UNITED STATES
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, 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

TIME WARNER INC.

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 in understanding anticipated future trends.

•

Results of operations. This section provides an analysis of the Company’s results of operations for the three and nine months ended September 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 September 30, 2004 and cash flows for the nine months ended September 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.

     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 liquidity, including its ability to reduce net 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 and liquidity 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. The Company has made films such as The Lord of the Rings trilogy, the Harry Potter series and Troy and television programs such as ER and The West Wing. During the nine months ended September 30, 2004, the Company generated revenues of $30.979 billion (up 8% from $28.661 billion in 2003), Operating Income before Depreciation and Amortization of $6.947 billion (up 15% from $6.064 billion in 2003), Operating Income of $4.562 billion (up 21% from $3.764 billion in 2003), Net Income of $2.237 billion (up 12% from $2.001 billion in 2003), Cash Provided by Operations of $5.388 billion (up 4% from $5.195 billion in 2003) and Free Cash Flow of $3.089 billion (up 10% from $2.806 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 29.0 million AOL brand subscribers in the U.S. and Europe at September 30, 2004. AOL reported total revenues of $6.509 billion (21% of the Company’s overall revenues), $1.439 billion in Operating Income before Depreciation and Amortization and $814 million in Operating Income for the nine months ended September 30, 2004. AOL generates its revenues primarily from subscription fees charged to subscribers and advertising services rendered.

     AOL’s business has 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 and lower-cost dial-up services. AOL’s strategy aims 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 such as AOL Call Alert. AOL continues to develop, change, test and implement marketing strategies to attract and retain subscribers. For example, AOL has recently announced that the McAfee VirusScan Online product, previously sold as a premium service, will be included in the AOL 9.0 Security Edition.

     In response to changing dynamics of the online advertising business, AOL 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 nine months of 2004, paid-search and traditional forms of advertising increased strongly as compared to the prior-year comparable period. The acquisition of Advertising.com in the third quarter of 2004, as discussed later, provides incremental growth in Advertising revenues and improves revenues on certain AOL inventory through Advertising.com’s advertising inventory yield management technology. The growth in AOL’s Advertising revenues 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 as compared to the prior year during the remainder of 2004 as a result of continued growth in traditional, paid-search and performance-based advertising.

     Cable. Time Warner’s cable business, Time Warner Cable Inc. and its subsidiaries (“TWC Inc.”), is the second largest cable operator in the U.S. (in terms of subscribers served). TWC Inc. managed 10.898 million basic cable subscribers (including 1.574 million subscribers of unconsolidated investees) at September 30, 2004, in highly clustered and upgraded systems in 27 states. TWC Inc. delivered $2.391 billion of Operating Income before Depreciation and Amortization, more than any of the Company’s other business segments, had revenues of $6.280 billion (20% of the Company’s overall revenues) and $1.267 billion in Operating Income for the nine months ended September 30, 2004.

     TWC Inc. offers three product lines — video, high-speed data and its newest service, Digital Phone. Video is TWC Inc.’s largest product line. The growth of its customer base for video cable service is limited, however, as the customer base has matured and industry-wide competition from direct-to-home satellite services has increased. Nevertheless, TWC Inc. is continuing to increase its video revenue through its offerings of advanced digital video services. Digital video, high-definition television (HDTV), Video-on-Demand (VOD), Subscription-Video-on-Demand (SVOD) and Digital Video Recorders (DVR) are available in all of its 31 divisions. TWC Inc.’s digital video penetration provides a broad base of potential customers for these advanced services. Video programming costs represent a major component of TWC Inc.’s expenses and continue to rise across the industry, especially for sports programming.

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

     High-speed data service has been one of TWC Inc.’s fastest-growing products 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 digital subscriber lines (DSL).

     TWC Inc.’s new voice product, Digital Phone, is expected to be available in each of TWC Inc.’s divisions by the end of 2004. At September 30, 2004, Digital Phone service was available commercially or on a test basis in all but one of TWC Inc.’s divisions. Digital Phone enables 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 products that are available from its competitors. Included in Operating Income before Depreciation and Amortization for the first nine months of the year are start-up costs associated with the rollout of Digital Phone services, which are expected to increase during the remainder of 2004.

     In addition to the subscription services described above, TWC Inc. also earns revenue by selling advertising time to national, regional and local businesses.

     Filmed Entertainment. Time Warner’s Filmed Entertainment businesses, Warner Bros. Entertainment Group (“Warner Bros.”) and New Line Cinema (“New Line”), generated revenues of $8.581 billion (26% of the Company’s overall revenues), $1.190 billion in Operating Income before Depreciation and Amortization and $956 million in Operating Income for the nine months ended September 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.

     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 successful releases of television series into the home video market. For the 2004/2005 television season, Warner Bros. has more current production on the air than any other studio, with prime-time series on all six broadcast networks (including such hits as Two and a Half Men, ER, Third Watch, The O.C., Cold Case, Smallville and The West Wing).

     Piracy, including physical piracy as well as illegal 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.

     Networks. Time Warner’s Networks group is composed of Turner Broadcasting System, Inc. (“Turner”), Home Box Office (“HBO”) and The WB Television Network (“The WB Network”). The segment delivered revenues of $6.761 billion (20% of the Company’s overall revenues), $2.031 billion in Operating Income before Depreciation and Amortization and $1.859 billion in Operating Income for the nine months ended September 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. More prime-time viewers now watch advertising-supported cable TV networks than the national broadcast networks and, in 2004, that share has increased further. For the first nine months of 2004, TNT and TBS ranked first and third, respectively, 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 strong advertising market. Keys to Turner’s success are its continued investments in high-quality programming focused on originals, sports, network premieres,

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

series, news and animation, 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 following an earlier successful rebranding of TNT as “We Know Drama.”

     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 is 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 also to reach 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 through Time Inc. and book publishing through the Time Warner Book Group and a number of direct marketing and direct selling businesses. The segment generated revenues of $3.926 billion (12% of the Company’s overall revenues), $791 million in Operating Income before Depreciation and Amortization and $593 million in Operating Income for the nine months ended September 30, 2004.

     Time Inc. publishes more than 130 magazines globally including Cooking Light, Entertainment Weekly, Fortune, Golf, In Style, People, Real Simple, Southern Living, Sports Illustrated and Time. It generates revenues primarily from advertising, magazine circulation and newsstand sales, and drives growth through higher circulation and advertising on existing magazines, acquisitions and new magazine launches. Time Inc. also owns IPC Media (the U.K.’s largest magazine company) and the magazine subscription marketer Synapse Group, Inc. In addition, Time Inc. is continuing to invest in new magazine launches, including All You, Cottage Living and Nuts, and has recently re-launched Life as a weekend magazine distributed in leading newspapers nationwide. 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 nine months of 2004, Time Warner Book Group had 42 titles on The New York Times bestseller list, including 32 new releases and 10 continuing bestsellers from prior years. Significant new additions to The New York Times bestseller list include James Patterson’s Sam’s Letters to Jennifer, Nicholas Sparks’ trade paperback edition of The Wedding, and David Baldacci’s mass market edition of Split Second.

     The Publishing segment’s Operating Income before Depreciation and Amortization increased in the first nine 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 recorded in 2003. Time Inc. has recently enjoyed strength in advertising revenues, with third quarter Advertising revenues growing 14%. 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. In addition, Operating Income before Depreciation and Amortization in 2003 was also impacted by a $29 million loss resulting from the sale of Time Life in the fourth quarter.

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

Other Key 2004 Developments

Update on 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, the methods used by the America Online segment to report its subscriber numbers and the accounting related to the consolidation of, and equity accounting for, America Online’s interest in AOL Europe prior to January 2002.

     The Company 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, except as discussed below, 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, the Company disclosed that the staff of the SEC had 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. Pursuant to a March 2000 agreement between the parties (the “Put/Call Agreement”), Bertelsmann had the right at two separate times to put a portion of its interest in AOL Europe to the Company (80% in January 2002 and the remaining 20% in July 2002) at a price established by the Put/Call Agreement. In separate agreements executed in March and December of 2001, the Company agreed to settle the put transactions under the Put/Call Agreement in cash rather than in stock, without any change to the put price previously established in the Put/Call Agreement. Contemporaneous with the agreements to pay in cash, Bertelsmann agreed to purchase additional advertising from the Company of $125 million and $275 million, respectively. For more details on the transactions, see Note 11, “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.

     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. The Office of the Chief Accountant concluded that such portion of the $400 million advertising 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 Bertelsmann transactions, including the related advertising arrangements, and has reiterated its conclusion that the Company’s accounting for the Bertelsmann transactions is incorrect.

     In its Quarterly Report on Form 10-Q for the quarter ended June 30, 2004, the Company reported that it had begun a review of the accounting related to the consolidation of, and equity accounting for, its interest in AOL Europe prior to January 2002. Prior to the execution of the Put/Call Agreement in March 2000, AOL Europe was a 50/50 joint venture between America Online and Bertelsmann in which each venture partner held 50% of the voting rights. Accordingly, the Company accounted for its interest in AOL Europe using the equity method of accounting and did not consolidate the financial results of AOL Europe. In

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

March 2000, as part of the Put/Call Agreement, Bertelsmann agreed, among other things, to terminate certain of its voting and other rights and agreed to have its members of the AOL Europe board of directors vote in the manner directed by America Online. The Company concluded in March of 2000 that the Put/Call Agreement did not alter the accounting treatment of its interest in AOL Europe because, among other things, Bertelsmann retained sufficient economic interests and substantive rights to preclude consolidation. Accordingly, the Company continued to account for the interest using the equity method of accounting until January 2002, when it acquired 80% of Bertelsmann’s interest and began consolidating the financial results of AOL Europe.

      In connection with its continuing review of these issues related to AOL Europe, including discussions with the staff of the SEC, the Company has determined that the financial results of AOL Europe should have been consolidated, beginning March 2000, upon execution of the Put/Call Agreement given the governance rights surrendered by Bertelsmann. Accordingly, for this reason, the Company’s consolidated financial results for the years ended December 31, 2000 and 2001 will be restated. Pending that restatement, the Company has determined that investors should not rely on the Company’s consolidated financial statements for the years ended December 31, 2000 and 2001 with respect to this matter.

     The impact of consolidating AOL Europe on the Company’s reported revenue, operating income (loss), net income (loss), cash flow provided (used) by operations, investing activities and financing activities and free cash flow for the years ended December 31, 2001 and 2000 would be as follows:

						Impact of
						Consolidating				Adjusted
		Time Warner				AOL Europe				Time Warner
		(as reported)				(unaudited)				(unaudited)
		(in millions)
2001:
Income Statement:
Revenue		$	33,507			$	810			$	34,317
Operating Income (Loss)			652				(734	)			(82	)
Net Loss1, 2			(4,221	)			—				(4,221	)
Cash Flow:
Cash Flows Provided (Used) by Operations		$	5,281			$	(565	)		$	4,716
Cash Used by Investing Activities			(5,257	)			(22	)			(5,279	)
Cash Provided (Used) by Financing Activities			(1,915	)			490				(1,425	)
Total Change in Cash			(1,891	)			(97	)			(1,988	)
Free Cash Flow3			1,497				(587	)			910
2000:
Income Statement:
Revenue		$	7,605			$	640			$	8,245
Operating Income (Loss)			1,766				(306	)			1,460
Net Income1			1,121				—				1,121
Cash Flow:
Cash Provided (Used) by Operations		$	1,951			$	(236	)		$	1,715
Cash Provided (Used) by Investing Activities			(2,316	)			43				(2,273	)
Cash Provided by Financing Activities			421				342				763
Total Change in Cash			56				149				205
Free Cash Flow			1,173				(256	)			917

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

reported revenue, operating income (loss), net income (loss), cash flow provided (used) by operations, investing activities and financing activities and free cash flow for the years ended December 31, 2001 and 2000 would be as follows:

     As previously noted, the table above assumes that, upon consolidation, the losses of AOL Europe would be fully allocated to the Company given the execution of the Put/Call Agreement. In contrast, if it were assumed that the Company should have recognized its proportionate share of AOL Europe’s losses (based on its voting percentage of ownership), the impact on the Company would be the same as presented above, except net income (loss) would only be reduced by the portion of AOL Europe’s losses absorbed by the Company. Specifically, the impact on the Company’s net income (loss) of consolidating AOL Europe, in this instance, would have been a net loss of approximately $422 million and approximately $154 million in 2001 and 2000, respectively.

     If the Company were to adjust the allocation of AOL Europe losses during 2001 and 2000 from the HLBV method to some other basis as described above, it would decrease the goodwill recognized upon acquisition of Bertelsmann’s interest in AOL Europe in 2002 by an equal amount, resulting in a corresponding reduction in the goodwill impairment charge recognized by the Company in the fourth quarter of 2002. Consequently, pending the outcome of this matter, investors also should not rely on the Company’s financial statements for the year ended December 31, 2002.

     Neither the conclusion that the Company should have begun consolidating its interest in AOL Europe upon execution of the Put/Call Agreement, nor any ultimate determination that the Company should have applied the equity method in a different manner, would have any impact on the consolidated financial statements as of and for the three and nine months ended September 30, 2004 and 2003 included in this report.

     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 and other 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 and the Company’s conclusion to consolidate AOL Europe, it is likely that the SEC would not declare effective any registration statement of the Company or its affiliates. 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.

     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. In addition, the Company has established reserves of $500 million in connection with the pending SEC and DOJ investigations. This amount represents the Company’s current best estimate of the amounts that would be involved ultimately to resolve these investigations. The Company believes that some portion of the amount reserved will be available for related shareholder litigation. The Company has not established any reserves associated with shareholder and civil litigation due to their preliminary status and because it is unable to reasonably estimate a range of possible loss.

Comcast Tolling and Optional Redemption Agreement

     On September 24, 2004, TWC Inc. entered into a Tolling and Optional Redemption Agreement (the “Agreement”), with Comcast Corporation (“Comcast”) and certain affiliates of Comcast, including the trust that holds shares of TWC Inc. on behalf of Comcast. Pursuant to the Agreement, Comcast has been granted an option (the “Option”), which can be exercised between December 1, 2004 and April 1, 2005, to require TWC Inc. to redeem a portion of the TWC Inc. stock held by Comcast in exchange for a TWC Inc. subsidiary with cable systems serving approximately 90,000 basic subscribers as of September 30, 2004, plus approximately $750 million in cash. Closing of the transactions contemplated by the Agreement is subject to the exercise of the Option, required governmental and regulatory approvals and other customary closing conditions.

     Comcast currently owns an effective interest of approximately 21% in TWC Inc.’s business — held through a 17.9% common stock interest in TWC Inc. and a 4.7% limited partnership interest in Time Warner Entertainment Company, L.P. (“TWE”). If the Option is exercised, Comcast will reduce its effective interest in TWC Inc.’s business to approximately 17% — consisting of a 13.7% common stock interest in TWC Inc. and a 4.7% limited partnership interest in TWE. Other than as provided in the Agreement, Comcast cannot require TWC Inc. to purchase its interest in TWC Inc.

     In connection with the restructuring of TWE completed in 2003 (the “TWE Restructuring”), Comcast received (1) customary registration rights relating to its 17.9% interest in the common stock of TWC Inc. and (2) the right, at any time following March 31, 2005, to require TWC Inc. or Time Warner to purchase all or a portion of Comcast’s 4.7% limited partnership interest in TWE at an appraised fair market value. The purchase price payable by TWC Inc. or Time Warner as consideration for Comcast’s limited partnership interest may be paid in cash, Time Warner or TWC Inc. common stock (if TWC Inc. common stock is then publicly

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

traded) or a combination of cash and stock. Following March 31, 2005, Comcast also has the right to sell all or a portion of its interest in TWE to a third party, subject to rights of first refusal by the Company and TWC Inc.

     The Agreement entered into on September 24, 2004 also provides that Comcast will not exercise or pursue registration rights with respect to the TWC Inc. stock owned by it until April 1, 2005, or earlier if the Agreement is terminated under certain limited circumstances. This provision of the Agreement supersedes Comcast’s request to TWC Inc. in December 2003 to register its TWC Inc. stock. For details related to the accounting for this transaction, see Note 4, “Time Warner Entertainment Company, L.P.”

Google Inc.

     As previously reported in the quarterly report on Form 10-Q for the second quarter of 2004, America Online exercised a warrant for approximately $22 million and received approximately 7.4 million shares of Series D Preferred Stock of Google Inc. in May 2004. Each of these shares converted automatically into shares of Google’s Class B Common Stock immediately prior to the closing of Google’s initial public offering on August 24, 2004. In connection with this offering, America Online converted 2,355,559 shares of its Google Class B Common Stock into an equal number of Google’s Class A Common Stock. Such Class A shares were sold in the offering for $195 million, net of the underwriters’ discounts and commissions, and the Company recorded a gain of approximately $188 million, which is included in “Other Income, net” in the accompanying consolidated statement of operations. Following this transaction, America Online holds 5,081,893 shares of Google’s Class B Common Stock. These shares are subject to restrictions on transfer pursuant to lock-up arrangements in connection with Google’s offering. In addition, future transfers will be subject to applicable securities laws requiring that sales be made either pursuant to a registration statement or under exemptions from registration.

     The Company does not consider its remaining interest in Google to be a strategic investment. As of September 30, 2004, the shares are recorded on the Company’s consolidated balance sheet (classified as available-for-sale securities) at their fair value of approximately $659 million. There is a corresponding unrealized gain of approximately $386 million, net of deferred taxes of approximately $257 million, reflected in shareholders equity. The fair value of the investment is calculated based on Google’s stock price ($129.60 at September 30, 2004) times the number of Google shares owned by the Company. A 5% appreciation in the stock price of Google would result in an increase in the Company’s unrealized gain on this investment of approximately $20 million, net of tax. Conversely, a 5% depreciation in the stock price of Google would result in a decrease in the Company’s unrealized gain on this investment of approximately $20 million, net of tax. As of October 28, 2004, Google stock closed at $193.30 per share, which increased the fair value of the Company’s position to approximately $982 million.

Advertising.com

     On August 2, 2004, America Online completed the previously announced acquisition of Advertising.com, Inc. (“Advertising.com”) for $445 million (net of cash acquired). Advertising.com purchases online advertising inventory from third-party web sites and principally sells this inventory using performance-based advertising arrangements. For the three and nine months ended September 30, 2004, Advertising.com contributed Advertising revenue from sales of advertising run on third-party websites of $35 million.

Agreement Regarding Investment in Gateway

       AOL owns both preferred and common stock in Gateway, Inc. (“Gateway”). Specifically, AOL owns Gateway Series A and Series C preferred stock and 2.7 million shares of Gateway common stock. The Series A preferred stock automatically converts into approximately 22.2 million shares of Gateway common stock (based on a minimum conversion price of $8.99 per share) in December 2004. The Series C preferred stock is redeemable, at AOL’s option, also in December 2004 for $200 million. Gateway has the option to pay the $200 million redemption price in Gateway common stock (based on the average price of Gateway’s common stock during a pricing period prior to the redemption date), cash or a combination thereof. AOL’s ability to resell these shares is limited by both contractual restrictions and applicable securities laws and regulations.

       On November 1, 2004, AOL entered into an agreement with Gateway covering the sale of the AOL-owned Gateway securities to Gateway. Under the terms of the agreement, AOL will receive total consideration of approximately $316 million consisting of: (1) approximately $186 million in cash at the closing; (2) the right to use approximately $33 million worth of Gateway securities to make payments to Gateway under certain existing customer acquisition agreements between the parties; and (3) approximately $97 million, which accretes at a specified rate, that can be (a) used to offset future performance-based payments that AOL would otherwise be required to make in cash under certain existing customer acquisition agreements between the parties; (b) paid in cash; or (c) a combination thereof, at Gateway’s option. Notwithstanding the use of any amounts to offset amounts owed to Gateway by AOL, AOL will continue to recognize marketing expense under its existing customer acquisition agreements with Gateway.

       The $316 million purchase price is based on a negotiated discount to Gateway’s closing price of $5.54 on October 18, 2004, which, after considering the aggregate impairment losses recognized by the Company on its investment in Gateway, will result in a net gain recognized on the sale of approximately $44 million. This transaction is expected to close on December 22, 2004 and is subject to customary conditions. Additionally, AOL and Gateway have agreed to settle existing commercial disputes resulting in AOL paying Gateway $2.5 million for the settlement.

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

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 50,000 basic subscribers at September 30, 2004, 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 the day-to-day management of Urban Cable. TWC Inc. and Inner City settled certain disputes regarding the joint venture for $34 million during the second quarter.

     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 in consolidation debt and interest owed to it by Urban Cable of $66 million and will assume $55 million of Urban Cable’s third-party debt. This transaction is expected to close before the end of the year. For the nine months ended September 30, 2004, Urban Cable’s revenues, Operating Income before Depreciation and Amortization and Operating Income were $35 million, $11 million, and $3 million, respectively.

VIVA Media AG and VIVA Plus

     In August 2004, Turner completed the previously announced sale of its 30.6% ownership stake in VIVA Media AG (“VIVA”) and its 49% stake in VIVA Plus to Viacom Inc. for approximately 109 million Euros (approximately $134 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 accounted for these assets as equity investments prior to the sale. For the three and nine months ended September 30, 2004, the Company recorded a gain of approximately $113 million as a component of “Other Income, net” in the accompanying consolidated statement of operations.

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. As previously announced, 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 its 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 nine months ended September 30, 2004, Warner Village revenues were $14 million and $73 million, respectively, its Operating Income (Loss) before Depreciation and Amortization was ($3) million and $9 million, respectively, and its Operating Income (Loss) was ($5) million and $3 million, respectively.

Discontinued Operations Presentation of Music Segment

     On March 1, 2004, the Company completed the sale of 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.

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

Sale of Winter Sports Teams

     On March 31, 2004, the Company completed the sale of the Turner winter sports teams (the Atlanta Thrashers, an NHL team, and the Atlanta Hawks, an NBA team) and the entity holding the operating rights to Philips Arena, an Atlanta sports and entertainment venue, to Atlanta Spirit LLC (“Atlanta Spirit”). In addition to the $178 million impairment charge recognized in the second quarter of 2003 and the $41 million charge recognized in the third quarter of 2003, the Company recorded a $7 million loss on the closing of the sale in the first quarter of 2004. As of September 30, 2004, Turner owns a 10% interest in Atlanta Spirit and accounts for its interest under the equity method of accounting.

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, AOL, 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 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 and nine months ended September 30, 2004, the Company recognized revenues of $13 million and $27 million, an Operating Loss before Depreciation and Amortization of $9 million and $12 million and an Operating Loss of $10 million and $16 million, respectively, associated with AOLA.

Reclassifications

     Certain reclassifications have been made to the 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 nine months ended September 30, 2003 was $25 million and $82 million, respectively. Such reclassifications did not affect Net Income, Cash Provided by Operations or Free Cash Flow.

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

Significant Transactions and Other Items Affecting Comparability

     As more fully described herein and in the related notes 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. The Company did not incur any restructuring charges during the three months ended September 30, 2004. During the nine months ended September 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 September 30, 2003, the Company incurred restructuring costs of $42 million, including $26 million at AOL, $13 million at Networks and $3 million at the Publishing segment. During the nine months ended September 30, 2003, the Company incurred restructuring costs totaling $72 million, including $30 million at AOL, $21 million at Networks and $21 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 financial statements.

Legal Reserves Related to the Government Investigations

     The Company has established $500 million in legal reserves related to the government investigations. This amount represents the Company’s current best estimate of the amounts that would be involved ultimately to resolve these investigations. The Company believes that some portion of the amount reserved will be available for related shareholder litigation. The Company has not established any reserves associated with shareholder and civil litigation due to their preliminary status and because it is unable to reasonably estimate a range of possible loss.

Asset Impairments

     For the nine months ended September 30, 2004, the Company recognized a $10 million impairment charge related to the pending sale of a building at the AOL segment. For the three and nine months ended September 30, 2003, Operating Income before Depreciation and Amortization included $41 million and $219 million of impairment charges, respectively, at the Networks segment, related to the writedown of the intangible assets of the winter sports teams, and the nine months also included a $99 million impairment charge at the Publishing segment related to the writedown of goodwill and intangible assets of the Time Warner Book

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

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.

Net Gain on Disposal of Assets

     For the three and nine months ended September 30, 2004, the Company recognized a $13 million gain at AOL related to the previously announced sale of AOL Japan, which closed on July 1, 2004. In addition, for the nine months ended September 30, 2004, the Company recognized an $8 million gain at the Publishing segment related to the sale of a building and a $7 million loss (after taking into consideration the $219 million of impairment charges described above) 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 nine months ended September 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 to the consolidated financial statements 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 for nine months ended September 30, 2003.

Investment Gains

     For the three and nine months ended September 30, 2004, the Company recognized $311 million and $366 million of gains, respectively, from the sale of investments, including a $188 million gain related to the sale of a portion of the Company’s interest in Google and a $113 million gain related the sale of the Company’s interest in VIVA and VIVA Plus. For the three months ended September 30, 2003, the Company recognized $127 million of gains from the sale of investments, including a $52 million gain from the sale of the Company’s interest in chinadotcom and $17 million from the sale of the Company’s equity interests in certain international cinemas. For the nine months ended September 30, 2003, the Company recognized gains from the sale of certain investments of $778 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”), a $52 million gain from sale of the Company’s interest in chinadotcom and $66 million in gains from the sale of the Company’s equity interest in certain international cinemas.

     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 nine months ended September 30, 2004, non-cash charges to reflect other-than-temporary declines in the Company’s investments were $15 million and $24 million, respectively. This amount reflects $10 million and $12 million, respectively, to reduce the carrying value of certain investments that experienced other-than-temporary declines in market value and $5 million and $12 million of losses, respectively, related to market fluctuations in equity derivative instruments.

     For the three months ended September 30, 2003, non-cash charges to reflect other-than-temporary declines in the Company’s investments were $10 million. These amounts consisted of $14 million to reduce the carrying value of certain investments that experienced other-than-temporary declines in market value and income of $4 million to reflect market fluctuations in equity derivative instruments. For the nine months ended September 30, 2003, non-cash charges to reflect other-than-temporary declines in the Company’s investments were $167 million. These amounts consisted of $184 million to reduce the carrying value of certain investments that experienced other-than-temporary declines in market value and income of $17 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.

12

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

Three and Nine Months Ended September 30, 2004 Compared to Three and Nine Months Ended September 30, 2003

Consolidated Results

     Revenues. For the three months ended September 30, 2004, consolidated revenues increased 5% to $9.965 billion. For the nine months ended September 30, 2004, consolidated revenues increased 8% to $30.979 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 th