996.
The following is a summary of the terms of these orders as well as current
significant federal, state and local laws and regulations affecting the growth
and operation of these businesses. In addition, various legislative and
regulatory proposals under consideration from time to time by Congress and
various federal agencies have in the past materially affected, and may in the
future materially affect, the Company.
FTC Consent Decree
On December 14, 2000, the FTC issued a Consent Decree in connection with
the America Online-Historic TW Merger. The consent decree provided that, with
the exception of Road Runner, Time Warner Cable was not permitted to launch an
affiliated ISP, like the AOL for Broadband service, in its 20 largest divisions,
until it launched the EarthLink service, an unaffiliated ISP, on those systems.
The Consent Decree also provided that Time Warner Cable had to enter into
agreements with two additional unaffiliated ISPs within 90 days after launching
an affiliated ISP. In addition, the Consent Decree required that, in its
remaining divisions, Time Warner Cable had to enter into agreements with three
unaffiliated providers within 90 days after launching an affiliated ISP. Each of
these agreements had to be approved by the FTC.
Time Warner Cable has now entered into, and received FTC approval for,
agreements with the required number of unaffiliated ISPs in all covered
divisions. If any of the required agreements expires or is terminated during the
term of the Consent Decree, Time Warner Cable will be required to replace it
with another approved agreement. Although offering multiple ISPs was required by
the terms of the Consent Decree, Time Warner Cable has entered into agreements
with unaffiliated ISPs beyond the number required by the Consent Decree.
The Consent Decree also requires that Time Warner Cable's FTC-approved
agreements contain a provision that requires Time Warner Cable to give notice to
the unaffiliated ISPs whenever Time Warner enters into an AOL for Broadband
affiliation agreement with any one of six specified cable operators. In that
event, the Company is required to give each unaffiliated ISP the option to adopt
all terms and conditions of the relevant AOL for Broadband affiliation
agreement. In addition, the Consent Decree requires that Time Warner continue to
offer and promote DSL service in areas served by Time Warner Cable to the same
extent and on terms similar to the terms offered in areas not served by Time
Warner Cable. America Online is also prohibited from entering into agreements
with cable MSOs that restrict the ability of that MSO to enter into agreements
with other ISPs or interactive television providers. The Company's obligations
under the Consent Decree expire on April 17, 2006.
FCC Memorandum Opinion and Order
On January 11, 2001, the FCC issued an Order imposing certain requirements
regarding Time Warner Cable's provision of multiple ISPs. Specifically, the
Order requires Time Warner Cable to provide ISP customers with a list of
available ISPs upon request, to allow ISPs to determine the content on their
first screen, and to allow ISPs to have direct billing arrangements with the
subscribers they obtain. The Order prohibits Time Warner Cable from requiring
customers to go through an affiliated ISP to reach an unaffiliated
23
ISP, from requiring ISPs to include particular content, and from discriminating
on the basis of affiliation with regard to technical system performance.
In addition, the FCC's Order prohibits the Company from entering into any
agreement with Comcast that gives any ISP affiliated with the Company exclusive
carriage rights on any former AT&T cable system for broadband ISP services or
that affects Comcast's ability to offer rates or other carriage terms to ISPs
that are not affiliated with the Company.
Turner FTC Consent Decree
The Company is also subject to the terms of a consent decree (the "Turner
Consent Decree") entered in connection with the FTC's approval of the
acquisition of TBS by Historic TW in 1996. Certain requirements imposed by the
Turner Consent Decree, such as carriage commitments for Time Warner Cable for
the rollout of at least one independent national news video programming service,
have been fully satisfied by the Company. Various other conditions remain in
effect, including certain restrictions which prohibit the Company from offering
programming upon terms that (1) condition the availability of, or the carriage
terms for, the HBO service upon whether a multichannel video programming
distributor carries a video programming service affiliated with TBS; and
(2) condition the availability of, or the carriage terms for, CNN, TBS
Superstation and TNT upon whether a multichannel video programming distributor
carries any video programming service affiliated with TWE. The Turner Consent
Decree also imposes certain restrictions on the terms by which a Turner video
programming service may be offered to an unaffiliated programming distributor
that competes in areas served by Time Warner Cable.
Other conditions of the Turner Consent Decree prohibit Time Warner Cable
from requiring, as a condition of carriage, that any national video programming
vendor provide a financial interest in its programming service or that such
programming vendor provide exclusive rights against any other multichannel
programming distributor. In addition, Time Warner Cable may not discriminate on
the basis of affiliation in the selection, terms or conditions of carriage for
national video programming vendors.
The Turner Consent Decree also requires that any Time Warner stock held by
Liberty Media Corporation ("Liberty Media"), its former corporate parent,
Tele-Communications, Inc. ("TCI"), which was merged with AT&T in 1999 and was
subsequently acquired by Comcast in 2002, as well as by the late Bob Magness and
John C. Malone as individuals, be non-voting except that such securities are
entitled to a vote of one-one hundredth (1/100) of a vote per share owned when
voting with the outstanding common stock on the election of directors and a vote
equal to the vote of the common stock with respect to corporate matters that
would adversely change the rights or terms of these non-voting securities. Upon
the sale of these non-voting securities to any independent third party, the
securities may be converted into voting stock of Time Warner. The Turner Consent
Decree also prohibits Liberty Media, TCI (now Comcast), the late Bob Magness and
John C. Malone as individuals, from holding ownership interests, collectively,
of more than 9.2% of the fully diluted equity of Time Warner. In 2002, Liberty
Media sought to eliminate these restrictions from the Turner Consent Decree; the
petition was denied by the FTC without prejudice. The Turner Consent Decree will
expire in February 2007.
Cable System Regulation
Communications Act and FCC Regulation
The Communications Act of 1934, as amended (the "Communications Act") and
the regulations and policies of the FCC affect significant aspects of Time
Warner Cable's cable system operations, including subscriber rates; carriage of
broadcast television stations, as well as the way Time Warner Cable sells its
program packages to subscribers; the use of cable systems by franchising
authorities and other third parties; cable system ownership; and use of utility
poles and conduits.
Subscriber Rates. The Communications Act and the FCC's rules regulate
rates for basic cable service and equipment in communities that are not subject
to "effective competition," as defined by federal law.
24
Where there is no effective competition, federal law authorizes franchising
authorities to regulate the monthly rates charged by the operator for the
minimum level of video programming service, referred to as basic service, which
generally includes local broadcast channels and public access or governmental
channels required by the franchise. This kind of regulation also applies to the
installation, sale and lease of equipment used by subscribers to receive basic
service, such as set-top boxes and remote control units. In many localities,
Time Warner Cable is no longer subject to this rate regulation, either because
the local franchising authority has not asked the FCC for permission to regulate
or because the FCC has found that there is effective competition.
Carriage of Broadcast Television Stations and Other Programming
Regulation. The Communications Act and the FCC's regulations contain broadcast
signal carriage requirements that allow local commercial television broadcast
stations to elect once every three years to require a cable system to carry
their stations, subject to some exceptions, or to negotiate with cable systems
the terms by which the cable systems may carry their stations, commonly called
"retransmission consent." The most recent election by broadcasters became
effective on January 1, 2003.
The Communications Act and the FCC's regulations require a cable operator
to devote up to one-third of its activated channel capacity for the mandatory
carriage of local commercial television stations. The Communications Act and the
FCC's regulations give local non-commercial television stations mandatory
carriage rights, but non-commercial stations do not have the option to negotiate
retransmission consent for the carriage of their signals by cable systems.
Additionally, cable systems must obtain retransmission consent for all "distant"
commercial television stations except for commercial satellite-delivered
independent "superstations," commercial radio stations, and some low-power
television stations.
FCC regulations require Time Warner Cable to carry the signals of both
commercial and non-commercial local digital-only broadcast stations and the
digital signals of local broadcast stations that return their analog spectrum to
the government and convert to a digital broadcast format. The FCC's rules give
digital-only broadcast stations discretion to elect whether the operator will
carry the station's signal in a digital or converted analog format, and the
rules also permit broadcasters with both analog and digital signals to tie the
carriage of their digital signals to the carriage of their analog signals as a
retransmission consent condition. The FCC is continuing to consider further
modifications to its digital broadcast signal carriage requirements.
The Communications Act also permits franchising authorities to negotiate
with cable operators for channels for public, educational and governmental
access programming. Moreover, it requires a cable system with 36 or more
activated channels to designate a significant portion of its channel capacity
for commercial leased access by third parties to provide programming that may
compete with services offered by the cable operator. The FCC regulates various
aspects of such third-party commercial use of channel capacity on our cable
systems, including the rates and some terms and conditions of the commercial
use.
High Speed Internet Access. From time to time, industry groups, telephone
companies and ISPs have sought local, state and federal regulations that would
require cable operators to sell capacity on their systems to ISPs under a common
carrier regulatory scheme. Cable operators have successfully challenged
regulations requiring this "forced access," although courts that have considered
these cases have employed varying legal rationales in rejecting these
regulations.
In 2002, the FCC released an order in which it determined that cable-modem
service constitutes an "information service" rather than a "cable service" or a
"telecommunications service," as those terms are used in the Communications Act.
According to the FCC, this conclusion may permit but does not require it to
impose "multiple ISP" requirements. In 2002, the FCC also initiated a rulemaking
proceeding to consider whether it may and should do so and whether local
franchising authorities should be permitted to do so. This rulemaking proceeding
remains pending.
Several ISPs appealed the FCC's order in federal court, arguing that cable
modem service is a "telecommunications service." If the ISPs prevail, cable
operators may become subject to a requirement that they carry any ISP desiring
carriage. In addition, several local franchising authorities also appealed the
order in federal court, arguing that the FCC should have held that cable-modem
service is a "cable service." If the local franchising authorities prevail,
cable operators may be required to collect and pay franchise fees on cable
25
modem service. On October 6, 2003, a three judge panel of the U.S. Court of
Appeals for the 9th Circuit vacated in part, and remanded in part for further
proceedings, the FCC's 2002 order. The FCC has requested an en banc rehearing of
this appeal, and the request remains pending before the 9th Circuit.
Ownership Limitations. There are various rules prohibiting joint ownership
of cable systems and other kinds of communications facilities. Local telephone
companies generally may not acquire more than a small equity interest in an
existing cable system in the telephone company's service area. In addition,
cable operators may not have more than a small interest in "multichannel
multipoint distribution services" facilities or "satellite master antenna
television" systems in their service areas. Finally, the FCC has been exploring
whether it should prohibit cable operators from holding ownership interests in
satellite operators.
The Communications Act also required the FCC to adopt "reasonable limits"
on the number of subscribers a cable operator may reach through systems in which
it holds an ownership interest. In September 1993, the FCC adopted a rule that
was later amended to prohibit any cable operator from serving more than 30% of
all cable, satellite and other multi-channel subscribers nationwide. The
Communications Act also required the FCC to adopt "reasonable limits" on the
number of channels that cable operators may fill with programming services in
which they hold an ownership interest. In September 1993, the FCC imposed a
limit of 40% of a cable operator's first 75 activated channels. In March 2001, a
federal appeals court struck down both limits. The FCC is currently exploring
whether it should re-impose any limits. The Company believes that it is unlikely
that the FCC will adopt limits more stringent than those struck down.
Local telephone companies may provide service as traditional cable
operators with local franchises or they may opt to provide their programming
over unfranchised "open video systems." Open video systems are subject to
specified requirements, including, but not limited to, a requirement that they
set aside a portion of their channel capacity for use by unaffiliated program
distributors on a non-discriminatory basis. A federal appellate court overturned
various parts of the FCC's open video rules, including the FCC's preemption of
local franchising requirements for open video operators. The FCC has modified
its open video rules to comply with the federal court's decision.
Pole Attachment Regulation. The Communications Act requires that utilities
provide cable systems and telecommunications carriers with nondiscriminatory
access to any pole, conduit or right-of-way controlled by the utility. The
Communications Act also requires the FCC to regulate the rates, terms and
conditions imposed by public utilities for cable systems' use of utility pole
and conduit space unless state authorities demonstrate to the FCC that they
adequately regulate pole attachment rates, as is the case in some states in
which Time Warner Cable operates. In the absence of state regulation, the FCC
administers pole attachment rates on a formula basis. The FCC's original rate
formula governs the maximum rate utilities may charge for attachments to their
poles and conduit by cable operators providing cable services. The FCC also
adopted a second rate formula that became effective in February 2001 and governs
the maximum rate utilities may charge for attachments to their poles and conduit
by companies providing telecommunications services. Any increase in attachment
rates resulting from the FCC's new rate formula is being phased in (in equal
annual installments) over a five-year period that began in February 2001. The
U.S. Supreme Court has upheld the FCC's jurisdiction to regulate the rates,
terms and conditions of cable operators' pole attachments that are being used to
provide both cable service and high speed data service.
Other Regulatory Requirements of the Communications Act and the FCC. The
Communications Act also includes provisions regulating customer service,
subscriber privacy, marketing practices, equal employment opportunity, technical
standards and equipment compatibility, antenna structure notification, marking,
lighting, emergency alert system requirements and the collection from cable
operators of annual regulatory fees, which are calculated based on the number of
subscribers served and the types of FCC licenses held.
Certain regulatory requirements are also applicable to set-top boxes.
Currently, many cable subscribers rent from their cable operator a set-top box
that performs both signal-reception functions and conditional-access security
functions. The lease rates cable operators charge for this equipment are subject
to rate regulation to the same extent as basic cable service. In 1996, Congress
enacted a statute seeking to allow subscribers to use set-top boxes obtained
from third-party retailers. The most important of the FCC's implementing
regulations requires cable operators to offer separate equipment providing only
the conditional-
26
access security function, so that subscribers can purchase boxes providing other
functions from other sources and to cease placing into service new set-top boxes
that have integrated conditional-access security. These regulations are
currently scheduled to go into effect on July 1, 2006.
In December, 2002, cable operators and consumer-electronics companies
entered into a standard-setting agreement relating to interoperability between
cable systems and reception equipment. Among other things, the agreement
envisions consumer electronics devices with a slot for a conditional-access
security card - a CableCARDฎ - provided by the cable operator. To implement the
agreement, the FCC recently promulgated regulations that require cable systems
with activated spectrum of 750 MHz or greater to support unidirectional digital
devices; establish a voluntary labeling system for unidirectional devices;
prohibit so-called "selectable output controls"; and adopt content-encoding
rules. The FCC has issued a notice of proposed rulemaking to consider additional
changes. Cable operators, consumer-electronics companies and other market
participants are holding discussions that are expected to lead to a similar set
of interoperability agreements covering digital devices capable of carrying
cable operators' two-way and interactive products and services.
Separately, the FCC has adopted cable inside wiring rules to provide
specific procedures for the disposition of residential home wiring and internal
building wiring where a subscriber terminates service or where an incumbent
cable operator is forced by a building owner to terminate service in a multiple
dwelling unit building. The FCC has also adopted rules providing that, in the
event that an incumbent cable operator sells the inside wiring, it must make the
wiring available to the multiple dwelling unit owner or the alternative cable
service provider during the 24-hour period prior to the actual service
termination by the incumbent, in order to avoid service interruption.
Compulsory Copyright Licenses for Carriage of Broadcast Stations, Music
Performance Licenses. Time Warner Cable's cable systems provide subscribers
with, among other things, local and distant television broadcast stations. Time
Warner Cable generally does not obtain a license to use this programming
directly from program owners. Instead, it obtains this programming pursuant to a
compulsory license provided by federal law, which requires it to make payments
to a copyright pool. The elimination or substantial modification of the cable
compulsory license could adversely affect Time Warner Cable's ability to obtain
suitable programming and could substantially increase the cost of programming
that remains available for distribution to its subscribers.
When Time Warner Cable obtains programming from third parties, it
generally obtains licenses that include any necessary authorizations to transmit
the music included in it. When Time Warner Cable creates its own programming and
provides various other programming or related content, including local
origination programming and advertising that it inserts into cable-programming
networks, it is required to obtain any necessary music performance licenses
directly from the rights holders. These rights are generally controlled by three
music performance rights organizations, each with rights to the music of various
artists. Time Warner Cable generally has obtained the necessary licenses, either
through negotiated licenses or through procedures established by consent decrees
entered into by some of the music performance rights organizations.
State and Local Regulation
Cable operators operate their systems under non-exclusive franchises.
Franchises are awarded, and cable operators are regulated, by municipal or other
local franchising authorities. In some states, cable regulation is imposed at
the state level as well. The Company believes it generally has good relations
with state and local cable regulators.
Franchise agreements typically require payment of franchise fees and
contain regulatory provisions addressing, among other things, upgrades, service
quality, cable service to schools and other public institutions, insurance and
indemnity bonds. The terms and conditions of cable franchises vary from
jurisdiction to jurisdiction. The Communications Act provides protections
against many unreasonable terms. In particular, the Communications Act imposes a
ceiling on franchise fees of five percent of revenues derived from cable
service. Time Warner Cable generally passes the franchise fee on to its
subscribers, listing it as a separate item on the bill.
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Franchise agreements usually have a term of ten to 15 years from the date
of grant, although some renewals may be for shorter terms. Franchises usually
are terminable only if the cable operator fails to comply with material
provisions. Time Warner Cable has not had a franchise terminated due to breach.
After a franchise agreement expires, a franchising authority may seek to impose
new and more onerous requirements, including requirements to upgrade facilities,
to increase channel capacity and to provide various new services. Federal law,
however, provides significant substantive and procedural protections for cable
operators seeking renewal of their franchises. In addition, although Time Warner
Cable occasionally reaches the expiration date of a franchise agreement without
having a written renewal or extension, it generally has the right to continue to
operate, either by agreement with the franchising authority or by law, while
continuing to negotiate a renewal. In the past, substantially all of the
material franchises relating to its systems have been renewed by the relevant
local franchising authority, though sometimes only after significant time and
effort. Despite its efforts and the protections of federal law, it is possible
that some Time Warner Cable franchises may not be renewed, and Time Warner Cable
may be required to make significant additional investments in its cable systems
in response to requirements imposed in the course of the franchise renewal
process.
Franchises usually require the consent of franchising authorities prior to
the sale, assignment, transfer or change of control of a cable system. Federal
law imposes various limitations on the conditions local authorities may impose
and requires localities to act on such requests within 120 days.
Regulation of Telephony
As of December 31, 2003, it was unclear whether and to what extent
regulators will subject Voice over Internet Protocol ("VoIP") service provided
by cable operators to the same regulations that apply to traditional circuit
switch telephone service provided by incumbent telephone companies. In
particular, it is unclear whether and to what extent the "access charge" and
"universal service" rules that apply to traditional circuit switch telephone
service will also apply to VoIP service. Finally, it is possible that regulators
will allow utility pole owners to charge cable operators offering VoIP service
higher rates for pole rental than for traditional cable service and cable-modem
service. In February 2004 the FCC opened a rulemaking proceeding on VoIP.
Network Regulation
Under the Communications Act and its implementing regulations, vertically
integrated cable programmers like the Turner Networks and the Home Box Office
Services, are generally prohibited from offering different prices, terms, or
conditions to competing unaffiliated multichannel video programming distributors
unless the differential is justified by certain permissible factors set forth in
the regulations. The rules also place certain restrictions on the ability of
vertically integrated programmers to enter into exclusive distribution
arrangements with cable operators. Certain other federal laws also contain
provisions relating to violent and sexually explicit programming, including
relating to the voluntary promulgation of ratings by the industry and requiring
manufacturers to build television sets with the capability of blocking certain
coded programming (the so-called "V-chip").
Marketing Regulation
Time Inc.'s magazine and book marketing activities, as well as other
marketing and billing activities by America Online and other divisions of the
Company, are subject to regulation by the FTC and each of the state Attorneys
General under general consumer protection statutes prohibiting unfair or
deceptive acts or practices. Certain areas of marketing activity are also
subject to specific federal rules and statutes, such as the Telephone Consumer
Protection Act, the Children's Online Privacy Protection Act, the
Gramm-Leach-Bliley Act (relating to financial privacy), the FTC Mail or
Telephone Order Merchandise Rule and the FTC Telemarketing Sales Rule. The FTC's
Telemarketing Sales Rule has been amended to establish a nationwide
telemarketing do-not-call list. In addition, certain of Time Inc.'s specific
marketing methods are subject to agreements with state Attorneys General, such
as the regulation of Time Inc.'s use of sweepstakes by a 48-state Assurance of
Voluntary Compliance agreed to in 2000. America Online is also subject to a 1998
FTC
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Consent Decree and a 43-state Assurance of Voluntary Compliance with state
Attorneys General and a separate 2004 FTC Consent Decree which address America
Online's marketing and billing activities. Further, as a result of the
settlement of a lawsuit between merchants and credit card companies, credit card
companies may be providing information to merchants which would allow merchants
to distinguish between charges made on credit cards and debit cards. As a
result, Time Inc. may be required to change its payment acceptance procedures,
which could result in decreased subscription renewals.
DESCRIPTION OF CERTAIN PROVISIONS OF AGREEMENTS
RELATED TO TWC INC.
The following description summarizes certain provisions of agreements
related to, and constituent documents of, TWC Inc. that affect and govern the
ongoing operations of TWC Inc. Such description does not purport to be complete
and is subject to, and is qualified in its entirety by reference to, the
provisions of such agreements and constituent documents.
Management and Operation of TWC Inc.
Stockholders of TWC Inc. As a result of the TWE Restructuring, Time Warner
and its subsidiaries received shares of TWC Inc. Class A common stock, which
generally has one vote per share, and shares of TWC Inc. Class B common stock,
which generally has ten votes per share, which together represent 89.3% of the
voting power of TWC Inc. and 82.1% of the equity of TWC Inc. A Comcast Trust
received shares of Class A common stock of TWC Inc. representing the remaining
10.7% of the voting power and 17.9% of the equity of TWC Inc. The Class B common
stock is not convertible into Class A common stock upon transfer or otherwise.
The Class A common stock and the Class B common stock vote together as a single
class on all matters, except with respect to the election of directors and
certain matters described below.
Board of Directors of TWC Inc. The Class A common stock votes, as a
separate class, with respect to the election of the Class A directors of TWC
Inc. (the "Class A Directors"), and the Class B common stock votes, as a
separate class, with respect to the election of the Class B directors of TWC
Inc. (the "Class B Directors"). Pursuant to the restated certificate of
incorporation of TWC Inc. (the "Certificate of Incorporation"), the Class A
Directors must represent not less than one-sixth and not more than one-fifth of
the directors of TWC Inc., and the Class B Directors must represent not less
than four-fifths of the directors of TWC Inc. As a result of its shareholdings,
Time Warner has the ability to cause the election of all Class A Directors and
Class B Directors, subject to certain restrictions on the identity of these
directors discussed below.
The TWC Inc. Certificate of Incorporation requires that there be at least
two independent directors on the board of directors of TWC Inc.. In addition, a
parent agreement (the "Parent Agreement") among Time Warner, TWC Inc. and
Comcast provides that until such time that an initial public offering of TWC
Inc. common stock is effected, at least 50% of the independent directors must be
reasonably satisfactory to the Comcast Trust. To the extent possible, all such
independent directors will be Class A Directors. If an initial public offering
of TWC Inc. is effected, the Certificate of Incorporation requires that at least
50% of the board of directors of TWC Inc. consist of independent directors for
three years.
Protections of Minority Class A Common Stockholders. The approval of the
holders of a majority of the voting power of the outstanding shares of Class A
common stock held by persons other than Time Warner is necessary in connection
with:
any merger, consolidation or business combination of TWC Inc. in which the
holders of Class A common stock do not receive per share consideration
identical to that received by the holders of Class B common stock (other
than with respect to voting power) or which would adversely affect the
Class A common stock relative to the Class B common stock;
any change to the Certificate of Incorporation that would have a material
adverse effect on the rights of the holders of the Class A common stock in a
manner different from the effect on the holders of the Class B common stock;
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any change to the provisions of the Certificate of Incorporation that would
affect the right of the Class A common stock to vote as a class in
connection with any merger as discussed above;
any change to the Certificate of Incorporation that would alter the number
of independent directors required on the TWC Inc. board of directors; and
through and until the fifth anniversary of the completion of an initial
public offering of TWC Inc., any change to provisions of TWC Inc.'s by-laws
concerning restrictions on transactions between TWC Inc. and Time Warner and
its affiliates.
Matters Affecting the Relationship between Time Warner and TWC Inc.
Indebtedness Approval Right. For so long as the indebtedness of TWC Inc.
is attributable to Time Warner, in Time Warner's reasonable judgment, TWC Inc.,
its subsidiaries and entities that it manages will not, without the consent of
Time Warner, create, incur or guarantee any indebtedness, including preferred
equity, or rental obligations if its ratio of indebtedness plus six times its
annual rental expense to EBITDA (as EBITDA is defined in the applicable
agreement and which is comparable to operating income (loss) before depreciation
and amortization) plus rental expense, or "EBITDAR," then exceeds or would
exceed 3:1.
Other Time Warner Rights. Under the Parent Agreement, as long as Time
Warner has the right to elect more than a majority of the directors of TWC Inc.,
TWC Inc. must obtain Time Warner's consent before it enters into any agreement
that binds or purports to bind Time Warner or its affiliates or that would
subject TWC Inc. to significant penalties or restrictions as a result of any
action or omission of Time Warner; or adopts a stockholder rights plan, becomes
subject to Section 203 of the Delaware General Corporation Law, adopts a "fair
price" provision or takes any similar action.
Time Warner Standstill. Under the Parent Agreement, Time Warner has agreed
that for three years following the completion of an initial public offering of
TWC Inc., Time Warner will not make or announce a tender offer or exchange offer
for the Class A common stock of TWC Inc. without the approval of a majority of
the independent directors of TWC Inc.; and for ten years following an initial
public offering of TWC Inc., Time Warner will not enter into any business
combination with TWC Inc., including a short-form merger, without the approval
of a majority of the independent directors of TWC Inc.
Transactions between Time Warner and TWC Inc. The by-laws of TWC Inc.
provide that Time Warner may only enter into transactions with TWC Inc. and its
subsidiaries, including TWE, that are on terms that, at the time of entering
into such transaction, are substantially as favorable to TWC Inc. or its
subsidiaries as they would be able to receive in a comparable arm's-length
transaction with a third party. Any such transaction involving reasonably
anticipated payments or other consideration of $50 million or greater also
requires the prior approval of a majority of the independent directors of TWC
Inc.
TWC Inc. Registration Rights Agreements
TWC Inc. Registration Rights Agreement with Comcast Trust. At the closing
of the TWE Restructuring, a Comcast Trust entered into a registration rights
agreement with TWC Inc. relating to its shares of Class A common stock, as well
as any common stock of TWC Inc. that it or another Comcast Trust may receive in
connection with a sale of a partnership interest in TWE under the Partnership
Interest Sale Agreement (see "Description of Certain Provisions of the TWE
Partnership Agreement - Exit Rights").
Subject to several exceptions, including TWC Inc.'s right to defer a
demand registration under some circumstances, the Comcast Trust has the right to
require that TWC Inc. take commercially reasonable steps to register for public
resale under the Securities Act of 1933 all shares of Class A common stock owned
by it that it requests be registered. On December 29, 2003, TWC Inc. received
notice from the Comcast Trust requesting that TWC Inc. commence to register for
sale in a firm underwritten offering all of Comcast's 17.9% common interest in
TWC Inc. The Company cannot predict the timing of an effective registration in
response to the Comcast Trust's notice. Under the registration rights agreement,
TWC Inc. is not obligated to effect more than one demand registration on behalf
of the Comcast Trust in any 270-day period. TWC Inc. is not obligated to effect
a demand registration on behalf of the Comcast Trust if the Comcast Trust has
received
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proceeds in excess of $250 million (or 10% of TWC Inc.'s market capitalization)
from private placements of and hedging transactions relating to TWC Inc.'s
common stock in the preceding 270-day period. Under the registration rights
agreement, the Comcast Trust may not engage in any private placement or hedging
transaction until the earlier of the first anniversary of the closing of the TWE
Restructuring and the date upon which TWC Inc. shall have sold at least
$2.1 billion worth of common stock. Any registered hedging transaction or other
monetization with respect to TWC Inc. common stock will be deemed to constitute
a demand registration.
In addition, the Comcast Trust has "piggyback" registration rights subject
to customary restrictions on any registration for TWC Inc.'s account or the
account of another stockholder, and TWC Inc. and Time Warner are permitted to
piggyback on the Comcast Trust's demand registrations.
If any registration requested by the Comcast Trust or Time Warner is in
the form of a firm underwritten offering, and if the managing underwriter of the
offering determines that the number of securities to be offered would jeopardize
the success of the offering, the number of shares included in the offering shall
be determined as follows:
first, securities to be offered for TWC Inc.'s account must be included
until TWC Inc. has sold $2.1 billion worth of securities, whether through
public offerings, private placements or hedging transactions;
second, securities to be offered for the account of the Comcast Trust must
be included until it has sold $3.0 billion worth of securities; and
third, TWC Inc. and the Comcast Trust have equal priority, and Time Warner
has last priority until the earlier of (x) the fifth anniversary of the
closing of the TWE Restructuring and (y) the date the Comcast Trust holds
less than $250 million of TWC Inc. common stock. After that date, TWC Inc.,
the Comcast Trust and Time Warner have equal priority.
Registration Rights Agreement between TWC Inc. and Time Warner. At the
closing of the TWE Restructuring, Time Warner and TWC Inc. entered into a
registration rights agreement relating to Time Warner's shares of TWC Inc.
common stock. Subject to several exceptions, including TWC Inc.'s right to defer
a demand registration under some circumstances, Time Warner may, under that
agreement, require that TWC Inc. take commercially reasonable steps to register
for public resale under the Securities Act of 1933 all shares of common stock
that Time Warner requests be registered. Time Warner may demand an unlimited
number of registrations. In addition, Time Warner has been granted "piggyback"
registration rights subject to customary restrictions, and TWC Inc. is permitted
to piggyback on Time Warner's registrations. Any registration statement filed
under the agreement is subject to the cut-back priority discussed above. Time
Warner has agreed that it will not, until the fifth anniversary of the closing
of the TWE Restructuring, dispose of its shares of TWC Inc. common stock other
than in registered offerings.
In connection with the registrations described above under both
registration rights agreements, TWC Inc. will indemnify the selling stockholders
and bear all fees, costs and expenses, except underwriting discounts and selling
commissions.
DESCRIPTION OF CERTAIN PROVISIONS OF THE
TWE PARTNERSHIP AGREEMENT
On March 31, 2003, the TWE Partnership Agreement was amended in connection
with the closing of the TWE Restructuring (as amended, the "New TWE Partnership
Agreement"). The following description summarizes certain provisions of the New
TWE Partnership Agreement relating to the ongoing operations of TWE. Such
description does not purport to be complete and is subject to, and is qualified
in its entirety by reference to, the provisions of the New TWE Partnership
Agreement.
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Management and Operations of TWE
Partners. Following the TWE Restructuring, the partnership interests in
TWE were recapitalized with one of the Comcast Trusts holding a partnership
interest representing a 4.7% residual equity interest in TWE, with a subsidiary
of the Company holding a partnership interest consisting of a $2.4 billion
preferred component and a 1% residual equity interest in TWE and with TWC Inc.
holding a partnership interest representing a 94.3% residual equity interest in
TWE.
Upon the completion of the TWE Restructuring, TWC Inc. became the general
partner of TWE and a subsidiary of Time Warner and one of the Comcast Trusts
became the limited partners of TWE.
Following the completion of the TWE Restructuring, TWC Inc., as the
general partner of TWE, assumed the exclusive authority to manage the business
and affairs of TWE, subject to certain protections over extraordinary actions
afforded the Comcast Trust under the New TWE Partnership Agreement. These
protections consist of consent rights over the dissolution or liquidation of TWE
and the transfer of control of TWE to a third party, in each case, prior to
March 31, 2006, and the right to approve of certain amendments to the New TWE
Partnership Agreement.
Certain Covenants
Transactions with Affiliates. The New TWE Partnership Agreement requires
that transactions between TWC Inc., as the managing partner, and TWE be
conducted on an arm's-length basis, with management, corporate or similar
services being provided by TWC Inc. on a "no mark-up" basis with fair
allocations of administrative costs and general overhead.
Exit Rights
Sale and Appraisal Rights of Trust. Under a partnership interest sale
agreement (the "Partnership Interest Sale Agreement") entered in connection with
the closing of the TWE Restructuring, at any time following March 31, 2005, the
Comcast Trust has the right to require TWC Inc. to purchase all or a portion of
the Comcast Trust's 4.7% residual limited partnership interest in TWE at an
appraised fair market value, subject to a right of first refusal in favor of
Time Warner. The fair market value of the interest will be determined separately
by two investment banks, one appointed by the Comcast Trust and one appointed by
TWC Inc. If the higher of the two valuations presented by the investment banks
is within 110% of the lower valuation, then the fair market value of the offered
partnership interest will be the average of the two valuations. If the higher
valuation is not within 110% of the lower valuation, a third investment bank
selected by the other two investment banks, or, if they are unable to agree on a
third investment bank, an investment bank selected by the American Arbitration
Association will choose one of the two valuations to be the fair market value of
the offered partnership interest, and that determination will be final and
binding.
Following March 31, 2005, the Comcast Trust also has the right, at any
time, to sell all or a portion of its interest in TWE to a third party in a bona
fide transaction, subject to a right of first refusal, first, in favor of Time
Warner and, second, in favor of TWC Inc. If TWC Inc. and Time Warner do not
collectively elect to purchase all of the Comcast Trust's offered partnership
interest, the Comcast Trust may proceed with the sale of the offered partnership
interest to that third party on terms no more favorable than those offered to
TWC Inc. and Time Warner, if that third party agrees to be bound by the same
terms and conditions applicable to the Comcast Trust as a limited partner in TWE
and under the Partnership Interest Sale Agreement.
In all cases, the purchase price payable by TWC Inc. or Time Warner as
consideration for the Comcast Trust's partnership interest may be cash; common
stock, if the common stock of the purchaser is then publicly traded, or a
combination of both, at the purchaser's election. Any Time Warner or TWC Inc.
common stock issued to purchase the Comcast Trust's partnership interests will
be valued based on the average of the volume-weighted trading price of the
common stock for a period of time prior to issuance and will be entitled to
registration rights.
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Redemption of Preferred Component. The preferred component of Time
Warner's partnership interest must be redeemed by TWE on April 1, 2023.
Restrictions on Transfer
The New TWE Partnership Agreement provides that TWC Inc. and Time Warner
may generally transfer their partnership interests in TWE at any time, except
that TWC Inc. may not transfer control of TWE prior to March 31, 2006. However,
the Comcast Trust may not transfer its partnership interest in TWE prior to
March 31, 2005 and, after that, the Comcast Trust may only transfer its
partnership interest pursuant to the Partnership Interest Sale Agreement,
described above.
No transfer of partnership interests may be made by any partner through
securities markets, and no transfer may be made by any partner if the transfer
causes TWE to have more than 100 partners or would result in, or have a material
risk of, TWE being treated as a corporation for federal income tax purposes.
DESCRIPTION OF CERTAIN PROVISIONS OF THE
TWE-A/N PARTNERSHIP AGREEMENT
The following description summarizes certain provisions of the TWE-A/N
Partnership Agreement relating to the ongoing operations of TWE-A/N. Such
description does not purport to be complete and is subject to, and is qualified
in its entirety by reference to, the provisions of the TWE-A/N Partnership
Agreement.
Partners of TWE-A/N
The general partnership interests in TWE-A/N are held by TWE, TWC Inc.
(TWE and TWC Inc. are together, the "TW Partners"), and Advance/Newhouse
Partnership, a partnership owned by wholly owned subsidiaries of Advance
Publications Inc. and Newhouse Broadcasting Corporation ("A/N"). The TW Partners
also hold preferred partnership interests.
2002 Restructuring of TWE-A/N
The TWE-A/N cable television joint venture was formed by TWE and
Advance/Newhouse in December 1995. A restructuring of the partnership was
completed during 2002. As a result of this restructuring, cable systems and
their related assets and liabilities serving 2.1 million subscribers as of
December 31, 2002 located primarily in Florida (the "A/N Systems"), were
transferred to a subsidiary of TWE-A/N (the "A/N Subsidiary"). As part of the
restructuring, effective August 1, 2002, A/N's interest in TWE-A/N was converted
into an interest that tracks the economic performance of the A/N Systems, while
the Company and TWE retain the economic interests and associated liabilities in
the remaining TWE-A/N cable systems. Also, in connection with the restructuring,
Time Warner effectively acquired A/N's interest in Road Runner. All of the
systems owned by TWE-A/N and the A/N Subsidiary continue to support multiple
ISPs, including AOL for Broadband, Road Runner and EarthLink. TWE-A/N's
financial results, other than the results of the A/N Systems, are consolidated
with the Company's.
Management and Operations of TWE-A/N
Management Powers and Services Agreement. Subject to the requirement to
act by unanimous consent with respect to some actions as described below, TWE is
the managing partner, with exclusive management rights of TWE-A/N, other than
with respect to the A/N Systems. As managing partner, TWE manages TWE-A/N, other
than the A/N Systems, on a day-to-day basis. Also, subject to the requirement to
act by unanimous consent with respect to some actions as described below, A/N
has authority for the supervision of the day-to-day operations of the A/N
Subsidiary and the A/N Systems. TWE entered into a services agreement with A/N
and the A/N Subsidiary under which TWE agreed to exercise various management
functions, including oversight of programming and various engineering-related
matters. TWE and A/N also agreed to periodically discuss cooperation with
respect to new product development.
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Actions Requiring Unanimous Consent. Some actions cannot be taken by
TWE-A/N, TWE or A/N without the unanimous consent of the TW Partners and A/N or
the unanimous consent of an executive committee consisting of members designated
by the TW Partners and A/N. These actions include, among other things:
any merger, consolidation or disposition of all or substantially all of the
assets of TWE-A/N (excluding the A/N Subsidiary) or the A/N Subsidiary;
any liquidation or dissolution of TWE-A/N or the A/N Subsidiary;
specified incurrences of debt by TWE-A/N or by the A/N Subsidiary; and
admission of a new partner or other issuances of equity interests in TWE-A/N
or the A/N Subsidiary.
Restrictions on Transfer
TW Partners. Each TW Partner is generally permitted to directly or
indirectly dispose of its entire partnership interest at any time to a wholly
owned affiliate of TWE (in the case of transfers by TWE) or to TWE, the Company
or a wholly owned affiliate of TWE or the Company (in the case of transfers by
TWC Inc.). In addition, the TW Partners are also permitted to transfer their
partnership interests through a pledge to secure a loan, or a liquidation of TWE
in which the Company, or its affiliates, receives a majority of the interests of
TWE-A/N held by the TW Partners. TWE is allowed to issue additional partnership
interests in TWE so long as the Company continues to own, directly or
indirectly, either 35% or 43.75% of the residual equity capital of TWE,
depending on when the issuance occurs.
A/N Partner. A/N is generally permitted to directly or indirectly transfer
its entire partnership interest at any time to certain members of the Newhouse
family or specified affiliates of A/N. A/N is also permitted to dispose of its
partnership interest through a pledge to secure a loan and in connection with
specified restructurings of A/N.
Restructuring Rights of the Partners
TWE and A/N each have the right to cause TWE-A/N to be restructured at any
time. Upon a restructuring, TWE-A/N would be required to distribute the A/N
Subsidiary with all of the A/N Systems to A/N in complete redemption of A/N's
interests in TWE-A/N, and A/N would be required to assume all liabilities of the
A/N Subsidiary and the A/N Systems. Following such a restructuring, TWE's
obligations to provide management services to A/N and the A/N Subsidiary would
terminate. As of the date of this annual report, neither TWE nor A/N has
delivered notice of the intent to cause a restructuring of TWE-A/N.
Rights of First Offer
TWE's Regular Right of First Offer. Subject to exceptions, A/N and its
affiliates are obligated to grant TWE a right of first offer with respect to any
sale of assets of the A/N Systems.
TWE's Special Right of First Offer. Within a specified time period
following the first, seventh, thirteenth and nineteenth anniversaries of the
deaths of two specified members of the Newhouse family (those deaths have not
yet occurred), A/N has the right to deliver notice to TWE stating that it wishes
to transfer some or all of the assets of the A/N Systems, thereby granting TWE
the right of first offer to purchase the specified assets. Following delivery of
this notice, an appraiser will determine the value of the assets proposed to be
transferred. Once the value of the assets has been determined, A/N has the right
to terminate its offer to sell the specified assets. If A/N does not terminate
its offer, TWE will have the right to purchase the specified assets at a price
equal to the value of the specified assets determined by the appraiser. If TWE
does not exercise its right to purchase the specified assets, A/N has the right
to sell the specified assets to an unrelated third party within 180 days on
substantially the same terms as were available to TWE.
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DESCRIPTION OF AGREEMENT WITH LIBERTY MEDIA CORPORATION
The following description summarizes certain provisions of the Company's
agreement with Liberty Media and certain of its subsidiaries (collectively,
"LMC") that was entered into in connection with the merger of Turner
Broadcasting System, Inc. in 1996 (the "TBS Transaction") and the Turner Consent
Decree. Such description does not purport to be complete and is subject to, and
is qualified in its entirety by reference to, the provisions of the Second
Amended and Restated LMC Agreement dated as of September 22, 1995 among Historic
TW, Time Warner Companies, Inc. and LMC (the "LMC Agreement").
Ownership of Time Warner Common Stock
Pursuant to the LMC Agreement, immediately following consummation of the
TBS Transaction, LMC exchanged the 50.6 million shares of Historic TW common
stock, par value $.01 per share received by LMC in the TBS Transaction on a
one-for-one basis for 50.6 million shares of Series LMCN-V Common Stock of
Historic TW. In June 1997, LMC and its affiliates received 6.4 million
additional shares of Series LMCN-V Common Stock pursuant to the provisions of an
option agreement between Time Warner and LMC and its affiliates. In May 1999,
the terms of the Series LMCN-V Common Stock were amended which effectively
resulted in a two-for-one stock split. At the time of the America
Online-Historic TW Merger, each share of Series LMCN-V Common Stock was
exchanged for one and one half shares of a substantially identical Series LMCN-V
Common Stock of the Company. Each share of Series LMCN-V Common Stock receives
the same dividends and otherwise has the same rights as a share of Time Warner
Common Stock except that (a) holders of Series LMCN-V Common Stock are entitled
to 1/100th of a vote per share on the election of directors and do not have any
other voting rights, except as required by law or with respect to limited
matters, including amendments to the terms of the Series LMCN-V Common Stock
adverse to such holders, and (b) unlike shares of Time Warner Common Stock,
shares of Series LMCN-V Common Stock are not subject to redemption by the
Company if necessary to prevent the loss by the Company of any governmental
license or franchise. The Series LMCN-V Common Stock is not transferable, except
in limited circumstances, and is not listed on any securities exchange.
LMC exchanged its shares of Historic TW common stock for Series LMCN-V
Common Stock in order to comply with the Turner Consent Decree, which
effectively prohibits LMC and its affiliates (including TCI) from owning voting
securities of the Company other than securities that have limited voting rights.
In 2002, LMC sought to eliminate these restrictions from the Turner Consent
Decree; the petition was denied by the FTC without prejudice. See "Regulation
and Legislation - Turner FTC Consent Decree," above. Each share of Series LMCN-V
Common Stock is convertible into one share of Time Warner Common Stock at any
time when such conversion would no longer violate the Turner Consent Decree or
have a Prohibited Effect (as defined below), including following a transfer to a
third party.
Other Agreements
Under the LMC Agreement, if the Company takes certain actions that have
the effect of (a) making the continued ownership by LMC of the Company's equity
securities illegal under any federal or state law, (b) imposing damages or
penalties on LMC under any federal or state law as a result of such continued
ownership, (c) requiring LMC to divest any such Company equity securities, or
(d) requiring LMC to discontinue or divest any business or assets or lose or
significantly modify any license under any communications law (each a
"Prohibited Effect"), then the Company will be required to compensate LMC for
income taxes incurred by it in disposing of all the Company's equity securities
received by LMC in connection with the TBS Transaction and related agreements
(whether or not the disposition of all such equity securities is necessary to
avoid such Prohibited Effect).
The agreements described in the preceding paragraph may have the effect of
requiring the Company to pay amounts to LMC in order to engage in (or requiring
the Company to refrain from engaging in) activities that LMC would be prohibited
under the federal communications laws from engaging in. Based on the current
businesses of the Company and LMC and based upon the Company's understanding of
applicable law, the Company does not expect these requirements to have a
material effect on its business.
35
CURRENCY RATES AND REGULATIONS
Time Warner's foreign operations are subject to the risk of fluctuation in
currency exchange rates and to exchange controls. Time Warner cannot predict the
extent to which such controls and fluctuations in currency exchange rates may
affect its operations in the future or its ability to remit dollars from abroad.
See Note 1, "Organization and Summary of Significant Accounting Policies -
Foreign Currency Translation" and Note 16, "Derivative Instruments - Foreign
Currency Risk Management" to the consolidated financial statements set forth in
the financial pages herein. For a discussion of revenues of international
operations, see Note 17, "Segment Information" to the consolidated financial
statements set forth in the financial pages herein.
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