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SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

[  x  ]    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT of 1934 for the quarterly period ended September 30, 2002 or

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

Commission file number 1-15062

AOL TIME WARNER INC.

75 Rockefeller Plaza
New York, New York 10019
(212) 484-8000

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes [  x  ]    No [      ]

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

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AOL TIME WARNER INC. AND
TIME WARNER ENTERTAINMENT COMPANY, L.P.

INDEX TO FORM 10-Q

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AOL TIME WARNER INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION

INTRODUCTION

         Management’s discussion and analysis of results of operations and financial condition (“MD&A”) is provided as a supplement to the accompanying consolidated financial statements and footnotes to help provide an understanding of AOL Time Warner Inc.’s (“AOL Time Warner” or the “Company”) financial condition, changes in financial condition and results of operations. The MD&A is organized as follows:

•		Overview. This section provides a general description of AOL Time Warner’s businesses, as well as recent developments that the Company believes are important in understanding the results of operations, as well as to anticipate future trends in those operations.
•		Results of operations. This section provides an analysis of the Company’s results of operations for the three and nine months ended September 30, 2002 relative to the comparable periods in 2001. This analysis is presented on both a consolidated and segment basis. In addition, a brief description is provided of transactions and events that impact the comparability of the results being analyzed.
•		Financial condition and liquidity. This section provides an analysis of the Company’s financial condition as of September 30, 2002 and cash flows for the nine months ended September 30, 2002.
•		Caution concerning forward-looking statements and risk factors. This section discusses how certain forward-looking statements made by the Company in this report, including throughout MD&A and in the consolidated financial statements, are based on management’s current expectations about future events and are inherently susceptible to uncertainty and changes in circumstances. In addition, a description is provided of the risk factors that could adversely affect the operations, business or financial results of the Company or its business segments.

OVERVIEW

Description of Business

         AOL Time Warner is the world’s leading media and entertainment company. The Company was formed in connection with the merger of America Online, Inc. (“America Online”) and Time Warner Inc. (“Time Warner”), which was consummated on January 11, 2001 (the “Merger”). As a result of the Merger, America Online and Time Warner each became a wholly owned subsidiary of AOL Time Warner.

         AOL Time Warner classifies its business interests into six fundamental areas: AOL, consisting principally of interactive services, Web properties, Internet technologies and electronic commerce services; Cable, consisting principally of interests in cable television systems; Filmed Entertainment, consisting principally of interests in filmed entertainment and television production; Networks, consisting principally of interests in cable television and broadcast network programming; Music, consisting principally of interests in recorded music, music publishing and DVD manufacturing; and Publishing, consisting principally of interests in magazine publishing, book publishing and direct marketing.

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

Use of EBITDA

         AOL Time Warner evaluates operating performance based on several factors, including its primary financial measure of operating income (loss) before noncash depreciation of tangible assets and amortization of intangible assets (“EBITDA”). AOL Time Warner considers EBITDA an important indicator of the operational strength and performance of its businesses, including the ability to provide cash flows to service debt and fund capital expenditures. In addition, EBITDA eliminates the uneven effect across all business segments of considerable amounts of noncash depreciation of tangible assets and amortization of certain intangible assets deemed to have finite useful lives that were recognized in business combinations accounted for by the purchase method. As such, the following comparative discussion of the results of operations of AOL Time Warner includes, among other measures, an analysis of changes in EBITDA. However, EBITDA should be considered in addition to, not as a substitute for, operating income (loss), net income (loss) and other measures of financial performance reported in accordance with generally accepted accounting principles. In addition, EBITDA should not be used as a substitute for the Company’s various cash flow measures (e.g., operating cash flow and free cash flow), which are discussed in detail beginning on page 27.

Recent Developments

Restatement of Prior Financial Information

         The Company is conducting an internal review of certain advertising and commerce transactions at the AOL segment under the direction of the Company’s Chief Financial Officer. In connection with this internal review, the financial results for each of the quarters ended September 30, 2000 through June 30, 2002 will be restated. The total impact of the adjustments will be to reduce the Company’s consolidated advertising and commerce revenues by $190 million over these eight quarterly periods, with corresponding reductions in EBITDA, operating income and net income for that same time period of $97 million, $83 million and $46 million, respectively. For the AOL segment, the impact of the adjustments will be to reduce advertising and commerce revenues by $168 million over these eight quarterly periods, with corresponding reductions in EBITDA and operating income for that same time period of $97 million and $83 million, respectively. The remaining impact on the Company’s consolidated advertising and commerce revenues of $22 million represents a reduction in revenues from certain transactions related to the AOL segment in which the advertising was delivered by other AOL Time Warner segments. The adjustments represent approximately 1% of the AOL segment’s total revenues for that same two-year period, approximately 3.4% of its advertising and commerce revenues, approximately 1.9% of its EBITDA and approximately 2.1% of its operating income. The largest impact of the adjustments is in the quarter ended September 30, 2000, where advertising and commerce revenues will be reduced by $66 million, both EBITDA and operating income will be reduced by $30 million and net income will be reduced by $18 million. The restatement will result in a decrease in basic earnings per share of $0.01 in both the third and fourth quarters of 2000.

         It is expected that the audited financial statements for the affected periods will be filed with the Securities and Exchange Commission (“SEC”) in the fourth quarter of 2002. Until such time, the Company’s financial statements for the affected periods, including the audited financial statements contained in the 2001 Annual Report on Form 10-K, should no longer be relied upon as a result of the announced restatement.

         The financial results presented in this report reflect the impact of the adjustments that will be made in the restatement of the Company’s financial results. For the three months ended September 30, 2001, the total impact of

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

these adjustments is a reduction of both the AOL segment’s and the Company’s consolidated advertising and commerce revenues of $16 million, with corresponding reductions in EBITDA of $6 million, operating income of $2 million and consolidated net income of $1 million. For the nine months ended September 30, 2002 and 2001, the total impact is a reduction of the Company’s consolidated advertising and commerce revenues of $12 million and $72 million, respectively, with corresponding reductions in EBITDA of $14 million and $14 million, respectively, operating income of $10 million and $7 million, respectively and net income of $2 million and $4 million, respectively. For the AOL segment, for the nine months ended September 30, 2002 and 2001, the impact of these adjustments is a reduction of advertising and commerce revenues of $6 million and $57 million, respectively, with corresponding reductions in EBITDA of $14 million and $14 million, respectively, and operating income of $10 million and $7 million, respectively. The remaining impact on the Company’s consolidated advertising and commerce revenues of $6 million and $15 million for the nine months ended September 30, 2002 and 2001, respectively, represents a reduction in revenues from certain transactions related to the AOL segment in which the advertising was delivered by other AOL Time Warner segments.

         The SEC and the Department of Justice (“DOJ”) are investigating the financial reporting and disclosure practices of the Company. The Company will continue its efforts to cooperate with the investigations. The Company is unable to predict the outcome of these investigations. Refer to Note 12 and Part II, Item 1 for additional information regarding the investigations.

Investment in Time Warner Entertainment Company, L.P.

         A majority of AOL Time Warner’s interests in the Filmed Entertainment and Cable segments, and a portion of its interests in the Networks segment, are held through Time Warner Entertainment Company, L.P. (“TWE”). Prior to the change in ownership discussed below, AOL Time Warner owned general and limited partnership interests in TWE consisting of 74.49% of the pro rata priority capital (“Series A Capital”) and residual equity capital (“Residual Capital”), and 100% of the junior priority capital (“Series B Capital”). The remaining 25.51% limited partnership interests in the Series A Capital and Residual Capital of TWE were held by subsidiaries of AT&T Corp. (“AT&T”).

         During the second quarter of 2002, AT&T exercised a one-time option to increase its ownership in the Series A Capital and Residual Capital of TWE. As a result, on May 31, 2002, AT&T’s interest in the Series A Capital and Residual Capital of TWE increased by approximately 2.13% to approximately 27.64% and AOL Time Warner’s corresponding interest in the Series A Capital and Residual Capital of TWE decreased by approximately 2.13% to approximately 72.36%. In accordance with Staff Accounting Bulletin No. 51, “Accounting for Sales of Stock of a Subsidiary”, AOL Time Warner has reflected the pretax impact of the dilution of its interest in TWE of approximately $690 million as an adjustment to paid-in capital (Note 6).

         In August 2002, AOL Time Warner and AT&T announced that they had agreed to restructure TWE. As part of the restructuring, AOL Time Warner will acquire complete ownership of TWE’s content assets, including Warner Bros. and Home Box Office, as well as TWE’s interests in The WB Network, Comedy Central and Court TV. In addition, almost all of AOL Time Warner’s interests in TWE and all of its interests in cable television systems held through wholly-owned subsidiaries will be contributed to an existing subsidiary of AT&T that will become a subsidiary of AOL Time Warner and be renamed “Time Warner Cable Inc.” In connection with the restructuring, AT&T will receive $2.1 billion in cash and AOL Time Warner common stock valued at $1.5 billion at the time of the closing of the restructuring and will retain both a 17.9% economic stake in Time Warner Cable Inc.

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

and a 4.7% economic stake in TWE. AT&T’s combined interests in Time Warner Cable Inc. and TWE will result in AT&T holding an approximately 21% economic interest in the business of Time Warner Cable Inc. AT&T’s 17.9% economic stake in Time Warner Cable Inc. will represent approximately a 10.7% voting interest in Time Warner Cable Inc. The Company anticipates that the restructuring will be completed in early 2003, upon the receipt of local cable franchise approvals, where required, and other required regulatory approvals. Clearance under the Hart-Scott-Rodino Antitrust Improvement Act of 1976 has been received.

         Based upon its controlling voting interest in Time Warner Cable Inc., AOL Time Warner will consolidate the results of Time Warner Cable Inc. for accounting purposes. At the closing of the restructuring, it is anticipated that Time Warner Cable Inc. will have approximately $8.1 billion in consolidated net debt and preferred equity. Subject to market conditions, AOL Time Warner plans to conduct an initial public offering of Time Warner Cable Inc. soon after the closing of the restructuring. It is anticipated that the first $2.1 billion raised in any such offering would be used to pay off Time Warner Cable Inc. debt incurred to fund the $2.1 billion cash payment to AT&T. Thereafter, AT&T will have certain priority registration rights with respect to its stake in Time Warner Cable Inc. (Note 6).

Restructuring of TWE-Advance/Newhouse Partnership and Road Runner

         As of June 30, 2002, the TWE-Advance/Newhouse Partnership (“TWE-A/N”) was owned approximately 64.8% by TWE, the managing partner, 33.3% by the Advance/Newhouse Partnership (“Advance/Newhouse”) and 1.9% indirectly by AOL Time Warner. Prior to August 1, 2002, the financial position and operating results of TWE-A/N were consolidated by AOL Time Warner and TWE, and the partnership interest owned by Advance/Newhouse was reflected in the consolidated financial statements of AOL Time Warner and TWE as minority interest. In addition, Road Runner, a high-speed cable modem Internet service provider, was owned by TWI Cable Inc. (a wholly owned subsidiary of AOL Time Warner), TWE and TWE-A/N, with AOL Time Warner owning approximately 65% on a fully attributed basis (i.e., after considering the portion attributable to the minority partners of TWE and TWE-A/N). AOL Time Warner’s interest in Road Runner was previously accounted for using the equity method of accounting prior to the restructuring because of certain approval rights held by Advance/Newhouse, a partner in TWE-A/N.

         On June 24, 2002, TWE and Advance/Newhouse agreed to restructure TWE-A/N, which, on August 1, 2002 (the “Debt Closing Date”), resulted in Advance/Newhouse assuming responsibility for the day-to-day operations of certain TWE-A/N cable systems serving approximately 2.1 million subscribers located primarily in Florida (the “Advance/Newhouse Systems”). The restructuring is anticipated to be completed by the end of 2002, upon the receipt of certain regulatory approvals. On the Debt Closing Date, Advance/Newhouse and its affiliates arranged for a new credit facility to support the Advance/Newhouse Systems and assumed and repaid approximately $780 million of TWE-A/N’s senior indebtedness. As of the Debt Closing Date, Advance/Newhouse assumed responsibility for the day-to-day operations of the Advance/Newhouse Systems. As a result, AOL Time Warner and TWE have deconsolidated the financial position and operating results of these systems. Additionally, all prior period results associated with the Advance/Newhouse Systems, including the historical minority interest allocated to Advance/Newhouse’s interest in TWE-A/N, have been reflected as a discontinued operation for all periods presented. Under the new TWE-A/N Partnership Agreement, effective as of the Debt Closing Date, Advance/Newhouse’s partnership interest tracks only the economic performance of the Advance/Newhouse Systems, including associated liabilities, while AOL Time Warner retains all of the economic interests in the other TWE-A/N assets and liabilities.

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

         As part of the restructuring of TWE-A/N, on the Debt Closing Date, AOL Time Warner effectively acquired Advance/Newhouse’s interest in Road Runner, thereby increasing its ownership to approximately 82% on a fully attributed basis. As a result of the termination of Advance/Newhouse’s minority rights in Road Runner, AOL Time Warner has consolidated the financial position and results of operations of Road Runner with the financial position and results of operations of AOL Time Warner’s Cable segment. As permitted under generally accepted accounting principles, the Company has consolidated the results of Road Runner retroactive to the beginning of the year.

         In connection with the TWE-A/N restructuring, AOL Time Warner recognized a noncash pretax gain of approximately $1.4 billion. Of this gain, approximately $1.2 billion related to the difference between the carrying value and fair value of AT&T’s interest in the Advance/Newhouse Systems, with the fair value being determined by reference to the fair value of AT&T’s additional interest acquired in the remaining TWE-A/N systems. This gain is included as part of discontinued operations in the accompanying consolidated statement of operations. However, because this gain relates in large part to AT&T’s interest in TWE-A/N, it is substantially offset by minority interest expense, which is similarly included as part of discontinued operations. The remaining pretax gain of $188 million relates to the amount that the fair value of AOL Time Warner’s acquired interest in the TWE-A/N systems remaining under the control of AOL Time Warner exceeded the carrying value of AOL Time Warner’s interest in the Advance/Newhouse Systems, and primarily relates to the portion of TWE-A/N debt assumed by Advance/Newhouse in excess of its pro rata share in effective compensation for certain adverse tax consequences to the Company as a result of the restructuring. The gain is significantly less than the gain recognized by AT&T because the carrying value of AOL Time Warner’s interest in TWE-A/N, including its interest in the Advance/Newhouse Systems, was recently adjusted to fair value as part of the purchase accounting for the Merger. The $188 million pretax gain is also included as part of discontinued operations of AOL Time Warner for the three and nine month periods ended September 30, 2002. Exclusive of the gains associated with these transactions, the impact of the TWE-A/N restructuring on AOL Time Warner’s consolidated net income is substantially mitigated because the earnings of TWE-A/N attributable to Advance/Newhouse’s historical one-third interest was reflected as minority interest expense. As stated previously, this historical minority interest expense is currently classified as part of the discontinued operations for all periods presented. Additionally, there is no impact on AOL Time Warner’s consolidated net income of consolidating Road Runner since the Company had previously accounted for its interest in Road Runner under the equity method of accounting.

Sale of Columbia House

         In June 2002, AOL Time Warner and Sony Corporation of America reached a definitive agreement to each sell 85% of its 50% interest in the Columbia House Company Partnerships (“Columbia House”) to Blackstone Capital Partners III LP (“Blackstone”), an affiliate of The Blackstone Group, a private investment bank. The sale has resulted in the Company recognizing a pretax gain of approximately $59 million, which is included in other expense, net, in the accompanying consolidated statement of operations. In addition, the Company has deferred an approximate $28 million gain on the sale. The deferred gain primarily relates to the estimated fair value of the portion of the proceeds received as a note receivable, which will be deferred until such time as the realization of such note becomes more fully assured. As a result of the sale, the Company’s interest in Columbia House has been reduced to 7.5%. As part of the transaction, AOL Time Warner will continue to license music and video product to Columbia House for a five-year period (Note 4).

$10 Billion Revolving Credit Facilities

         In July 2002, AOL Time Warner, together with certain of its consolidated subsidiaries, entered into two

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

new senior unsecured long-term revolving bank credit agreements with an aggregate borrowing capacity of $10 billion (the “2002 Credit Agreements”) and terminated three existing bank credit facilities with an aggregate borrowing capacity of $12.6 billion (the “Old Credit Agreements”), which were scheduled to expire during 2002. The 2002 Credit Agreements are comprised of a $6 billion five-year revolving credit facility and a $4 billion 364-day revolving credit facility, borrowings under which may be extended for a period up to two years following the initial term. The borrowers under the 2002 Credit Agreements are AOL Time Warner, TWE, TWE-A/N and AOL Time Warner Finance Ireland. Borrowings bear interest at specific rates, generally based on the credit rating for each of the borrowers, which is currently equal to LIBOR plus .625%, including facility fees of .10% and .125% on the total commitments of the 364-day and five-year facilities, respectively. In addition, the Company is required to pay an additional usage fee of .0625% if the two facilities in the aggregate have more than 33% outstanding and .125% if the facilities have more than 66% outstanding. Currently, the Company is paying the additional  .0625% usage fee. The 2002 Credit Agreements provide same-day funding, multi-currency capability and letter of credit availability. They contain maximum leverage ratio and minimum GAAP net worth covenants of 4.5 times and $50 billion, respectively, for AOL Time Warner and a maximum leverage ratio covenant of 5.0 times for each of TWE and TWE-A/N, but do not contain any credit ratings-based defaults or covenants, nor an ongoing covenant or representation specifically relating to a material adverse change in the Company’s financial condition or results of operations. Borrowings may be used for general business purposes and unused credit is available to support commercial paper borrowings (Note 9).

RESULTS OF OPERATIONS
Transactions Affecting Comparability of Results of Operations

         AOL Time Warner’s results for 2002 have been impacted by the following transactions and events that cause them not to be comparable to the results reported in 2001.

•      New Accounting Standard for Goodwill and Other Intangible Assets. During 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 142 “Goodwill and Other Intangible Assets” (“FAS 142”), which requires that, effective January 1, 2002, goodwill, including the goodwill included in the carrying value of investments accounted for using the equity method of accounting, and certain other intangible assets deemed to have an indefinite useful life, cease amortizing (Note 3).

•     Consolidation of AOL Europe, S.A. (“AOL Europe”). On January 31, 2002, AOL Time Warner acquired 80% of Bertelsmann AG’s (“Bertelsmann”) 49.5% interest in AOL Europe for $5.3 billion in cash and on July 1, 2002 acquired the remaining 20% of Bertelsmann’s interest for $1.45 billion in cash (Note 5). As a result of the purchase of Bertelsmann’s interest in AOL Europe, AOL Time Warner has a majority interest in and began consolidating AOL Europe, retroactive to the beginning of 2002.

•     Consolidation of IPC Group Limited (“IPC”). In October 2001, AOL Time Warner’s Publishing segment acquired IPC, the parent company of IPC Media, from Cinven, one of Europe’s leading private equity firms, for approximately $1.6 billion.

•     Consolidation of Road Runner. In August 2002, AOL Time Warner’s Cable segment acquired Advance/Newhouse’s 17% indirect ownership in Road Runner, increasing the Company’s fully attributed ownership to approximately 82%. As a result of the termination of Advance/Newhouse’s minority rights in Road Runner, AOL Time Warner has consolidated the financial position and results of operations of Road Runner with the financial

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

position and results of operations of AOL Time Warner’s Cable segment. As permitted under generally accepted accounting principles, the Company has consolidated the results of Road Runner retroactive to the beginning of 2002.

Discontinued Operations

         As previously discussed in “Restructuring of TWE-Advance/Newhouse Partnership and Road Runner,” the Company’s results of operations have been adjusted to reflect the results of the Advance/Newhouse Systems as a discontinued operation for all periods presented. For the six months ended June 30, 2002, the net impact of the deconsolidation of these systems was a reduction of the Cable segment’s previously reported revenues, EBITDA and operating income of $715 million, $333 million and $206 million, respectively. For the three months ended September 30, 2001, the net impact of the deconsolidation of the Advance/Newhouse Systems was a reduction of the Cable segment’s reported revenues, EBITDA and operating income of $316 million, $141 million and $74 million, respectively. For the nine months ended September 30, 2001, the net impact was a reduction of the Cable segment’s reported revenues, EBITDA and operating income of $912 million, $412 million and $225 million, respectively. In addition, as of December 31, 2001, the Advance/Newhouse Systems had current assets and total assets of approximately $64 million and $2.7 billion, respectively, and current liabilities and total liabilities of approximately $210 million and $963 million, respectively, including debt assumed in the restructuring.

New Accounting Standards

         In addition to the transactions previously discussed, in the first quarter of 2002, the Company adopted new accounting guidance in several areas that require retroactive restatement of all periods presented to reflect the new accounting provisions.

Reimbursement of “Out-of-Pocket” Expenses

         In January 2002, the FASB’s Emerging Issues Task Force (“EITF”) reached a consensus on EITF Issue No. 01-14, “Income Statement Characterization of Reimbursements Received for ‘Out-of-Pocket’ Expenses Incurred” (“EITF 01-14”). EITF 01-14 requires that reimbursements received for out-of-pocket expenses be classified as revenue on the income statement and was effective for AOL Time Warner in the first quarter of 2002. The new guidance requires retroactive restatement of all periods presented to reflect the new accounting provisions. This change in revenue classification impacts AOL Time Warner’s Cable and Music segments, resulting in an increase in both revenues and costs of approximately $92 million for the third quarter of 2001 and $287 million for the first nine months of 2001.

Emerging Issues Task Force Issue No. 01-09

         In April 2001, the FASB’s EITF reached a final consensus on EITF Issue No. 00-25, “Vendor Income Statement Characterization of Consideration Paid to a Reseller of the Vendor’s Products,” which was later codified along with other similar issues, into EITF 01-09, “Accounting for Consideration Given by a Vendor to a Customer or a Reseller of the Vendor’s Products” (“EITF 01-09”). EITF 01-09 was effective for AOL Time Warner in the first quarter of 2002. EITF 01-09 clarifies the income statement classification of costs incurred by a vendor in connection with the reseller’s purchase or promotion of the vendor’s products, resulting in certain cooperative advertising and product placement costs previously classified as selling expenses to be reflected as a reduction of revenues earned from that activity. The new guidance impacts AOL Time Warner’s AOL, Music and Publishing segments. As a

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

result of applying the provisions of EITF 01-09, the Company’s revenues and costs each were reduced by an equal amount of approximately $44 million in the third quarter of 2001 and $154 million for the first nine months of 2001.

Other Significant Transactions and Nonrecurring Items

         As more fully described herein and in the related footnotes to the accompanying consolidated financial statements, the comparability of AOL Time Warner’s operating results has been affected by certain significant transactions and nonrecurring items in each period.

2002 Other Significant Transactions and Nonrecurring Items

         AOL Time Warner’s operating results for the nine months ended September 30, 2002 included (i) merger and restructuring costs of $184 million ($107 million in the first quarter and $77 million in the third quarter)(Note 2), (ii) a noncash pretax charge of $1.678 billion ($581 million in the first quarter, $364 million in the second quarter and $733 million in the third quarter) to reduce the carrying value of certain investments that experienced other-than-temporary declines in market value (Note 4), (iii) an approximate $59 million gain in the second quarter on the sale of a portion of the Company’s interest in Columbia House (Note 4) and (iv) an approximate $31 million gain in the second quarter on the redemption of a portion of the Company’s interest in TiVo Inc. (“TiVo”) (Note 4).

2001 Other Significant Transactions and Nonrecurring Items

         For the nine months ended September 30, 2001, AOL Time Warner’s operating results included (i) merger-related costs of approximately $205 million ($71 million in the first quarter and $134 million in the third quarter) (Note 2) and (ii) a noncash pretax charge of approximately $816 million ($620 million in the first quarter and $196 million in the third quarter) to reduce the carrying value of certain investments that experienced other-than-temporary declines in market value and to reflect fluctuations in derivative instruments (Note 4).

         The impact of the significant transactions and nonrecurring items discussed above on the operating results for the three and nine months ended September 30, 2002 and 2001 is as follows:

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

FAS 142

         In addition, the Company adopted, effective January 1, 2002, new accounting rules for goodwill and certain intangible assets. Among the requirements of the new rules is that goodwill and certain intangible assets be assessed for impairment using fair value measurement techniques. During the first quarter of 2002, the Company completed its impairment review and recorded a $54 billion noncash pretax charge for the impairment of goodwill, substantially all of which was generated in the Merger. The charge reflects overall market declines since the Merger was announced in January 2000, is non-operational in nature and reflected as a cumulative effect of an accounting change in the accompanying consolidated financial statements (Note 3).

         The Company will perform its annual impairment review during the fourth quarter of each year, commencing in the fourth quarter of 2002. While the Company’s overall goodwill impairment analysis will not be completed until the fourth quarter, based on the current market capitalization of AOL Time Warner as implied by the Company’s stock price, lower than expected performance at the AOL segment, and current market conditions in the cable industry, management believes that it is probable that a substantial overall goodwill impairment has occurred as of September 30, 2002. At this time, management is unable to reasonably estimate the magnitude of such an impairment. The factors that will affect the magnitude of impairment include management’s revised operating plan of the AOL segment, the results of the Company’s overall current budgeting and long-term plan process, and a valuation of assets (including unrecognized intangible assets) and liabilities, all of which will be completed in the fourth quarter. Additionally, the magnitude of any impairment will take into consideration AOL Time Warner’s overall market capitalization as well as the extent to which the stock price of comparable companies in the cable industry continue to experience a sustained decline in values. Any impairment charge would be noncash in nature and, therefore, is not expected to affect the Company’s liquidity or result in the non-compliance with any debt covenants, including the covenant to maintain at least $50 billion of GAAP net worth contained in the 2002 Credit Agreements. In addition, the Company would record any such noncash charge as a component of operating income.

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

Three Months Ended September 30, 2002 Compared to Three Months Ended September 30, 2001

         Revenues and EBITDA by business segment are as follows (in millions):

Consolidated Results

         Revenues. AOL Time Warner’s revenues increased to $9.983 billion in 2002, compared to $9.068 billion in 2001. This overall increase in revenues was driven by an increase in Subscription revenues of 21% to $4.818 billion and an increase in Content and Other revenues of 8% to $3.467 billion, offset in part by a decrease in Advertising and Commerce revenues of 10% to $1.698 billion.

         As discussed more fully below, the increase in Subscription revenues was principally due to increases in the number of subscribers and in subscription rates at the AOL, Cable and Networks segments, as well as the impact of the acquisitions of AOL Europe and IPC and the consolidation of Road Runner. The increase in Content and Other revenues was principally due to increased revenue at the Filmed Entertainment segment, principally related to improved worldwide home video results, offset in part by lower results at the AOL segment, primarily related to the termination of the iPlanet alliance with Sun Microsystems, Inc. (“Sun Microsystems”) in the third quarter of 2001.

         The decline in Advertising and Commerce revenues compared to 2001 was due to lower advertising revenues (from $1.572 billion to $1.388 billion) principally related to the AOL segment, due to the continued weakness in online advertising sales and the decline in the current benefit from prior period contract sales, which are expected to continue into 2003. However, excluding the AOL segment, advertising revenues increased 9% primarily

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

related to growth at both the Networks and Publishing segments, including the impact of the acquisition of IPC. Commerce revenues ($310 million in 2002 and $308 million in 2001) were essentially flat.

         Intersegment Revenues. AOL Time Warner’s intersegment revenues increased to $796 million in 2002 compared to $462 million in 2001. The increase in intersegment revenues was principally due to an increase in film product sold by the Filmed Entertainment segment to the Company’s Networks segment. In addition, intersegment advertising and commerce revenues increased to $138 million in 2002 from $97 million in 2001. Since intersegment revenues are eliminated in consolidation, they do not impact the Company’s consolidated results.

         Corporate. AOL Time Warner’s corporate EBITDA loss increased to $87 million in 2002 from $74 million in 2001. The increase in the EBITDA loss was principally due to legal and other professional fees related to the SEC and DOJ investigations into the accounting practices of the Company, which are expected to continue into 2003.

         Depreciation and Amortization. Depreciation and amortization decreased to $777 million in 2002 from $2.229 billion in 2001. This decrease was due to a decrease in amortization expense to $181 million in 2002 from $1.784 billion in 2001 due to the adoption of FAS 142, which resulted in goodwill and certain intangible assets ceasing to be amortized. The decrease was offset in part by an increase in depreciation expense to $596 million in 2002 from $445 million in 2001. The increase in depreciation expense reflects higher levels of capital spending at the Cable segment related to the roll-out of digital services over the past three years and increased capital spending on equipment that varies with the number of new subscribers and is depreciated over a shorter useful life. In addition, depreciation at the AOL segment increased primarily due to an increase in network assets acquired as well as a decrease in the useful life of certain network assets.

         Operating Income (Loss). AOL Time Warner’s operating income increased to $1.315 billion in 2002 from an operating loss of $47 million in 2001. The improvement primarily related to a decrease in amortization expense due to the adoption of FAS 142, offset in part by a decrease in EBITDA, which is discussed in detail under “Business Segment Results,” and an increase in depreciation expense.

         Interest Expense, Net. Interest expense, net, increased to $489 million in 2002, from $341 million in 2001 due principally to incremental borrowings to purchase AOL Europe and IPC, the change in the mix of debt to higher fixed rate borrowings and reduced interest income due to the automatic conversion of the Company’s investment in Hughes Electronics Corp. (“Hughes”) from interest-bearing preferred stock to common stock in June 2002.

         Other Expense, Net. Other expense, net, increased to $851 million in 2002 from $437 million in 2001. Other expense, net, in each period included pretax noncash charges to reduce the carrying value of certain investments that experienced an other-than-temporary decline in value (Note 4). In 2002, this charge was approximately $733 million, primarily related to the Company’s investments in Hughes and America Online Latin America, Inc. (“AOL Latin America”). In 2001, the Company recorded a charge of approximately $196 million. Excluding these charges, other expense, net, decreased by $123 million in 2002 compared to 2001, primarily due to a reduction of losses from equity method investees related to reduced amortization associated with the adoption of FAS 142.

         Depending upon general market conditions and the performance of individual investments in the Company’s portfolio, the Company may be required in the future to record additional noncash charges to reduce the carrying value of individual investments to their fair value for other-than-temporary declines. In addition to investments in the Company’s portfolio as of September 30, 2002, the Company is committed to provide up to an

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additional $89 million in funding to AOL Latin America prior to December 31, 2002 in exchange for senior convertible notes. Based upon the financial condition of AOL Latin America and general market conditions, the Company may be required to record an additional noncash charge related to this investment. Any such noncash charge would be unrelated to the Company’s core operations and would be recorded in other expense, net (Note 4). Excluding equity method investees, as of September 30, 2002, the fair value and carrying value of the Company’s portfolio were approximately $1.742 billion and $1.699 billion, respectively.

         Minority Interest Income (Expense). Minority interest income (expense) was $55 million of expense in 2002, compared to $12 million of minority interest income in 2001. The 2002 expense primarily reflects the impact of adopting FAS 142, which resulted in a reduction in amortization expense at the Company’s partially owned consolidated investees, thereby resulting in higher income attributable to minority partners.

         Income Tax Provision. AOL Time Warner had an income tax benefit of $25 million in 2002, compared to income tax expense of $174 million in 2001. The effective tax rate in each period differs from the 35% U.S. federal statutory rate as a result of several factors, including the Company’s pretax income relative to the amount of non-temporary differences (i.e., certain financial statement expenses that are not deductible for income tax purposes), foreign income taxed at different rates and state and local income taxes. The most significant non-temporary difference in 2002 relates to foreign losses with no tax benefit and in 2001 relates to nondeductible amortization of goodwill.

         As of September 30, 2002, the Company had net operating loss carryforwards of approximately $12.0 billion, primarily resulting from stock option exercises. These carryforwards are available to offset future U.S. Federal taxable income and are, therefore, expected to reduce Federal income taxes paid by the Company. If the net operating losses are not utilized, they expire in varying amounts, starting in 2011 through 2021.

         Net Income (Loss) and Net Income (Loss) Per Common Share. AOL Time Warner had net income of $57 million in 2002 compared to a net loss of $997 million in 2001. Basic and diluted net income per common share was $0.01 in 2002 compared to basic and diluted net loss per common share of $0.22 in 2001.

         As previously described and summarized in the table on page 9, the comparability of the Company’s operating results for 2002 and 2001 have been affected by the recognition of certain significant and nonrecurring items. These items totaled pretax losses of $810 million in 2002 and $330 million in 2001. In addition, beginning in the third quarter of 2002, the Company has reported the results of the Advance/Newhouse Systems as a discontinued operation for all periods presented. The impact of the discontinued operations was income of $112 million in 2002, primarily relating to a gain on the disposition of the Advance/Newhouse Systems compared to a loss of $10 million in 2001. Excluding the impact of the significant and nonrecurring items and the discontinued operations, the Company’s normalized net income from continuing operations was $431 million in 2002 compared to a loss of $789 million in 2001. Similarly, the normalized basic and diluted net income from continuing operations per common share was $0.10 in 2002 compared to a loss of $0.18 per share in 2001. The improvement primarily reflects reduced amortization associated with the adoption of FAS 142, offset in part by an overall decrease in AOL Time Warner’s EBITDA and increased depreciation expense, interest expense, net, and other expense, net.

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Management Evaluation

         As noted above, the acquisition of AOL Europe and IPC, the consolidation of Road Runner, as well as the implementation of FAS 142, significantly impacted the comparability of AOL Time Warner’s 2002 results. In addition, other significant transactions and nonrecurring items occurred in each year, which also impacted the comparability of the Company’s results. As such, in reviewing the performance of its businesses, management also evaluates the Company’s results assuming that the acquisitions of AOL Europe and IPC, the consolidation of Road Runner and the adoption of FAS 142 occurred as of the beginning of 2001. In addition, management evaluates results excluding the previously discussed other significant transactions and nonrecurring items. Giving effect to these items, the Company’s total revenues would have increased 6% (from $9.417 billion to $9.983 billion), EBITDA would have decreased 1% (from $2.187 billion to $2.169 billion), operating income would have declined 11% (from $1.570 billion to $1.392 billion) and income from continuing operations would have declined 27% (from $592 million to $431 million).

Business Segment Results

         AOL. Revenues increased 2% to $2.215 billion in 2002, compared to $2.173 billion in 2001. EBITDA decreased 41% to $432 million in 2002, compared to $736 million in 2001.

         Revenues benefited from a 33% increase in Subscription revenues (from $1.374 billion to $1.827 billion), which was offset in part by a 47% decrease in Advertising and Commerce revenues (from $601 million to $321 million) and a 66% decrease in Content and Other revenues (from $198 million to $67 million).

         The growth in subscription revenues was primarily related to the acquisition of AOL Europe in 2002, as well as domestic revenue growth. Domestically, subscription revenues increased 11% and were principally driven by membership growth. The number of AOL brand subscribers in the U.S. was 26.7 million at September 30, 2002 compared to 24.2 million at September 30, 2001. The average monthly subscription revenue per domestic subscriber for the quarter increased 2% to $18.34 as compared to $18.06 in the prior year quarter. This increase is due to the standard unlimited rate increase of $1.95 per month to $23.90 (effective beginning in July 2001) and a shift in the mix of members to new higher premium rate plans. These increases were offset in part by new member acquisition programs and member service and retention programs that offer incentives in the form of discounts and free months to AOL’s members.

         The majority of AOL’s domestic subscribers are on standard unlimited pricing plans. Additionally, AOL has entered into certain bundling programs with original equipment manufacturers (“OEMs”) that generally do not result in subscription revenues during introductory periods, as well as the sale of bulk subscriptions at a discounted rate to AOL’s selected strategic partners for distribution to their employees. As of September 30, 2002, of the 26.7 million domestic AOL members, approximately 82% were on standard unlimited pricing plans (including 11% under various free trial, member service and retention programs), 13% were on lower priced plans, including Bring Your Own Access (“BYOA”), bulk employee programs with strategic partners, and limited usage plans (weighted average monthly rate of approximately $11.45), and the remaining 5% were on OEM bundled plans.

         The number of AOL brand subscribers in Europe was 6.1 million at September 30, 2002 and the average monthly subscription revenue per European subscriber for the third quarter of 2002 was $15.48. This compares to AOL brand subscribers in Europe of 5.0 million at September 30, 2001 and average monthly subscription revenue per European subscriber for the third quarter of 2001 of $12.97. The average monthly subscription revenue per European subscriber in 2002 was impacted by price increases implemented earlier this year in various European countries offering the AOL service and the positive effect of changes in foreign currency exchange rates.

         The decline in Advertising and Commerce revenues resulted from a decline in advertising revenues (from $547 million to $267 million), as commerce revenues were flat. The decline in advertising revenues is principally

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due to a reduction in benefits from prior period domestic contract sales and continued weakness in online advertising sales, which is expected to extend into 2003. The advertising revenue decline was slightly offset by contributions from AOL Europe. Domestic contractual commitments received in prior periods contributed advertising revenue of $164 million in the 2002 period compared to $431 million in the comparable prior year period. Included in the amount of revenue from domestic contractual commitments received in prior periods was revenue recognized from the termination of contractual commitments, which declined to less than $1 million in the 2002 period compared to $72 million in the comparable prior year period. Also contributing to the decline in advertising is a slight decline in intercompany sales of advertising to other business segments of AOL Time Warner in 2002 compared to 2001 (from $40 million to $37 million). Of the $267 million of advertising revenue in the current quarter, approximately $89 million related to the five most significant domestic advertisers. Similarly, of the $547 million of advertising revenue in the prior year quarter, approximately $185 million related to the five most significant domestic advertisers.

         During the quarter, domestic advertising commitments for future periods declined to $648 million as of September 30, 2002 from approximately $860 million as of June 30, 2002. This compares to advertising commitments of $1.378 billion as of September 30, 2001 and $1.760 billion as of June 30, 2001. During the three months ended September 30, 2002, in addition to the $164 million recognized in revenue, remaining commitments were reduced by approximately $80 million, without any revenue being recognized, to reflect a decline in future consideration to be received related to the termination or restructuring of various contracts. Similarly, during the three months ended September 30, 2001, in addition to the $431 million recognized in revenue, remaining commitments were reduced by approximately $20 million, without any revenue being recognized, to reflect a decline in future consideration to be received related to the termination or restructuring of various contracts. Included in the $648 million of advertising commitments for future periods as of September 30, 2002 are approximately $217 million of commitments for the five largest commitments. Similarly, included in the $1.378 billion of advertising commitments for future periods as of September 30, 2001 are $442 million of commitments for the five largest commitments.

         The Company expects to complete performance on a majority of the remaining domestic advertising commitments by the end of 2003. Further declines in future consideration to be received, and revenue that would otherwise be recognized, could occur from additional terminations or restructurings of such commitments. As services under certain large longer term contracts signed in previous periods are completed, the Company expects to enter into fewer long term contracts as the Company develops its online advertising strategy, reducing its reliance on long-term arrangements, including arrangements which involve significant non-advertising components, as the market continues to migrate to more traditional short-term advertiser arrangements. The Company expects that the level of advertising commitments for future periods will decline as traditional advertiser arrangements typically involve shorter terms. The Company is uncertain whether the amount of revenue from the more traditional short-term advertising arrangements will reach the levels of current and prior advertising revenue even if the online advertising market improves. The Company also is uncertain of its ability to replace or renew advertising sales for some of its largest advertisers.

         The decrease in Content and Other revenues is primarily due to the termination of AOL’s iPlanet alliance with Sun Microsystems in the third quarter of 2001, which contributed approximately $131 million of revenue and approximately $129 million of EBITDA during the third quarter of 2001. This was offset in part by $30 million of intercompany network revenues which are derived primarily through network services provided to Road Runner, which began in November 2001.

         The decline in EBITDA is primarily due to the advertising revenue shortfall, the absence of revenues from the iPlanet alliance and an increase in domestic marketing expenses. EBITDA was also impacted by an increase in

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intercompany advertising purchased by AOL on properties of other AOL Time Warner business segments (from $64 million to $68 million), including advertising purchased on Time Warner Cable properties in support of the rollout of AOL Broadband services. In the third quarter of 2002, EBITDA losses at AOL Europe were $1 million. It is expected that fourth quarter losses at AOL Europe will increase compared to the current quarter, due to seasonal increases in marketing efforts as well as member usage and, the rate of year over year improvement will slow in 2003.

         The current year results are significantly impacted by the acquisition of AOL Europe as discussed above. Accordingly, management also evaluates the current period results assuming the operations of AOL Europe were consolidated beginning January 1, 2001. Assuming such consolidation as of January 1, 2001, AOL’s revenues would have decreased by 7% to $2.215 billion in 2002, compared to $2.378 billion in 2001. Subscription revenues would have increased by 15% to $1.827 billion in 2002, compared to $1.586 billion in 2001, Advertising and Commerce revenues would have decreased 48% to $321 million in 2002, compared to $612 million in 2001, Content and Other revenues would have decreased 63% to $67 million in 2002, as compared to $180 million in 2001, and EBITDA would have decreased 30% to $432 million in 2002, compared to $617 million in 2001.

         Cable. Revenues increased 15% to $1.753 billion in 2002 compared to $1.525 in 2001. EBITDA increased 5% to $680 million in 2002 from $650 million in 2001.

         Revenues increased due to a 16% increase in Subscription revenues (from $1.381 billion to $1.601 billion) and a 6% increase in Advertising and Commerce revenues (from $144 million to $152 million). The increase in Subscription revenues was due to higher basic cable rates, increases in high-speed data services subscribers, digital cable subscribers and basic cable subscribers, as well as the impact of the consolidation of Road Runner in 2002. In 2002, as compared to the prior year comparable period, high-speed data subscribers increased by 69% to 2.313 million, digital cable subscribers increased by 47% to 3.456 million and basic cable subscribers increased by 1.5% to 10.862 million. In addition, total customer relationships, representing the number of customers that receive at least one level of service, increased by 4% to approximately 11.2 million as of September 30, 2002 compared to approximately 10.8 million as of September 30, 2001 and revenue generating units, representing the total of all analog video, digital video, high-speed data and telephony customers, increased by 16% to approximately 16.6 million in 2002 compared to approximately 14.4 million in 2001. The Company’s subscriber amounts include subscribers at both consolidated entities and investees accounted for under the equity method of accounting. High speed data subscribers include residential subscribers, as well as commercial and bulk (e.g., apartment buildings and universities) subscribers. Due to their nature, commercial and bulk subscribers are charged at a higher amount than residential subscribers. The number of commercial and bulk high speed data subscribers is calculated by dividing commercial and high speed data revenue by the lower average rate charged to residential customers.

         The increase in Advertising and Commerce revenues was primarily related to higher intercompany sales of advertising to other business segments of AOL Time Warner (from $11 million to $31 million) offset in part by lower levels of advertising purchased by programming vendors to promote their channels, including new channel launches (from $36 million to $19 million). The Company expects fourth quarter 2002 advertising sales to programming vendors to be below fourth quarter 2001 levels and overall 2003 amounts to be lower than 2002.

         EBITDA increased principally as a result of the revenue gains, offset in part by increases in programming and other operating costs and the consolidation of Road Runner in 2002. Video programming costs increased 19%, relating to general programming rate increases across both basic and digital services, the addition of new

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programming services and higher basic and digital subscriber levels. Programming costs are expected to continue to increase as general programming rates increase and digital services continue to be rolled out. Other operating costs increased as a result of the roll out of new services and higher development spending in the Interactive Personal Video division (from $0 to $9 million).

         As noted above, the consolidation of Road Runner effective January 1, 2002 significantly impacted the comparability of the Cable segment’s 2002 results by increasing revenues and decreasing EBITDA. As such, management of the Company also evaluates the results of the Cable segment assuming that the results of Road Runner were included in both periods. Assuming that the results of Road Runner were included in both periods, total revenues would have increased 14% (from $1.543 billion to $1.753 billion), Subscription revenues would have increased 15% (from $1.398 billion to $1.601 billion) and EBITDA would have increased 11% (from $612 million to $680 million).

         Filmed Entertainment. Revenues increased 25% to $2.643 billion in 2002, compared to $2.112 billion in 2001. EBITDA increased 8% to $331 million in 2002, compared to $307 million in 2001.

         Revenues increased and EBITDA decreased at Warner Bros. while revenues and EBITDA increased at the filmed entertainment businesses of Turner Broadcasting System, Inc. (the “Turner filmed entertainment businesses”), which include New Line Cinema, Castle Rock and the former film and television libraries of Metro-Goldwyn-Mayer, Inc. and RKO pictures.

         For Warner Bros., the revenue increase was primarily related to international home video performance, including Harry Potter and the Sorcerer’s Stone and Ocean’s Eleven, syndication revenues from the initial availability of Will & Grace and revenues from the sale of cable broadcasting rights to The Drew Carey Show to the cable networks of Turner Broadcasting System, Inc. (the “Turner cable networks”). This was offset in part by the reduction in 2002 of revenues related to the sale of broadcasting rights for Friends and reduced commerce revenues related to the closure of its Studio Stores. For the Turner filmed entertainment businesses, revenues increased primarily due to the home video performance of The Lord of the Rings: The Fellowship of the Ring, revenues from the sale of Seinfeld broadcasting rights to the Turner cable networks and the domestic theatric