ITEM 1. BUSINESS
Time Warner Inc. (the "Company") was incorporated in the State of Delaware in August 1983 and is the successor to a New York corporation originally organized in 1922. The Company changed its name from Time Incorporated following its acquisition of 59.3% of the common stock of Warner Communications Inc. ("WCI") in July 1989. WCI became a wholly owned subsidiary of the Company in January 1990 upon the completion of the merger of WCI and a subsidiary of the Company (the "Merger"). As used in this report, the terms "Registrant," the "Company" and "Time Warner" refer to Time Warner Inc. and its subsidiaries and divisions, and includes Time Warner Entertainment Company, L.P. ("TWE"), which conducts substantially all of the Entertainment businesses of the Company, unless the context otherwise requires.
The Company is the largest media and entertainment company in the world. Its businesses are carried on in three principal groups: Publishing, Music and Entertainment. The Publishing group consists principally of the publication and distribution of magazines and books; the Music group consists principally of the production and distribution of recorded music and the ownership and administration of music copyrights; and the Entertainment group consists principally of the production and distribution of motion pictures and television programming, the distribution of videocassettes, the ownership and operation of retail stores and theme parks, the production and distribution of pay television and cable programming, and the operation of cable television systems. These businesses are conducted throughout the world through numerous wholly owned, and in certain cases less than wholly owned, subsidiaries and affiliates.
TWE was formed as a Delaware limited partnership in February 1992 pursuant to an Agreement of Limited Partnership, dated as of October 29, 1991, as amended (the "TWE Partnership Agreement"), and has, since its capitalization on June 30, 1992 (the "TWE Capitalization"), owned and operated substantially all of the Entertainment group businesses, and certain other businesses, previously owned and operated by the Company. Upon the TWE Capitalization, certain wholly owned subsidiaries of the Company (the "Time Warner General Partners"), contributed such businesses, or assigned the net cash flow derived therefrom (or an amount equal to the net cash flow derived therefrom), to TWE and became general partners of TWE. Also upon the TWE Capitalization, wholly owned subsidiaries of ITOCHU Corporation (formerly C. Itoh & Co., Ltd.), a corporation organized under the laws of Japan ("ITOCHU"), and Toshiba Corporation, a corporation organized under the laws of Japan ("Toshiba"), collectively contributed $1 billion to TWE and became limited partners of TWE. On September 15, 1993, TWE consummated the transactions contemplated by the Admission Agreement, dated as of May 16, 1993, as amended (the "Admission Agreement"), between TWE and U S WEST, Inc., a Colorado corporation ("U S WEST"). Pursuant to the Admission Agreement, a wholly owned subsidiary of U S WEST made a capital contribution of $2.553 billion and became a limited partner of TWE (the "U S WEST Transaction"). As a result of the U S WEST Transaction, the Time Warner General Partners collectively own 63.27% pro rata priority capital and residual equity interests in TWE and wholly owned subsidiaries of ITOCHU, Toshiba and U S WEST (the "Class A Partners" or the "Limited Partners") own pro rata priority capital and residual equity interests in TWE of 5.61%, 5.61% and 25.51%, respectively. Each of ITOCHU and Toshiba has the right to maintain its original 6.25% pro rata priority capital and residual equity interests by acquiring additional partnership interests. In addition, the Time Warner General Partners own priority capital interests senior and junior to the pro rata priority capital interests.
The Admission Agreement provides that TWE will use its best efforts to upgrade a substantial portion of its cable systems to "Full Service Network(TM)" capacity by the end of 1998. As systems are designated for such upgrade and after any required approvals are obtained, U S WEST and TWE will share joint control of those systems through a 50-50 management committee. The "Full Service Network" business is expected to include substantially all of TWE's cable systems, subject to obtaining necessary regulatory consents and approvals. See "Entertainment--Description of Certain Provisions of the TWE Partnership Agreement."
In September 1994, the Company agreed to acquire Summit Communications Group, Inc. ("Summit"), which owns cable television systems serving approximately 162,000 subscribers in Winston-Salem, North
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Carolina and in certain suburbs of Atlanta, Georgia, in exchange for 900,000 shares of the Company's common stock, par value $1.00 per share ("Common Stock"), and 3.2 million shares of a new Time Warner convertible preferred stock ("Series C Preferred Stock"). The Series C Preferred Stock will have a liquidation value of $100 per share, be convertible into 6.7 million shares of Common Stock at an effective price of $48 per share of Common Stock, receive an annual dividend of $3.75 per share for five years, and be redeemable at liquidation value plus unpaid dividends after five years, or exchangeable in part for Common Stock plus unpaid dividends by the holder beginning after the third year and by the Company after the fourth year at the stated conversion price plus a declining premium in years four and five and no premium thereafter.
Also in September 1994, TWE agreed to form a cable television joint venture with subsidiaries of Advance Publications, Inc. and Newhouse Broadcasting Corporation ("Advance/Newhouse") to which Advance/Newhouse will contribute cable television systems serving approximately 1.4 million subscribers and related assets and TWE will contribute cable television systems (or interests therein) serving approximately 2.8 million subscribers and related assets. TWE will own a two-thirds equity interest in the TWE-Advance/Newhouse Partnership and be the managing partner. Advance/Newhouse will own a one-third equity interest in the partnership. Advance/Newhouse can require TWE to purchase its equity interest for fair market value at specified intervals following the death of both of its principal shareholders. Beginning in the third year, either partner can initiate a dissolution in which TWE would receive two-thirds and Advance/Newhouse would receive one-third of the partnership's net assets. The new venture will enlarge existing cable clusters already owned by the partners in North Carolina, Florida and New York.
In January 1995, the Company agreed to acquire KBLCOM Incorporated ("KBLCOM"), a subsidiary of Houston Industries Incorporated, that owns cable television systems serving approximately 690,000 subscribers and a 50% interest in Paragon Communications ("Paragon"), which serves an additional 967,000 cable subscribers. TWE owns the other 50% interest in Paragon. To acquire KBLCOM, the Company will issue 1 million shares of Common Stock and 11 million shares of a new Time Warner convertible preferred stock ("Series D Preferred Stock") and assume or incur approximately $1.24 billion of indebtedness. The Series D Preferred Stock will have a liquidation value of $100 per share, be convertible into approximately 22.9 million shares of Common Stock at an effective price of $48 per share of Common Stock, and receive an annual dividend of $3.75 per share for four years. The Company will have the right to exchange the Series D Preferred Stock for Common Stock at the stated conversion price plus unpaid dividends after four years, or redeem the Series D Preferred Stock at the liquidation value per share plus unpaid dividends after five years. KBLCOM's systems serve subscribers in San Antonio and Laredo, Texas, the Minneapolis metropolitan area, Portland, Oregon and Orange County, California. Paragon owns systems in Tampa, Florida and northern Manhattan, as well as other locations.
In February 1995, the Company agreed to acquire Cablevision Industries Corporation ("CVI") and related companies that own cable television systems serving approximately 1.3 million subscribers principally in New York, North Carolina, Florida, California's San Fernando Valley and Columbia, South Carolina. In acquiring CVI and related companies, the Company will issue 2.5 million shares of Common Stock and 6.5 million shares of new convertible preferred stocks (3.25 million shares of Series E Preferred Stock and 3.25 million shares of Series F Preferred Stock) and assume approximately $2 billion of debt of CVI and related companies. Each series of preferred stock will have a liquidation value of $100 per share, be convertible into approximately 13.5 million shares of Common Stock at an effective price of $48 per share of Common Stock, and receive an annual dividend of $3.75 per share for a period of five years with respect to the Series E Preferred Stock and a period of four years with respect to the Series F Preferred Stock. The Company will have the right to exchange the Series E Preferred Stock for Common Stock at the stated conversion price plus unpaid dividends after five years and to exchange the Series F Preferred Stock for Common Stock at the stated conversion price plus unpaid dividends after four years. In addition, the Company may redeem either series of preferred stock at the liquidation value per share plus unpaid dividends after five years.
The Summit and Advance/Newhouse transactions are expected to close in the first half of 1995. The KBLCOM and CVI transactions are expected to close later in the year. All transactions are subject to customary closing conditions, including the receipt of certain franchise and regulatory approvals.
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The Company also has announced its intention to enhance its financial position and that of the Entertainment Group through sales of non-core assets, such as the stock of Turner Broadcasting System, Inc. ("TBS") owned by Time Warner, and/or certain smaller unclustered cable systems owned by Time Warner or the Entertainment Group. Proceeds from asset sales will be used to reduce debt. No assurance can be given as to whether or when any particular assets may be sold, or the amount of the proceeds that may be received by the Company from any such sales. Because of the announced transactions, Time Warner will explore the possibility of bringing its various interests in cable operations together in a separate, self-financed operating unit. This process is expected to be undertaken over a 12-18 month period and will be dependent, among other things, on successful negotiations with TWE's partners and certain creditors, and receipt of franchise and other regulatory approvals. Accordingly, there can be no assurance that the effort will succeed.
For financial information about the Company's industry segments and operations in different geographical areas with respect to each of the years in the three-year period ended December 31, 1994, see Note 10, "Segment Information," to the Company's consolidated financial statements at pages through herein.
The Company's Entertainment Group, consisting of the Company's interests in certain entertainment companies, principally TWE, was deconsolidated effective January 1, 1993 as a result of the U S WEST Transaction. The TWE Partnership Agreement and the TWE credit agreement impose restrictions on the ability of TWE to make distributions to the Company and the Time Warner General Partners. See Note 1, "Summary of Significant Accounting Policies," and Note 2, "Entertainment Group," to the Company's consolidated financial statements at pages through herein.
PUBLISHING
The Company's wholly owned publishing division, Time Inc., publishes magazines and books and develops products for the multimedia and television markets. It conducts these activities through wholly owned subsidiaries, joint ventures, equity investments and partnerships.
MAGAZINES
General
Time Inc. publishes TIME, PEOPLE, SPORTS ILLUSTRATED, FORTUNE, MONEY, LIFE, SPORTS ILLUSTRATED FOR KIDS and ENTERTAINMENT WEEKLY. In June 1994, Time Inc. launched IN STYLE, a monthly celebrity life style publication.
Time Inc. Ventures ("TIV") and its subsidiary Time Publishing Ventures, Inc. ("TPV") are responsible for international, regional and special interest publishing and development activities, including Southern Progress Corporation ("Southern Progress"), Sunset Publishing Corporation ("Sunset Publishing"), PARENTING, BABY TALK, HEALTH, HIPPOCRATES, MARTHA STEWART LIVING, and WHO WEEKLY magazines and various joint ventures.
Southern Progress publishes SOUTHERN LIVING, PROGRESSIVE FARMER, SOUTHERN ACCENTS and COOKING LIGHT magazines.
Time Inc., either directly or indirectly, has equity interests in ASIAWEEK, American Family Publishers and Publishers Express. In 1994, Time Inc. sold its interest in ELLE JAPON and YAZHOU ZHOUKAN and acquired full ownership of President, Inc., which publishes PRESIDENT and DANCYU magazines.
TIV has management responsibility for most of the American Express Publishing Corporation's operations, including TRAVEL & LEISURE and FOOD & WINE magazines. TIV also operates an in-store advertising and demonstration business, Time Inc. In-Store Marketing.
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Each magazine published by the Company has an editorial staff under the general supervision of a managing editor and a business staff under the management of a president or publisher. Magazine manufacturing and distribution activities are generally managed by centralized staffs at Time Inc. Fulfillment activities for Time Inc.'s magazines are generally administered from a centralized facility in Tampa, Florida. PARENTING, SUNSET, BABY TALK, HEALTH, HIPPOCRATES, MARTHA STEWART LIVING, VIBE, and Time Inc.'s overseas operations employ independent fulfillment services and undertake their own manufacturing and distribution.
Magazine publishing follows a seasonal pattern with revenues being generally higher in the second and fourth quarters and lower in the first and third quarters.
The individual magazines of the Company are summarized below:
TIME, a weekly magazine, summarizes the news and brings original interpretation and insight to the week's events. The domestic advertising rate base of TIME as of January 1995 was 4,000,000, which is unchanged from January 1994.
TIME Asia, TIME Atlantic, TIME Canada, TIME Latin America and TIME South Pacific are weekly English-language editions of TIME which circulate outside the United States. These editions had an aggregate worldwide advertising rate base of 1,460,000 as of January 1995, compared to 1,480,000 in January 1994.
SPORTS ILLUSTRATED is a weekly magazine which covers the activities of, and is designed to appeal to, spectators and participants in virtually all forms of recreational and competitive sports. The advertising rate base as of January 1995 was 3,150,000, the same as in January 1994.
SPORTS ILLUSTRATED FOR KIDS is a monthly sports-oriented magazine geared to children ages eight through fourteen. Its advertising rate base as of January 1995 was 950,000, compared to 900,000 in January 1994, including 243,000 copies distributed free to over 1,100 schools.
PEOPLE, a weekly magazine, reports on celebrities and other notable personalities. The advertising rate base as of January 1995 was 3,150,000, the same as in January 1994.
ENTERTAINMENT WEEKLY is a weekly magazine which includes reviews and reports on television, movies, video, music and books. The advertising rate base as of January 1995 was 1,125,000, compared to 1,075,000 in January 1994.
FORTUNE, a biweekly magazine, reports on worldwide economic and business developments. The worldwide advertising rate base was 860,000 as of January 1995, compared to 870,000 in January 1994.
MONEY is a monthly magazine which reports on personal finance. The advertising rate base as of January 1995 was 1,900,000, the same as in January 1994.
LIFE is a monthly magazine which features photographic essays. The advertising rate base as of January 1995 was 1,500,000, the same as in January 1994.
IN STYLE is a monthly magazine which focuses on celebrities' lives and lifestyles. The advertising rate base as of January 1995 was 550,000.
SOUTHERN LIVING is a monthly regional home, garden, food and travel magazine focused on the South with an advertising rate base of 2,300,000 as of January 1995, which is the same as in January 1994.
PROGRESSIVE FARMER is a monthly regional farming magazine with an advertising rate base of 410,000 as of January 1995, compared to 415,000 in January 1994.
SOUTHERN ACCENTS, published six times a year, features architecture, fine homes and gardens, arts and travel and is targeted to affluent Southerners. Its advertising rate base as of January 1995 was 275,000, compared to 250,000 in January 1994.
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COOKING LIGHT is published nine times a year and features health and fitness through active lifestyles and good nutrition. The advertising rate base as of January 1995 was 1,200,000, compared to 1,100,000 in January 1994.
PARENTING is published ten times a year and is aimed at parents of children under the age of ten. The advertising rate base increased as of January 1995 to 1,000,000, compared to 925,000 in January 1994.
SUNSET, The Magazine of Western Living, is a monthly regional magazine focused on lifestyles in the West. The advertising rate base increased to 1,425,000 in January 1995, compared to 1,400,000 in January 1994.
HEALTH is a consumer health magazine published seven times a year, and HIPPOCRATES is published ten times a year. Although similar in editorial content, HEALTH is targeted at the consumer market, while HIPPOCRATES is a trade magazine targeted at physicians and carries primarily trade advertising. HEALTH had an advertising rate base of 900,000 in January 1995, the same as in January 1994. HIPPOCRATES had a controlled circulation of 125,000 primary care physicians in January 1995, the same as in January 1994.
MARTHA STEWART LIVING is published ten times a year and presents Martha Stewart's personal perspective on entertaining, cooking, decorating and gardening. Its advertising rate base as of January 1995 was 800,000, compared to 725,000 in January 1994.
BABY TALK is published ten times a year and is targeted at expectant and new mothers. In February 1995 its advertising rate base was 1,000,000, compared to 1,300,000 in January 1994. BABY TALK's ancillary publications are BABY ON THE WAY (published semi-annually) and BABY ON THE WAY BASICS (published annually).
WHO WEEKLY is an Australian version of PEOPLE which focuses on celebrities and other notable personalities. The advertising rate base as of January 1995 was 230,000, compared to 200,000 in January 1994.
VIBE is published ten times a year by a joint venture between a subsidiary of TPV and affiliates of Quincy Jones Entertainment Company. It covers rap, rhythm and blues, reggae and dance music, as well as politics and fashion. The advertising rate base as of January 1995 was 250,000, compared to 200,000 in January 1994.
Circulation
The Company's publications are sold primarily by subscription. Subscription copies are delivered to subscribers through the mail. Subscriptions are sold by direct-mail solicitation, subscription sales agencies, television and telephone solicitation and insert cards in the Company's magazines and other publications. Single copies of magazines are sold through retail news dealers who are supplied in turn by regional wholesalers.
Advertising
Advertising carried in the Company's magazines is predominantly consumer advertising. Many of the Company's magazines have numerous regional and demographic editions which contain the same basic editorial material but permit advertisers to concentrate their advertising in specific markets. Through the use of selective binding and ink-jet technology, the Company creates special custom editions targeted towards specific groups. This allows the Company to deliver advertisers a more highly targeted audience by segmenting subscriber lists to identify those subscribers advertisers desire most, as well as providing the opportunity to personalize advertising messages.
Paper and Printing
Lightweight coated paper, which for certain magazines is recycled, constitutes a significant component of physical costs in the production of magazines. Time Inc. has contractual commitments to ensure an
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adequate supply of paper, but periodic shortages may occur in the event of strikes or other unexpected disruptions in the paper industry. During 1994, paper prices were relatively flat with some upward movement in the fourth quarter. In 1995, the Company expects that paper prices will increase as a result of increased demand in the paper market. Time Inc. purchases paper principally from four independent manufacturers, in each case under contracts that, for the most part, are either fixed-term or open-ended at prices determined on a market price or formula price basis.
Printing and binding for the Company's magazines are accomplished primarily by major domestic and international printing concerns in 20 locations. Magazine printing contracts are either fixed-term or open-ended at fixed prices with, in some cases, adjustments based on certain criteria.
BOOKS
General
The Company's book operations include Time Life Inc., Book-of-the-Month Club, Inc., Warner Books, Inc. and Little, Brown and Company, each of which is a wholly owned subsidiary of Time Inc., and the Oxmoor House and Sunset Books divisions of Southern Progress and Sunset Publishing, respectively. In 1994, the book operations distributed, in aggregate, approximately 159 million gross units.
Time Life
Time Life is composed of several divisions including: Books, Music, Video and Television, Education, Digital, Medical and International. Time Life is one of the nation's largest direct marketers of books, music and videos. The products are sold by direct response, including mail order, television and telephone, through retail, institutional and license channels, and by door-to-door independent distributors in some foreign markets. Editions of the books are currently sold in 23 languages worldwide and approximately 40% of Time Life's revenues are generated outside the United States. In 1994, Time Life created Time-Life Digital, a division designed to develop all forms of digital media from the company's extensive library of titles. Time-Life Medical was formed as a joint venture in January 1995 to create and sell patient-education materials.
Editorial material is created by in-house staffs as well as through outside book packagers. A significant product in 1994 was Time-Life Music's platinum series "The Rolling Stone Collection: 25 Years of Essential Rock." Other 1994 best sellers included "Weight Watchers (R) Smart Choice Recipe Collection" from Time-Life Books, "Sounds of the 70's" from Time-Life Music, and "Predators of the Wild" from Time-Life Video. In 1993, Time Life began the development of two ten-hour television documentary series, "Lost Civilizations" and "The History of Rock 'n' Roll," each of which draw on Time Life's existing editorial resources. First-run television rights to "Lost Civilizations" have been pre- sold to NBC and "The History of Rock 'n' Roll," co-produced with TWE's Telepictures Productions, aired in March 1995.
Manufacturing for Time-Life Books is done by several independent companies. Manufacturing contracts are entered into on a series rather than a single title basis and are fixed-price with provisions for cost of labor, material and specification adjustments. These contracts, subject to certain limitations, may be terminated by Time Life or the manufacturer. Time Life's fulfillment activities, excluding international operations, are conducted from a centralized facility in Richmond, Virginia.
Book-of-the-Month Club
Book-of-the-Month Club operates seven book clubs and three continuity businesses with combined membership in excess of 3.1 million. Two of the clubs, Book-of-the-Month Club and Quality Paperback Book Club, are general interest clubs and the remaining clubs specialize in history, cooking and crafts, business, children's books and the books of a particular author. In addition, multimedia, audio and video products are offered through the clubs. In 1993, Book-of-the-Month Club launched its businesses internationally, and now operates in over 40 countries in Europe, Asia, Latin America and the Middle East.
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Book-of-the-Month Club acquires the rights from publishers to manufacture and distribute books and then has them printed by independent printing concerns. Book-of-the-Month Club runs its own fulfillment and warehousing operations in Mechanicsburg, Pennsylvania.
Warner Books
Warner Books publishes hardcover, mass market and trade paperback books. Among its best selling hardcover books in 1994 were Robert James Waller's "Old Songs in a New Cafe," "Slow Waltz in Cedar Bend" and "The Bridges of Madison County" and James Redfield's "The Celestine Prophecy." Mass market paperback books on the best seller list in 1994 included "Pleading Guilty" by Scott Turow, "Along Came a Spider" by James Patterson, and "Where There's Smoke" and "Hidden Fires" by Sandra Brown.
During 1994, Warner Books acquired a minority equity interest in The Reference Press, Inc., a Texas-based print and electronic publisher of business information and company profiles. In addition, through a joint venture with Little, Brown, Warner Books operates Time Warner Electronic Publishing, which is engaged in on-line and multimedia publishing.
Little, Brown
Little, Brown publishes general and children's trade books, legal and medical reference books and textbooks. Through its subsidiary, Little, Brown (U.K.), it also publishes general hardcover and mass market paperback books in the United Kingdom. Among the trade hardcover books published by Little, Brown in 1994 were "The Day After Tomorrow" by Allan Folsom and "Long Walk to Freedom" by Nelson Mandela.
Little, Brown handles book distribution for itself, Warner Books and Sunset Books, as well as other publishers. The marketing of trade books is primarily to retail stores and wholesalers throughout the United States, Canada and the United Kingdom. Law and medical textbooks are sold primarily to university retail stores. Professional reference books are sold to practitioners through retail stores and direct marketing. Through their combined U.S. and U.K. operations, Little, Brown and Warner Books have the ability to acquire English- language publishing rights for the distribution of hard and softcover books throughout the world.
Warner Books, Little, Brown, and Warner Music Group's Atlantic Records operate a joint venture, Time Warner AudioBooks, to develop and market audio versions of books and other materials published by Warner Books, Little, Brown and other outside publishers.
Oxmoor House and Leisure Arts
Oxmoor House, the book publishing division of Southern Progress, markets how- to books on a wide variety of topics including food and crafts, as well as illustrated volumes on art and other subjects. Acquired in 1992 and integrated into Oxmoor House, Leisure Arts is a well-established publisher and distributor of instructional leaflets, continuity books series and magazines for the needlework and crafts market.
Sunset Books
Sunset Books, the book publishing division of Sunset Publishing, markets books on topics such as building and decorating, cooking, gardening and landscaping, and travel. Sunset Books' unique marketing formula includes an extensive network of home repair and garden centers.
OTHER PUBLISHING OPERATIONS
Multimedia and Television
Time Inc. continues to actively develop products for emerging technologies such as on-line computer networks, the Full Service Network, and the CD-ROM market. In 1994, Time Inc. launched PATHFINDER (TM), a site on the Internet that includes electronic editions of editorial content derived from Time Inc.'s magazine and book publications, as well as original content created exclusively for the Internet. Time Inc. has also licensed its editorial content to various other on-line information services, and has produced CD-ROM products through licensing arrangements with third party CD-ROM developers.
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Time Inc. has undertaken development efforts in various television ventures, both in combination with other Company divisions and independently. The most significant of these activities is an entertainment news show, "EXTRA--The Entertainment Magazine," produced in conjunction with the Telepictures division of TWE, a six-day-a-week program utilizing the editorial resources of Time Inc. to break exclusive stories.
Time Inc. In-Store Marketing
Time Inc. In-Store Marketing, an umbrella organization which is a subsidiary of TIV, operates all of Time Inc.'s in-store advertising and demonstration businesses, including Media Holdings, Inc. ("Media One") and SmartDemo Inc. ("SmartDemo"). Media One's primary product is a two-sided backlit advertising display unit that is installed in supermarket checkout lanes. SmartDemo is an in-store demonstration, couponing, sampling and merchandising business.
American Express Publishing
Time Inc., through its TIV subsidiary, has management responsibility for most of American Express Publishing Corporation's operations, including its core lifestyle magazines, TRAVEL & LEISURE and FOOD & WINE. TIV receives a fee for managing these properties, as well as incentives for improving profitability.
American Family Publishers
Time Inc. is a 50% partner in American Family Publishers ("AFP"), a direct mail magazine subscription sales agency. AFP sells magazine subscriptions for approximately 200 major magazines in the United States, including many of the Company's publications. AFP sells primarily through two heavily-promoted nationwide sweepstakes mailings conducted each year.
Time Distribution Services
In January 1995, Time Distribution Services Inc. ("TDS"), a wholly owned subsidiary of Time Inc., acquired substantially all of the assets of Time Distribution Services, a joint venture between Time Inc. and Gruner & Jahr (the successor to the New York Times Company's interest in Time Distribution Services). TDS markets and distributes magazines published by Time Inc. and certain other publishers in the United States and Canada, through wholesalers to retail outlets such as newsstands and directly to supermarkets and drugstore chains.
Warner Publisher Services
Warner Publisher Services ("WPS") is a major distributor of magazines and paperback books sold through wholesalers in the United States and Canada, and internationally. WPS is the sole national distributor for MAD magazine, the publications of DC Comics and certain publications owned by other publishers, including TEEN, VOGUE, WOMAN'S DAY, and the Dell Puzzle Books. WPS also distributes the paperback books published by Warner Books as well as the full paperback line of the Berkley Group. WPS is wholly owned by Time Inc.
Publishers Express
Time Inc. owns 23.5% of Publishers Express Inc., a corporation whose shareholders consist of eleven other publishers, printers, paper companies and direct mailers established to deliver second- and third-class mail and advertising material in competition with the U.S. Postal Service. As of January 1995, the corporation was delivering in 24 cities throughout the United States.
POSTAL RATES
Postal costs represent a significant operating expense for the Company's publishing activities. There were no general postal rate increases in 1994. An increase of approximately 10% for first class and 14% for second, third and fourth classes was implemented in January 1995 by the Postal Service.
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Publishing operations continue to minimize postal expense through the use of certain cost-saving measures, including the utilization of contract carriers to transport books and magazines to central postal centers. It has been the Company's practice in selling books and other products by mail to include a charge for postage and handling, which is adjusted from time to time to partially offset any increased postage or handling costs.
COMPETITION
The Company's magazine operations compete for sales with numerous other publishers and retailers, as well as other media. The general circulation magazine industry is highly competitive both within itself and with other advertising media which compete with the Company's magazines for audience and advertising revenue.
The Company's book publishing operations compete for sales with numerous other publishers and retailers as well as other media. In addition, the acquisition of publication rights to important book titles is highly competitive, and Warner Books and Little, Brown compete with numerous other book publishers. WPS and TDS meet with direct competition from other distributors operating throughout the United States and Canada in the distribution of magazines and paperback books.
MUSIC
GENERAL
The Company's music business, conducted under the umbrella name Warner Music Group ("WMG"), consists principally of a vertically integrated worldwide recorded music business and a worldwide music publishing business.
The Company's domestic recorded music business, which was restructured in 1994 and early 1995, is conducted primarily through a division of WMG called Warner Music U.S. ("WMUS") and its constituent companies, Elektra Entertainment Group ("Elektra"), The Atlantic Group ("Atlantic") and Warner Bros. Records ("WBR"), and their affiliated labels; and through Warner Media Manufacturing and Distribution ("WMMD") and its constituent companies, Warner-Elektra- Atlantic Corporation ("WEA"), WEA Manufacturing Inc. ("WEA Mfg.") and Ivy Hill Corporation ("Ivy Hill"). Outside of the United States, the Company's recorded music business is conducted in more than 65 countries through WEA International Inc. and a division of WCI, Warner Music International, and their subsidiaries and affiliates ("WMI"), as well as through non-affiliated licensees. WMG also conducts a home video business specializing in children's videos and fitness videos through WarnerVision, a division of WMUS.
The Company's music publishing business is conducted principally through wholly owned subsidiaries of WCI (collectively, "Warner/Chappell").
In 1994, approximately 57% of WMG's recorded music revenues were derived from sources outside of the United States.
RECORDED MUSIC AND RELATED ACTIVITIES
WMI, WBR, Atlantic and Elektra produce, sell and license compact discs, cassette tapes and music videos (in both videocassette and video laserdisc configurations) of the performances of recording artists under contract to them or for whose recordings they have acquired rights. WMG's recorded music and video product is marketed under various labels, including the proprietary labels "Warner Bros.," "Reprise," "Sire," "Tommy Boy," "Warner Nashville," "Elektra," "Asylum," "Nonesuch," "Atlantic," "WarnerVision," "EastWest America," "Big Beat," "Atlantic Nashville," "WEA," "EastWest," "Teldec," "CGD," "Carrere," "Erato," "MMG," "DRO," "Telegram," "D-Day," "Muser" and "Fazer."
In addition, WMG has entered into joint venture agreements pursuant to which WMG companies manufacture, distribute and market (both domestically and, in most cases, internationally) recordings owned by such joint ventures. The terms of such agreements vary widely, but each agreement typically provides the
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WMG record company with an equity interest and a profit participation in the venture, with financing furnished either solely by WMG or by both parties. Included among these arrangements are the labels "American Recordings," "Giant," "Interscope," "Maverick," "Qwest" and "Rhino." In early 1995, Elektra entered into a joint venture arrangement with Sub Pop Ltd. ("Sub Pop"), an independent record company based in Seattle.
WMG's record companies also acquire rights pursuant to agreements to manufacture and distribute certain recordings that are marketed under the licensor's proprietary label. Included among the labels distributed by WMUS under such arrangements are "Beggars Banquet," "Curb," "Mammoth," "Matador" and "Slash."
Recording artists are engaged under arrangements that generally provide that the artist is to receive a percentage of the suggested retail selling price of compact discs, cassette tapes and music videos sold. Most artists receive non- returnable advance payments against future royalties.
Among the artists whose albums resulted in significant sales for WMG's record companies during 1994 were: All-4-One, Anita Baker, Candlebox, Collective Soul, Eric Clapton, Green Day, Madonna, Luis Miguel, John Michael Montgomery, Laura Pausini, R.E.M., Stone Temple Pilots, Keith Sweat, Mariya Takeuchi and The Three Tenors. In 1995, WMG's record companies expect to release albums by the following artists: Tori Amos, AC/DC, Bjork, Tevin Campbell, Enya, En Vogue, Michael Feinstein, Philip Glass, Van Halen, Quincy Jones, Andy Lau, Bette Midler, Red Hot Chili Peppers, Linda Ronstadt, David Sanborn, Simply Red, Rod Stewart and Skid Row.
WMG's domestic manufacturing, packaging and distribution operations are conducted through WMMD and its constituent companies.
WEA Mfg. is engaged in the domestic manufacturing of audio and CD-ROM compact discs, cassette tapes and videocassettes. WEA Mfg. conducts its operations from facilities situated in Olyphant, Pennsylvania and in the greater Los Angeles area. WEA Mfg. participated in the development of digital video discs ("DVD"), the new digital configuration developed by Time Warner and Toshiba, and expects to be manufacturing DVD early in 1996.
Ivy Hill is engaged in the offset lithography and packaging business through facilities situated in four states. Ivy Hill is a major supplier of packaging to the recorded music industry (including WMG's record companies) and also supplies packaging for a wide variety of other consumer products.
WMG's recorded music product is marketed and distributed in the continental United States by WEA, which supplies, directly or indirectly through sub- distributors and wholesalers, thousands of record stores, department stores, discount centers and other retail outlets across the country. Alternative Distribution Alliance, a distribution company specializing in alternative rock music, with a focus on new artists, operates as a joint venture among WMG, its labels, Restless Records and Sub Pop.
Warner Special Products produces, primarily for telemarketers, compilations of music for which it has obtained rights from WMG's recorded music companies, as well as from third parties.
In foreign markets, WMI produces, distributes, promotes and sells recordings of local artists and, in most cases, distributes the recordings of those artists for whom WMG's domestic recording companies have international rights. In certain countries, WMI licenses to non-affiliated parties rights to distribute recordings of WMG's labels. WMI strengthened its operations during 1994 with the creation of Warner Music Benelux, combining affiliates in the Netherlands and Belgium; the establishment of Warner Music Thailand; the acquisition of NVC Arts, a classical video company in the U.K.; and the formation of an international marketing alliance with China Records in the U.K. WMI also operates two plants in Germany that manufacture compact discs, cassette tapes and vinyl records for WMI's European affiliates and licensees and for WMI companies outside Europe, as well as for unrelated parties.
Warner Music Enterprises ("WME"), a direct marketing company, operates magazine-plus-CD/audio cassette continuity programs specializing in classical music (BBC Music) and country music (New Country).
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During 1994, WME added a new rock music magazine, huH, to its existing Rock Video Monthly service and launched Jazziz, a new jazz-oriented service. In February 1995, WME launched Radio Aahs, a similar service for children.
Through joint ventures, WMG and Sony Music Entertainment ("Sony Music") operate The Columbia House Company, the leading direct marketer of compact discs, cassette tapes and videocassettes in the United States and Canada. WCI owns a minority portion of Time Warner's 50% interest in the U.S. partnership and all of Time Warner's 50% interest in the Canadian partnership. WMG and Sony Music are also partners in Music Sound Exchange, a direct marketing catalog that is primarily directed to selling music and related products to consumers age 35 and over.
In March 1995, WMG entered into a joint venture with PolyGram International Ltd. ("PolyGram") and Sony Music to directly market recorded music and filmed entertainment repertoire in Europe through music clubs and video clubs.
WMG, with other partners, including another subsidiary of the Company, has an equity interest in Digital Cable Radio Associates, an audio programming service that delivers multiple channels of CD-quality stereo music via cable television. In Europe, where the service is known as Music Choice Europe, it is delivered via cable television and direct-to-home satellite.
WMG is a partner with Sony Pictures Entertainment, Inc. ("Sony Pictures"), PolyGram, Thorn EMI ("EMI") and Hamburg radio executive Frank Otto in VIVA, a 24-hour German language music video channel carried on cable television in Germany.
In January 1995, WMG entered into a joint venture with STAR TV, Bertlesmann Music Group, EMI and Sony Pictures to develop programming for STAR TV's existing pan-Asian music channel, Channel [V].
During 1994 and early 1995, WMG acquired the U.K. multimedia developer Renegade and signed software development agreements in the U.S. with several leading interactive programming creators, including Hyperbole Studios, Imagination Pilots and Accolade (and acquired a minority interest in that company). Also in 1994, WMG, along with Home Box Office and software developer Michael Nash, created a new multimedia joint venture known as Inscape. WMG also announced the formation of WarnerActive, a division of WEA that will publish multimedia titles in the U.S., and Warner Interactive Entertainment which will publish multimedia titles in international markets. Time Warner's other divisions involved in CD-ROM production, including Time Warner Interactive Group, will also be utilizing WarnerActive's services.
MUSIC PUBLISHING
Time Warner's music publishing companies own or control the rights to over a million standard and contemporary compositions, including numerous popular hits, folk songs and music from the stage and motion pictures. Certain works of the following artists, authors and composers are included in Warner/Chappell's catalogues: John Bettis, Michael Bolton, The Black Crowes, Phil Collins, Comden & Green, Dubin & Warren, Genesis, George and Ira Gershwin, Gin Blossoms, Victor Herbert, Michael Jackson, Elton John, Leiber & Stoller, Lerner & Lowe, Madonna, Henry Mancini, Johnny Mercer, George Michael, Midnight Oil, Cole Porter, the artist formerly known as Prince, R.E.M., Rodgers & Hart, Soul Asylum, Jule Styne, Bernie Taupin, Van Halen, John Williams and the foreign administration of the works of Irving Berlin.
Warner/Chappell also administers the film music of several television and motion picture companies, including Lucasfilm, Ltd., Viacom Enterprises, Samuel Goldwyn Productions and Famous Music (outside the United States and Japan).
Warner/Chappell's printed music division markets publications throughout the world containing the works of Alabama, Phil Collins, Bon Jovi, The Eagles, The Grateful Dead, Michael Jackson, Led Zeppelin, Madonna, John Mellencamp, the artist formerly known as Prince, Rush, Bob Seger and many others. In July 1994, Warner/Chappell acquired CPP/Belwin, Inc., one of the world's largest publishers of printed music.
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Principal sources of revenues to Warner/Chappell are license fees for use of its music copyrights on radio and television, in motion pictures and in other public performances; royalties for use of its music copyrights on compact discs, cassette tapes, vinyl records, music videos and in commercials; and sales of published sheet music and song books for the home musician as well as the professional and school markets, including methods for teaching musical instruments.
LEGISLATION
As digital technology is applied to broadcast, cable and other means of distribution, and more particularly to the interactive networks comprising the "information superhighway," the virtually flawless reception and improved potential for recording that digitization entails is expected to be the subject of legislation in 1995. A bill has been introduced in the Senate (S.227), and it is anticipated that one will be introduced shortly in the House, which will provide royalties to performers and producers of sound recordings that are publicly performed on digital subscription music services. Sound recordings are the only copyrighted works for which there is no compensation for their public performance. Passage of this legislation would favorably impact WMG's interests. Prospects for passage may be improved by the bill's exclusion of conventional analog distribution.
In addition, a bill to extend the term of ownership of copyrights for an additional 20 years has been introduced in the House (H.R. 989). Passage of this legislation would benefit all of the Company's copyright businesses, including the businesses of WMG.
No assurance can be given that either of these bills will become law.
COMPETITION
The recorded music business is highly competitive. The revenues and income of a company in the recording industry depend upon the public acceptance of the company's recording artists and the recordings released in a particular year. Although WMG is one of the largest recorded music companies in the world, its competitive position is dependent upon its continuing ability to attract and develop talent that can achieve a high degree of public acceptance. The recorded music business continues to be adversely affected by counterfeiting, piracy, parallel imports and, in particular, the home taping of recorded music. In addition, the recorded music business also meets with competition from other forms of entertainment, such as television, pre-recorded videocassettes and video games.
Competition in the music publishing business is intense. Although WMG's music publishing business is the largest on a worldwide basis, it competes with every other music publishing company in acquiring musical compositions and in having them recorded and performed.
ENTERTAINMENT
The Company's Entertainment Group consists of TWE's Filmed Entertainment, Programming--HBO and Cable businesses, and also Time Warner's interests in certain other businesses. Each of the three principal businesses is operated as a separate division of TWE and, except as described below, in the same manner as it was operated by the Company at the time of the TWE Capitalization. See "--Description of Certain Provisions of the TWE Partnership Agreement-- Management and Operations of TWE."
As a result of the U S WEST Transaction, TWE may be deemed an "affiliated enterprise" of a Regional Bell Operating Company ("RBOC") and, as such, may be subject to certain restrictions of the Modification of Final Judgment entered on August 24, 1982 by the United States District Court for the District of Columbia and related decisions and decrees (the "Modification of Final Judgment"). Generally, the Modification of Final Judgment prohibits the RBOCs, including U S WEST, and any of their "affiliated enterprises," from among other things, (i) providing long distance telecommunications services, which may include operating or providing long distance services using TVROs or satellites, or coaxial cable, fiber or microwave facilities, (ii) manufacturing or providing telecommunications equipment and (iii) manufacturing
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"customer premises equipment," which may include cable television converter or multimedia boxes. In addition, the Modification of Final Judgment may prohibit the RBOCs and their "affiliated enterprises" from holding certain financial interests in ventures that engage in the foregoing activities. Several bills that would alleviate many of the restrictions contained in the Modification of Final Judgment are under active consideration in the U.S. Congress.
In order to ensure compliance with the Modification of Final Judgment, prior to U S WEST's investment in TWE, TWE distributed to the Time Warner General Partners certain assets, including the satellite receiving dishes and broadcast antennae used by TWE's cable division, the transponders and other transmission equipment used by TWE's cable television programming and filmed entertainment divisions and equity interests in certain programming entities (collectively, the "TW Service Partnership Assets"). Such partners then contributed such assets to newly formed sister partnerships in which the Time Warner General Partners and subsidiaries of ITOCHU and Toshiba are the partners (the "Time Warner Service Partnerships"). Upon the distribution of the TW Service Partnership Assets to the Time Warner General Partners, the Time Warner General Partners' junior priority capital interests were reduced by approximately $300 million. See "--Other Entertainment Group Assets--Time Warner Service Partnerships."
On October 24, 1994, U S WEST was granted a waiver (the "Waiver") of certain provisions of the Modification of Final Judgment that affected some of TWE's businesses. Although the Waiver permits TWE, to a large extent, to conduct its businesses as it did before the U S WEST Transaction, it does not remove all of the "line of business" restrictions and requirements imposed by the Modification of Final Judgment. As a result of the Waiver, TWE is no longer prohibited from owning substantially all of the TW Service Partnership Assets. Accordingly, pursuant to the terms of certain agreements, the TW Service Partnership Assets no longer subject to such restrictions will be recontributed to TWE on September 15, 1995 (or September 15, 1997 in the case of certain assets), or earlier under certain circumstances, at their then fair market value, in exchange for partnership interests in TWE.
FILMED ENTERTAINMENT DIVISION
General
TWE's principal operations in the fields of motion pictures and television are conducted by its Warner Bros. division ("WB"). The filmed entertainment business includes the production, financing and distribution of feature motion pictures, television series, made-for-television movies, mini-series for television, first-run syndication programming, and animated programming for theatrical and television exhibition; and the distribution of pre-recorded videocassettes and videodiscs. TWE also is engaged in product licensing and the ownership and operation of retail stores, movie theaters and theme parks; and, since January 1995, the ownership and operation of a new national broadcast television network, The WB.
Feature motion pictures and television programs are produced at various locations throughout the world, including The Warner Bros. Studio in Burbank, California and The Warner Hollywood Studio in West Hollywood, California. For additional information, see Item 2
ITEM 2. PROPERTIES
PUBLISHING, MUSIC AND CORPORATE
The following table sets forth certain information as of December 31, 1994 with respect to the Company's principal properties (over 250,000 square feet in area) that are used primarily by its publishing and music divisions or occupied for corporate offices, all of which the Company considers adequate for its present needs, and all of which were substantially used by the Company or were leased to outside tenants:
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ENTERTAINMENT
The following table sets forth certain information as of December 31, 1994 with respect to TWE's principal properties (over 125,000 square feet in area), all of which TWE considers adequate for its present needs, and all of which were substantially used by TWE or were leased to outside tenants.
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-------- (a) Ten acres consist of various parcels adjoining The Warner Bros. Studio, with mixed commercial, office and residential uses. (b) 1,640 acres of which are undeveloped land available for expansion. (c) Excludes 9,085,000 sq. ft. of owned and 2,021,000 sq. ft. of leased properties used by the Cable division for headend, hub, and tower sites. (d) Includes 108,000 sq. ft. of office space occupied by Time Warner corporate staff who provide services to TWE pursuant to arrangements set forth in the TWE Partnership Agreement.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company and its subsidiaries are parties, in the ordinary course of business, to litigations involving property, personal injury and contract claims. The amounts that the Company believes may be recoverable in these matters are either covered by insurance or are not material.
In June 1989, a purported stockholder class action was filed in the Supreme Court of the State of New York, County of New York, entitled Northern Laminating, Inc. Retirement Fund v. Munro, et al., Index No. 12653-89, against the Company and its Board of Directors, alleging that defendants breached their fiduciary duties by the Company's tender offer (the "Tender Offer") for WCI (pursuant to which the Company purchased 100 million shares of WCI common stock on July 24, 1989) and by the terms of the Agreement and Plan of Merger (as amended, the "Merger Agreement") among the Company, TW Sub Inc., then a wholly owned subsidiary of the Company, and WCI which purports to prevent defendants from considering other offers, and that defendants, by similar acts, engaged in a combination and conspiracy in restraint of trade. Plaintiff seeks, among other things, a declaratory judgment that defendants breached their fiduciary duties and monetary damages for defendants' purported breach of fiduciary duties. Defendants have not been required to respond to the amended complaint. A Stipulation of Voluntary Discontinuance without prejudice was submitted to the court on September 14, 1994, and is awaiting approval.
Since 1989, there has been pending in the Court of Chancery for the State of Delaware, in and for New Castle County (the "Delaware Chancery Court") a consolidated stockholder litigation, In re Warner Communications Inc. Shareholders Litigation, Consol. Civ. Action No. 10671 (the "Warner Stockholder
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Litigation"), commenced against WCI, its Board of Directors and the Company, alleging that WCI's Board of Directors breached their fiduciary duties to WCI's stockholders, and the Company aided and abetted such alleged breach, by not ensuring that the securities distributed to WCI stockholders in the Merger contained certain protective covenants and redemption provisions. The amended complaint seeks, among other things, to enjoin the consummation of the Tender Offer and the Merger, or to rescind the Tender Offer and the Merger. The defendants have not yet been required to respond to the amended complaint. The action has been stayed pending resolution of the Berger action described below.
Another 1989 purported stockholder class action, Berger, et al. v. Warner Communications Inc., et al., Index No. 91-3735, filed in the New York Supreme Court against WCI, certain of WCI's directors, the Company, Wasserstein Perella & Co., Inc. ("Wasserstein Perella"), Shearson Lehman Hutton Inc. ("Shearson Lehman") and Lazard Freres & Co. ("Lazard") alleges, among other things, that WCI's directors and the Company breached their fiduciary duties to WCI's stockholders by structuring the Merger as a freezeout of WCI's minority stockholders, and by failing to ensure that the securities to be distributed to stockholders in the Merger would in fact trade at the value imputed to those securities, and that Wasserstein Perella, Shearson Lehman and Lazard aided and abetted those breaches of fiduciary duty. The complaint seeks, among other things, a declaratory judgment that defendants have breached their fiduciary duties, compensatory damages and a judgment declaring the Merger a nullity. On April 9, 1991, a court order effected defendants' stipulation to the certification of a plaintiff class consisting of those persons who held shares of WCI common stock on August 23, 1989 and before the effective date of the Merger, except defendants in this litigation and any person or entity related to or affiliated with any defendants. Argument on both sides' motions for partial summary judgment on plaintiffs' contract claim for additional interest of approximately $20 million in connection with the consideration paid in the merger transaction was heard on February 22, 1994. On August 16, 1994, the court granted defendants' motion for partial summary judgment and dismissed plaintiffs' contract claim. Plaintiffs filed a Notice of Appeal on September 14, 1994.
On January 24, 1994, a purported class action entitled Dr. Arun Shingala v. Gerald M. Levin, et al., Civil Action No. 13356, was filed against the Company and its directors in the Court of Chancery of the State of Delaware, New Castle County, on behalf of all stockholders of the Company, other than defendants and their related or affiliated entities. The complaint alleges that the defendant directors acting on behalf of the Company have adopted a plan ("rights plan") to thwart any attempt to take over control of the Company which the defendants find unfavorable to their personal interests. Plaintiff contends that defendants' actions are in violation of their fiduciary duties and seeks a judgment rescinding the adoption of the rights plan and ordering the director defendants jointly and severally to account for all damages which reasonably flow from the actions and transactions alleged. The parties have agreed to dismiss the action without prejudice and without compensation to the plaintiffs or their attorneys. An order effecting that agreement was approved by the court on March 16, 1995.
In November 1992, TWE filed a federal lawsuit seeking to overturn major provisions of the 1992 Cable Act primarily on First Amendment grounds. The complaint, filed in the U.S. District Court for the District of Columbia against the FCC and the United States of America, challenges the provisions of the 1992 Cable Act relating to rate regulation, must carry, retransmission consent, terms of dealing by vertically integrated programmers, uniform pricing and operation of cable systems by municipal authorities, the number of subscribers that a cable operator could serve nationwide, free previews of certain premium channels and educational channel set-aside requirements for direct broadcast satellite service. In addition, the complaint seeks to overturn several parts of the 1984 Cable Act relating to public, educational and government access requirements and commercial leased channels. The complaint seeks injunctions against the enforcement or implementation of these provisions. Several other parties have also filed similar lawsuits and these actions have been at least partially consolidated with the action filed by TWE. Hearings on the plaintiffs' motions for summary judgment and the defendants' motions to dismiss or for summary judgment were held in March 1993. On April 8, 1993, in a 2-1 decision, the District Court upheld the constitutionality of the must carry provisions of the 1992 Cable Act. On May 3, 1993, TWE filed an appeal from this decision directly to the U.S. Supreme Court. The U.S. Supreme Court heard argument on that appeal in January 1994 and on June 27, 1994 the U.S. Supreme Court vacated the judgment of the District Court regarding the must-carry
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provisions and remanded the case to that court for further factual findings. On September 16, 1993, a one-judge District Court upheld the constitutionality on First Amendment grounds of all the other challenged provisions except restrictions on the number of subscribers that a cable operator could serve nationwide, free pay TV previews and direct broadcast channel usage. TWE appealed this decision to the U.S. Court of Appeals for the D.C. Circuit on November 12, 1993. Briefing on the appeal is scheduled to be completed by early July 1995. For a description of the 1984 Cable Act and the 1992 Cable Act, see Item 1 "Business--Cable Division--Regulation and Legislation."
By letters dated July 15, 1993 and September 21, 1993 (the "Access Letters"), the Dallas Regional Office of the Federal Trade Commission (the "FTC") informed WEA that it is conducting a preliminary investigation to determine whether WEA is "unreasonably restricting the resale of previously owned compact discs" and "unreasonably restricting the sale of new compact discs." The Access Letters allege that WEA's conduct may violate Section 5 of the Federal Trade Commission Act, but also say that neither the Access Letters nor the existence of the investigation "should be viewed as an accusation by the FTC or its staff of any wrongdoing by [WEA]." The Access Letters request that WEA voluntarily submit the documents and information requested therein. The FTC investigation also includes other major distributors of recorded music. In the course of the investigation, the FTC issued a subpoena for the deposition of a former WEA executive. WEA has complied with the Access Letters and subpoena. In early October 1994, WEA (and other major distributors of recorded music) received a follow-up subpoena for the production of documents, stating that the FTC is investigating whether members of the pre-recorded music distributing industry may be engaging in unfair methods of competition by fixing prices or by engaging in concerted activities to limit the availability of cooperative advertising or promotional funds to retailers who distribute used compact discs or advertise prices of compact discs below specified levels. WEA produced documents in late December in response to the subpoena.
In October 1993, a purported class action was filed in the United States District Court for the Northern District of Georgia entitled Samuel D. Moore, et al. v. American Federation of Television and Radio Artists, et al., No. 93- Civ-2358. The action was brought by fifteen named music performers or representatives of deceased performers on behalf of an alleged class of performers who participated in the creation or production of phonograph recordings for one or more of the defendant recording companies. The named defendants include the American Federation of Television and Radio Artists ("AFTRA"), the AFTRA Health and Retirement Fund ("Fund"), each present trustee of the Fund and fifty named recording companies, including four WCI subsidiaries. The named defendant recording companies comprise substantially all of the domestic recording industry and the complaint seeks to establish a defendant class for purposes of the litigation. The complaint seeks recovery against the recording companies for, among other things, breach of contract, breach of fiduciary duty, fraud, embezzlement and RICO violations, all growing out of alleged failure by the recording companies to make proper contributions to the Fund pursuant to the Phono Code, which is negotiated by AFTRA and most of the domestic recording companies, and other alleged failures to meet the terms of the Phono Code and individual contracts. Plaintiffs seek from the defendant record companies substantial monetary damages, treble damages, attorneys' fees and costs and the imposition of a constructive trust over the master recordings created from recorded performances of the plaintiffs. In March 1994, plaintiffs filed an amended complaint. In March and April 1994, AFTRA, the Fund, the Fund's trustees and certain of the defendant recording companies, including the four WCI subsidiaries, moved to dismiss plaintiffs' amended complaint. On August 2, 1994, the court, among other things, dismissed the claims against the Fund and the Fund's trustees, converted AFTRA's motion to one for summary judgment (and allowed re-briefing) and dismissed all claims against the defendant recording companies except the RICO claim. The record company defendants in the one remaining RICO claim have answered the amended complaint and filed a motion for summary judgment seeking dismissal of the claim. The court has granted AFTRA's motion, and the record company defendants' motion for summary judgment remains pending.
On February 21, 1995, counsel for plaintiffs filed a new lawsuit, entitled Samuel D. Moore, et al. v. Sony Music Entertainment Group, et al., No. 95-Civ- 1221, in the United States District Court for the Southern
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District of New York. The action was brought by all but one of the named plaintiffs in the Georgia federal suit, with one new plaintiff. The plaintiffs are suing on behalf of an alleged class of performers and derivatively on behalf of the AFTRA Fund. The named defendants include the Fund's trustees, the Fund, and the recording companies that were named as defendants in the Georgia federal suit. The complaint is based on substantially the same allegations as the complaint in the Georgia federal suit, and seeks to recover substantial monetary damages, liquidated damages, and attorney's fees from the recording companies. The record company defendants have simultaneously moved in the Southern District of New York for an order transferring the new case to the Northern District of Georgia, and moved in the Northern District of Georgia for an order staying plaintiffs from proceeding with the New York federal action.
On July 14, 1994, the Company received a civil investigative demand from the United States Department of Justice in furtherance of an investigation into certain worldwide activities of the Warner Music Group and other companies in the recorded music industry principally related to cable, wire and satellite- delivered music and music video programmers. The Company has complied with the civil investigative demand to the extent that it sought information and documents with respect to domestic activities of the Warner Music Group and has objected to responding with respect to foreign activities on the ground that the Department of Justice lacks jurisdiction to inquire into such activities. On November 3, 1994, the Department of Justice filed a petition in the United States District Court for the District of Columbia seeking to compel the Company and the other companies to provide documents from their files in the United States that deal with overseas activities.
The Company and its subsidiaries are also subject to industry investigations by certain government agencies and/or proceedings under the antitrust laws that have been filed by private parties in which, in some cases, other companies in the same or related industries are also defendants. The Company and its subsidiaries have denied or will deny liability in all of these actions. In all but a few similar past actions, the damages, if any, recovered from the Company or the amounts, if any, for which the actions were settled were small or nominal in relation to the damages sought; and it is the opinion of the management of the Company that any settlements or adverse judgments in the similar actions currently pending will not involve the payment of amounts or have other results that would have a material adverse effect on the financial condition of the Company.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not Applicable.
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EXECUTIVE OFFICERS OF THE COMPANY
Pursuant to General Instruction G (3), the information regarding the Company's executive officers required by Item 401(b) of Regulation S-K is hereby included in Part I of this report.
The following table sets forth the name of each executive officer of the Company, the office held by such officer and the age, as of March 17, 1995, of such officer:
Set forth below are the principal positions held by each of the executive officers named above since March 1, 1990:
Mr. Levin.................. Chairman of the Board of Directors and Chief Executive Officer since January 21, 1993. Prior to that he served as President and Co-Chief Executive Officer from February 20, 1992; Vice Chairman and Chief Operating Officer from May 1991; and Vice Chairman of the Board prior to that.
Mr. Parsons................ President since February 1, 1995. Prior to that he served as Chairman of The Dime Savings Bank of New York, FSB ("DSB") from January 1991 and Chief Executive Officer of DSB from July 1990. Prior to that he was President of DSB.
Mr. Haje................... Executive Vice President and General Counsel since October 1, 1990 and Secretary since May 20, 1993. Prior to that, he was a member of the law firm of Paul, Weiss, Rifkind, Wharton & Garrison.
Mr. Boggs.................. Senior Vice President since November 19, 1992. Prior to that he served as Vice President of Public Affairs.
Mr. Bressler............... Senior Vice President and Chief Financial Officer since March 16, 1995. Prior to that he served as Senior Vice President, Finance from January 2, 1995; and as a Vice President prior to that.
Mr. Hullin................. Senior Vice President since February 7, 1991. Prior to that, he served as Senior Vice President, Corporate Affairs of SmithKline Beecham (diversified health care company).
Mr. Lochner................ Senior Vice President since July 18, 1991. Prior to that, he was a Commissioner of the Securities and Exchange Commission from March 1990 to June 1991. Prior to his tenure with the SEC, Mr. Lochner served as Deputy General Counsel and Senior Vice President of Time Warner from January to March 1990.
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PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The principal market for the Company's Common Stock is the New York Stock Exchange. The Common Stock is also listed on the Pacific Stock Exchange and the London Stock Exchange. For quarterly price information with respect to the Company's Common Stock for the two years ended December 31, 1994, see "Quarterly Financial Information" at page herein, which information is incorporated herein by reference.
The approximate number of holders of record of the Company's Common Stock as of March 1, 1995 was 19,000.
For information on the frequency and amount of dividends paid with respect to the Company's Common Stock during the two years ended December 31, 1994, see "Quarterly Financial Information" at page herein, which information is incorporated herein by reference.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The selected financial information of the Company for the five years ended December 31, 1994 is set forth at page herein and is incorporated herein by reference.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The information set forth under the caption "Management's Discussion and Analysis" at pages through herein is incorporated herein by reference.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements and supplementary data of the Company and the report of independent auditors thereon set forth at pages through and herein are incorporated herein by reference.
Quarterly Financial Information set forth at page herein is incorporated herein by reference.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not Applicable.
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PART III
ITEMS 10, 11, 12 AND 13. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT; EXECUTIVE COMPENSATION; SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT; CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information called for by PART III (Items 10, 11, 12 and 13) is incorporated by reference from the Company's definitive Proxy Statement to be filed in connection with its 1995 Annual Meeting of Stockholders pursuant to Regulation 14A, except that the information regarding the Company's executive officers called for by Item 401(b) of Regulation S-K has been included in PART I of this report and the information called for by Items 402(k) and 402(l) of Regulation S-K is not incorporated by reference.
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PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) (1)-(2) Financial Statements and Schedules:
(i) The list of consolidated financial statements and schedules set forth in the accompanying Index to Consolidated Financial Statements and Other Financial Information at page herein is incorporated herein by reference. Such consolidated financial statements and schedules are filed as part of this report.
(ii) The financial statements of the Time Warner Service Partnerships and the report of independent auditors thereon, set forth at pages through in the 1994 Annual Report on Form 10-K of Time Warner Entertainment Company, L.P. (Reg. No. 33-53742) (the "TWE's 1994 Form 10-K") are incorporated herein by reference and are filed as an exhibit to this report.
(iii) The financial statements and financial statement schedule of Paragon Communications and the report of independent accountants thereon, set forth at pages through in TWE's 1994 Form 10-K, are incorporated herein by reference and are filed as an exhibit to this report.
(3) Exhibits:
The exhibits listed on the accompanying Exhibit Index are filed or incorporated by reference as part of this report and such Exhibit Index is incorporated herein by reference. Exhibits 10.1 through 10.24 listed on the accompanying Exhibit Index identify management contracts or compensatory plans or arrangements required to be filed as exhibits to this report, and such listing is incorporated herein by reference.
(b) No reports on Form 8-K were filed by Time Warner during the quarter ended December 31, 1994.
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SIGNATURES
PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.
Time Warner Inc.
/s/ Peter R. Haje By .................................. PETER R. HAJE EXECUTIVE VICE PRESIDENT, GENERAL COUNSEL AND SECRETARY
Date: March 30, 1995
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
/s/ Gerald M. Levin ............................. Director, Chairman of the March 30, (GERALD M. LEVIN) Board and Chief Executive 1995 Officer (principal executive officer)
/s/ Richard J. Bressler ............................. Senior Vice President and March 30, (RICHARD J. BRESSLER) Chief Financial Officer 1995 (principal financial officer)
/s/ John A. LaBarca ............................. Vice President and Controller March 30, (JOHN A. LABARCA) (principal accounting 1995 officer)
* ............................. Director March 30, (MERV ADELSON) 1995
* ............................. Director March 30, (LAWRENCE B. BUTTENWIESER) 1995
* ............................. Director March 30, (EDWARD S. FINKELSTEIN) 1995
* ............................. Director March 30, (BEVERLY SILLS GREENOUGH) 1995
* ............................. Director March 30, (CARLA A. HILLS) 1995
* ............................. Director March 30, (DAVID T. KEARNS) 1995
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SIGNATURE TITLE DATE
* ............................. Director March 30, (HENRY LUCE III) 1995
* ............................. Director March 30, (REUBEN MARK) 1995
* ............................. Director March 30, (MICHAEL A. MILES) 1995
* ............................. Director March 30, (J. RICHARD MUNRO) 1995
* ............................. Director March 30, (RICHARD D. PARSONS) 1995
* ............................. Director March 30, (DONALD S. PERKINS) 1995
* ............................. Director March 30, (RAYMOND S. TROUBH) 1995
* ............................. Director March 30, (FRANCIS T. VINCENT, JR.) 1995
/s/ Peter R. Haje *By: ........................ ATTORNEY-IN-FACT
IV-3
TIME WARNER INC. AND TIME WARNER ENTERTAINMENT COMPANY, L.P. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND OTHER FINANCIAL INFORMATION
All other financial statements and schedules are omitted because the required information is not present, or is not present in amounts sufficient to require submission of the financial statements or schedules, or because the information required is included in the consolidated financial statements and notes thereto.
TIME WARNER INC. CONSOLIDATED BALANCE SHEET DECEMBER 31, (MILLIONS, EXCEPT PER SHARE AMOUNTS)
See accompanying notes.
TIME WARNER INC. CONSOLIDATED STATEMENT OF OPERATIONS YEARS ENDED DECEMBER 31, (MILLIONS, EXCEPT PER SHARE AMOUNTS)
See accompanying notes.
TIME WARNER INC. CONSOLIDATED STATEMENT OF CASH FLOWS YEARS ENDED DECEMBER 31, (MILLIONS)
-------- (a) The 1994 and 1993 financial statements reflect the deconsolidation of the Entertainment Group, principally TWE, effective January 1, 1993. The 1992 historical financial statements have not been changed; however, financial statements for 1992 retroactively reflecting the deconsolidation are presented as supplementary information under the column heading "restated" to facilitate comparative analysis (Note 1).
(b) Includes $70 million increase in deferred income tax liability as a result of a new tax law enacted in 1993 and $57 million extraordinary loss on the retirement of debt.
See accompanying notes.
TIME WARNER INC. CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (MILLIONS, EXCEPT PER SHARE AMOUNTS)
See accompanying notes.
TIME WARNER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1.SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF CONSOLIDATION AND ACCOUNTING FOR INVESTMENTS
The consolidated financial statements include 100% of the assets, liabilities, revenues, expenses, income, loss and cash flows of Time Warner Inc. ("Time Warner" or the "Company") and all companies in which Time Warner has a controlling voting interest ("subsidiaries"), as if Time Warner and its subsidiaries were a single company. Significant intercompany accounts and transactions between the consolidated companies have been eliminated.
Investments in companies in which Time Warner has significant influence but less than a controlling voting interest are accounted for using the equity method. Under the equity method, only Time Warner's investment in and amounts due to and from the equity investee are included in the consolidated balance sheet, only Time Warner's share of the investee's earnings is included in the consolidated operating results, and only the dividends, cash distributions, loans or other cash received from the investee, less any additional cash investment, loan repayments or other cash paid to the investee, are included in the consolidated cash flows.
Prior to 1993, Time Warner's Entertainment Group companies ("Entertainment Group"), principally Time Warner Entertainment Company, L.P. ("TWE"), were consolidated. Due to changes in TWE's governance provisions at the time U S WEST, Inc. ("U S WEST") was admitted as an additional limited partner (Note 2), TWE and the other Entertainment Group companies were deconsolidated, effective as of January 1, 1993, and have since been accounted for using the equity method. The 1992 historical financial statements of Time Warner were not changed; accordingly, they include TWE and other Entertainment Group companies on a consolidated basis. However, financial statements for 1992 retroactively reflecting the deconsolidation of the Entertainment Group also are presented under the caption "restated" to facilitate comparative analysis.
In accordance with Financial Accounting Standards Board ("FASB") Statement No. 115, "Accounting for Certain Investments in Debt and Equity Securities," investments in companies in which Time Warner does not have the controlling interest or an ownership and voting interest so large as to exert significant influence are accounted for at market value, if the investments are publicly traded and there are no resale restrictions, or at cost, if the sale of a publicly-traded investment is restricted or if the investment is not publicly traded. Unrealized gains and losses on investments accounted for at market value are reported net-of-tax in a separate component of shareholders' equity until the investment is sold, at which time the realized gain or loss is included in income. Dividends and other distributions of earnings from both market value and cost method investments are included in income when declared.
Time Warner's $14 billion cost to acquire Warner Communications Inc. ("WCI") was allocated to the net assets acquired as of December 31, 1989 in accordance with the purchase method of accounting for business combinations. The acquisition was financed principally by $8.3 billion of long-term debt and $5.6 billion of Series C and Series D preferred stock ("old Series C and Series D preferred stock"), which was redeemed with or exchanged for debt in 1993 (Notes 5 and 7).
The effect of changes in Time Warner's ownership interests resulting from the issuance of equity capital by consolidated subsidiaries or equity investees to unaffiliated parties is included in income. The effect of the four-for-one common stock split on September 10, 1992 has been reflected retroactively. Certain reclassifications have been made to the prior years' financial statements to conform to the 1994 presentation.
REVENUES AND COSTS
The unearned portion of paid subscriptions is deferred until magazines are delivered to subscribers. Upon each delivery, a proportionate share of the gross subscription price is included in revenues.
TIME WARNER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Inventories of magazines, books, cassettes and compact discs are stated at the lower of cost or estimated realizable value. Cost is determined using first-in, first-out; last-in, first-out; and average cost methods. In accordance with industry practice, certain products are sold to customers with the right to return unsold items. Revenues from such sales represent gross sales less a provision for future returns. Returned goods included in inventory are valued at estimated realizable value but not in excess of cost.
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are stated at cost. Depreciation is provided generally on the straight-line method over useful lives ranging up to twenty- five years for buildings and improvements and up to fifteen years for furniture, fixtures and equipment.
INTANGIBLE ASSETS
Intangible assets are recorded when the cost of acquired companies exceeds the fair value of their tangible assets. Generally accepted accounting principles require that all intangible assets be amortized over no more than a forty-year period. Amortization of goodwill amounted to $158 million, $148 million and $257 million ($142 million on a restated basis) in 1994, 1993 and 1992, respectively; amortization of music copyrights, artists' contracts and record catalogues amounted to $115 million, $113 million and $113 million; and amortization of other intangible assets amounted to $31 million, $31 million and $310 million ($8 million on a restated basis). Accumulated amortization of intangible assets at December 31, 1994 and 1993 amounted to $1.505 billion and $1.245 billion, respectively.
FOREIGN CURRENCY
The financial position and operating results of substantially all foreign operations are consolidated using the local currency as the functional currency. Local currency assets and liabilities are translated at the rates of exchange on the balance sheet date, and local currency revenues and expenses are translated at average rates of exchange during the period. Resulting translation gains or losses, which have not been material, are included in accumulated deficit. Foreign currency transaction gains and losses, which have not been material, are included in operating results.
Foreign exchange contracts are used primarily to hedge the risk that unremitted or future royalties and license fees owed to Time Warner or TWE domestic companies for the sale or anticipated sale of U.S. copyrighted products abroad may be adversely affected by changes in exchange rates. At December 31, 1994, Time Warner had contracts for the sale of $551 million and the purchase of $109 million of foreign currencies at fixed rates, primarily Japanese yen (25% of net contract value), French francs (19%), English pounds (17%), Canadian dollars (9%) and German marks (14%), compared to contracts for the sale of $653 million and the purchase of $80 million of foreign currencies at December 31, 1993. Unrealized gains or losses are recorded in income; accordingly, the carrying value of foreign exchange contracts approximates market value. Time Warner had $33 million and TWE had $20 million of net losses on foreign exchange contracts during 1994, which were or are expected to be offset by corresponding increases in the dollar value of foreign currency royalties and license fee payments that have been or are anticipated to be received from the sale of U.S. copyrighted products abroad. Time Warner reimburses or is reimbursed by TWE for contract gains and losses related to TWE's foreign currency exposure. Foreign currency contracts are placed with a number of major financial institutions in order to minimize credit risk.
INCOME TAXES
Income taxes are provided using the liability method prescribed by FASB Statement No. 109, "Accounting for Income Taxes." Under the liability method, deferred income taxes reflect tax carryforwards and the net tax effects of temporary differences between the carrying amount of assets and liabilities for financial statement and income tax purposes, as determined under enacted tax laws and rates. The financial effect of changes in tax laws or rates is accounted for in the period of enactment.
TIME WARNER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Realization of the net operating loss and investment tax credit carryforwards, which were acquired in acquisitions, are accounted for as a reduction of goodwill.
The principal operations of the Entertainment Group are conducted by partnerships. Income tax expense includes all income taxes related to Time Warner's allocable share of partnership income and its equity in the income tax expense of corporate subsidiaries of the partnerships.
INTEREST RATE SWAP CONTRACTS
Interest rate swap contracts are used to adjust the proportion of total debt that is subject to changes in short-term interest rates and the proportion that is subject to fixed rates. Under interest rate swap contracts, the Company either agrees to pay an amount equal to a specified floating-rate of interest times a notional principal amount, and to receive in return an amount equal to a specified fixed-rate of interest times the same notional principal amount or, vice versa, to receive a floating-rate amount and to pay a fixed-rate amount. The notional amounts of the contracts are not exchanged. No other cash payments are made unless the contract is terminated prior to maturity, in which case the amount paid or received in settlement is equal to the present value, at current rates of interest, of the remaining obligations to exchange payments under the terms of the contract. Interest rate swap contracts are entered into with a number of major financial institutions in order to minimize credit risk.
The net amounts paid or payable, or received or receivable, through the end of the accounting period are included in interest expense. Gains or losses on the termination of contracts are deferred and amortized to income over the remaining average life of the terminated contracts.
TREASURY STOCK
The purchase of Time Warner common and other capital stock by Time Warner or its subsidiaries is accounted for as if the stock had been retired and is no longer outstanding.
LOSS PER COMMON SHARE
Loss per common share is based upon the net loss applicable to common shares after preferred dividend requirements and upon the weighted average of common shares outstanding during the period. The conversion of securities convertible into common stock and the exercise of stock options were not assumed in the calculations of loss per common share because the effect would have been antidilutive.
2.ENTERTAINMENT GROUP
Time Warner's investment in and amounts due to and from the Entertainment Group at December 31, 1994 and 1993 consist of the following:
TIME WARNER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
TWE is a Delaware limited partnership that was capitalized on June 30, 1992 to own and operate substantially all of the Filmed Entertainment, Programming- HBO and Cable businesses previously owned by subsidiaries of Time Warner. The Time Warner subsidiaries are the general partners ("Time Warner General Partners") and subsidiaries of U S WEST, ITOCHU Corporation ("ITOCHU") and Toshiba Corporation ("Toshiba") are the limited partners. The Time Warner General Partners contributed the assets and liabilities or the rights to the cash flow of substantially all of Time Warner's Filmed Entertainment, Programming-HBO and Cable businesses at the initial capitalization of TWE, and ITOCHU and Toshiba each contributed $500 million of cash. On September 15, 1993, U S WEST contributed $1.532 billion of cash and a $1.021 billion 4.4% note ("U S WEST Note") for its interests. The initial capital amounts assigned to each partner were based on the fair value of the assets each contributed to the partnership and have the following priority in the event of liquidation or dissolution:
-------- (a) Excludes partnership income or loss (to the extent earned) allocated thereto.
Under the TWE partnership agreement, partnership income, to the extent earned, is first allocated to the partners so that the economic burden of the income tax consequences of partnership operations is borne as though the partnership were taxed as a corporation ("special tax allocations"), then to the senior, pro rata priority and junior priority capital interests, in order of priority, at rates of return ranging from 8% to 13.25% per annum, and finally to the residual equity interests. For the purpose of the foregoing allocations, partnership income is based on the fair value of assets contributed to the partnership, and differs from net income of TWE, which is based on the historical cost of contributed assets. Partnership losses generally are allocated first to eliminate prior allocations of partnership income to, and then to reduce the initial capital amounts of, the residual equity, junior priority capital and pro rata priority capital interests, in that order, then to reduce the Time Warner General Partners' senior capital, including partnership income allocated thereto, and finally to reduce any special tax allocations. To the extent partnership income is insufficient to satisfy all special allocations in a particular accounting period, the unearned portion is carried over until satisfied out of future partnership income.
The senior capital owned by the Time Warner General Partners and partnership income allocated thereto is required to be distributed in three annual installments beginning July 1, 1997; earlier distributions may be made under certain circumstances. The junior priority capital owned by the Time Warner General Partners may be increased if certain performance targets are achieved between 1992 and 2001.
TWE reported net income of $161 million, $198 million and $160 million in 1994, 1993 and 1992, respectively, no portion of which was allocated to the limited partners. Time Warner did not recognize a gain when TWE was capitalized. TWE recorded the assets contributed by the Time Warner General Partners at Time Warner's historical cost. The excess of the Time Warner General Partners' interest in the net assets of TWE over the net book value of their investment in TWE is being amortized to income over a twenty year period at the rate of $17 million per year prior to the admission of U S WEST, and $72 million per year thereafter.
U S WEST has an option to obtain up to an additional 6.33% of pro rata priority capital and residual equity interests, depending on cable operating performance. The option is exercisable between January 1, 1999
TIME WARNER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
and on or about May 31, 2005 at a maximum exercise price of $1.25 billion to $1.8 billion, depending on the year of exercise. Either U S WEST or TWE may elect that the exercise price be paid with partnership interests rather than cash. Each of ITOCHU and Toshiba have options to obtain up to an additional .64% of pro rata priority capital and residual equity interests in certain circumstances, payable in cash.
Each Time Warner General Partner has guaranteed a pro rata portion of $7 billion of TWE's debt and accrued interest at December 31, 1994, based on the relative fair value of the net assets each Time Warner General Partner contributed to TWE. Such indebtedness is recourse to each Time Warner General Partner only to the extent of its guarantee. In addition to their interests in TWE and the other Entertainment Group companies, the assets of the Time Warner General Partners include the equivalent of 29.6 million common shares of Turner Broadcasting System, Inc., 12.1 million common shares of Hasbro, Inc., 43.7 million common shares of Time Warner, and substantially all the assets of Time Warner's music business. There are no restrictions on the ability of the Time Warner General Partner guarantors to transfer assets, other than TWE assets, to parties that are not guarantors.
The summarized financial information for the Entertainment Group set forth below reflects the consolidation of Six Flags Entertainment Corporation ("Six Flags") as of January 1, 1993 as a result of the increase in TWE's ownership from 50% to 100% in September 1993. The 1992 historical financial information has not been changed; however, financial information for 1992 retroactively reflecting the consolidation is presented as supplementary information under the column heading "restated" to facilitate comparative analysis.
TIME WARNER ENTERTAINMENT GROUP
TIME WARNER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The assets and cash flows of TWE are restricted by the TWE partnership and credit agreements and are unavailable for use by the partners except through the payment of certain fees, reimbursements, cash distributions and loans, which are subject to limitations. The Time Warner General Partners received $115 million of tax-related distributions from TWE in 1994. There was an additional $334 million of such distributions due from TWE at December 31, 1994, compared to $276 million at December 31, 1993. The Time Warner General Partners also had accrued $89 million and $271 million, respectively, of stock option related distributions due from TWE at December 31, 1994 and December 31, 1993, respectively, based on closing prices of Time Warner common stock of $35.125 and $44.25, respectively. Time Warner is paid when the options are exercised and received $5 million and $20 million of stock option distributions in 1994 and 1993, respectively. In addition to the tax, stock option and Time Warner General Partners' senior capital distributions, TWE may make other distributions, generally depending on excess cash and credit agreement limitations. The Time Warner General Partners' full share of such distributions may be deferred if the limited partners do not receive certain threshold amounts by certain dates.
In the normal course of conducting their businesses, Time Warner and its subsidiaries and affiliates have had various transactions with TWE and other Entertainment Group companies, generally on terms resulting from a negotiation between the affected units that in management's view results in reasonable allocations. Time Warner provides TWE with certain corporate support services for which it receives a fee of $60 million per year through June 30, 1995, and increasing annual amounts as adjusted for inflation thereafter.
3. CABLE TRANSACTIONS
In September 1994, Time Warner agreed to acquire Summit Communications Group, Inc. ("Summit"), which owns cable television systems serving 162,000 subscribers, in exchange for 900,000 shares of Time Warner common stock and 3.2 million shares of a new Time Warner convertible preferred stock ("new Series C preferred stock") having a liquidation value of $100 per share. The new Series C preferred stock will be convertible into 6.7 million shares of Time Warner common stock at an effective price of $48 of liquidation value per common share, receive an annual dividend of $3.75 per share for five years, and be redeemable at liquidation value plus unpaid dividends after five years, or exchangeable in part for common stock by the holder beginning after the third year and by Time Warner after the fourth year at the stated conversion price plus a declining premium in years four and five and no premium thereafter. The Time Warner consideration is subject to adjustment after closing based on the working capital of Summit at closing.
In September 1994, TWE agreed to form a cable television joint venture with subsidiaries of Advance Publications, Inc. and Newhouse Broadcasting Corporation ("Advance/Newhouse") to which
TIME WARNER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Advance/Newhouse will contribute cable television systems serving 1.4 million subscribers and related assets and TWE will contribute cable television systems (or interests therein) serving 2.8 million subscribers and related assets. TWE will own a two-thirds equity interest in the TWE-Advance/Newhouse Partnership and be the managing partner. Advance/Newhouse will own a one-third equity interest in the partnership. Advance/Newhouse can require TWE to purchase its equity interest for fair market value at specified intervals following the death of both of its principal shareholders. Beginning in the third year, either partner can initiate a dissolution in which TWE would receive two-thirds and Advance/Newhouse would receive one-third of the partnership's net assets.
In January 1995, Time Warner agreed to acquire KBLCOM Incorporated ("KBLCOM"), a subsidiary of Houston Industries Incorporated that owns cable television systems serving approximately 690,000 subscribers and a 50% interest in Paragon Communications ("Paragon"), which serves an additional 967,000 cable subscribers. TWE owns the other 50% interest in Paragon. To acquire KBLCOM, Time Warner will issue 1 million shares of common stock and 11 million shares of a new convertible preferred stock ("new Series D preferred stock") and assume or incur $1.24 billion of indebtedness. The new Series D preferred stock will have a liquidation value of $100 per share, be convertible into 22.9 million shares of Time Warner common stock at an effective price of $48 of liquidation value per common share, and receive an annual dividend of $3.75 per share for four years. Time Warner will have the right to exchange the new Series D preferred stock for common stock at the stated conversion price after four years.
In February 1995, Time Warner agreed to acquire Cablevision Industries Corporation ("CVI") and related companies that own cable television systems serving 1.3 million subscribers. To acquire CVI and related companies, Time Warner will issue 2.5 million shares of common stock and 6.5 million shares of new convertible preferred stocks (3.25 million shares of "Series E preferred stock" and 3.25 million shares of "Series F preferred stock") and assume approximately $2 billion of debt of CVI and related companies. The Series E and F preferred stocks will have a liquidation value of $100 per share, be convertible into 13.5 million shares of Time Warner common stock at an effective price of $48 of liquidation value per common share, and receive an annual dividend of $3.75 per share for a period of five years with respect to the Series E preferred stock and a period of four years with respect to the Series F preferred stock. Time Warner will have the right to exchange the Series E preferred stock for common stock at the stated conversion price after five years and to exchange the Series F preferred stock for common stock at the stated conversion price after four years. The amount of common stock and Series F preferred stock to be issued will be adjusted if the level of indebtedness, negative working capital and related items at the closing differ from approximately $2 billion.
To the extent that any of the new Series C, D, E or F preferred stocks remain outstanding following the end of the period in which the $3.75 per share dividend is to be paid, holders will receive a dividend equal to the common dividend declared times the number of common shares into which their preferred shares are convertible. While they are outstanding, each of the Series C, D, E and F preferred stocks will be entitled to vote with the common stock on all matters on which the common stock is entitled to vote, and each share of any such preferred stock will be entitled to two votes per share on any such matter.
The Summit and Advance/Newhouse transactions are expected to close in the first half of 1995. The KBLCOM and CVI transactions are expected to close later in the year. All transactions are subject to customary closing conditions, including the receipt of certain franchise and regulatory approvals.
TIME WARNER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
4.OTHER INVESTMENTS
Time Warner's other investments consist of:
-------- (1) Unrestricted marketable equity securities not accounted for using the equity method are stated at market value. Such amounts include the market value of 12.058 million shares of common stock of Hasbro, Inc., which can be used, at Time Warner's option, to satisfy its obligations with respect to the zero coupon exchangeable notes due 2012 (Note 5).
In addition to TWE and its equity investees, companies accounted for using the equity method include Turner Broadcasting System, Inc. ("TBS") (19.6% owned); Cinamerica Theatres, L.P. (50% owned) and The Columbia House Company partnerships (50% owned) and other music joint ventures (generally 50% owned). Equity investees of TWE include Paragon Communications (50% owned), certain other cable system joint ventures (generally 50% owned) and Comedy Partners, L.P. (50% owned).
A summary of financial information as reported by the equity investees of Time Warner and TWE on a 100% basis is set forth below:
The market value and cost of Time Warner's investment in TBS at December 31, 1994 was $900 million and $527 million, respectively. The sale, transfer or other disposition of substantially all of the shares of TBS capital stock is restricted pursuant to shareholder agreements. The TBS securities also may be considered restricted securities under the Securities Act of 1933 and, if so, could only be sold pursuant to an effective registration statement or in a transaction exempt from the registration requirements of the Securities Act of 1933.
TIME WARNER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
5. LONG-TERM DEBT
Long-term debt consists of:
-------- (1) Classified as long-term in 1993 because of the intent and ability to refinance under Time Warner's credit agreement with TWE.
Time Warner and TWE entered into a credit agreement in 1994 that allows Time Warner to borrow up to $400 million from TWE through September 15, 2000. Outstanding borrowings from TWE bear interest at LIBOR plus 1% per annum. Time Warner borrowed $400 million in 1994 under the credit agreement, and used the proceeds principally to repay its 9.5% notes due November 1, 1994 and its 5.2% notes due April 15, 1994. Under TWE's bank credit agreement, TWE's loans to Time Warner cannot exceed $1.1 billion at December 31, 1994, increasing to no more than $1.5 billion on July 1, 1995.
The redeemable reset notes due August 15, 2002 do not pay interest for periods prior to August 15, 1995, the first redemption date, at which time an interest rate will be set. The interest rate will be reset on August 15, 1998, the second redemption date. The notes are redeemable at par on each redemption date, payable in any combination of cash and debt securities, if Time Warner elects to redeem the notes, or in any combination of cash or equity or debt securities of Time Warner or any other entity, as Time Warner will determine, if the holders elect to have the notes redeemed. Unamortized discount was $82 million and $229 million at December 31, 1994 and 1993, respectively.
The zero coupon notes do not pay interest until maturity. The zero coupon exchangeable notes due December 17, 2012 are exchangeable at any time by the holder into 7.301 shares of common stock of Hasbro, Inc. ("Hasbro shares") per $1,000 principal amount, subject to Time Warner's right to pay in whole or in part with cash instead of Hasbro shares. Time Warner can elect to redeem the notes any time after December 17, 1997, and holders can elect to have the notes redeemed prior thereto in the event of a change of control, at the issue price plus accrued interest. Holders also can elect to have the notes redeemed at the issue price plus accrued interest on December 17, 1997, 2002 and 2007, subject to Time Warner's right to pay in whole or in part with Hasbro shares instead of cash. Unamortized discount was $1.104 billion and $1.137 billion at December 31, 1994 and 1993, respectively.
TIME WARNER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The zero coupon convertible notes due June 22, 2013 are convertible at any time by the holders into 18.7 million shares of Time Warner common stock at the rate of 7.759 shares for each $1,000 principal amount of notes. Time Warner can elect to redeem the notes any time after June 22, 1998, and holders can elect to have the notes redeemed prior thereto in the event of a change in control, at the issue price plus accrued interest. Holders also can elect to have the notes redeemed at the issue price plus accrued interest on June 22, 1998, 2003 and 2008, subject to Time Warner's right to pay in whole or in part with Time Warner common stock instead of cash. Unamortized discount was $1.445 billion and $1.492 billion at December 31, 1994 and 1993, respectively.
$3.125 billion of 8.75% convertible subordinated debentures due January 10, 2015 were issued in exchange for the old Series C preferred stock in April 1993 (Note 7). $900 million of such debentures were redeemed in July 1993. The $2.226 billion of 8.75% convertible subordinated debentures outstanding at December 31, 1994 are convertible into 46.6 million shares of Time Warner common stock at the rate of $47.73 principal amount of indebtedness per common share and are redeemable at any time, in whole or in part, at Time Warner's option, at 104.375% of par until January 9, 1996, decreasing ratably each year thereafter to 100% of par on January 10, 2000.
An after-tax cost of $57 million was incurred in connection with the redemption of debt in 1993, principally the redemption of $900 million of 8.75% convertible subordinated debentures and $529 million of WCI senior and subordinated debentures.
Each Time Warner General Partner has guaranteed a pro rata portion of $7 billion of TWE's debt and accrued interest at December 31, 1994, as more fully described in Note 2. TWE's credit agreement contains certain restrictive covenants relating to, among other things, additional indebtedness; cash flow coverage and leverage ratios; and loans, advances, distributions or other cash payments or transfers of assets to Time Warner and its subsidiaries.
At December 31, 1994, Time Warner had interest rate swap contracts to pay floating-rates of interest (average six-month LIBOR rate of 5.9%) and receive fixed-rates of interest (average rate of 5.5%) on $2.9 billion notional amount of indebtedness, effectively converting approximately 32% of Time Warner's underlying debt, substantially all of which is fixed-rate, to a floating-rate basis. The notional amount of outstanding contracts by year of maturity is as follows: 1995-$300 million; 1996-$300 million; 1998-$700 million; 1999-$1.2 billion; and 2000-$400 million.
Based on the level of interest rates prevailing at December 31, 1994, the fair value of Time Warner's fixed-rate debt was $572 million less than its carrying value and it would have cost $236 million to terminate the related interest rate swap contracts, which combined is the equivalent of an unrealized gain of $336 million. Based on the level of interest rates prevailing at December 31, 1993, the fair value of Time Warner's fixed-rate debt exceeded its carrying value by $530 million and the Company would have received $4 million to terminate its interest rate swap contracts, which combined was the equivalent of an unrealized loss of $526 million. Accounting recognition is not given to unrealized gains or losses on debt or interest rate swap contracts unless the debt is retired or the contracts are terminated prior to their maturity.
Interest expense amounted to $769 million in 1994, $698 million in 1993 and $729 million in 1992 ($287 million on a restated basis, which was before the old Series C and D preferred stocks were redeemed with or exchanged for long- term debt). The weighted average interest rate on Time Warner's total debt, including the effect of interest rate swap contracts, was 8.1% and 7.6% at December 31, 1994 and 1993, respectively.
Annual repayments of long-term debt for the five years subsequent to December 31, 1994 consist of $500 million due in 1998. Such repayments exclude the aggregate repurchase or redemption prices of $1.801 billion in 1995, $656 million in 1997 and $1.151 billion in 1998 relating to the redeemable reset notes, zero coupon exchangeable notes and zero coupon convertible notes, respectively, in the years in which the holders of such debt may first exercise their redemption options.
TIME WARNER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
6. INCOME TAXES
Domestic and foreign pretax income (loss) are as follows:
-------- (1) Includes utilization of tax carryforwards of $48 million in 1994, $136 million in 1993 and $15 million in 1992. Excludes current tax benefits of $11 million in 1994 and $14 million in 1993 resulting from the exercise of stock options and vesting of restricted stock awards, which were credited directly to paid-in-capital, and $6 million of current tax benefits resulting from the retirement of debt, which reduced the extraordinary loss in 1993. (2) Includes $70 million unusual charge in 1993 to increase deferred tax liability for increase in tax rate. (3) Includes foreign withholding taxes of $74 million in 1994, $79 million in 1993 and $57 million in 1992.
The differences between income taxes expected at the U.S. federal statutory income tax rate and income taxes provided are as set forth below. The relationship between income before income taxes and income tax expense is most affected by the amortization of goodwill and certain other financial statement expenses that are not deductible for income tax purposes and by a $70 million charge ($.19 per common share) in 1993 to adjust the deferred income tax liability for the increase in the U.S. federal statutory rate from 34% to 35% enacted into law that year.
TIME WARNER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Significant components of Time Warner's net deferred tax liabilities are as follows:
U.S. income and foreign withholding taxes have not been recorded on permanently reinvested earnings of foreign subsidiaries aggregating approximately $700 million at December 31, 1994. Determination of the amount of unrecognized deferred U.S. income tax liability with respect to such earnings is not practicable. If such earnings are repatriated, additional U.S. income and foreign withholding taxes are expected to be offset by the accompanying foreign tax credits.
U.S. federal tax carryforwards at December 31, 1994 consisted of $39 million of net operating losses that expire from 1997 to 2008, $224 million of investment tax credits that expire from 1996 to 2008, and $26 million of alternative minimum tax credits that have no expiration dates. The utilization of certain carryforwards is subject to limitations under U.S. federal income tax laws.
7.CAPITAL STOCK
The outstanding capital stock of Time Warner at December 31, 1994 consisted of 962,068 shares of Series B preferred stock and 379.3 million shares of common stock (net of 45.7 million shares of common stock in treasury, as to which 43.7 million were held by the Time Warner General Partners). At January 31, 1995, there were approximately 19,000 holders of record of Time Warner common stock.
Pursuant to a shareholder rights plan adopted in January 1994, Time Warner distributed one right per common share which becomes exercisable in certain events involving the acquisition of 15% or more of Time Warner common stock. Upon the occurrence of such an event, each right entitles its holder to purchase for $150 the economic equivalent of common stock of Time Warner, or in certain circumstances, of the acquiror, worth twice as much. In connection with the plan, 4 million shares of preferred stock were reserved. The rights expire on January 20, 2004.
Each share of Series B preferred stock is: (1) entitled to a liquidation preference of $145, (2) entitled to earn dividends at a rate of 6.4% per annum of its $145 liquidation value through May 31, 1995 and at a rate of 3% per annum thereafter, payable quarterly in cash, (3) not entitled to vote, except in certain circumstances, and (4) redeemable, in whole or in part, (a) by Time Warner prior to May 31, 1995 in exchange for shares or fractional shares of any class or series of publicly-traded Time Warner stock ("Public Stock") equal in value to the liquidation value of the Series B stock and (b) by Time Warner or the holder on or after May 31, 1995 in exchange for, at Time Warner's option, cash or shares or fractional shares of Public Stock equal in value to the liquidation value of the Series B stock plus a premium of 2% of liquidation value for each year after May 31, 1995 to the redemption date.
TIME WARNER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
In 1993, Time Warner redeemed its old Series D preferred stock for cash and exchanged its old Series C preferred stock for 8.75% convertible subordinated debentures due January 10, 2015. The old Series D redemption was financed principally by the proceeds from the issuance of long-term notes and debentures.
At December 31, 1994, Time Warner had reserved 143.8 million shares of common stock for the conversion of the 8.75% convertible subordinated debentures, zero coupon convertible notes and other convertible securities, and for the exercise of outstanding options to purchase shares of common stock. Approximately 43 million additional shares will be reserved for the conversion of the new Series C, D, E and F preferred stocks issuable in the cable acquisitons that are expected to close in 1995 (Note 3).
8. STOCK OPTION PLANS
Options to purchase Time Warner common stock under various stock option plans have been granted to employees of Time Warner and TWE, generally at fair market value at the date of grant. Generally, the options become exercisable over a three-year vesting period and expire ten years from the date of grant. A summary of stock option activity under all plans is as follows:
For options granted to employees of TWE, Time Warner is reimbursed for the amount by which the market value of Time Warner common stock on the exercise date exceeds the exercise price, or the greater of the exercise price or $27.75 for options granted prior to the TWE capitalization. There were 30.2 million options held by employees of TWE at December 31, 1994, 21.3 million of which were exercisable (Note 2).
There were 4.8 million options exercised in 1993 at prices ranging from $8- $36 per share, 933,000 options exercised in 1992 at prices ranging from $8-$28 per share, and 57.7 million options exercisable and 4.4 million options available for grant at December 31, 1993.
9. BENEFIT PLANS
Time Warner and its subsidiaries have defined benefit pension plans covering substantially all domestic employees. Pension benefits are based on formulas that reflect the employees' years of service and compensation levels during their employment period. Qualifying plans are funded in accordance with government pension and income tax regulations. Plan assets are invested in equity and fixed income securities.
Pension expense included the following:
TIME WARNER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The following assumptions were used in accounting for pension plans:
Employees of Time Warner's operations in foreign countries participate to varying degrees in local pension plans, which in the aggregate are not significant.
Time Warner also has an employee stock ownership plan, 401(k) savings plans and profit sharing plans, as to which the expense was $51 million in 1994, $46 million in 1993 and $57 million ($41 million on a restated basis) in 1992. Contributions to the 401(k) plans are based upon a percentage of the employees' elected contributions. Contributions to the employee stock ownership and profit sharing plans are determined by management and approved by the board of directors of the participating companies.
10. SEGMENT INFORMATION
Information as to the operations of Time Warner and the Entertainment Group in different business segments is set forth below:
TIME WARNER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
-------- (1) Amortization includes all amortization relating to the acquisition of WCI in 1989, the acquisition of the minority interest in American Television and Communications Corporation ("ATC") in 1992 and other business combinations accounted for by the purchase method.
TIME WARNER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Information as to the assets and capital expenditures of Time Warner and the Entertainment Group is as follows:
-------- (1)The 1994 increase was funded in part through $234 million of collections on the U S WEST Note (Note 2).
TIME WARNER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) Information as to Time Warner's operations in different geographical areas is as follows:
-------- (1) Time Warner's revenues in 1994, 1993 and on a restated basis in 1992 do not include the revenues of the Entertainment Group, which had export revenues of $1.693 billion in 1994, $1.650 billion in 1993 and $1.379 billion in 1992, principally from the sale of Filmed Entertainment products abroad.
11.COMMITMENTS AND CONTINGENCIES
Total rent expense amounted to $157 million in 1994, $163 million in 1993 and $258 million ($159 million on a restated basis) in 1992. The minimum rental commitments under noncancellable long-term operating leases are: 1995- $137 million; 1996-$126 million; 1997-$115 million; 1998-$123 million; 1999- $118 million and after 1999-$998 million.
Minimum commitments and guarantees under certain licensing, artists and other agreements aggregated approximately $2 billion at December 31, 1994, which are payable principally over a seven-year period. Such amounts do not include the Time Warner General Partner guarantees of approximately $7 billion of TWE debt.
Pending legal proceedings are substantially limited to litigation incidental to the businesses of Time Warner and alleged damages in connection with class action lawsuits. In the opinion of counsel and management, the ultimate resolution of these matters will not have a material effect on the financial statements of Time Warner.
TIME WARNER INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
12.ADDITIONAL FINANCIAL INFORMATION
Additional financial information with respect to cash flows is as follows:
During the year ended December 31, 1994, Time Warner realized $179 million from the securitization of receivables. On April 1, 1993, Time Warner issued $3.125 billion of debentures in a noncash exchange for the old Series C preferred stock (Notes 5 and 7).
The principal balance sheet effects of the deconsolidation of the Entertainment Group in 1993 were to decrease cash and equivalents by $36 million, receivables by $1.060 billion, inventories by $2.632 billion, investments by $690 million, property, plant and equipment by $2.548 billion, cable television franchises by $3.660 billion, goodwill by $4.356 billion, other assets by $733 million, debt by $7.178 billion, minority interests by $961 million and other liabilities by $2.184 billion, and to increase the investments in and amounts due to and from the Entertainment Group by $5.392 billion. The principal balance sheet effects of the acquisition of the ATC minority interest in 1992 were to increase investments by $156 million, cable television franchise costs by $865 million, goodwill by $410 million, deferred income taxes by $299 million and long-term debt by $1.312 billion, and to eliminate the ATC minority interest of $180 million. On a restated basis, the investments in and amounts due to and from the Entertainment Group were increased $1.431 billion.
Investment proceeds in 1992 on a restated basis include $875 million from the collection of a note receivable from TWE. Cash equivalents consist of commercial paper and other investments that are readily convertible into cash, and have original maturities of three months or less.
Other current liabilities consist of:
REPORT OF MANAGEMENT
The accompanying consolidated financial statements have been prepared by management in conformity with generally accepted accounting principles, and necessarily include some amounts that are based on management's best estimates and judgments.
Time Warner maintains a system of internal accounting controls designed to provide management with reasonable assurance that assets are safeguarded against loss from unauthorized use or disposition, and that transactions are executed in accordance with management's authorization and recorded properly. The concept of reasonable assurance is based on the recognition that the cost of a system of internal control should not exceed the benefits derived and that the evaluation of those factors requires estimates and judgments by management. Further, because of inherent limitations in any system of internal accounting control, errors or irregularities may occur and not be detected. Nevertheless, management believes that a high level of internal control is maintained by Time Warner through the selection and training of qualified personnel, the establishment and communication of accounting and business policies, and its internal audit program.
The Audit Committee of the Board of Directors, composed solely of directors who are not employees of Time Warner, meets periodically with management and with Time Warner's internal auditors and independent auditors to review matters relating to the quality of financial reporting and internal accounting control, and the nature, extent and results of their audits. Time Warner's internal auditors and independent auditors have free access to the Audit Committee.
REPORT OF INDEPENDENT AUDITORS
THE BOARD OF DIRECTORS AND SHAREHOLDERS TIME WARNER INC.
We have audited the accompanying consolidated balance sheet of Time Warner Inc. ("Time Warner") as of December 31, 1994 and 1993, and the related consolidated statements of operations, cash flows and shareholders' equity for each of the three years in the period ended December 31, 1994. Our audits also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and schedule are the responsibility of Time Warner's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Time Warner at December 31, 1994 and 1993, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
Ernst & Young LLP
New York, New York February 7, 1995
TIME WARNER INC. SELECTED FINANCIAL INFORMATION
The selected financial information for each of the five years in the period ended December 31, 1994 set forth below has been derived from and should be read in conjunction with the financial statements and other financial information presented elsewhere herein. The selected historical financial information for 1994 and 1993 reflects the deconsolidation of the Entertainment Group, principally TWE, effective January 1, 1993. The selected historical financial information for periods prior to such date have not been changed; however, selected financial information for 1992 retroactively reflecting the deconsolidation is presented as supplementary information under the column heading "restated" to facilitate comparative analysis.
The selected historical financial information for 1993 reflects the issuance of $6.1 billion of long-term debt and the use of $.5 billion of cash and equivalents in 1993 for the exchange or redemption of preferred stock having an aggregate liquidation preference of $6.4 billion. The selected historical financial information for 1992 reflects the capitalization of TWE on June 30, 1992 and associated refinancings, and the acquisition of the 18.7% minority interest in ATC as of June 30, 1992, using the purchase method of accounting for business combinations.
Per common share amounts and average common shares have been restated to give effect to the four-for-one common stock split that occurred on September 10, 1992.
-------- (a) The net loss for the year ended December 31, 1993 includes an extraordinary loss on the retirement of debt of $57 million ($.15 per common share) and an unusual charge of $70 million ($.19 per common share) from the effect of the new income tax law on Time Warner's deferred income tax liability. The net loss for the year ended December 31, 1991 includes a $36 million after-tax charge ($.12 per common share) relating to the restructuring of the Publishing division. (b) In August 1991, Time Warner completed the sale of 137.9 million shares of common stock pursuant to a rights offering. Net proceeds of $2.558 billion from the rights offering were used to reduce indebtedness under Time Warner's bank credit agreement. If the rights offering had been completed at the beginning of 1991, net loss for the year would have been reduced to $33 million, or $1.70 per common share, and there would have been 369.3 million shares of common stock outstanding during the year.
TIME WARNER INC. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
-------- (a) The net loss for the second quarter of 1993 includes an extraordinary loss on the retirement of debt of $35 million ($.09 per common share). The net loss for the third quarter of 1993 includes an extraordinary loss on the retirement of debt of $22 million ($.06 per common share) and an unusual charge of $70 million ($.19 per common share) due to the effect of the new income tax law on Time Warner's deferred income tax liability. (b) After preferred dividend requirements.
TIME WARNER INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
RESULTS OF OPERATIONS
1994 VS. 1993
Time Warner had revenues of $7.396 billion and a net loss of $91 million ($.27 per common share) in 1994, compared to revenues of $6.581 billion and a net loss of $221 million ($.90 per common share) in 1993. Included in the 1993 results is an extraordinary loss on the retirement of debt of $57 million ($.15 per common share) and a one-time tax charge of $70 million ($.19 per common share) that resulted from the effect on the Company's deferred income tax liability of the increase in the corporate income tax rate enacted in August 1993.
Operating income and EBITDA for Time Warner and the Entertainment Group in 1994 and 1993 were as follows:
Time Warner's equity in the pretax income of the Entertainment Group was $176 million in 1994, compared to $281 million in 1993. During the first quarter of 1993, the Entertainment Group had a one-time gain from the sale of certain assets that was substantially offset by investment reserves included in Time Warner's other expenses.
The relationship between income before income taxes and income tax expense of Time Warner is principally affected by the amortization of goodwill and certain other financial statement expenses that are not deductible for income tax purposes, and by the one-time tax charge in 1993. Income tax expense of Time Warner includes all income taxes related to its allocable share of partnership income and its equity in the income tax expense of corporate subsidiaries of the Entertainment Group.
Certain factors affecting comparative operating results are discussed below on a business segment basis. That discussion includes, among other factors, an analysis of changes in the operating income of the business segments before depreciation and amortization ("EBITDA") in order to eliminate the effect on the operating performance of the music, filmed entertainment and cable businesses of significant amounts of amortization of intangible assets recognized in the $14 billion acquisition of WCI in 1989, the $1.3 billion acquisition of the ATC minority interest in 1992 and other business combinations accounted for by the purchase method. Financial analysts generally consider EBITDA to be an important measure of comparative operating performance for the businesses of Time Warner and the Entertainment Group, and when used in comparison to debt levels or the coverage of interest expense, as a measure of liquidity. However, EBITDA should be considered in addition to, not as a substitute for, operating income, net income, cash flow and other measures of financial performance and liquidity reported in accordance with generally accepted accounting principles.
TIME WARNER INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION--(CONTINUED)
TIME WARNER
Publishing. Revenues increased to $3.433 billion, compared to $3.270 billion in 1993. Operating income increased to $347 million from $295 million. Depreciation and amortization amounted to $83 million in 1994 and $77 million in 1993. EBITDA increased to $430 million from $372 million. Revenues benefited principally from increases in magazine advertising and circulation revenues, which were aided in part by several special issues during 1994. Significant revenue gains were achieved by People, Sports Illustrated and Southern Living. Operating income, EBITDA and operating margins improved principally as a result of the revenue gains and continued cost containment.
Music. Revenues increased to $3.986 billion, compared to $3.334 billion in 1994. Operating income increased to $366 million from $296 million. Depreciation and amortization, including amortization related to the purchase of WCI, amounted to $354 million in 1994 and $347 million in 1993. EBITDA increased to $720 million from $643 million. The revenue growth resulted from increases in both domestic and international recorded music revenues, which benefited from a number of popular releases during the year and an increase in the percentage of compact disc to total unit sales, and increased music publishing revenues. Operating income and EBITDA benefited from these revenue gains and increased results from direct marketing activities attributable to new members and lower amortization of member acquisition costs, offset in part by costs associated with the reorganization of the domestic music companies and continuing investment in new business ventures.
Interest and Other, Net. Interest and other, net, increased to $724 million in 1994, compared to $718 million in 1993. Interest expense increased to $769 million from $698 million as a result of a full twelve months of interest on the debt issued during the first three months of 1993 to redeem or exchange preferred stock, offset in part by savings from lower-cost debt used to fund the redemption of certain notes and debentures in 1993. There was other income, net, of $45 million in 1994, compared to other expense, net, of $20 million in 1993, principally because of an increase in investment-related income, including an increase in the amortization of the excess of the Time Warner General Partners' interest in the net assets of TWE over the net book value of their investment in TWE to reflect U S WEST as a partner for a full year. Investment-related income was reduced in part in both years by adjustments to the carrying value of certain investments, expenses in connection with the settlement of certain employment contracts and losses on foreign exchange contracts used to hedge foreign exchange risk.
ENTERTAINMENT GROUP
Filmed Entertainment. Revenues increased to $5.041 billion, compared to $4.565 billion in 1993. Operating income decreased to $275 million from $286 million. Depreciation and amortization, including amortization related to the purchase of WCI, amounted to $290 million in 1994 and $263 million in 1993. EBITDA increased to $565 million from $549 million. Worldwide home video, syndication and consumer products revenues increased at Warner Bros., offset in part by lower worldwide theatrical revenues. Revenues at Six Flags increased as a result of overall attendance growth and higher revenues per visitor. Operating income and EBITDA margins decreased principally as a result of lower theatrical results in comparison to the exceptionally strong theatrical results in 1993.
Programming--HBO. Revenues increased to $1.513 billion, compared to $1.441 billion in 1993. Operating income increased to $237 million from $213 million. Depreciation and amortization amounted to $20 million in 1994 and $17 million in 1993. EBITDA increased to $257 million from $230 million. Revenues benefited from an increase in subscribers and higher pay-TV rates. Operating income, EBITDA and operating margins improved principally as a result of the revenue gains.
TIME WARNER INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION--(CONTINUED)
Cable. Revenues increased to $2.242 billion, compared to $2.208 billion in 1993. Operating income decreased to $340 million from $406 million. Depreciation and amortization, including amortization related to the purchase of WCI and the acquisition of the ATC minority interest, amounted to $649 million in 1994 and $629 million in 1993. EBITDA decreased to $989 million from $1.035 billion. Revenues and operating results in 1994 were adversely affected by two rounds of cable rate regulation that in general reduced the rates cable operators are allowed to charge for regulated services, the first of which went into effect in September 1993 and the second of which went into effect in July 1994. The unfavorable effects of rate regulation were offset in part by an increase in subscribers and nonregulated revenues. Actions that were undertaken to mitigate the impact of rate regulation included a number of cost containment measures and a continued emphasis on near and long-term strategies to increase revenues from unregulated services.
Interest and Other, Net. Interest and other, net, increased to $616 million in 1994, compared to $564 million in 1993. Interest expense decreased to $567 million, compared with $580 million in 1993. There was other expense, net, of $49 million in 1994, compared to other income, net, of $16 million in 1993. Investment-related and foreign currency contract losses in 1994 exceeded an increase in interest income on higher cash balances and the interest-bearing note receivable from U S WEST. A gain on the sale of certain assets and other investment-related income exceeded investment losses in 1993.
1993 VS. 1992
Time Warner had 1993 revenues of $6.581 billion, a loss of $94 million ($.56 per common share) before a one-time tax charge and an extraordinary loss, and a net loss of $221 million ($.90 per common share), compared to 1992 revenues of $13.070 billion ($6.309 billion on a restated basis) and net income of $86 million (a loss of $1.46 per common share after preferred dividends). The one- time tax charge of $70 million ($.19 per common share) resulted from the effect on the company's deferred income tax liability of the increase in the corporate income tax rate enacted in August 1993; the extraordinary loss of $57 million ($.15 per common share) resulted from the retirement of debt in 1993. The improvement in per share results in 1993 includes the after-tax benefits of replacing preferred stock with debt in the first quarter. Preferred dividends were $118 million in 1993, compared to $628 million in 1992.
Operating income and EBITDA for Time Warner and the Entertainment Group in 1993 and 1992 were as follows:
TIME WARNER INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION--(CONTINUED)
Time Warner's equity in the pretax income of the Entertainment Group was $281 million in 1993, compared to $226 million on a restated basis in 1992. The Entertainment Group had a one-time gain from the sale of certain assets in 1993.
TIME WARNER
Publishing. Revenues increased to $3.270 billion compared to $3.123 billion in 1992. Operating income increased to $295 million from $254 million. Depreciation and amortization amounted to $77 million in 1993 and $74 million in 1992. EBITDA increased to $372 million from $328 million. Revenues benefited from increased magazine circulation revenues, higher book publishing revenues and the full year impact of the 1992 Leisure Arts acquisition. Magazine circulation revenues reflected higher overall subscription and newsstand sales, led by People, Time and Entertainment Weekly, as well as increases at American Family Publishers, the subscription agency. Despite a difficult market, advertising revenues were nearly flat. Operating income and EBITDA increased as a result of the revenue gains and improved operating margins achieved through continued cost savings.
Music. Revenues increased to $3.334 billion compared to $3.214 billion in 1992. Operating income increased to $296 million from $275 million. Depreciation and amortization, including amortization related to the purchase of WCI, amounted to $347 million in 1993 and $310 million in 1992. EBITDA increased to $643 million from $585 million. The revenue gains primarily reflected an increase in domestic recorded music sales and Warner/Chappell Music Publishing revenues. An increase in unit volume was achieved internationally, principally because of an increase in Pacific Rim sales. International dollar-denominated revenues did not increase, however, because of exchange rate fluctuations. Overall, revenues benefited from a broad range of popular releases from both new and established artists, increased unit sales of compact discs and higher average unit selling prices. Operating income and EBITDA increased principally as a result of the revenue gains and improved margins, offset in part by start-up costs for new business ventures.
Interest and Other, Net. Interest and other, net, decreased to $718 million in 1993 compared to $882 million ($351 million on a restated basis) in 1992. Interest expense decreased to $698 million compared to $729 million ($287 million on a restated basis) in 1992. The decrease in interest and other, net, on an historical basis resulted primarily from the exclusion in 1993 of the expenses of the Entertainment Group, which was deconsolidated in 1993, offset in part by an increase in interest expense from higher debt levels associated with the redemption and exchange of preferred stock. Other expenses, net, in 1993 included reductions in the carrying value of certain investments offset by investment-related income. Other expenses, net, in 1992 included an expense in connection with the settlement of senior management employment contracts, ATC minority interest expense and litigation-related costs.
ENTERTAINMENT GROUP
Filmed Entertainment. Revenues increased to $4.565 billion compared to $3.455 billion ($3.945 billion on a restated basis) in 1992. Operating income increased to $286 million from $213 million ($254 million on a restated basis). Depreciation and amortization, including amortization related to the purchase of WCI, amounted to $263 million in 1993 and $197 million ($266 million on a restated basis) in 1992. EBITDA increased to $549 million from $410 million ($520 million on a restated basis). The increase in revenues, operating income and EBITDA on an historical basis resulted primarily from the inclusion in 1993 of the operating results of Six Flags, which previously had been accounted for using the equity method. Revenues at Warner Bros. increased during the period primarily due to increases in international theatrical, international syndication and domestic home video revenues, as well as increased revenues from retail
TIME WARNER INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION--(CONTINUED)
operations. Record international revenues of $1.650 billion would have been greater but for unfavorable exchange rate fluctuations. Warner Bros. ranked number one at both the domestic and international box office in 1993, led by the success of The Fugitive and The Bodyguard. Revenues at Six Flags increased, benefiting from higher revenues per visitor. Operating income and EBITDA benefited from the revenue gains.
Programming--HBO. Revenues decreased to $1.441 billion compared to $1.444 billion in 1992. Operating income increased to $213 million from $201 million. Depreciation and amortization amounted to $17 million in 1993 and $14 million in 1992. EBITDA increased to $230 million from $215 million. The decrease in revenues reflects lower HBO Video sales, which in 1992 were favorably affected by a children's sell-thru title, offset in part by higher subscriber revenues, principally as a result of higher pay-TV rates at HBO and an increase in subscribers. Operating income and EBITDA benefited primarily from improved results from new businesses, including Time Warner Sports and the Comedy Central joint venture.
Cable. Revenues increased to $2.208 billion compared to $2.091 billion in 1992. Operating income increased to $406 million from $400 million. Depreciation and amortization, including amortization related to the purchase of WCI and the acquisition of the ATC minority interest, amounted to $629 million in 1993 and $577 million in 1992. EBITDA increased to $1.035 billion from $977 million. Revenues increased principally as a result of growth in the number of cable subscribers and increases in advertising sales and pay-per- view. The increase in subscribers accounted for approximately three quarters of the revenue increase. Operating income and EBITDA benefited from the revenue gains and increased income from cable joint ventures, but was negatively affected in the fourth quarter by the first round of cable rate regulation, which went into effect on September 1, 1993.
Interest and Other, Net. Interest and other, net, increased to $564 million in 1993 compared to $531 million ($569 million on a restated basis) in 1992. Interest expense increased to $580 million compared to $442 million ($491 million on a restated basis) in 1992. The increase in interest expense resulted primarily from the higher average debt levels attributable to the TWE capitalization, the higher interest cost of the TWE notes and debentures issued to refinance TWE bank debt, and the consolidation of Six Flags' interest expense in 1993. Other income, net, in 1993 included gains on the sale of certain assets partially offset by losses from and reductions in the carrying value of certain investments. Other expenses, net, on a restated basis in 1992 is principally attributable to losses on certain investments and litigation- related costs.
FINANCIAL CONDITION AND LIQUIDITY
DECEMBER 31, 1994
TIME WARNER
Despite the $14 billion of debt incurred as a result of the 1989 acquisition of Warner Communications, Time Warner continues to be able to finance growth and expansion in critical areas. In the last three years alone, the Company on a combined basis (Time Warner and the Entertainment Group together) spent in excess of $1.4 billion making new investments and acquisitions and $2.8 billion on capital expenditures. Significant year-to-year improvements in EBITDA and the $14 billion refinancing of higher cost debt and preferred stocks during 1992 and 1993, which was aided by favorable conditions in the credit markets and the investment in TWE by ITOCHU, Toshiba and U S WEST, have enabled the Company to finance this level of investment while at the same time improving its leverage and coverage ratios.
A commonly-used leverage ratio is total debt, less cash ("Net debt") to total business segment EBITDA, less corporate expenses ("Adjusted EBITDA"). A commonly-used coverage ratio is Adjusted EBITDA to total interest expense and preferred dividends. Those ratios for 1994 and 1993 were as set forth below for
TIME WARNER INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION--(CONTINUED)
both Time Warner and Time Warner and the Entertainment Group combined. Certain rating agencies and other credit analysts place more emphasis on the combined ratios while others place more emphasis on the Time Warner stand-alone ratios. It should be understood, however, that the assets of the Entertainment Group are not freely available to meet the cash needs of Time Warner.
Time Warner had $9.2 billion of debt, $282 million of cash and equivalents (net debt of $8.9 billion), and $1.1 billion of equity at December 31, 1994, compared to $9.4 billion of debt, $200 million of cash and equivalents (net debt of $9.2 billion), and $1.4 billion of equity at December 31, 1993. On a combined basis, there was $15 billion of net debt at both the beginning and end of the year.
During the latter half of 1994 and continuing into 1995, the Company announced that it will significantly expand its reach in cable television by acquiring Summit, KBLCOM and CVI and related companies, which together own systems serving approximately 2.2 million basic cable subscribers and a 50% partnership interest in Paragon (with TWE as the other partner), which owns systems serving approximately 967,000 basic cable subscribers. Time Warner will issue 4.4 million shares of common stock and approximately $2.1 billion liquidation value of new 3.75% convertible preferred stocks, and assume or incur approximately $3.4 billion of debt to acquire these companies. In addition, subsidiaries of Advance and Newhouse will contribute cable television systems that serve approximately 1.4 million basic cable subscribers to a joint venture in which TWE will have a two-thirds interest. In accordance with the TWE-Advance/Newhouse joint venture agreement, certain of Time Warner's newly- acquired cable systems may be transferred on a tax-efficient basis to the TWE- Advance/Newhouse Partnership. Such transfers, if they are made, are expected to be structured on a leveraged basis.
The new preferred stocks that are to be issued in the cable transactions will initially have annual dividends totalling $78 million and generally will be convertible immediately or exchangeable after four or five years into approximately 43 million shares of Time Warner common stock at an effective conversion price of $48 of liquidation value per common share. New or revised bank credit facilities will be required for Time Warner, TWE and the TWE- Advance/Newhouse Partnership as a result of these transactions, which management feels will be obtained at a reasonable cost. Upon consummation of the transactions, which are subject to customary franchise and regulatory approvals, the total number of cable subscribers under the management of Time Warner Cable is expected to increase to approximately 11.5 million, compared to 7.5 million at the end of 1994.
The Company also has announced its intention to enhance its financial position and that of the Entertainment Group through sales of non-core assets, such as the TBS stock owned by Time Warner, certain investments owned by the Entertainment Group or certain, smaller unclustered cable systems owned by Time Warner or the Entertainment Group. Proceeds from asset sales will be used to reduce debt. The Entertainment Group's interest in QVC, Inc. was sold in February 1995 to a group that had tendered for all of that company's capital stock. Approximately $200 million of proceeds will be used to reduce debt.
TIME WARNER INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION--(CONTINUED)
The Company does not expect its leverage and coverage ratios to deteriorate as a result of the cable acquisitions and asset dispositions. In the first full year after the cable transactions are completed, operating results are expected to be negatively impacted by approximately $.40 to $.45 per common share, principally as a result of the non cash amortization of the intangible assets that will be recognized in the allocation of the purchase price. Asset sales are expected to result in one-time gains.
Because of the announced transactions, the Company will explore the possibility of bringing its various interests in cable operations together in a separate, self-financed operating unit. This process is expected to be undertaken over a 12-18 month period and will be dependent on, among other things, successful negotiations with TWE's partners and certain creditors, and the receipt of franchise and other regulatory approvals. Accordingly, there can be no assurance that the effort will succeed.
During 1994, cash provided by Time Warner's operations amounted to $473 million and consisted of $1.150 billion of EBITDA from the Publishing and Music businesses, $120 million of net distributions from TWE and $179 million from the securitization of receivables, less $539 million of interest payments, $339 million of income taxes, $76 million of corporate expenses and working capital requirements. Cash provided by operations of $257 million in 1993 consisted of $1.015 billion of EBITDA from the Publishing and Music businesses and $20 million of net distributions from TWE, less $330 million of interest payments, $182 million of income taxes, $73 million of corporate expenses, and working capital requirements.
Cash flows used in investing activities in 1994, excluding investment proceeds, were $351 million, compared to $373 million in 1993. Cash dividends paid decreased to $142 million in 1994, compared to $299 million in 1993, principally as a result of the redemption and exchange of preferred stock in 1993. Time Warner has no claim on the assets and cash flows of TWE except through the payment of certain fees and reimbursements, cash distributions and loans. Tax-related distributions of $115 million were received from TWE in 1994 and are expected to exceed $350 million in 1995.
Time Warner and TWE entered into a credit agreement in 1994, which allows Time Warner to borrow up to $400 million from TWE through September 15, 2000. Time Warner borrowed $400 million in 1994 under the credit agreement, and used the proceeds to reduce other debt. TWE is permitted under its bank credit agreement to make additional loans to Time Warner, which in the aggregate cannot exceed $1.1 billion at December 31, 1994, increasing to no more than $1.5 billion on July 1, 1995. Management believes that 1995 operating cash flow, cash and marketable securities and additional borrowing capacity are sufficient to meet Time Warner's liquidity needs without distributions and loans from TWE above those permitted by existing agreements.
Time Warner uses derivative financial instruments to manage its risk against fluctuations in interest rates and foreign currency exchange rates. Interest rate swap contracts are used to adjust the proportion of total debt that is subject to changes in short-term rates. At December 31, 1994, Time Warner had interest rate swap contracts to pay floating-rates of interest (average six- month LIBOR rate of 5.9%) and receive fixed-rates of interest (average rate of 5.5%) on $2.9 billion notional amount of indebtedness, effectively converting 32% of Time Warner's underlying debt, substantially all of which is fixed-rate, and 37% of the debt of Time Warner and the Entertainment Group combined, to a floating-rate basis. Based on the current levels of outstanding debt and interest rate swap contracts, a 25 basis point increase in the level of interest rates prevailing at December 31, 1994 would reduce Time Warner's annual pretax income by an estimated $12 million. The notional amount of outstanding contracts at December 31, 1994 by year of maturity, along with the related average fixed-rates of interest to be received and the average floating-rates of interest to be paid, are as follows: 1995-$300 million (receive-6.05%; pay-6.95%); 1996-$300 million (receive-4.55%; pay-6.13%); 1998- $700 million (receive-5.52%; pay-6.06%); 1999-$1.2 billion (receive-5.51%; pay- 5.66%); and 2000-$400 million (receive-5.48%; pay-5.50%).
TIME WARNER INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION--(CONTINUED)
Foreign exchange contracts are used primarily to hedge the risk that unremitted or future royalties and license fees owed to Time Warner and TWE domestic companies for the sale or anticipated sale of U.S. copyrighted products abroad may be adversely affected by changes in exchange rates.
Time Warner often closes foreign exchange sale contracts by purchasing an offsetting purchase contract. A summary of foreign exchange contracts at December 31, 1994 and 1993 is set forth below:
ENTERTAINMENT GROUP
The financial condition of the Entertainment Group companies, principally TWE, at December 31, 1994 remained essentially unchanged from year end 1993, but is expected to be significantly affected by the formation of the TWE- Advance/Newhouse Partnership and the other cable transactions announced for 1995 by Time Warner. TWE had $7.2 billion of long-term debt at December 31, 1994, $1.7 billion of Time Warner General Partners' senior capital and $6.2 billion of partners' capital (net of the $771 million uncollected portion of the U S WEST Note), compared to $7.1 billion of long-term debt, $1.5 billion of Time Warner General Partners' senior capital and $6 billion of partners' capital at December 31, 1993. Cash and equivalents were $1.1 billion at December 31, 1994 compared to $1.3 billion at December 31, 1993, resulting in net debt of $6.1 billion and $5.8 billion, respectively.
Entertainment Group leverage and coverage ratios for 1994 and 1993 were as follows:
TIME WARNER INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION--(CONTINUED)
The formation of the TWE-Advance/Newhouse Partnership and sales of non-core assets are expected to improve the Entertainment Group's leverage and coverage ratios. In accordance with the TWE-Advance/Newhouse joint venture agreement, certain of Time Warner's newly-acquired cable systems may be transferred on a tax-efficient basis to the TWE-Advance/Newhouse Partnership. Such transfers, if they are made, are expected to be structured on a leveraged basis, which could result in an overall adverse impact on the Entertainment Group ratios.
During 1994, cash provided by Entertainment Group operations amounted to $1.341 billion and consisted of $1.811 billion of EBITDA from the Filmed Entertainment, Programming-HBO and Cable businesses and a reduction in working capital requirements, less $521 million of interest payments, $69 million of income taxes and $60 million of corporate expenses. Cash provided by operations of $1.276 billion in 1993 consisted of $1.814 billion of business segment EBITDA and a reduction in working capital requirements, less $450 million of interest payments, $70 million of income taxes and $60 million of corporate expenses. Capital expenditures increased to $1.235 billion in 1994, compared to $613 million in 1993. Capital spending by Time Warner Cable amounted to $778 million in 1994, compared to $353 million in 1993, and was financed in part through $234 million of collections on the U S WEST Note. Cable capital expenditures are budgeted to exceed $1 billion for 1995, and are expected to be partially financed by $550 million of collections on the U S WEST Note. Because management believes that the conversion from coaxial to fiber-optic cable is essential to achieving long-term growth in revenue from telephony and unregulated cable services, significant cable capital expenditures also are expected in subsequent years and will be timed to match the rate at which demand for the new services develops.
Warner Bros.' backlog, representing the amount of future revenue not yet recorded from cash contracts for the licensing of films for pay and basic cable, network and syndicated television exhibition, amounted to $852 million at December 31, 1994, compared to $724 million at December 31, 1993 (including amounts relating to HBO of $175 million at December 31, 1994 and $178 million at December 31, 1993). The backlog excludes advertising barter contracts.
Management believes that TWE's 1995 operating cash flow, cash and equivalents, collections on the U S WEST Note and additional borrowing capacity are sufficient to meet its capital and liquidity needs.
TIME WARNER INC. SCHEDULE VIII--VALUATION AND QUALIFYING ACCOUNTS YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992
-------- (a) The 1994 and 1993 financial statements reflect the deconsolidation of the Entertainment Group, principally TWE, effective January 1, 1993. The historical financial statements for periods prior to such date have not been changed; however, financial information for 1992 retroactively reflecting the deconsolidation is presented as supplementary information under the column heading "restated" to facilitate comparative analysis. (b) Represents uncollectible receivables charged against reserve. (c) Represents returns or allowances applied against reserve. (d) The distribution of magazines not owned by Time Warner results in a receivable recorded at the sales price and a corresponding liability to the publisher recorded at the sales price less the distribution commission recognized by Time Warner as revenue. Therefore, it would be misleading to compare magazine revenues to the provision charged to the reserve for magazine returns that is deducted from accounts receivable without also considering the related offsetting activity in the reserve for magazine returns that is deducted from the liability due to the publishers.
TIME WARNER ENTERTAINMENT COMPANY, L.P. CONSOLIDATED BALANCE SHEET DECEMBER 31, (MILLIONS)
See accompanying notes.
TIME WARNER ENTERTAINMENT COMPANY, L.P. CONSOLIDATED STATEMENT OF OPERATIONS YEARS ENDED DECEMBER 31, (MILLIONS)
See accompanying notes.
TIME WARNER ENTERTAINMENT COMPANY, L.P. CONSOLIDATED STATEMENT OF CASH FLOWS YEARS ENDED DECEMBER 31, (MILLIONS)
--------
(a)The 1994 and 1993 financial statements reflect the consolidation of Six Flags effective January 1, 1993 as a result of the 1993 Six Flags acquisition. The 1992 historical financial statements have not been changed; however, financial statements for 1992 retroactively reflecting the consolidation are presented as supplementary information under the column heading "restated" to facilitate comparative analysis (Notes 1 and 3).
See accompanying notes.
TIME WARNER ENTERTAINMENT COMPANY, L.P. CONSOLIDATED STATEMENT OF PARTNERSHIP CAPITAL (MILLIONS)
-------- (a) Distributions in 1994, 1993 and 1992 included $173 million, $252 million and $24 million, respectively, of tax-related distributions, and $50 million and $13 million of cash distributions to the Time Warner Service Partnerships in 1994 and 1993, respectively. Stock option distributions of $274 million and $17 million were accrued in 1993 and 1992, respectively, because of an increase in the market price of Time Warner common stock and $177 million of such previously-accrued stock option distributions were reversed in 1994 because the market price of Time Warner common stock declined during the period. In addition, Time Warner General Partners' junior priority capital was reduced in 1993 for the $95 million historical cost of the Time Warner Service Partnership Assets distributed to the Time Warner General Partners. A $12 million contribution was made by the Time Warner General Partners in 1992 after the TWE Capitalization pursuant to the net worth adjustment provision of the partnership agreement. (Note 7.)
See accompanying notes.
TIME WARNER ENTERTAINMENT COMPANY, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
Time Warner Entertainment Company, L.P., a Delaware limited partnership ("TWE"), was capitalized on June 30, 1992 (the "TWE Capitalization") to own and operate substantially all of the Filmed Entertainment, Programming-HBO and Cable businesses previously owned by subsidiaries of Time Warner Inc. ("Time Warner"). At December 31, 1994, the general partners of TWE, subsidiaries of Time Warner ("Time Warner General Partners"), together directly and indirectly held 63.27% pro rata priority capital and residual equity partnership interests in TWE, and certain priority capital interests senior and junior to the pro rata priority capital interests, which they received for the net assets, or the rights to cash flows, they contributed to the partnership at the TWE Capitalization; and subsidiaries of U S WEST, Inc. ("U S WEST"), ITOCHU Corporation ("ITOCHU") and Toshiba Corporation ("Toshiba" and collectively, the "Limited Partners"), held 25.51%, 5.61% and 5.61% pro rata priority capital and residual equity partnership interests, respectively. ITOCHU and Toshiba each contributed $500 million of cash at the TWE Capitalization for their limited partnership interests. U S WEST contributed $1.532 billion of cash and a $1.021 billion 4.4% note ("U S WEST Note") on September 15, 1993 for its limited partnership interests.
In lieu of contributing certain assets (the "Beneficial Assets"), the Time Warner General Partners assigned to TWE the net cash flow generated by such assets or agreed to pay an amount equal to the net cash flow generated by such assets. TWE has the right to receive from the Time Warner General Partners, at the limited partners' option, an amount equal to the fair value of the Beneficial Assets, net of associated liabilities, that have not been contributed to TWE by June 30, 1996, rather than continuing to receive the net cash flow, or an amount equal to the net cash flow, generated by such Beneficial Assets. The consolidated financial statements include the assets and liabilities of the businesses contributed by the Time Warner General Partners, including the Beneficial Assets and associated liabilities, all at Time Warner's historical cost basis of accounting.
Time Warner's $14 billion acquisition of Warner Communications Inc. ("WCI") as of December 31, 1989, and $1.3 billion acquisition of the minority interest in American Television and Communications Corporation ("ATC") on June 26, 1992 were accounted for by the purchase method of accounting. WCI subsequently contributed filmed entertainment and cable assets to TWE, and ATC subsequently contributed its cable assets. The financial statements of TWE reflect an allocable portion of Time Warner's cost to acquire WCI and the ATC minority interest in accordance with the pushdown method of accounting.
BASIS OF CONSOLIDATION AND ACCOUNTING FOR INVESTMENTS
The consolidated financial statements include 100% of the assets, liabilities, revenues, expenses, income, loss and cash flows of TWE and all companies in which TWE has a controlling voting interest ("subsidiaries"), as if TWE and its subsidiaries were a single company. Significant intercompany accounts and transactions between the consolidated companies have been eliminated. Significant accounts and transactions between TWE and its partners and affiliates are disclosed as related party transactions (Note 12).
Investments in companies in which TWE has significant influence but less than a controlling voting interest are accounted for using the equity method. Under the equity method, only TWE's investment in and amounts due to and from the equity investee are included in the consolidated balance sheet, only TWE's share of the investee's earnings is included in the consolidated operating results, and only the dividends, cash distributions, loans or other cash received from the investee, less any additional cash investment, loan repayments or other cash paid to the investee, are included in the consolidated cash flows.
TIME WARNER ENTERTAINMENT COMPANY, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
In accordance with Financial Accounting Standards Board ("FASB") Statement No. 115, "Accounting for Certain Investments in Debt and Equity Securities," investments in companies in which TWE does not have the controlling interest or an ownership and voting interest so large as to exert significant influence are accounted for at market value if the investments are publicly traded and there are no resale restrictions, or at cost, if the sale of a publicly-traded investment is restricted or if the investment is not publicly traded. Unrealized gains and losses on investments accounted for at market value are reported in partners' capital until the investment is sold, at which time, the realized gain or loss is included in income. Dividends and other distributions of earnings from both market value and cost method investments are included in income when declared.
Six Flags Entertainment Corporation ("Six Flags") was consolidated effective January 1, 1993 as a result of the increase of TWE's ownership and voting control in Six Flags from 50% to 100% in September 1993 (Note 3). The 1992 historical financial statements of TWE were not changed; accordingly, they include Six Flags on the equity method. However, financial statements for 1992 retroactively reflecting the consolidation also are presented under the caption "restated" to facilitate comparative analysis. Certain other reclassifications have been made to the prior years' financial statements to conform to the 1994 presentation.
REVENUES AND COSTS
Feature films are produced or acquired for initial exhibition in theaters followed by distribution in the home video, pay cable, basic cable, broadcast network and syndicated television markets. Generally, distribution to the theatrical, home video and pay cable markets (the primary markets) is completed within eighteen months of initial release. Theatrical revenues are recognized as the films are exhibited. Home video revenues, less a provision for returns, are recognized when the home videos are sold. Revenues from cable and broadcast television distribution are recognized when the films are available to telecast. Television films and series are initially produced for the networks or first-run television syndication (the primary markets) and may be subsequently licensed to foreign or other domestic television markets. Revenues from television license agreements are recognized when the films or series are available to telecast, except for barter agreements where the recognition of revenue is deferred until the related advertisements are telecast.
Inventories of theatrical and television product are stated at the lower of amortized cost or net realizable value. Cost includes direct production and acquisition costs, production overhead and capitalized interest. A portion of the cost to acquire WCI was allocated to its theatrical and television product as of December 31, 1989, including an allocation to product that had been exhibited at least once in all markets ("Library"). Individual films and series are amortized, and the related participations and residuals are accrued, based on the proportion that current revenues from the film or series bear to an estimate of total revenues anticipated from all markets. These estimates are revised periodically and losses, if any, are provided in full. WCI acquisition cost allocated to the Library is amortized on a straight-line basis over twenty years. Current film inventories include the unamortized cost of completed feature films allocated to the primary markets, television films and series in production pursuant to a contract of sale, film rights acquired for the home video market and advances pursuant to agreements to distribute third-party films in the primary markets. Noncurrent film inventories include the unamortized cost of completed theatrical and television films allocated to the secondary markets, theatrical films in production and WCI acquisition cost allocated to the Library.
A significant portion of cable system and cable programming revenues are derived from subscriber fees, which are recorded as revenue in the period the service is provided. The right to exhibit feature films and other programming on pay cable services during one or more availability periods ("programming costs") generally is recorded when the programming is initially available for exhibition, and is allocated to the appropriate availability periods and amortized as the programming is exhibited.
TIME WARNER ENTERTAINMENT COMPANY, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are stated at cost. Additions to cable property, plant and equipment generally include material, labor, overhead, interest and certain start-up costs incurred in developing new franchises. Depreciation is provided generally on the straight-line method over useful lives ranging up to twenty-five years for buildings and improvements and up to fifteen years for furniture, fixtures and cable television and other equipment.
INTANGIBLE ASSETS
Intangible assets are recorded when the cost of acquired companies exceeds the fair value of their tangible assets. Generally accepted accounting principles require that all intangible assets be amortized over no more than a forty-year period. Amortization of goodwill amounted to $129 million in 1994, $132 million in 1993 and $115 million ($124 million on a restated basis) in 1992; amortization of cable television franchises amounted to $208 million, $222 million and $194 million, respectively; and amortization of other intangible assets amounted to $141 million, $122 million and $108 million ($129 million on a restated basis), respectively. Accumulated amortization of intangible assets at December 31, 1994 and 1993 amounted to $1.867 billion and $1.438 billion, respectively.
FOREIGN CURRENCY
The financial position and operating results of substantially all of the foreign operations of TWE are consolidated using the local currency as the functional currency. Local currency assets and liabilities are translated at the rates of exchange on the balance sheet date, and local currency revenues and expenses are translated at average rates of exchange during the period. Resulting translation gains or losses, which have not been material, are included in partners' capital. Foreign currency transaction gains and losses, which have not been material, are included in operating results.
Foreign exchange contracts are used primarily to hedge the risk that unremitted or future license fees owed to TWE domestic companies for the sale or anticipated sale of U.S. copyrighted products abroad may be adversely affected by changes in exchange rates. TWE is reimbursed by or reimburses Time Warner for Time Warner contract gains and losses related to TWE's exposure. At December 31, 1994, Time Warner had contracts for the sale of $551 million and the purchase of $109 million of foreign currencies at fixed rates and maturities of three months or less. Of Time Warner's $442 million net sale contract position, $188 million related to TWE's exposure, primarily Japanese yen (41% of net contract position related to TWE), French francs (18%), German marks (12%) and Canadian dollars (11%), compared to a net sale contract position of $226 million of foreign currencies at December 31, 1993. Unrealized gains or losses are recorded in income; accordingly, the carrying value of foreign exchange contracts approximates market value. TWE had $20 million of net losses on foreign exchange contracts during 1994, which were or are expected to be offset by corresponding increases in the dollar value of foreign currency license fee payments that have been or are anticipated to be received from the sale of U.S. copyrighted products abroad. Time Warner places foreign currency contracts with a number of major financial institutions in order to minimize credit risk.
INCOME TAXES
As a Delaware limited partnership, TWE is not subject to U.S. federal and state income taxation. However, certain of TWE's operations are conducted by subsidiary corporations that are subject to domestic or foreign taxation. Income taxes are provided on the income of such corporations using the liability method of accounting for income taxes prescribed by FASB Statement No. 109, "Accounting for Income Taxes." The consolidated financial statements for periods prior to the TWE Capitalization include, for comparative purposes, the income and withholding tax consequences of those TWE operations subject to domestic or foreign taxation, as determined on a stand-alone basis consistent with the liability method of accounting for income taxes.
TIME WARNER ENTERTAINMENT COMPANY, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
INTEREST RATE SWAP CONTRACTS
TWE used interest rate swap contracts in 1992 and prior years to adjust the proportion of total debt that was subject to changes in short-term interest rates and the proportion that was subject to fixed rates. There were no material amounts of contracts outstanding during the years ended December 31, 1994 and 1993. Under the previous interest rate swap contracts, TWE had agreed to pay an amount equal to a specified fixed-rate of interest times a notional principal amount, and to receive in return an amount equal to a specified floating-rate of interest times the same notional principal amount. The notional amounts of the contracts were not exchanged. No other cash payments were made unless the contracts were terminated prior to maturity, in which case the amount paid or received in settlement was equal to the present value, at current rates of interest, of the remaining obligations to exchange payments under the terms of the contract. The interest rate swap contracts were entered into with a number of major financial institutions in order to minimize credit risk.
The net amounts paid or payable, or received or receivable, through the end of the accounting period was included in interest expense. Gains or losses on the termination of contracts were deferred and amortized to income over the remaining average life of the terminated contracts.
2. TWE--ADVANCE/NEWHOUSE PARTNERSHIP
In September 1994, TWE agreed to form a cable television joint venture with subsidiaries of Advance Publications, Inc. and Newhouse Broadcasting Corporation ("Advance/Newhouse") to which Advance/ Newhouse will contribute cable television systems serving 1.4 million subscribers and related assets, and TWE will contribute cable television systems (or interests therein) serving 2.8 million subscribers and related assets. TWE will own a two-thirds equity interest in the TWE-Advance/Newhouse Partnership and be the managing partner. Advance/Newhouse will own a one-third equity interest in the partnership. Advance/Newhouse can require TWE to purchase its equity interest for fair market value at specified intervals following the death of both of its principal shareholders. Beginning in the third year, either partner can initiate a dissolution in which TWE would receive two-thirds and Advance/Newhouse would receive one-third of the partnership's net assets. The transaction is expected to close in the first half of 1995 and is subject to customary closing conditions, including the receipt of certain franchise and regulatory approvals.
3. INVESTMENTS
TWE's investments consist of:
Companies accounted for using the equity method include Paragon Communications (50% owned), certain other cable system joint ventures (generally 50% owned), Comedy Partners, L.P. (50% owned), Six Flags (50% owned in 1992), E! Entertainment Corporation (50% owned in 1992), and in 1994 only, certain
TIME WARNER ENTERTAINMENT COMPANY, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
international cable and programming joint ventures (generally 25% owned). A summary of financial information as reported by the equity investees of TWE on a 100% basis is set forth below:
In September 1993, TWE provided Six Flags with $136 million to repurchase the 50% common stock interest held by other stockholders and preferred stock of certain subsidiaries. TWE also provided $414 million to finance the repurchase or retirement of all indebtedness of Six Flags and its subsidiaries, except for the zero coupon notes due 1999. As a result, TWE has consolidated Six Flags effective January 1, 1993.
4. INVENTORIES
TWE's inventories consist of:
Excluding the Library, the unamortized cost of completed films at December 31, 1994 amounted to $1.079 billion, more than 90% of which is expected to be amortized within three years after release. Excluding the effects of accounting for the acquisition of WCI, the total cost incurred in the production of theatrical and television films amounted to $1.667 billion in 1994, $1.784 billion in 1993 and $1.652 billion in 1992; and the total cost amortized amounted to $1.640 billion, $1.619 billion and $1.535 billion, respectively.
TIME WARNER ENTERTAINMENT COMPANY, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
5. LONG-TERM DEBT
Long-term debt consists of:
Each Time Warner General Partner has guaranteed a pro rata portion of substantially all of TWE's debt and accrued interest thereon based on the relative fair value of the net assets each Time Warner General Partner contributed to TWE (the "Time Warner General Partner Guarantees"). Such indebtedness is recourse to each Time Warner General Partner only to the extent of its guarantee. The indenture pursuant to which TWE's notes and debentures have been issued (the "Indenture") requires the unanimous consent of the holders of the notes and debentures to terminate the Time Warner General Partner Guarantees prior to June 30, 1997, and the consent of a majority of such holders to effect a termination thereafter. There are generally no restrictions on the ability of the Time Warner General Partner guarantors to transfer material assets, other than TWE assets, to parties that are not guarantors.
As of December 31, 1994, the TWE bank credit agreement provided for up to $5.2 billion of borrowings and consisted of a $4.2 billion revolving credit facility with available credit reducing at June 30, 1995 and thereafter by $200 million per quarter through June 30, 1996, by $125 million per quarter from September 30, 1996 through September 30, 1999, and by $1.575 billion at final maturity on December 31, 1999; and a $986 million term loan with repayments of $66 million on June 30, 1995, $98 million per quarter beginning September 30, 1995 through March 31, 1996, $27 million per quarter beginning June 30, 1996 through June 30, 1999, $20 million on September 30, 1999 and a final repayment of $255 million on December 31, 1999. Unused credit is available for general business purposes and to support commercial paper borrowings. Outstanding borrowings under the credit agreement generally bear interest at LIBOR plus 5/8% per annum. The credit agreement contains covenants relating to, among other things, additional indebtedness; liens on assets; acquisitions and investments; cash flow coverage and leverage ratios; and loans, advances, distributions or other cash payments or transfers of assets to its partners or their affiliates.
An after-tax cost of $10 million was incurred by Six Flags in 1993 in connection with the retirement of its debt (Note 3). The Six Flags zero coupon senior notes due 1999 are guaranteed by TWE.
Based on the level of interest rates prevailing at December 31, 1994, the fair value of TWE's long-term debt was $460 million less than its carrying value. Based on the level of interest rates prevailing at December 31, 1993, the fair value of TWE's long-term debt exceeded its carrying value by $290 million. Accounting recognition is not given to unrealized gains or losses on debt unless the debt is retired prior to its maturity.
TIME WARNER ENTERTAINMENT COMPANY, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Interest expense was $563 million in 1994, $573 million in 1993 and $436 million in 1992 ($486 million on a restated basis). The weighted average interest rate on TWE's total debt was 7.6% and 6.7% at December 31, 1994 and 1993, respectively. Interest expense in 1992 prior to the TWE Capitalization includes interest expense related to Time Warner's credit and interest rate swap contracts on a pushdown basis and interest expense on $875 million of loans due to WCI, which were repaid at the TWE Capitalization.
Annual repayments of long-term debt for the five years subsequent to December 31, 1994 are: 1995- $262 million; 1996-$179 million; 1997-$108 million; 1998- $372 million and 1999-$2.4 billion.
6. INCOME TAXES
Domestic and foreign pretax income (loss) are as follows:
As a partnership, TWE is not subject to U.S. federal, state or local income taxation (Note 1). Income taxes (benefits) of TWE and subsidiary corporations are as set forth below:
-------- (1)Includes utilization of Six Flags' tax carryforwards in the amount of $35 million in 1994 and $75 million in 1993. (2)Includes foreign withholding taxes of $44 million in 1994, $59 million in 1993 and $34 million in 1992.
The financial statement basis of TWE's assets exceeds the corresponding tax basis by $9.5 billion at December 31, 1994, principally as a result of differences in accounting for depreciable and amortizable assets for financial statement and income tax purposes.
TIME WARNER ENTERTAINMENT COMPANY, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
7. TWE PARTNERS' CAPITAL
The TWE partnership agreement provides for special allocations of income, loss and distributions of partnership capital, including priority distributions in the event of liquidation or dissolution. The initial capital amounts assigned to each partner were based on the fair value of the assets each contributed to the partnership. Partnership income, to the extent earned, is first allocated to the partners so that the economic burden of the income tax consequences of partnership operations is borne as though the partnership were taxed as a corporation ("special tax allocations"), then to the senior, pro rata and junior priority capital interests, in order of priority, at rates of return ranging from 8% to 13.25% per annum, and finally to the residual equity interests. For the purpose of the foregoing allocations, partnership income is based on the fair value of assets contributed to the partnership, and differs from net income of TWE, which is based on the historical cost of contributed assets. Partnership losses generally are allocated first to eliminate prior allocations of partnership income to, and then to reduce the initial capital amounts of, the residual equity, junior priority capital and pro rata priority capital interests, in that order, then to reduce Time Warner General Partners' senior capital, including partnership income allocated thereto, and finally to reduce any special tax allocations. To the extent partnership income is insufficient to satisfy all special allocations in a particular accounting period, the unearned portion is carried over until satisfied out of future partnership income.
A summary of the priority of contributed capital and limitations on the allocation of partnership income is as set forth below:
-------- (a)Excludes partnership income or loss (to the extent earned) allocated thereto. (b)11.00% to the extent concurrently distributed. (c)11.25% to the extent concurrently distributed.
Senior capital and partnership income allocated thereto is required to be distributed in three annual installments beginning July 1, 1997; earlier distributions may be made under certain circumstances ("Senior Capital Distributions"). Senior capital and partnership income allocated thereto amounted to $1.663 billion at December 31, 1994, consisting of $1.364 billion initial capital amount plus accrued income. Junior priority capital is subject to a retroactive adjustment based on TWE's operating performance over five- and ten-year periods.
U S WEST has an option to increase its pro rata priority capital and residual equity interests to as much as 31.84%, depending on cable operating performance. The option is exercisable between January 1, 1999
TIME WARNER ENTERTAINMENT COMPANY, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
and on or about May 31, 2005 at a maximum exercise price ranging from $1.25 billion to $1.8 billion, depending on the year of exercise. U S WEST or TWE may elect that the exercise price be paid with partnership interests rather than cash. Prior to the exercise of the U S WEST option, each of ITOCHU and Toshiba has the right to maintain its original 6.25% pro rata priority capital and residual equity interests by acquiring additional partnership interests at fair market value; thereafter, each would have the right to maintain the percentage of the pro rata priority capital and residual equity interests it held immediately prior to U S WEST's exercise.
Distributions and loans to the partners are subject to partnership and credit agreement limitations. Generally, TWE must be in compliance with the cash flow coverage and leverage ratios, restricted payment limitations and other credit agreement covenants in order to make such distributions or loans.
Certain assets of TWE (the "Time Warner Service Partnership Assets") were distributed to the Time Warner General Partners prior to the admission of U S WEST in 1993 in order to ensure compliance with the Modification of Final Judgment entered on August 24, 1982 by the United States District Court for the District of Columbia (the "MFJ") applicable to U S WEST and its affiliated companies, which may have included TWE. The Time Warner General Partners contributed the Time Warner Service Partnership Assets to newly-formed partnerships (the "Time Warner Service Partnerships") in which the Time Warner General Partners are the general partners and subsidiaries of ITOCHU and Toshiba are the limited partners. The Time Warner Service Partnerships make certain of their assets and related services available to TWE (Note 12). If TWE is clearly not prohibited from owning or operating the Time Warner Service Partnership Assets, they will be recontributed to TWE on September 15, 1995 (or September 15, 1997 in the case of certain assets), or earlier under certain circumstances, at their then fair market value in exchange for partnership interests in TWE. As a result of a judicial order issued to U S WEST on October 24, 1994, TWE is no longer prohibited from owning or operating substantially all of the Time Warner Service Partnership Assets.
For financial statement purposes, the distribution of Time Warner Service Partnership Assets was accounted for at historical cost. For partnership agreement purposes, the initial capital amount of General Partners' junior priority capital of $3 billion was reduced by approximately $300 million to give effect to such distribution. TWE is required to make quarterly cash distributions of Time Warner General Partners' junior priority capital in the amount of $12.5 million to the Time Warner General Partners ("TWSP Distributions"), which the General Partners are then required to contribute to the Time Warner Service Partnerships. TWE paid $50 million and $12.5 million of TWSP Distributions to the Time Warner General Partners in 1994 and 1993, respectively, which were recorded as additional reductions of Time Warner General Partners' junior priority capital.
TWE reimburses Time Warner for the amount by which the market price on the exercise date of Time Warner common stock options granted to employees of TWE exceeds the exercise price or, with respect to options granted prior to the TWE Capitalization, the greater of the exercise price and $27.75, the market price of the common stock at the TWE Capitalization ("Stock Option Distributions"). TWE accrues Stock Option Distributions and a corresponding liability with respect to unexercised options when the market price of Time Warner common stock increases during the accounting period, and reverses previously-accrued Stock Option Distributions and the corresponding liability when the market price of Time Warner common stock declines. At December 31, 1994 and 1993, TWE had recorded a liability for Stock Option Distributions of $89 million and $271 million, respectively, based on the unexercised options and the market prices at such dates of $35.125 and $44.25, respectively, per Time Warner common share. TWE paid $5 million of Stock Option Distributions to Time Warner in 1994, compared to $20 million in 1993.
Cash distributions are required to be made to the partners to permit them to pay income taxes at statutory rates based on their allocable taxable income from TWE ("Tax Distributions"), including any
TIME WARNER ENTERTAINMENT COMPANY, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
taxable income generated by the Beneficial Assets, subject to limitations referred to herein. The aggregate amount of such Tax Distributions is computed generally by reference to the taxes that TWE would have been required to pay if it were a corporation. TWE paid $115 million of Tax Distributions to the Time Warner General Partners in 1994 and had recorded an additional liability to the Time Warner General Partners for Tax Distributions of $334 million at December 31, 1994, compared to a liability of $276 million at December 31, 1993. All Tax Distributions are permitted to be paid beginning July 1, 1995 and, accordingly, such amounts are classified as a current liability at December 31, 1994.
In addition to Stock Option Distributions, Tax Distributions, Senior Capital Distributions and TWSP Distributions, quarterly cash distributions may be made to the partners to the extent of excess cash, as defined ("Excess Cash Distribution"). Assuming that no additional partnership interests are issued to new partners and that certain cash distribution thresholds are met, cash distributions other than Stock Option Distributions, Tax Distributions, Senior Capital Distributions and TWSP Distributions will in the aggregate be made 63.27% to the Time Warner General Partners and 36.73% to the Limited Partners prior to June 30, 1998; thereafter, the Time Warner General Partners also will be entitled to additional distributions with respect to junior priority capital. If aggregate distributions made to the Limited Partners, generally from all sources, have not reached approximately $800 million by June 30, 1997, cash distributions to the Time Warner General Partners with respect to the Time Warner General Partners' pro rata priority and residual equity capital, other than Stock Option Distributions and Tax Distributions, will be deferred until such threshold is met. Similarly, if such aggregate distributions to the Limited Partners have not reached approximately $1.6 billion by June 30, 1998, cash distributions with respect to junior priority capital, other than TWSP Distributions, will be deferred until such threshold is met. If any such deferral occurs, a portion of the corresponding partnership income allocations with respect to such deferred amounts will be made at a rate higher than otherwise would have been the case. If a division of TWE or a substantial portion thereof is sold, the net proceeds of such sale, less expenses and proceeds used to repay outstanding debt, will be required to be distributed with respect to the partners' partnership interests. Similar distributions are required to be made in the event of a financing or refinancing of debt. Subject to any limitations on the incurrence of additional debt contained in the TWE partnership and credit agreements, and the Indenture, TWE may borrow funds to make distributions.
8. STOCK OPTION PLANS
Options to purchase Time Warner common stock under various stock option plans have been granted to employees of TWE, generally at fair market value at the date of grant. Generally, the options become exercisable over a three-year vesting period and expire ten years from the date of grant. A summary of stock option activity with respect to employees of TWE is as follows:
TWE reimburses Time Warner for the use of Time Warner stock options on the basis described in Note 7. There were 1.9 million options exercised by employees of TWE in 1993 and 129,000 options exercised in 1992 at prices ranging from $8-$36 per share, and there were 18.5 million options exercisable at December 31, 1993.
TIME WARNER ENTERTAINMENT COMPANY, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
9. BENEFIT PLANS
TWE and its divisions have defined benefit pension plans covering substantially all domestic employees. Pension benefits are based on formulas that reflect the employees' years of service and compensation levels during their employment period. Qualifying plans are funded in accordance with government pension and income tax regulations. Plan assets are invested in equity and fixed income securities.
Pension expense included the following:
The status of funded pension plans is as follows:
The following assumptions were used in accounting for pension plans:
Certain domestic employees of TWE participate in multiemployer pension plans as to which the expense amounted to $18 million in 1994, $19 million in 1993 and $20 million in 1992. Employees in foreign countries participate to varying degrees in local pension plans, which in the aggregate are not significant.
Certain domestic employees also participate in Time Warner's 401(k) savings plans and profit sharing plans, as to which the expense was $23 million in 1994, $20 million in 1993 and $16 million in 1992. Contributions to the 401(k) plans are based upon a percentage of the employees' elected contributions. Contributions to the profit sharing plans are determined by management.
TIME WARNER ENTERTAINMENT COMPANY, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
10. SEGMENT INFORMATION
Information as to the operations of TWE in different business segments is as set forth below:
-------- (1) Amortization includes amortization relating to the acquisitions of WCI in 1989 and the ATC minority interest in 1992 and to other business combinations accounted for by the purchase method.
TIME WARNER ENTERTAINMENT COMPANY, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Information as to the assets and capital expenditures of TWE is as follows:
-------- (1)The 1994 increase was funded in part through $234 million of collections on the U S WEST Note (Note 1).
11.COMMITMENTS AND CONTINGENCIES
Total rent expense amounted to $143 million in 1994, $119 million in 1993 and $99 million ($107 million on a restated basis) in 1992. The minimum rental commitments under noncancellable long-term operating leases are: 1995-$132 million; 1996-$130 million; 1997-$117 million; 1998-$110 million; 1999-$100 million and after 1999-$784 million.
Minimum commitments and guarantees under certain programming, licensing, franchise and other agreements at December 31, 1994 aggregated approximately $3.7 billion, which are payable principally over a five-year period.
Pending legal proceedings are substantially limited to litigation incidental to the businesses of TWE. In the opinion of counsel and management, the ultimate resolution of these matters will not have a material effect on the consolidated financial statements.
12.RELATED PARTY TRANSACTIONS
In the normal course of conducting their businesses, TWE units have had various transactions with Time Warner units, generally on terms resulting from a negotiation among the affected parties that in management's view results in reasonable allocations. Employees of TWE participate in various Time Warner medical, stock option (Note 8) and other benefit plans (Note 9) for which TWE is charged its allocable share of plan expenses, including administrative costs. Time Warner's corporate group provides various other services to TWE. The Music division of WCI provides home videocassette distribution services to certain
TIME WARNER ENTERTAINMENT COMPANY, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
TWE operations, and certain TWE units have placed advertising in magazines published by Time Warner's Publishing division.
TWE is required to pay a $130 million advisory fee to U S WEST over a five- year period ending September 15, 1998 for U S WEST's expertise in telecommunications, telephony and information technology, and its participation in the management and upgrade of the cable systems to Full Service Network(TM) capacity.
Time Warner provides TWE with certain corporate support services for which Time Warner is paid $60 million per year through June 30, 1995, and increasing annual amounts as adjusted for inflation thereafter. The corporate services agreement runs through June 30, 1997, and may be extended by agreement of both parties. Management believes that the corporate services fee is representative of the cost of corporate services that would be necessary for the stand-alone operations of TWE.
Time Warner and TWE entered into a credit agreement in 1994 that allows Time Warner to borrow up to $400 million from TWE through September 15, 2000. Outstanding borrowings from TWE bear interest at LIBOR plus 1% per annum. Time Warner borrowed $400 million in 1994 under the credit agreement. Under TWE's bank credit agreement, TWE's loans to Time Warner cannot exceed $1.1 billion at December 31, 1994, increasing to no more than $1.5 billion on July 1, 1995.
TWE has service agreements with the Time Warner Service Partnerships for program signal delivery and transmission services, and TWE provides billing, collection and marketing services to the Time Warner Service Partnerships. TWE also has distribution and merchandising agreements with Time Warner Entertainment Japan Inc., a company owned by partners of TWE to conduct TWE's businesses in Japan.
In addition to transactions with its partners, TWE has had transactions with Paragon Communications, Comedy Partners, L.P. and its other equity investees and with Turner Broadcasting System, Inc., The Columbia House Company partnerships, Cinamerica Theatres, L.P. and other equity investees of Time Warner, generally with respect to sales of product in the ordinary course of business.
Long-term debt and interest expense prior to the TWE Capitalization include the effects of the pushdown of a portion of the Time Warner credit agreement debt that was related to the WCI acquisition, based on the proportion that the fair value of the WCI contributed businesses acquired bore to the fair value of all of the WCI net assets acquired. Interest expense prior to the TWE Capitalization also reflects interest on $875 million of loans due to WCI, which were repaid at the TWE Capitalization, at a rate approximating the rate applicable to borrowings under the Time Warner credit agreement.
13.SUPPLEMENTAL INFORMATION
Supplemental information with respect to cash flows is as follows:
TIME WARNER ENTERTAINMENT COMPANY, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The principal balance sheet effects of the consolidation of Six Flags in 1993 were to increase cash and equivalents by $11 million, property, plant and equipment by $398 million, goodwill by $310 million, other assets by $159 million, debt by $608 million and other liabilities by $238 million, and to decrease investments by $32 million. The principal balance sheet effects of the acquisition of the ATC minority interest in 1992 were to increase investments by $156 million, cable television franchises by $865 million, goodwill by $410 million and partners' capital by $1.431 billion. A noncash effect of the TWE Capitalization in 1992 was the assumption by TWE of $2.545 billion of Time Warner debt in excess of the amount reflected as a liability prior to the TWE Capitalization. Cash equivalents consist of commercial paper and other investments that are readily convertible into cash, and have original maturities of three months or less.
Other current liabilities consist of:
REPORT OF INDEPENDENT AUDITORS
THE PARTNERS OF TIME WARNER ENTERTAINMENT COMPANY, L.P.
We have audited the accompanying consolidated balance sheet of Time Warner Entertainment Company, L.P. ("TWE") as of December 31, 1994 and 1993, and the related consolidated statements of operations, cash flows and partnership capital for each of the three years in the period ended December 31, 1994. Our audits also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and schedule are the responsibility of TWE's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of TWE at December 31, 1994 and 1993, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
Ernst & Young LLP
New York, New York February 7, 1995
TIME WARNER ENTERTAINMENT COMPANY, L.P. SELECTED FINANCIAL INFORMATION
The selected financial information for each of the five years in the period ended December 31, 1994 set forth below has been derived from and should be read in conjunction with the consolidated financial statements and other financial information presented elsewhere herein. Capitalized terms are as defined and described in such consolidated financial statements, or elsewhere herein. The selected historical financial information for 1994 and 1993 gives effect to the consolidation of Six Flags effective as of January 1, 1993, as a result of the 1993 Six Flags acquisition. The selected historical financial information for periods prior to such date has not been changed; however, selected financial information for 1992 retroactively reflecting the consolidation is presented as supplementary information under the column heading "restated" to facilitate comparative analysis.
The selected historical financial information for 1993 gives effect to the admission of U S WEST as an additional limited partner of TWE as of September 15, 1993 and the issuance of $2.6 billion of TWE debentures during the year to reduce indebtedness under the TWE credit agreement, and for 1992 gives effect to the initial capitalization of TWE and associated refinancings as of the dates such transactions were consummated and Time Warner's acquisition of the ATC minority interest as of June 30, 1992, using the purchase method of accounting and reflected in the consolidated financial statements of TWE under the pushdown method of accounting.
TIME WARNER ENTERTAINMENT COMPANY, L.P. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
-------- (a) Net income for each of the second and third quarters of 1993 includes an extraordinary loss on the retirement of debt of $2 million and $8 million, respectively.
TIME WARNER ENTERTAINMENT COMPANY, L.P. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
RESULTS OF OPERATIONS
1994 VS. 1993
TWE had revenues of $8.460 billion and net income of $161 million in 1994, compared to revenues of $7.946 billion and net income of $198 million in 1993. An extraordinary loss on the retirement of debt of $10 million and a one-time gain from the sale of certain assets are included in the 1993 results.
Operating income and EBITDA for TWE in 1994 and 1993 were as follows:
As a U.S. partnership, TWE is not subject to U.S. federal and state income taxation. Income and withholding taxes of $40 million in the year ended December 31, 1994, and $64 million in the year ended December 31, 1993 have been provided in respect of the operations of TWE's domestic and foreign subsidiary corporations.
Certain factors affecting comparative operating results are discussed below on a business segment basis. That discussion includes, among other factors, an analysis of changes in the operating income of the business segments before depreciation and amortization ("EBITDA") in order to eliminate the effect on the operating performance of the filmed entertainment and cable businesses of significant amounts of amortization of intangible assets recognized in Time Warner's $14 billion acquisition of WCI in 1989, the $1.3 billion acquisition of the ATC minority interest in 1992 and other business combinations accounted for by the purchase method. Financial analysts generally consider EBITDA to be an important measure of comparative operating performance for the businesses of TWE, and when used in comparison to debt levels or the coverage of interest expense, as a measure of liquidity. However, EBITDA should be considered in addition to, not as a substitute for, operating income, net income, cash flow and other measures of financial performance and liquidity reported in accordance with generally accepted accounting principles.
Filmed Entertainment. Revenues increased to $5.033 billion, compared to $4.557 billion in 1993. Operating income decreased to $257 million from $263 million. Depreciation and amortization, including amortization related to the purchase of WCI, amounted to $285 million in 1994 and $258 million in 1993. EBITDA increased to $542 million from $521 million. Worldwide home video, syndication and consumer products revenues increased at Warner Bros., offset in part by lower worldwide theatrical revenues. Revenues at Six Flags increased as a result of overall attendance growth and higher revenues per visitor. Operating income and EBITDA margins decreased principally as a result of lower theatrical results in comparison to the exceptionally strong theatrical results in 1993.
Programming--HBO. Revenues increased to $1.494 billion, compared to $1.435 billion in 1993. Operating income increased to $236 million from $213 million. Depreciation and amortization amounted to $19 million in 1994 and $17 million in 1993. EBITDA increased to $255 million from $230 million. Revenues benefited from an increase in subscribers and higher pay-TV rates. Operating income, EBITDA and operating margins improved principally as a result of the revenue gains.
TIME WARNER ENTERTAINMENT COMPANY, L.P. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION--(CONTINUED)
Cable. Revenues increased to $2.220 billion, compared to $2.205 billion in 1993. Operating income decreased to $355 million from $407 million. Depreciation and amortization, including amortization related to the purchase of WCI and the acquisition of the ATC minority interest, amounted to $639 million in 1994 and $627 million in 1993. EBITDA decreased to $994 million from $1.034 billion. Revenues and operating results in 1994 were adversely affected by two rounds of cable rate regulation that in general reduced the rates cable operators are allowed to charge for regulated services, the first of which went into effect in September 1993 and the second of which went into effect in July 1994. The unfavorable effects of rate regulation were offset in part by an increase in subscribers and nonregulated revenues. Actions that were undertaken to mitigate the impact of rate regulation included a number of cost containment measures and a continued emphasis on near and long-term strategies to increase revenues from unregulated services.
Interest and Other, Net. Interest and other, net, increased to $587 million in 1994, compared to $551 million in 1993. Interest expense decreased to $563 million, compared with $573 million in 1993. There was other expense, net, of $24 million in 1994, compared to other income, net, of $22 million in 1993. Investment-related and foreign currency contract losses in 1994 exceeded an increase in interest income on higher cash balances and the interest-bearing note receivable from U S WEST. A gain on the sale of certain assets and other investment-related income exceeded investment losses in 1993.
1993 VS. 1992
TWE had 1993 revenues of $7.946 billion, income of $208 million before an extraordinary loss of $10 million on the retirement of debt and net income of $198 million, compared to 1992 revenues of $6.761 billion ($7.251 billion on a restated basis) and net income of $160 million.
Operating income and EBITDA for TWE for 1993 and 1992 were as follows:
Filmed Entertainment. Revenues increased to $4.557 billion compared to $3.455 billion ($3.945 billion on a restated basis) in 1992. Operating income increased to $263 million from $194 million ($235 million on a restated basis). Depreciation and amortization, including amortization related to the purchase of WCI, amounted to $258 million in 1993 and $191 million ($260 million on a restated basis) in 1992. EBITDA increased to $521 million from $385 million ($495 million on a restated basis). The increase in revenues, operating income and EBITDA on an historical basis resulted primarily from the inclusion in 1993 of the operating results of Six Flags, which previously had been accounted for using the equity method. Revenues at Warner Bros. increased during the period primarily due to increases in international theatrical, international syndication and domestic home video revenues, as well as increased revenues from retail operations. Record international revenues of $1.650 billion would have been greater but for unfavorable exchange rate fluctuations. Warner Bros. ranked number one at both the domestic and international box office in 1993, led by the success of The Fugitive and The Bodyguard. Revenues at Six Flags increased, benefiting from higher revenues per visitor. Operating income and EBITDA benefited from the revenue gains.
TIME WARNER ENTERTAINMENT COMPANY, L.P. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION--(CONTINUED)
Programming--HBO. Revenues decreased to $1.435 billion compared to $1.444 billion in 1992. Operating income increased to $213 million from $201 million. Depreciation and amortization amounted to $17 million in 1993 and $14 million in 1992. EBITDA increased to $230 million from $215 million. The decrease in revenues reflects lower HBO Video sales, which in 1992 were favorably affected by a children's sell-thru title, offset in part by higher subscriber revenues, principally as a result of higher pay-TV rates at HBO and an increase in subscribers. Operating income and EBITDA benefited primarily from improved results from new businesses, including Time Warner Sports and the Comedy Central joint venture.
Cable. Revenues increased to $2.205 billion compared to $2.091 billion in 1992. Operating income increased to $407 million from $400 million. Depreciation and amortization, including amortization related to the purchase of WCI and the acquisition of the ATC minority interest amounted to $627 million in 1993 and $577 million in 1992. EBITDA increased to $1.034 billion from $977 million. Revenues increased principally as a result of growth in the number of cable subscribers and increases in advertising sales and pay-per- view. The increase in subscribers accounted for approximately three quarters of the revenue increase. Operating income and EBITDA benefited from the revenue gains and increased income from cable joint ventures, but was negatively affected in the fourth quarter by the first round of cable rate regulation, which went into effect on September 1, 1993.
Interest and Other, Net. Interest and other, net, increased to $551 million in 1993 from $525 million ($563 million on a restated basis) in 1992. Interest expense increased to $573 million compared with $436 million ($486 million on a restated basis) in 1992. The increase in interest expense resulted primarily from the higher average debt levels attributable to the TWE capitalization, the higher interest cost of the TWE notes and debentures issued to refinance TWE bank debt, and the consolidation of Six Flags' interest expense in 1993. Other income, net, in 1993 included gains on the sale of certain assets partially offset by losses from and reductions in the carrying value of certain investments. Other expenses, net, on a restated basis in 1992 is principally attributable to losses on certain investments and litigation-related costs.
FINANCIAL CONDITION AND LIQUIDITY
DECEMBER 31, 1994
Despite the $7 billion of debt incurred by Time Warner in its 1989 acquisition of Warner Communications Inc. that was allocated to TWE under the pushdown method of accounting and the adverse effects on the cable business since September 1993 from government-imposed rate regulation, TWE continues to be able to finance growth and expansion in critical areas. In the last three years alone, TWE has spent approximately $900 million making new investments and acquisitions and approximately $2.2 billion on capital expenditures. Annual improvements in EBITDA and the $2.8 billion of capital contributions (excluding the $771 million uncollected portion of the U S WEST Note) by ITOCHU, Toshiba and U S WEST, have enabled TWE to finance this level of investment while at the same time maintaining its leverage and coverage ratios at relatively constant levels.
A commonly-used leverage ratio is total debt, less cash ("Net debt") to total business segment EBITDA, less corporate expenses ("Adjusted EBITDA"). A commonly-used coverage ratio is Adjusted EBITDA to total interest expense. Those ratios for 1994 and 1993 were as follows:
TIME WARNER ENTERTAINMENT COMPANY, L.P. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION--(CONTINUED)
The financial condition of TWE at December 31, 1994 remained essentially unchanged from year end 1993, but is expected to be significantly affected by the formation of the TWE-Advance/Newhouse Partnership and other cable transactions announced by Time Warner for 1995. TWE had $7.2 billion of long- term debt at December 31, 1994, $1.7 billion of Time Warner General Partners' senior capital and $6.2 billion of partners' capital (net of the $771 million uncollected portion of the U S WEST Note), compared to $7.1 billion of long- term debt, $1.5 billion of Time Warner General Partners' senior capital and $6 billion of partners' capital at December 31, 1993. Cash and equivalents were $1.1 billion at December 31, 1994 compared to $1.3 billion at December 31, 1993, resulting in net debt of $6.1 billion and $5.8 billion, respectively. Time Warner and TWE entered into a credit agreement in 1994 that allows Time Warner to borrow up to $400 million from TWE through September 15, 2000. Time Warner borrowed $400 million in 1994 under the credit agreement. Under TWE's bank credit agreement, TWE's loans to Time Warner cannot exceed $1.1 billion at December 31, 1994, increasing to no more than $1.5 billion on July 1, 1995.
During the latter half of 1994 and continuing into 1995, Time Warner and TWE announced a series of cable transactions, all of which are subject to customary franchise and regulatory approvals, that are expected to increase the total number of cable subscribers under the management of Time Warner Cable to approximately 11.5 million, compared to 7.5 million at the end of 1994. As part of this cable television expansion, TWE will own a two-thirds interest in a joint venture it will form with subsidiaries of Advance and Newhouse, which will contribute cable television systems that serve approximately 1.4 million basic television subscribers. In accordance with the TWE-Advance/Newhouse joint venture agreement, certain cable systems to be acquired by Time Warner in its acquisitions of Summit Communications Group, Inc., KBLCOM Incorporated and Cablevision Industries Corporation and related companies, may be transferred on a tax-efficient basis to the TWE-Advance/Newhouse Partnership. Such transfers, if they are made, are expected to be structured on a leveraged basis. New or revised bank credit facilities will be required for TWE and the TWE-Advance/Newhouse Partnership as a result of these transactions, which management feels will be obtained at a reasonable cost.
Time Warner also has announced its intention to enhance its financial position and that of TWE through sales of non-core assets, which may include certain smaller, unclustered cable systems and certain investments owned by TWE. Proceeds from asset sales will be used to reduce debt.
The formation of the TWE-Advance/Newhouse Partnership and sales of non-core assets are expected to improve TWE's leverage and coverage ratios. In accordance with the TWE-Advance/Newhouse joint venture agreement, certain of Time Warner's newly-acquired cable systems may be transferred on a tax- efficient basis to the TWE-Advance/Newhouse Partnership. Such transfers, if they are made, are expected to be structured on a leveraged basis, which could result in an overall adverse impact on the TWE ratios.
Because of the announced transactions, Time Warner will explore the possibility of bringing its various interests in cable operations together in a separate, self-financed operating unit. This process is expected to be undertaken over a 12-18 month period and will be dependent on, among other things, successful negotiations with TWE's partners and certain creditors, and the receipt of franchise and other regulatory approvals. Accordingly, there can be no assurance that the effort will succeed.
During 1994, cash provided by TWE operations amounted to $1.296 billion and consisted of $1.791 billion of EBITDA from the Filmed Entertainment, Programming-HBO and Cable businesses and a reduction in working capital requirements, less $521 million of interest payments, $69 million of income taxes and $60 million of corporate expenses. Cash provided by operations of $1.271 billion in 1993 consisted of
TIME WARNER ENTERTAINMENT COMPANY, L.P. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION--(CONTINUED)
$1.785 billion of business segment EBITDA and a reduction in working capital requirements, less $450 million of interest payments, $70 million of income taxes and $60 million of corporate expenses. Capital expenditures increased to $1.153 billion in 1994, compared to $613 million in 1993. Capital spending by Time Warner Cable amounted to $699 million in 1994, compared to $352 million in 1993, and was financed in part through $234 million of collections on the U S WEST Note. Cable capital expenditures are budgeted to exceed $1 billion for 1995, and are expected to be partially financed by $550 million of collections on the U S WEST Note. Because management believes that the conversion from coaxial to fiber-optic cable is essential to achieving long-term growth in revenue from telephony and unregulated cable services, significant cable capital expenditures also are expected in subsequent years and will be timed to match the rate at which demand for the new services develops.
Warner Bros.' backlog, representing the amount of future revenue not yet recorded from cash contracts for the licensing of films for pay and basic cable, network and syndicated television exhibition, amounted to $852 million at December 31, 1994, compared to $724 million at December 31, 1993 (including amounts relating to HBO of $175 million at December 31, 1994 and $178 million at December 31, 1993). The backlog excludes advertising barter contracts.
Management believes that TWE's 1995 operating cash flow, cash and equivalents, collections on the U S WEST Note and additional borrowing capacity are sufficient to meet its capital and liquidity needs.
Foreign exchange contracts are used primarily to hedge the risk that unremitted or future license fees owed to TWE domestic companies for the sale or anticipated sale of U.S. copyrighted products abroad may be adversely affected by changes in exchange rates. TWE is reimbursed by or reimburses Time Warner for Time Warner contract gains and losses related to TWE's exposure. At December 31, 1994, Time Warner had contracts for the sale of $551 million and the purchase of $109 million of foreign currencies at fixed rates and maturities of three months or less. Of Time Warner's $442 million net sale contract position, $188 million related to TWE's exposure, primarily Japanese yen (41% of net contract position related to TWE), French francs (18%), German marks (12%) and Canadian dollars (11%), compared to a net sale contract position of $226 million of foreign currencies at December 31, 1993.
TIME WARNER ENTERTAINMENT COMPANY, L.P. SUPPLEMENTARY INFORMATION SUMMARIZED FINANCIAL INFORMATION OF SIX FLAGS
Six Flags was formed by a group of companies, including a subsidiary of Time Warner ("Enterprises") which owned 50% of Six Flags common stock, to effect the acquisition on December 29, 1991 of Six Flags Theme Parks Inc. ("1991 SF Acquisition"). Enterprises' interest in Six Flags was contributed to TWE at the TWE capitalization. In December 1992, Six Flags redeemed certain of its equity with $102 million of proceeds from the issuance of zero coupon senior notes due 1999 and $12 million of proceeds from the issuance of additional shares of Six Flags common stock ("1992 SF Recapitalization"). TWE continued to own 50% of the common stock of Six Flags following the 1992 SF Recapitalization, until September 17, 1993, when it provided Six Flags with $136 million to repurchase all the common stock held by the other stockholders and preferred stock of certain subsidiaries. TWE also provided $414 million to finance the repurchase or retirement of all the indebtedness of Six Flags and its subsidiaries, except for the zero coupon senior notes due 1999 ("1993 SF Acquisition and Refinancing"). As a result of the 1993 SF Acquisition and Refinancing, TWE has consolidated Six Flags effective January 1, 1993. Summarized financial information of Six Flags is set forth below:
SIX FLAGS ENTERTAINMENT CORPORATION
-------- (a) The 1993 SF Acquisition and Refinancing, certain transactions with respect to the 1992 SF Recapitalization, and the 1991 SF Acquisition were accounted for using the purchase method of accounting for business combinations. If the 1993 SF Acquisition and Refinancing had occurred at the beginning of the year, the 1993 income before extraordinary item would have been $7 million; if the 1992 SF Recapitalization had occurred at the beginning of the year, the 1992 net loss would have been $18 million.
(b) Six Flags has entered into sale and leaseback transactions with TWE with respect to all of its wholly-owned theme parks. Sale proceeds of $114 million in 1994 and $301 million in 1993 were used to repay indebtedness to TWE incurred in connection with the 1993 SF Acquisition and Refinancing. The leases have been accounted for as capital leases and expire in 2008.
TIME WARNER ENTERTAINMENT COMPANY, L.P. SCHEDULE VIII-VALUATION AND QUALIFYING ACCOUNTS YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992
-------- (a) Represents uncollectible receivables charged against the reserve. (b) Represents returns or allowances applied against the reserve.
EXHIBIT INDEX
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The Registrant hereby agrees to furnish to the Securities and Exchange Commission at its request copies of long-term debt instruments defining the rights of holders of the Registrant's outstanding long-term debt that are not required to be filed herewith.
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