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

FORM 10-Q

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

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

Commission File Number 1-15062

TIME WARNER INC.

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

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

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

Yes  x  No     

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

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

TIME WARNER INC.
INDEX TO FORM 10-Q

Table of Contents

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

INTRODUCTION

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

•

Overview. This section provides a general description of Time Warner’s businesses, as well as recent developments that the Company believes are important in understanding the results of operations and financial condition or to anticipate future trends.

•

Results of operations. This section provides an analysis of the Company’s results of operations for the three and six months ended June 30, 2004 compared to the same periods in 2003. This analysis is presented on both a consolidated and a business segment basis. In addition, a brief description is provided of significant 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 June 30, 2004 and cash flows for the six months ended June 30, 2004.

•

Risk factors and caution concerning forward-looking statements. This section provides a description of risk factors that could adversely affect the operations, business or financial results of the Company or its business segments and how certain forward-looking statements made by the Company in this report, including in MD&A and the consolidated financial statements, are based on management’s current expectations about future events, which are inherently susceptible to uncertainty and changes in circumstances.

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

     The Company utilizes Operating Income before Depreciation and Amortization, among other measures, to evaluate the performance of its businesses. Operating Income before Depreciation and Amortization is considered an important indicator of the operational strength of the Company’s businesses. Operating Income before Depreciation and Amortization eliminates the uneven effect across all business segments of considerable amounts of non-cash depreciation of tangible assets and amortization of certain intangible assets that were recognized in business combinations. A limitation of this measure, however, is that it does not reflect the periodic costs of certain capitalized tangible and intangible assets used in generating revenues in the Company’s businesses. Management evaluates the costs of such tangible and intangible assets, the impact of related impairments, as well as asset sales through other financial measures, such as capital expenditures, investment spending and return on capital.

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

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

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

OVERVIEW

     Time Warner is a leading media and entertainment company whose major businesses encompass an array of the most respected and successful media brands. Among the Company’s brands are HBO, CNN, AOL, Time, People, Sports Illustrated, and Time Warner Cable, and the Company has made such films as The Lord of the Rings trilogy, the Harry Potter series and Troy and such television programs as Friends, ER and The West Wing. During the six months ended June 30, 2004, the Company generated revenues of $21.014 billion (up 10% from $19.158 billion in 2003), Operating Income before Depreciation and Amortization of $5.042 billion (up 29% from $3.901 billion in 2003), Operating Income of $3.454 billion (up 45% from $2.387 billion in 2003), Net Income of $1.738 billion (up 19% from $1.460 billion in 2003), Cash Provided by Operations of $3.306 billion (down 13% from $3.795 billion in 2003) and Free Cash Flow of $1.743 billion (down 25% from $2.309 billion in 2003).

Time Warner Businesses

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

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

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

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

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

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

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

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

     High-speed data service has been TWC Inc.’s fastest-growing business over the past several years and is a key driver of its results. However, its rate of subscriber growth has begun to slow, reflecting increasing penetration rates and increased competition from DSL.

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

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

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

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

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

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

     Piracy, including physical piracy as well as online file-sharing, continues to be a significant issue for the filmed entertainment industry. Piracy has expanded from music to movies and television programming due to changes in technology. The Company has taken a variety of actions to combat piracy over the last several years and will continue to do so, both individually and together with industry associations.

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

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

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

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

     The Turner networks generate revenue principally from the sale of advertising time and monthly subscriber fees paid by cable system operators, satellite companies and other affiliates. Turner has benefited from strong ratings and a growing advertising opportunity in the latter months of 2003 and first half of 2004. Keys to Turner’s success are its continued investments in high-quality programming focused on kids, sports, series, movies and news, as well as brand awareness and operating efficiency. In the second quarter of 2004, Turner launched a rebranding of TBS under the “tbs very funny” slogan.

     HBO operates the HBO and Cinemax multichannel pay television programming services, with the HBO service being the nation’s most widely distributed pay television network. HBO generates revenues principally from monthly subscriber fees from cable system operators, satellite companies and other affiliates. An additional source of revenues is from the ancillary sales of its original programming, including The Sopranos, Sex and the City, Six Feet Under and Band of Brothers.

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

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

     Time Inc. publishes more than 130 magazines including Time, People, Sports Illustrated, Entertainment Weekly, Southern Living, In Style, Fortune, Money, Real Simple and Cooking Light. It generates revenues primarily from advertising, magazine circulation and newsstand sales, and drives growth through higher circulation and advertising on existing magazines, acquisitions and the launch of new magazines. Time Inc. also owns IPC Media (the U.K.’s largest magazine company), magazine subscription marketer Synapse Group Inc. and Time4Media (previously Times Mirror Magazines), a leading publisher of leisure-time magazines. In addition, Time Inc. is continuing to invest in new magazine launches, including four launches in 2004. Its direct-selling division, Southern Living At Home, sells home decor products through approximately 35,000 independent consultants at parties hosted in people’s homes throughout the United States.

     Time Warner Book Group’s Warner Books and Little, Brown and Company offer a full range of titles spanning entertainment, literature and informative non-fiction. In the first six months of 2004, Time Warner Book Group had 30 titles on The New York Times bestseller list, including 20 new releases and 10 continuing bestsellers from prior-

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

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

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

Other Key 2004 Developments

Advertising.com

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

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

Urban Cable Works of Philadelphia, L.P.

     Urban Cable Works of Philadelphia, L.P. (“Urban Cable”) is an unconsolidated joint venture of TWC Inc., with approximately 52,000 basic subscribers, that operates cable television systems in Philadelphia, Pennsylvania. Urban Cable is 40% owned by TWC Inc. and 60% owned by an investment group led by Inner City Broadcasting (“Inner City”). Under a management agreement, TWC Inc. is responsible for day-to-day management of Urban Cable. TWC Inc. and Inner City have agreed to settle certain disputes regarding the joint venture. TWC Inc. accrued $27 million in March 2004, based on an estimate of TWC Inc.’s cost to resolve this dispute, and accrued an additional $7 million during the second quarter in connection with the final settlement. TWC Inc. has also agreed to purchase, subject to receipt of applicable regulatory approvals, all of Inner City’s interests in the venture for approximately $53 million in cash. In addition, upon closing, TWC Inc. will eliminate debt and interest owed to it by Urban Cable of $65 million and will assume $58 million of Urban Cable’s third-party debt. This transaction is expected to close before the end of the year. For the six months ended June 30, 2004, Urban Cable’s revenues, Operating Income before Depreciation and Amortization and Operating Income were $24 million, $8 million, and $2 million, respectively.

VIVA Media AG and VIVA Plus

     In June 2004, Turner agreed to sell its 30.6% ownership stake in VIVA Media AG (“VIVA”) and its 49% stake in VIVA Plus to Viacom Inc. (“Viacom”) for approximately 109 million Euros (approximately $132 million). VIVA primarily owns a music television channel in Germany and also operates a portfolio of music channels in other European countries, as well as Brainpool TV GmbH, a major independent television producer in Germany. VIVA Plus is a smaller music television channel that operates in Germany. The Company accounts for these assets as equity investments. This transaction is expected to close in the third quarter of 2004, subject to receipt of applicable regulatory approvals, and is expected to generate a pretax gain of approximately $110 million.

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

Warner Village Cinemas S.P.A.

     Warner Village Cinemas S.P.A. (“Warner Village”) is a joint venture arrangement that operates cinemas in Italy and is owned 45% by Warner Bros., 45% by Village Cinemas International Pty. Ltd. (“Village Cinemas”) and 10% by a third-party investor. In April 2004, Warner Bros. and Village Cinemas agreed that: (i) Warner Bros. would control the voting rights associated with Village Cinemas’ 45% interest and (ii) beginning in March 2007 and continuing for one year, Village Cinemas can request that Warner Bros. buy Village Cinemas’ interest at fair value. In the event Warner Bros. does not agree to buy such interests, both Warner Bros. and Village Cinemas would place their collective interests for sale. If such right is not exercised by Village Cinemas, the voting rights associated with the 45% interest will revert to Village Cinemas in March 2008.

     As a result of controlling Village Cinemas’ voting interest, Warner Bros. began consolidating the results of Warner Village in the second quarter of 2004. As permitted by accounting principles generally accepted in the United States, Warner Village results have been consolidated retroactive to the beginning of the year. For the three and six months ended June 30, 2004, Warner Village revenues were $23 million and $59 million, respectively, its Operating Income before Depreciation and Amortization was $2 million and $12 million, respectively, and its Operating Income was $0 and $8 million, respectively.

Discontinued Operations Presentation of Music Segment

     On March 1, 2004, the Company closed on its previously announced agreement to sell the Warner Music Group’s (“WMG”) recorded music and music publishing operations to a private investment group for approximately $2.6 billion in cash and an option to re-acquire a minority interest in the operations sold. In addition, on October 24, 2003, the Company completed the sale of WMG’s CD and DVD manufacturing, printing, packaging and physical distribution operations to Cinram International Inc. for approximately $1.05 billion in cash (Note 3).

     With the completion of these transactions, the Company disposed of its entire Music segment. Accordingly, the Company has presented the financial condition and results of operations of the Music segment as discontinued operations for all periods presented.

Debt Reduction Program

     In January 2003, the Company announced its intention to reduce its overall level of indebtedness. Specifically, the Company indicated its intention was to reduce consolidated net debt (defined as total debt less cash and cash equivalents) to approximately $20 billion by the end of 2004.

     As of June 30, 2004, the Company’s net debt totaled $18.1 billion, down from $22.7 billion at December 31, 2003, as described in more detail under “Financial Condition and Liquidity.” With the receipt of the $2.6 billion in cash proceeds upon the closing of the sale of the Company’s recorded music and music publishing businesses in the first quarter of 2004, as well as the generation of significant Free Cash Flow, the Company achieved its previously announced net debt reduction target in the first quarter, almost a full year ahead of schedule.

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

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

SEC and DOJ Investigations

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

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

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

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

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

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

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

Sale of Winter Sports Teams

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

Comcast Registration Rights

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

RESULTS OF OPERATIONS

Transactions Affecting Comparability of Results of Operations

     The comparability of the Company’s results of operations, financial position and cash flows has been affected by certain new accounting principles adopted by the Company and certain significant transactions occurring during each period as discussed further below.

New Accounting Principles

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

Consolidation of Variable Interest Entities

     Pursuant to the provisions of FASB Interpretation No. 46, “Consolidation of Variable Interest Entities — an Interpretation of ARB No. 51” (“FIN 46”) and the revision of FIN 46 (“FIN 46R”) issued in December 2003 to replace FIN 46, the Company began consolidating the operations of America Online Latin America, Inc. (“AOLA”) as of March 31, 2004. AOLA is a publicly traded entity whose significant shareholders include the Company, the Cisneros Group (a private investment company) and Banco Itau (a leading Brazilian bank). AOLA provides online services principally to customers in Brazil, Mexico, Puerto Rico and Argentina. The Company has no obligation to provide additional funding for AOLA’s operations and the creditors of AOLA have no recourse to the Company.

     In accordance with the transition provisions of FIN 46R, the assets and liabilities of AOLA were recorded in the Company’s consolidated balance sheet as of March 31, 2004 in the amounts at which they would have been carried if FIN 46R had been effective when the Company first met the conditions to be considered the primary beneficiary of AOLA. Upon consolidating the balance sheet of AOLA, the Company recorded incremental assets of approximately $85 million and liabilities of $29 million, with the difference of $56 million recognized as the pretax cumulative effect of an accounting change ($34 million on an after-tax basis). Prior periods have not been restated. The Company consolidated the operating results of AOLA’s operations commencing April 1, 2004. In order to

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

provide the time necessary to consolidate and evaluate the AOLA financial information, the AOLA financial statements are consolidated by the Company on a one-quarter time lag. For the three months ended June 30, 2004, the Company recognized revenues of $14 million, an Operating Loss before Depreciation and Amortization of $3 million and an Operating Loss of $6 million associated with AOLA.

Reclassifications

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

Significant Transactions and Other Items Affecting Comparability

     As more fully described herein and in the related footnotes to the accompanying consolidated financial statements, the comparability of Time Warner’s results from continuing operations has been affected by certain significant transactions and other items in each period as follows:

Restructuring Costs

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

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

Asset Impairments

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

Gain (Loss) on Disposal of Assets

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

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

Microsoft Settlement

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

Investment Gains

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

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

Loss on Investments, net

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

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

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

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

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

Consolidated Results

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

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

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

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

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

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

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

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

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

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

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

     Reconciliation of Operating Income before Depreciation and Amortization to Operating Income and Net Income.

     The following table reconciles Operating Income before Depreciation and Amortization to Operating Income. In addition, the table provides the components from Operating Income to Net Income for purposes of the discussions that follow:

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

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

     Corporate Operating Loss before Depreciation and Amortization. Time Warner’s Corporate Operating Loss before Depreciation and Amortization was $112 million and $276 million for the three and six months ended June 30, 2004 compared to $112 million and $213 million for the three and six months ended June 30, 2003, respectively. Included in the 2004 amounts are $14 million and $67 million of costs for the three and six months, respectively, associated with the relocation from the Company’s former corporate headquarters. Of the $67 million charge, approximately $26 million relates to a non-cash write-off of the fair value lease adjustment, which was established in purchase accounting at the time of the merger of America Online and Time Warner Inc., now known as Historic TW Inc. (“Historic TW”).

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

     Also included in Corporate Operating Loss before Depreciation and Amortization are legal and other professional fees related to the SEC and DOJ investigations into the Company’s accounting and disclosure practices and the defense of various shareholder lawsuits ($6 million and $14 million for the three and six months ended June 30, 2004, respectively, compared to $20 million and $35 million for the three and six months ended June 30, 2003, respectively). It is not yet possible to predict the outcome of these investigations and lawsuits, and costs are expected to continue to be incurred in future periods.

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

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

     Amortization Expense. Amortization expense increased to $157 million and $311 million for the three and six months ended June 30, 2004 from $150 million and $282 million for the three and six months ended June 30, 2003, respectively. The increase relates principally to an increase in the amortization associated with customer-related intangible assets at the Cable segment, which were established with the purchase price allocation associated with the 2003 restructuring of Time Warner Entertainment Company, L.P. (the “TWE Restructuring”). The purchase price allocation was finalized on March 31, 2004.

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

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

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

     The Microsoft Settlement, declines in investment-related gains and the declines in the losses on writedown of investments are discussed above in detail under “Significant Transactions and Other Items Affecting Comparability.” Excluding the impact of these items, Other Income, net, improved in 2004 as compared to the prior-year primarily from an increase in income from equity method investees.

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

     Minority Interest Expense. Time Warner had $62 million and $118 million of minority interest expense for the three and six months ended June 30, 2004 compared to $60 million and $116 million for the three and six months ended June 30, 2003, respectively. The increase reflects higher earnings at the Cable segment allocated to Comcast, which for the six months, was offset partially by the elimination of minority interest in AOL Europe as a result of the Company’s purchase of the remaining preferred securities and payment of accrued dividends in April 2003.

     Income Tax Provision. Income tax expense from continuing operations was $544 million for the three months ended June 30, 2004, compared to $792 million for the three months ended June 30, 2003 and was $1.019 billion for the six months ended June 30, 2004, compared to $1.105 billion for the six months ended June 30, 2003. The Company’s actual income tax expense differs from the amounts derived by applying the 35% U.S. Federal statutory rate to pretax income as a result of several factors, including non-temporary differences (i.e., certain financial statement expenses that are not deductible for income tax purposes), foreign income taxed at different rates and state and local income taxes. The Company’s effective tax rate for continuing operations was 38% and 39% for the three and six months ended June 30, 2004, respectively, as compared to 43% for both the same periods in the prior year. The decline in the effective tax rate results primarily from increased foreign tax credit utilization, additional deductions related to certain foreign source income and an increase in state and local tax attribute utilization.

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

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

     Discontinued Operations, Net of Tax. The 2004 and 2003 results include the impact of the treatment of the music segment as a discontinued operation. Included in the results for the three and six months ended June 30, 2004 are pretax losses of $93 million and $16 million, respectively, and a related tax provision of $12 million and tax benefit of $126 million, respectively. Such losses and the corresponding taxes relate primarily to adjustments to the initial estimates of the assets sold to, and liabilities assumed by, the acquirors in such transactions and to the resolution of various tax matters surrounding the music business dispositions.

     Included in the results for the three and six months ended June 30, 2003 are $2 million of pretax income and a pretax loss of $48 million, respectively, from the music operations and $1 million and $17 million, respectively, of income tax benefits.

     Cumulative Effect of Accounting Change, Net of Tax. As previously discussed, the Company recorded an approximate $34 million benefit, net of tax, as a cumulative effect of accounting change upon the