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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
(MARK ONE)
[ ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED
OR
[x] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM JULY 1, 2000 TO DECEMBER 31, 2000
COMMISSION FILE NUMBER 001-15062
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AOL TIME WARNER INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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DELAWARE 13-4099534
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
75 ROCKEFELLER PLAZA, NEW YORK, N.Y. 10019
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (212) 484-8000
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SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
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Common Stock, $.01 par value New York Stock Exchange
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
None
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months, and (2) has been subject to such filing
requirements for the past 90 days. Yes [x] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [x]
As of the close of business on February 28, 2001, there were 4,248,098,682
shares of registrant's Common Stock and 171,185,826 shares of registrant's
Series LMCN-V Common Stock outstanding. The aggregate market value of the
registrant's voting securities held by non-affiliates of the registrant (based
upon the closing price of such shares on the New York Stock Exchange Composite
Tape on February 28, 2001) was approximately $179.56 billion.
DOCUMENTS INCORPORATED BY REFERENCE:
DESCRIPTION OF DOCUMENT PART OF THE FORM 10-K
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Portions of the Definitive Proxy Statement to be Part III (Item 10 through Item 13)
used in connection with the registrant's 2001
Annual Meeting of Stockholders.
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AOL Time Warner Inc.
Corporate Organization Chart
Included in the Form 10-K for AOL Time Warner Inc. ("AOL Time Warner") is a
chart illustrating AOL Time Warner's corporate organization, providing the
following information:
AOL Time Warner Inc. owns 100% of each of America Online, Inc. ("America
Online") and Time Warner Inc. ("Time Warner").
America Online owns 100% of the America Online business.
Time Warner Inc. owns 100% of Turner Broadcasting System, Inc. (Networks and
Filmed Entertainment - New Line) and 100% of Time Warner Companies, Inc.
Time Warner Companies, Inc. owns 100% of the Publishing division, TWI Cable and
the AOL Time Warner General and Limited Partners.(1)
Time Warner Entertainment Company, L.P. ("TWE") is 25.51%-owned by the AT&T
Limited Partner(2) and 74.49%-owned by the AOL Time Warner General and Limited
Partners.(3)
TWE owns 100% of Time Warner Cable, Networks - HBO and The WB, and Filmed
Entertainment-Warner Bros., and 64.8% of the TWE - A/N Partnership (Cable). The
TWE - A/N Partnership is also 1.9%-owned by TWI Cable and 33-l/3% - owned by
Advance/Newhouse.(4)
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(1) Time Warner Companies, Inc. directly or indirectly owns 100% of the capital
stock of each of the AOL Time Warner General and Limited Partners.
(2) Interest held by AT&T Corp.'s subsidiary, MediaOne TWE Holdings, Inc.
(3) Pro rata priority capital and residual equity interests. In addition, the
AOL Time Warner General Partners own 100% of the priority capital interests
that are junior to the pro rata priority capital interests. See Note 6 to
Time Warner Inc.'s consolidated statements included in AOL Time Warner's
Current Report on Form 8-K/A dated January 11, 2001 (filed February 9,
2001).
(4) Direct or indirect common equity interests. In addition, TWI Cable
indirectly owns preferred partnership interests.
PART I
ITEM 1. BUSINESS
AOL Time Warner Inc. (the 'Company' or 'AOL Time Warner') is the world's
first fully integrated, Internet-powered media and communications company. The
Company was formed in connection with the merger of America Online, Inc.
('America Online') and Time Warner Inc. ('Time Warner') which was consummated on
January 11, 2001 (the 'Merger' or the 'AOL-Time Warner merger'). As a result of
the Merger, America Online and Time Warner each became wholly owned subsidiaries
of AOL Time Warner. Accordingly, the following discussion will be of the
businesses of AOL Time Warner, which comprise the combined businesses previously
conducted by America Online and Time Warner. However, because the Merger was not
consummated on or before December 31, 2000, in accordance with the applicable
Federal securities regulations, the accompanying consolidated financial
statements and management's discussion and analysis of results of operations and
financial condition set forth on pages F-1 through F-52 reflect only the
financial results of America Online, as predecessor to the Company.
The Company classifies its business interests into the following fundamental
areas:
o America Online, consisting principally of interactive services, Web brands,
Internet technologies and electronic commerce;
o Cable, consisting principally of interests in cable television systems;
o Filmed Entertainment, consisting principally of interests in filmed
entertainment and television production;
o Networks, consisting principally of interests in cable television and
broadcast television networks;
o Music, consisting principally of interests in recorded music and music
publishing; and
o Publishing, consisting principally of interests in magazine publishing,
book publishing and direct marketing.
The Company has undertaken a number of business initiatives to advance
cross-divisional activities, including cross-promotions of the Company's various
businesses, cross-divisional advertising opportunities, and shared
infrastructures. During 2000, each of the divisions entered into arrangements
with America Online either for promotion of that division on the AOL service or
of the AOL service on the division's property or to provide content on an AOL
service, Web site or property. The Company expects to continue and expand such
arrangements.
For convenience, the terms the 'Registrant,' 'Company' and 'AOL Time Warner'
are used in this report to refer to both the parent company and collectively to
the parent company and the subsidiaries through which its various businesses are
conducted, unless the context otherwise requires.
TWE
Time Warner Entertainment Company, L.P. ('TWE') is a Delaware limited
partnership that was formed in 1992 to own and operate substantially all of the
business of Warner Bros., Home Box Office and the cable television businesses
owned and operated by Time Warner prior to such date. Currently, the Company,
through its wholly owned subsidiaries, owns general and limited partnership
interests in 74.49% of the pro rata priority capital ('Series A Capital') and
residual equity capital ('Residual Capital') of TWE and 100% of the junior
priority capital. The remaining 25.51% limited partnership interests in the
Series A Capital and Residual Capital of TWE are held by MediaOne TWE Holdings,
Inc., a subsidiary of AT&T Corp. ('AT&T').
The Company and AT&T have been engaged in discussions regarding AT&T's
interest in TWE. In addition, AT&T has delivered to the Company and TWE notice
of its exercise of certain rights under the TWE partnership agreement that could
result in a public sale or the purchase by TWE of some or all of AT&T's interest
in TWE. See 'Description of Certain Provisions of the TWE Partnership
Agreement -- Registration Rights' at page I-30 herein.
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CAUTION CONCERNING FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K includes certain 'forward-looking
statements' within the meaning of the Private Securities Litigation Reform Act
of 1995. These statements are based on management's current expectations and are
naturally subject to uncertainty and changes in circumstances. Actual results
may vary materially from the expectations contained herein due to changes in
economic, business, competitive, technological and/or regulatory factors. More
detailed information about those factors is set forth on pages F-16 through F-18
herein. AOL Time Warner is under no obligation to (and expressly disclaims any
such obligation to) update or alter its forward-looking statements whether as a
result of new information, future events or otherwise.
AMERICA ONLINE
America Online, a wholly owned subsidiary of the Company based in Dulles,
Virginia, is the world's leader in interactive services, Web brands, Internet
technologies, and electronic commerce services. America Online's operations
include: two worldwide Internet services, the AOL service and the CompuServe
service; 'AOL Anywhere' services; Netscape; AOL local brands such as Digital
City, AOL Moviefone, and MapQuest; AOL messaging services such as ICQ and AOL
Instant Messenger; and AOL music properties such as Spinner.com, Winamp and
SHOUTcast. Utilizing its 'AOL Anywhere' strategy, key services, features and
content of the AOL service are available through multiple platforms and devices.
Through iPlanet E-Commerce Solutions, its strategic alliance with Sun
Microsystems, Inc., America Online also develops and offers easy-to-deploy,
end-to-end electronic commerce and enterprise solutions for companies operating
in and doing business on the Internet.
THE AOL SERVICE
The flagship AOL service, a subscription-based service with more than 26
million members at December 31, 2000, provides members with a global,
interactive community offering a wide variety of content, features and tools.
The range of content, features, and tools offered on the AOL service includes
the following:
o Online Community -- The AOL service promotes interactive community through
electronic mail services, message boards, the Buddy List feature (for
instant messaging) and public and private 'chat rooms.' 'You've Got
Pictures' allows members to receive their developed photos online, share
the photos with others via e-mail, organize and store photos online and
order reprints and gifts.
o Content -- Content on the AOL service is organized in a variety of ways for
easy access by members, including channels, favorite places, toolbar icons
and customization tools. Channels such as the following offer informational
content and commerce and community opportunities: News, Sports, Travel,
International, Personal Finance, Computer Center, Research & Learn, Autos,
Entertainment, Games, House & Home, Shopping, Health, Careers & Work,
Music, Parenting, Women, Teens, Kids Only and Local Guide. Content on the
AOL service comes from diverse sources, including CBS News, Hachette
Filipacchi Magazines, Time Inc. Magazines, Bloomberg and Business Week.
o Customization and Control Features -- Members can customize their
experience on the AOL service through features and tools such as an
interactive calendar, 'My Places,' which allows customization of the
Welcome Screen, a reminder service, Mail Controls, which allow members to
limit who may send them e-mail and to block certain types of e-mail, and
Favorite Places, which allows members to mark particular Web sites or AOL
areas. Parental Controls help parents form their children's online
experience and include tools that limit access to particular AOL areas, Web
sites or to certain features.
o Search Capability -- AOL Search enables AOL members to search the Internet
and AOL's exclusive content without leaving the AOL service.
o AOL Plus -- The AOL Plus feature provides additional multimedia online
content to members connecting to the AOL service through high-speed
broadband technologies, including DSL, cable, satellite and wireless
technologies. The expanded content includes streaming audio, full-motion
video, games and online catalogue shopping features.
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AOL ANYWHERE
Under its 'AOL Anywhere' strategy, America Online has taken steps to make
the services, features and content of the AOL service and other properties
available through multiple connections and devices in addition to personal
computers, such as televisions, wireless telephones, hand-held and pocket
devices, and specialized Internet appliances. America Online launched a number
of key initiatives under AOL Anywhere in 2000, including the AOLTV service,
AOLbyPhone, a voice portal that allows members to access e-mail via the
telephone, and versions of its AOL service that are accessible on mobile
platforms, such as mobile phones, pagers and handheld computer devices. In
April 2000, America Online and Gateway announced the development of a family of
specialized Internet appliances featuring the 'Instant AOL' service, a
customized version of the standard AOL service. A countertop appliance was
launched in the fall of 2000 and additional devices will include a wireless
Web pad and a desktop appliance.
The AOL Anywhere Web site (http://www.aol.com) offers AOL members and other
Internet users content, features and tools from the AOL service, including AOL
Mail, AOL Search, the AOL Instant Messenger service, My News, a personalized
news service, and My Calendar, a personalized calendar service.
America Online launched the AOLTV service, an interactive television service
for mass-market consumers, in the summer of 2000 in three initial
markets -- Phoenix, Sacramento and Baltimore. With the AOLTV service, consumers
can watch television using their existing signal and choose from a range of
additional interactive features, such as e-mail, instant messaging, and chat,
utilizing a set-top box and a wireless keyboard or universal remote control. The
AOLTV service offers additional content provided by partners that complements
the television programming and a program guide that organizes the television
channels into different categories and allows users to select channels by
clicking on words and graphics.
The AOL mobile services deliver a variety of the AOL service's features and
content to users of wireless devices, such as mobile phones, pagers and other
handheld devices. The content and services include wireless access to e-mail,
news, weather, sports and stock quotes, as well as content from America Online's
other properties, such as Digital City, MapQuest.com and Moviefone. In the fall
of 2000, America Online introduced the AOL Mobile Communicator service, which
offers wireless access to e-mail and instant messaging using pager-sized two-way
wireless devices. America Online also provides text entry solutions for wireless
devices through its subsidiary, Tegic Communications, Inc. Tegic's leading
product, the T9 Text Input software, enables individuals to send e-mail, short
messaging services and instant messages, as well as perform other text-based
functions and access the Internet, using the standard telephone keypad to enter
words or sentences.
THE COMPUSERVE SERVICE
The CompuServe service, with approximately 3 million members at December 31,
2000, targets the value-oriented portion of the U.S. market and the professional
business-oriented market outside of the U.S. It is available in over 500 cities
worldwide, including in the U.S., Canada and Europe. CompuServe offers three
services -- CompuServe 2000, CompuServe 2000 Premier, which has been available
with CompuServe's consumer electronic rebate program, and CompuServe Classic.
Version 6.0 of CompuServe 2000, launched in January 2001, offers improvements
such as enhanced e-mail applications, a built-in media player, the CompuServe
Shopping Assistant, expanded personalization options, a more streamlined look
and feel, and other enhancements. CompuServe has created a Custom Solutions
group to develop and operate co-branded and custom versions of the CompuServe
2000 software. This group operates the Gateway.net Internet Service Provider.
The Custom Solutions group also offers private label Internet solutions for
strategic partners.
NETSCAPE
NETSCAPE.COM
Netscape (http://www.netscape.com) offers a variety of products and
services, including news and information, opportunities to purchase goods and
services, Internet site directories, software, software downloads, and product
and technical support information. More than 36 million users have registered
with
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Netscape as of December 31, 2000. In the fall of 2000, Netscape launched
Netscape Netbusiness (http://netbusiness.netscape.com/), an Internet site
targeted to owners of small businesses that offers easy-to-use and fully
customizable information resources, productivity and communications tools.
Netscape's services include search and navigation services, such as
SmartBrowsing; programming channels; communications and community services such
as e-mail and message board services; personalization services, and
opportunities for electronic commerce. CNN Interactive is now a premier news
provider for Netscape. Netscape includes a co-branded version of the AOL Instant
Messenger service and local content provided by Digital City. A Netscape-branded
toolbar is included on the Company's Time, People, Money and Warner Bros. Web
sites to enable visitors to the sites to access Netscape features such as
instant messaging, e-mail and online searches.
NETSCAPE BROWSERS
The next-generation Netscape 6 browser software was released in November
2000. Powered by Netscape's Gecko technology, which features a faster and more
powerful browser engine technology, Netscape 6 allows individual developers to
tailor the browser software to their own use, and it is designed to operate
across multiple platforms, so that it can be deployed on a range of Internet
devices. Gecko can run on multiple computing systems, including LINUX, Mac OS
and Windows. The Netscape 6 browser software offers a number of new features,
such as a customizable integrated search engine, and also integrates e-mail and
instant messaging within the browser environment.
Netscape also offers Netscape Communicator, a suite of open HTML-based
client software that integrates browsing, e-mail, Web-based word processing and
group scheduling that enables users to communicate, share and access
information. The latest version, Communicator 4.75, was released in August 2000
and features SmartBrowsing, as well as streaming audio and visual capabilities.
With SmartBrowsing, consumers can search the Web and connect to Web sites
covering a variety of topics by entering common words or topics (Netscape
Internet Keywords) into the browser location bar.
AOL MUSIC: SPINNER.COM, WINAMP AND SHOUTCAST
Spinner.com is a free music service that offers over 150 music channels.
Spinner's content library includes over 420,000 songs. The Spinner music player
displays artist and song information as the songs are played, and provides links
that enable real-time listener feedback and instant ordering of the music being
played. Winamp is a branded MP3 player for Windows, and SHOUTcast is an MP3
streaming audio service. Winamp surpassed 55 million registered installations as
of December 31, 2000. The SHOUTcast streaming audio service enables individuals
to broadcast their own audio stream over the Internet.
INTERACTIVE PROPERTIES
The AOL Interactive Properties group leads the local services and instant
messaging initiatives for America Online.
AOL LOCAL: DIGITAL CITY, MOVIEFONE AND MAPQUEST
America Online has a number of branded local services that operate across
multiple services and/or platforms, such as Digital City, Moviefone, and
MapQuest. Digital City, Inc., is the leading local online city guide offering
local products and services in over 200 U.S. markets. Digital City provides
original and third-party news, sports, weather, and local directories that offer
information and reviews on events, restaurants, health care, housing and job
listings. Digital City provides local interactive content and services for all
of America Online's interactive services and properties, including the AOL
service, the AOL Anywhere services and devices, the CompuServe service,
Netscape, and on the Web (digitalcity.com).
Moviefone is the largest movie guide and ticketing service in the United
States in terms of the number of users and tickets sold remotely. Through its
interactive telephone service (777-FILM), its online service (Moviefone.com),
and its wireless services, Moviefone provides millions of moviegoers each week
with a free
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directory of movies, showtimes and theater locations, and also provides the
ability to purchase tickets via any device and platform.
MapQuest, acquired by America Online in June 2000, is a leader in online
destination solutions. Through licensing agreements with more than 1,750
business partners, MapQuest helps businesses integrate maps and driving
directions into their Internet, intranet and call center applications for
improved marketing and customer service functions. MapQuest also provides
customized maps, destination information and driving directions to consumers
through its Web site (MapQuest.com) and its wireless partners.
AOL MESSAGING: AOL INSTANT MESSENGER AND ICQ
AOL Instant Messenger is a Web-based communications service that enables
Internet users to know when other users of the service are online and to send
and receive instant messages in real time. The service offers other limited
features. AOL Instant Messenger had over 84 million registered users as of
December 31, 2000. AOL Instant Messenger is free and available for downloading
on the AOL Anywhere Web site and on America Online's other brands and services,
on a co-branded basis, including the CompuServe service and Netscape. America
Online has also developed co-branded versions of the AOL Instant Messenger
service for numerous other companies.
ICQ Ltd., is an Internet-based real-time communications service that
utilizes the ICQ ('I seek you') instant communications and chat technology with
a constant desktop presence. ICQ also has a Web site (ICQ.com) that offers
community and content products and services. At December 31, 2000, ICQ had over
88 million registered users, approximately two-thirds of whom were outside the
U.S.
AOL INTERNATIONAL
AOL International oversees the AOL and CompuServe services and operations
outside the United States, as well as the Netscape Online service, which
operates in the United Kingdom. As of December 31, 2000, the AOL and CompuServe
services had nearly 6 million members outside the United States. One component
of AOL International's strategy is to provide consumers with local services in
key international markets featuring local language, content, marketing and
community. Central to the strategy has been the formation of strategic alliances
with strong local and regional partners and the provision of access for all
members of international services. The AOL, CompuServe and/or Netscape branded
services are offered through joint ventures or distribution arrangements in
Argentina, Australia, Austria, Brazil, Canada, France, Germany, Hong Kong,
Japan, Mexico, the Netherlands, Sweden, Switzerland and the United Kingdom.
Globally, members are able to access these services in over 100 countries. In
addition, U.S. and global subscribers to AOL services can access selected
content and communities offered on the other global AOL services.
During the past year, America Online has launched services in several new
foreign markets and has taken steps to develop or enhance services in existing
markets:
o EUROPE: AOL Europe, S.A., a joint venture between America Online and
Bertelsmann AG, provides the AOL service and the CompuServe service in
several European countries, Netscape Online in the United Kingdom and
CompuServe Office in Germany. In March 2000, America Online and Bertelsmann
announced plans to restructure the AOL Europe joint venture pursuant to a
put and call arrangement to provide for the terms of the eventual exit of
Bertelsmann from the joint venture and to undertake a new strategic
alliance providing for expanded distribution of Bertelsmann's media content
and electronic commerce properties over America Online's interactive brands
worldwide. For further information on the restructuring, see note 6 to
Notes to Financial Statements. In the fall of 2000, AOL Europe entered into
a joint venture with Banco Santander Central Hispano, S.A., and Prodigios
Interactivos, S.A., to launch the AOL-Avant branded service in Spain.
o AUSTRALIA: In March 2000, America Online formed a new joint venture with
AAPT Limited, Australia's third largest telecommunications company, to
operate the AOL Australia service. This followed Bertelsmann's transfer of
its 50% interest in AOL Australia to America Online in connection with the
entry into the put and call arrangements between America Online and
Bertelsmann.
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o LATIN AMERICA: AOL Latin America, a joint venture originally formed with
the Cisneros Group of Companies, has launched services in three Latin
American countries: Argentina (August 2000), Brazil (November 1999) and
Mexico (July 2000). In August 2000, America Online Latin America, Inc.
completed an initial public offering of common stock and, concurrently,
Banco Itau, a regional bank in Latin America with online banking
operations, became a minority shareholder.
o AOL JAPAN: During 2000, America Online, Mitsui and Nikkei expanded and
restructured their joint venture in Japan, with the addition of NTT DoCoMo,
Japan's largest mobile communications company, to the joint venture.
NETSCAPE ENTERPRISE SOLUTIONS
IPLANET E-COMMERCE SOLUTIONS
The Netscape Enterprise Group operates primarily through a strategic
alliance formed in November 1998 between America Online and Sun Microsystems,
Inc. which is now referred to as the iPlanet E-Commerce Solutions, a
Sun-Netscape Alliance. The alliance develops, markets, sells and supports on a
collaborative basis an Internet software platform that enables enterprises to
put their businesses online, deploy new services and scale to growing demand.
The infrastructure product portfolio includes: messaging (e-mail) and calendar,
collaboration, Web, application, directory and certificate (security) servers.
The electronic commerce applications include commerce exchange, procurement,
selling and billing applications.
TECHNOLOGIES
AOL NET
America Online employs a multiple vendor strategy in designing, structuring
and operating the network services utilized in its interactive online services.
AOLnet, a transfer control protocol/Internet protocol (TCP/IP) network of
third-party network service providers, including Sprint Communications Company,
Genuity Inc., WorldCom, Inc. and Level 3 Communications, is used for the AOL
service and certain versions of the CompuServe service in North America,
including CompuServe 2000. America Online anticipates continuing to build AOLnet
in order to increase its network capacity, provide members of its online
services with higher speed access and reduce data network costs on a per-hour
basis. The AOL service grew as of December 31, 2000 to achieve peaks of over 2.0
million simultaneous users and the exchange of approximately 180 million e-mail
messages a day.
America Online enters into multiple-year data communications agreements to
support AOLnet. In connection with those agreements, America Online may commit
to purchase certain minimum data communications services or to pay a fixed cost
for the network services. The expansion of AOLnet requires a substantial
investment in telecommunications equipment. In addition to purchasing
telecommunications equipment, America Online also enters into operating leases
for the use of this equipment.
SERVICE PLATFORMS
America Online supports a variety of software platforms and conduits for
access to the interactive services and Web-based properties. Today, the vast
majority of members and users of interactive services access such services
through personal computers. Operating systems on which the AOL and CompuServe
services are available include primarily the Windows (3.1, 95 and 98) and
Macintosh operating systems. America Online has also taken steps to adopt new
technology and developments in the delivery of interactive services. America
Online has upgraded AOLnet to support the v.90 standard for high-speed access at
56 kps, and is also investing in the development of alternative technologies to
deliver its interactive online services, including cable modems, Digital
Subscriber Line (DSL) access, satellite and wireless technologies (as discussed
under 'AOL Anywhere'). America Online plans to continue to offer its members
higher-speed options when they become easy-to-use and commercially viable for
the mass market. America Online has formed strategic alliances with
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Verizon Communications and SBC Communications to use new DSL technology to make
available a high-speed upgrade connection to subscribers. The initial roll out
began in the summer of 1999.
America Online formed a strategic alliance with Hughes Electronic
Corporation, a subsidiary of General Motors Corporation, in June 1999 to develop
and market integrated digital entertainment and Internet services. The alliance
provides for the delivery of AOL Plus to members via Hughes' DirectPC satellite
Internet network, as well as delivery over Hughes' next generation satellite
system for two-way, broadband connectivity. In connection with the alliance,
America Online made a $1.5 billion investment in Hughes in the form of a General
Motors preference stock, which carries a 6 1/4% coupon rate and has a mandatory
conversion into General Motors Class H common stock (GMH) in 2002.
ADVERTISING AND COMMERCE
America Online offers its advertising and commerce partners a variety of
customized programs, which may include premier placement or select sponsorship
of particular online areas or Web pages for designated time periods. As
merchants recognize the value in reaching the large, growing and active
subscriber base to the AOL and CompuServe services and users of the Web-based
properties, America Online has been able to earn additional revenues by offering
selected merchants preferred rights to market particular goods or services
within one or more of the online services and properties. In those transactions,
America Online provides its commerce partners certain marketing and promotional
opportunities and in return receives cash payments, the opportunity for revenue
sharing, cross-promotions and competitive pricing and online conveniences for
subscribers. Certain of the transactions also include an equity component from
the partner, such as a warrant to purchase stock or a direct equity interest in
the partner. These investments are accounted for in accordance with
Company accounting policies. See note 2 to Notes to Financial Statements.
In addition, these investments can also represent an additional potential source
of income or loss to the Company upon their disposition.
An important component of America Online's strategy is to continue
increasing revenues from advertising and commerce sources and from the direct
sale of merchandise, as well as from additional sources such as transaction and
licensing fees. It continues to establish a wide variety of relationships with
advertising and commerce partners to grow and diversify its non-subscription-
based revenues and to provide subscribers on the interactive services with
access to a broad selection of competitively priced, easy-to-order products and
services. America Online has also expanded the scope, range and types of
businesses involved in advertising and commerce relationships; many of its
advertising and commerce contracts are with mainstream industry leaders such
as Coca-Cola, Kodak, Sears and Citigroup. America Online frequently has entered
into advertising arrangements that encompass multiple brands within the AOL
family of brands. AOL Time Warner intends to continue this practice and to
increase the number of advertising arrangements that include two or more of the
Company's lines of businesses by drawing upon and making full use of its brands
and assets.
MARKETING
America Online utilizes a common marketing infrastructure for its multiple
brands of interactive services and Web properties. To support its goals of
attracting and retaining members or users, as applicable, and developing and
differentiating the family of brands, America Online markets its products,
services and brands through a broad array of programs and strategies, including
broadcast television and radio advertising campaigns, direct mail, magazine
inserts (including magazines published by the Company's publishing business) and
advertisements, co-marketing, retail distribution, bundling agreements, Web
advertising and alternate media. America Online also markets through extensive
online and offline cross-promotion and co-branding with a wide variety of
partners. Additionally, through multi-year bundling agreements, the interactive
online services and products are installed on a range of computers made by
personal computer manufacturers and are available to consumers by clicking on an
icon during the computer's initial setup process.
America Online utilizes targeted or limited promotions and marketing
programs and pricing plans designed to appeal to particular groups of potential
users of its interactive online services and to distinguish and develop its
different brands. For example, in connection with the positioning of the
CompuServe service in the United
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States as a value-oriented brand, CompuServe uses a series of consumer
electronic rebate programs with retailers. Under these promotions, consumers
signing up for two-year memberships to the CompuServe 2000 Premier service at
$21.95 per month will receive a rebate of $200 in connection with the purchase
of designated merchandise.
COMPETITION
America Online competes for subscription revenues and members' usage with a
large number of companies providing Internet access, including online services
such as the Microsoft Network and AT&T Worldnet, local and national Internet
service providers, cable Internet access providers, and telephone companies and
other companies that provide Internet access among other services. It also
competes more broadly for subscription revenues and members' usage with cable,
information, entertainment and media companies. America Online competes for
advertising and commerce revenues with a wide range of companies, including
those that focus on the Internet, such as online services, Internet access
companies, Web-based portals, and individual Web sites providing content,
commerce, community and similar features, and media companies, such as those
with newspaper or magazine publications, radio stations and broadcast stations
or networks. America Online's Netscape Enterprise group also competes with a
wide range of companies in the development and sale of electronic commerce
infrastructure and applications.
America Online faces competition in developing technologies and risks from
potential new developments in distribution technologies and equipment in
Internet access. In particular, America Online faces competition from
developments in the following types of Internet access distribution technologies
or equipment and must keep pace with the developments:
o broadband distribution technologies used in cable Internet access services;
o advanced personal computer-based access services offered through digital
subscriber line technologies offered by local telecommunications companies;
o other advanced digital services offered by satellite and wireless
companies;
o television-based interactive services;
o personal digital assistants or handheld computers;
o enhanced mobile phones;
o other equipment offering functional equivalents to the AOL Anywhere
services.
CABLE
The Company's Cable business consists principally of interests in cable
television systems. Of the approximately 12.8 million subscribers served by the
Company at December 31, 2000, approximately 1.8 million are in systems owned by
TWI Cable Inc. ('TWI Cable'), a wholly owned subsidiary of the Company, and
approximately 11 million are in systems owned or managed by TWE. TWE's cable
systems include approximately 6.7 million subscribers in a joint venture between
TWE and Advance/Newhouse known as TWE-A/N; 1.1 million of these TWE-A/N
subscribers are part of the Texas Cable Partners 50-50 joint venture with AT&T.
TWE-A/N is owned 33.3% by Advance/Newhouse, 64.8% by TWE and 1.9% by TWI Cable.
Time Warner Cable, a division of TWE, generally manages all such systems and
receives a fee for management of the systems owned by TWI Cable and TWE-A/N.
SYSTEMS OPERATIONS
Time Warner Cable is one of the largest operators of cable television
systems in the United States with more than 90% of its customers served by
clustered cable systems with 100,000 subscribers or more. As of December 31,
2000, Time Warner Cable had 35 distinct geographic system groupings serving more
than 100,000 subscribers. This clustering strategy has enabled, among other
things, significant cost and marketing
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efficiencies, more effective pursuit of local and regional cable advertisers,
the development of local news channels, and the roll-out of advanced services
over a geographically concentrated customer base.
Over the past several years, Time Warner Cable has pursued a strategy of
upgrading its existing cable systems generally to 750 MHz capability, based on a
hybrid fiber optic/coaxial cable architecture. By year-end 2000, Time Warner
Cable had completed the upgrade of approximately 92% of its cable plant.
Upgraded systems can deliver increased channel capacity and provide two-way
transmission capability with improved network management systems. Upgrading also
permits Time Warner Cable to roll out new advanced services, including digital
and high-definition television ('HDTV') programming, high-speed Internet
service, video-on-demand, telephony and other services. See 'New Cable Services'
below.
FRANCHISES
Cable systems are constructed and operated under non-exclusive franchises
granted by state or local governmental authorities. Franchises typically contain
many conditions, such as time limitations on commencement or completion of
construction; conditions of service, including number of channels; provision of
free services to schools and other public institutions; and the maintenance of
insurance and indemnity bonds. Cable franchises are subject to various federal,
state and local regulations. See 'Regulation and Legislation' below.
PROGRAMMING
Programming is generally made available to customers by tiers, which are
packages of different programming services provided for prescribed monthly fees.
The available analog channel capacity of Time Warner Cable's systems has been
expanding as system upgrades are completed. As Time Warner Cable rolls out
digital services in its systems, the number of channels of video programming a
customer may elect to receive are further increased such that over 150 video
channels are available.
Video programming available to customers includes local and distant
broadcast television stations, cable programming services like CNN, A&E and
ESPN, and premium cable services like HBO, Showtime and Starz! The terms and
conditions of carriage of programming services are generally established through
affiliation agreements between the programmers and Time Warner Cable. Many
programming services impose a monthly license fee per subscriber upon the cable
operator. Programming costs generally have been increasing sharply in recent
years and depending on the terms of a specific agreement, the cost of providing
any cable programming service may continue to rise. Time Warner Cable sometimes
has the right to cancel contracts and generally has the right not to renew them.
In addition, Time Warner Cable may not always be able to renew contracts when it
wishes to do so. It is unknown whether the loss of any one popular supplier
would have a material adverse effect on Time Warner Cable's operations.
SERVICE CHARGES AND ADVERTISING
Subscribers to the Company's cable systems are charged monthly subscription
fees based on the level of service selected, which fees in some cases include
equipment charges. Subscription revenues account for most of Time Warner Cable's
revenues. A one-time installation fee is generally charged for connecting
subscribers to the cable television system. Although regulation of certain cable
programming rates ended on March 31, 1999, rates for 'basic' programming and for
equipment and installation continue to be regulated pursuant to federal law. See
'Regulation and Legislation' below.
Subscribers may purchase premium programming services and, in certain
systems, other per-channel services, for an additional monthly fee for each such
service, with discounts generally available for the purchase of more than one
service. Subscribers may discontinue purchasing services at any time.
Pay-per-view programming offers movies and special events, such as boxing, for a
separate charge.
Time Warner Cable also generates revenue by selling advertising time to
national, regional and local businesses. Cable television operators receive an
allocation of advertising time availabilities on certain cable
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programming services into which commercials can be inserted at the local system
level. The clustering of Time Warner Cable's systems expands the share of
viewers that Time Warner Cable reaches within a local DMA (Designated Market
Area), which helps local ad sales personnel to compete more effectively with
broadcast and other media. In addition, in many localities, contiguous cable
system operators have formed advertising interconnects to deliver locally
inserted commercials across wider geographic areas, replicating the reach of the
broadcast stations as much as possible. Eighteen of Time Warner Cable's 39 field
divisions participate in a local cable advertising interconnect.
LOCAL NEWS CHANNELS
Time Warner Cable operates, alone or in partnerships, 24-hour local news
channels in New York City (NY1 News), Tampa Bay (Bay News 9), Orlando (Central
Florida News 13), Rochester, NY (R/News), and Austin (News 8 Austin).
Preparations are underway to launch news channels in Houston, San Antonio,
Charlotte, Raleigh, Syracuse and Albany. These channels have developed into
successful vehicles for local advertising.
NEW CABLE SERVICES
DIGITAL CABLE SERVICES
Digital Tier Service
During 2000, Time Warner Cable continued its aggressive roll-out of digital
cable service in its cable systems. As of December 31, 2000, Time Warner Cable
had more than 1.7 million digital service subscribers. As of March 1, 2001, 38
of Time Warner Cable's 39 field divisions are offering digital cable and the one
remaining division is expected to commence offering digital service in 2001. A
digital format allows a signal to be compressed so that it occupies less
bandwidth, which substantially increases the number of channels that can be
provided over a system. The digital set-top boxes delivered to subscribing
customers will offer a digital programming tier with the potential for more than
100 networks, 40 CD-quality music services, more pay-per-view options, more
channels of multiplexed premium services, a digital interactive program guide,
and other features such as parental control options.
HDTV
Pursuant to FCC order, television broadcast stations have been granted
additional over-the-air spectrum to provide, under a prescribed roll-out
schedule, high definition and digital television signals to the public. Time
Warner Cable's upgraded hybrid fiber optic/coaxial cable architecture should
provide a technologically superior means of distributing HDTV signals. To date,
Time Warner Cable has agreed to carry the high definition television signals and
other digital signals that will be broadcast by television stations owned and
operated by the ABC, CBS, NBC and Fox networks, and also by nearly all public
television stations, in Time Warner Cable's operating areas. Time Warner Cable
is seeking similar arrangements with other broadcasters. Time Warner Cable is
also carrying the HDTV versions of HBO and Showtime in certain areas.
Video-on-Demand
By adding digital servers and software to its digital television service
platform, Time Warner Cable will be able to offer network-based video-on-demand
services, including 'virtual' VCR features such as pause, rewind and fast
forward. Time Warner Cable began testing of video-on-demand equipment in 1999 in
its-Austin, Texas; Tampa Bay, Florida; and Hawaii systems, and provided a
movies-on-demand service on a trial basis to customers in those systems during
2000. Additional testing is continuing in 2001. Time Warner Cable is negotiating
with a number of studios to obtain video-on-demand distribution rights for
movies to support commercial launches. Depending on the results of the
foregoing, video-on-demand services are expected to be launched in a number of
additional locations in 2001.
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INTERNET SERVICES
Road Runner
To date, Time Warner Cable has offered the Road Runner high-speed Internet
service as its sole cable modem service providing high-speed Internet services
to customers. Customers connect their personal computers to Time Warner Cable's
two-way hybrid fiber optic/coaxial cable system which, together with the Road
Runner backbone network, enables customers to access the Internet and Road
Runner's content at speeds much greater than traditional telephone modems.
The Road Runner service, as of March 1, 2001, has been launched by Time
Warner Cable in 36 of its 39 field divisions. In January 2001, Time Warner
Cable's Road Runner customer base exceeded 1,000,000 customers, a significant
milestone for the service. Time Warner Cable intends to continue aggressively
rolling out the Road Runner service throughout its divisions during 2001.
Starting in 1998, Road Runner was provided by a joint venture (the 'RR JV')
of TWE, TWE-A/N, TWI Cable, MediaOne, and subsidiaries of Microsoft Corp.
('Microsoft') and Compaq Computer Corp. ('Compaq'). The agreements between the
RR JV and Time Warner Cable restricted Time Warner Cable's ability to distribute
the services of other Internet service providers ('ISPs') over Time Warner
Cable's cable systems. In connection with AT&T's acquisition of MediaOne, the
Department of Justice ordered the divestiture of MediaOne's interest in the RR
JV. As a result, in December 2000, AT&T and Time Warner announced that the Road
Runner service would be restructured and that the RR JV will terminate. This
restructuring, under which TWE, TWE-A/N and TWI Cable will obtain sole ownership
and control of certain RR JV assets, is expected to be completed during the
second quarter of 2001. Microsoft's and Compaq's interests in the RR JV were
acquired by the RR JV in February 2001.
Multiple ISP Services
In connection with the announcement of the AOL-Time Warner merger, Time
Warner and America Online entered into a Memorandum of Understanding in February
2000. Time Warner committed that it would enter into agreements with multiple
ISPs to offer its customers a choice of ISP services, including services not
owned by AOL Time Warner. During 2000, Time Warner Cable began the technical and
operational work necessary to develop a cable platform capable of providing the
services of multiple ISPs and, during the summer, began working with a number of
ISPs and vendors on a trial of its multiple ISP service platform in Columbus,
Ohio.
Time Warner Cable's first definitive agreement with an unaffiliated ISP,
EarthLink, was entered into in November 2000 and Time Warner Cable expects to
commence launching the EarthLink service in its divisions in the second half of
2001. Discussions with other ISPs regarding distribution terms have also
commenced. America Online and Time Warner Cable have also entered into a
definitive agreement to provide the AOL service over Time Warner Cable's
broadband cable system, and Time Warner Cable expects to commence launching the
AOL service in the same timeframe as the launch of the EarthLink service. Time
Warner Cable's provision of the AOL service and its obligation to make multiple
ISP service available to its customers are subject to compliance with the terms
of the FTC Consent Decree and the FCC Order entered in connection with the
regulatory clearance of the AOL-Time Warner merger. (See 'Regulation and
Legislation' below, for a description of these terms).
TELEPHONY
Time Warner Telecom Inc. ('Time Warner Telecom') is a leading fiber
facilities-based integrated communications provider that offers a wide range of
business telephony services in selected metropolitan areas across the United
States. Time Warner Telecom was formed in 1998 through a restructuring of the
business telephony operations of Time Warner Cable. As of January 31, 2001, the
Company's aggregate equity interest in Time Warner Telecom was approximately 44%
and the Company's aggregate voting interest in Time Warner Telecom, consisting
of high-voting common stock, was approximately 66%.
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COMPETITION
Cable television systems face strong competition for viewers and
subscriptions from a wide variety of news, information and entertainment
providers. These include multichannel video providers like DTH, MMDS, SMATV
systems (which are described immediately below) and telephone companies, other
sources of video programs (such as broadcast television and videocassettes), and
additional sources for news, entertainment and information, including the
Internet. Cable television systems also face strong competition from all media
for advertising dollars.
DTH (Direct-to-home). DTH services offer pre-packaged programming services
that can be received by relatively small and inexpensive receiving dishes. In
many metropolitan areas, DTH services now also include local broadcast signals.
MMDS/Wireless Cable (Multichannel microwave distribution services). Wireless
cable operators, including digital wireless operators, use microwave technology
to distribute video programming.
SMATV (Satellite-master antenna television). Additional competition comes
from private cable television systems servicing condominiums, apartment
complexes and certain other multiple unit residential developments, often on an
exclusive basis, with local broadcast signals and many of the same
satellite-delivered program services offered by franchised cable television
systems.
Overbuilds. Under the 1992 Cable Act, franchising authorities are prohibited
from unreasonably refusing to award additional franchises. There are an
increasing number of overlapping cable systems operating in Time Warner Cable
franchise areas, including municipally-owned systems.
Telephone Companies. Under the 1996 Telecommunications Act, telephone
companies are now free to enter the retail video distribution business within
their local exchange service areas, including through DTH, MMDS and SMATV, as
traditional franchised cable system operators, or as operators of 'open video
systems' subject to certain local authorizations and local fees.
Additional Competition. In addition to multichannel video providers, cable
television systems compete with all other sources of news, information and
entertainment including over-the-air television broadcast reception, live
events, movie theaters, home video products, and the Internet.
'On-Line' Competition. Time Warner Cable's systems face competition in its
cable modem services from a variety of companies that service customers with
various other forms of 'on-line' services, including DSL high-speed Internet
access services and dial-up services over ordinary telephone lines. Monthly
prices of these ISPs are often comparable to cable offerings. Other developing
new technologies, such as Internet access via satellite or wireless connections,
compete with cable and cable modem services as well.
FILMED ENTERTAINMENT
The Company's Filmed Entertainment businesses produce and distribute
theatrical motion pictures, television shows, animation and other programming,
distribute home video product, license rights to the Company's programs and
characters and operate motion picture theaters. All of the foregoing businesses
are principally conducted by Warner Bros., which is a division of TWE. The
filmed entertainment business also includes New Line Cinema Corporation ('New
Line Cinema'), as well as the Turner classic film and animation libraries, all
of which are wholly owned through Turner Broadcasting System, Inc. ("TBS").
WARNER BROS. FEATURE FILMS
Warner Bros. Pictures produces feature films both wholly on its own and
under co-financing arrangements with others, and also distributes completed
films produced and financed by others. The terms of Warner Bros. Pictures'
agreements with independent producers and other entities are separately
negotiated and vary depending upon the production, the amount and type of
financing by Warner Bros., the media and territories covered, the distribution
term and other factors.
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Warner Bros. Pictures' strategy focuses on building movie franchises, which
will continue with the planned expansion of The Matrix into a series of films
and the introduction in 2001 of the first of a planned series of Harry Potter
motion pictures. Warner Bros. Pictures also is pursuing a strategy to release
films with a diversified mix of genres, talent and budgets. In response to the
rising cost of producing theatrical films, Warner Bros. Pictures has entered
into a number of joint venture agreements with other companies to co-finance
films, decreasing its financial risk while in most cases retaining substantially
all worldwide distribution rights. During 2000, Warner Bros. Pictures released a
total of 22 motion pictures for theatrical exhibition (including the re-release
of The Exorcist), of which 7 were wholly financed by Warner Bros. Pictures and
15 were produced by or with others. 2000 releases from Warner Bros. Pictures
(both wholly financed and co-produced) included A Perfect Storm, Miss
Congeniality and Space Cowboys. A total of 33 motion pictures are currently
slated to be released during 2001 (including the re-release of Superman), of
which 5 are wholly financed by Warner Bros. Pictures, and 28 are produced by or
with others.
Warner Bros. Pictures' joint venture arrangements include: (i) Bel-Air
Entertainment, a joint venture with Canal+ to co-finance the production,
overhead and development costs of motion pictures; (ii) a joint venture with
Village Roadshow Pictures to co-finance the production of motion pictures;
(iii) an exclusive worldwide distribution arrangement with Alcon Entertainment;
and (iv) an arrangement with Gaylord Entertainment ('Gaylord') to co-finance the
production of motion pictures with medium to high budgets, and with Gaylord's
wholly-owned subsidiary, Pandora Investments SARL, to co-finance the production
of lower budget pictures.
Warner Bros. Pictures has distribution servicing agreements with Morgan
Creek Productions Inc. ('Morgan Creek') through June 2003 pursuant to which,
among other things, Warner Bros. provides domestic distribution services for all
Morgan Creek pictures and certain foreign distribution services for selected
pictures. Warner Bros. Pictures has entered into a distribution arrangement with
Franchise Entertainment LLC ('Franchise') under which it will obtain domestic
distribution rights in certain motion pictures produced by Franchise.
Warner Bros. Pictures has begun to collaborate with AOL to promote its
feature films to AOL subscribers in advance of a film's opening in theaters. The
marketing campaign for The Perfect Storm, which was featured on the AOL welcome
screen, generated many advance viewings of the trailer and made it easy for AOL
subscribers to order tickets for the movie through Moviefone.
NEW LINE AND OTHER FILMED ENTERTAINMENT
Theatrical films are also produced and distributed by New Line Cinema, which
is a wholly owned subsidiary of TBS. New Line is a leading independent producer
and distributor of theatrical motion pictures with two film divisions, New Line
Productions and Fine Line Features. New Line Cinema's 2000 releases included
Frequency, Final Destination, Thirteen Days and The Cell. A total of 18 motion
pictures are currently slated for theatrical release by New Line Cinema during
2001, including the first installment of The Lord of the Rings trilogy.
Castle Rock Television, also owned by TBS, produced the highly rated Emmy
Award-winning series Seinfeld, which is distributed by a third party for a fee.
Distributed throughout the world, Seinfeld was successfully sold to broadcast
television stations in 1998 for a second syndication cycle commencing in 2001 as
well as to TBS Superstation for basic cable exhibition commencing in 2002.
HOME VIDEO
Warner Home Video ('WHV') distributes for home video use pre-recorded
videocassettes and DVDs containing the filmed entertainment product produced or
distributed by the Company's Warner Bros. Pictures, WarnerVision Entertainment,
New Line Cinema and Home Box Office divisions. WHV also distributes other
companies' product for which it has acquired the rights.
WHV sells and/or licenses its product in the United States and in major
international territories to retailers and/or wholesalers through its own sales
force, with warehousing and fulfillment handled by divisions of Warner Music
Group and third parties. In some international countries, WHV's product is
distributed through licensees.
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Videocassette product is manufactured under contract with independent
duplicators. DVD product is replicated by Warner Music Group companies and third
parties.
In North America, WHV released nine titles on videocassette for home rental
in 2000 whose sales and licensed units exceeding one million units each,
including: The Green Mile, The Whole Nine Yards, and Three Kings. Additionally,
WHV released eleven titles on videocassette in the North American sell-through
market that generated sales of more than one million units each, including The
Perfect Storm, How the Grinch Stole Christmas (animated) and Pokemon -- The
Movie.
During 2000, DVDs further increased their presence in the North American and
international markets. Since inception of the format, WHV has released over 850
titles on DVD, led by The Matrix with worldwide sales in excess of seven million
units.
TELEVISION
Warner Bros. is one of the world's leading suppliers of television
programming, distributing programming in more than 175 countries and in more
than 40 languages. Warner Bros. both develops and produces new television
series, made-for-television movies, mini-series, reality-based entertainment
shows and animation programs and also distributes television programming for
exhibition on all media. The distribution library owned or managed by Warner
Bros. currently has approximately 6,500 feature films, 32,000 television titles,
and 13,500 animated titles (including 1,500 classic animated shorts).
Warner Bros.' television programming is primarily produced by Warner Bros.
Television ('WBTV'), which produces primetime dramatic and comedy programming
for the major networks, and Telepictures Productions ('Telepictures'), which
specializes in reality-based and talk/variety series for the syndication
markets. Returning network primetime series from WBTV include, among others, ER,
Friends, The Drew Carey Show, Whose Line Is It Anyway? and the Emmy-award
winning series, The West Wing. Telepictures has successfully launched, among
others, The Rosie O'Donnell Show.
Warner Bros. Animation is responsible for the creation, development and
production of contemporary television and feature film animation, as well as for
the creative use and production of classic animated characters from Warner
Bros.', TBS's and DC Comics' libraries, including Looney Tunes and the
Hanna-Barbera libraries.
Warner Bros. Television has begun to collaborate with AOL to promote its
television shows to AOL subscribers. For example, The Drew Carey Show Web site
appearing on Warner Bros. Online featured a 'Name Mimi's Baby' contest, allowing
fans to submit potential baby names for one of the lead characters on the show.
AOL's promotion of the contest on its welcome screen both helped to make the
contest successful and to draw additional traffic for the show's promotional Web
site.
BACKLOG
Backlog represents the future revenue not yet recorded from cash contracts
for the licensing of theatrical and television programming for pay cable,
network, basic cable and syndicated television exhibition. Backlog for all of
AOL Time Warner's filmed entertainment companies amounted to $3.523 billion at
December 31, 2000, compared to $3.595 billion at December 31, 1999 (including
amounts relating to the intercompany licensing of film product to the Company's
cable television networks of $1.269 billion and $1.176 billion as of
December 31, 2000 and December 31, 1999, respectively). The backlog excludes
advertising barter contracts.
CONSUMER PRODUCTS AND STUDIO STORES
Warner Bros. Consumer Products licenses rights in both domestic and
international markets to the names, photographs, logos and other representations
of characters and copyrighted material from the films and television series
produced or distributed by Warner Bros., including the superhero characters of
DC Comics, Hanna-Barbera characters, Turner classic films and the literary
phenomenon Harry Potter.
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In January 2001, the Company announced that it intends to sell or close its
domestic Warner Bros. Studio Store operations. International operations,
consisting of 53 stores operated by franchisees and licensees in 13 countries
and territories as of December 31, 2000, will continue, although it is
anticipated that the number of franchised international stores will decrease
substantially in 2001.
OTHER ENTERTAINMENT ASSETS
TWE and a wholly owned subsidiary of the Company each own a 50% interest in
DC Comics. DC Comics publishes more than 50 regularly issued comics magazines,
among the most popular of which are Superman, Batman, Wonder Woman and The
Sandman. DC Comics also derives revenues from motion pictures, television,
product licensing and books. The Company wholly owns E.C. Publications, Inc.,
the publisher of MAD magazine.
COMPETITION
The production and distribution of theatrical motion pictures, television
and animation product and videocassettes/videodiscs/DVDs are highly competitive
businesses, as each vies with the other, as well as with other forms of
entertainment and leisuretime activities, including video games, the Internet
and other computer-related activities for viewers' attention. Furthermore, there
is increased competition in the television industry evidenced by the increasing
number and variety of broadcast networks and basic cable and pay television
services now available. There is active competition among all production
companies in these industries for the services of producers, directors, writers,
actors and others and for the acquisition of literary properties. With respect
to the distribution of television product, there is significant competition from
independent distributors as well as major studios. Revenues for filmed
entertainment product depend in part upon general economic conditions, but the
competitive position of a producer or distributor is still greatly affected by
the quality of, and public response to, the entertainment product it makes
available to the marketplace. Warner Bros. competes in its character
merchandising and other licensing and retail activities with other licensors and
retailers of character, brand and celebrity names. Many of the major film and
television producers, including the Company's filmed entertainment divisions,
have been accelerating their production schedules in preparation for possible
strikes by actors and writers in connection with the re-negotiation of the
Screen Actors Guild and Writers Guild of America collective bargaining
agreements which expire on June 30 and May 1 of 2001, respectively. If such
strikes occur and continue for a sustained period, businesses related to the
production, distribution and exploitation of filmed entertainment products,
including the Company's filmed entertainment businesses, may be adversely
affected.
NETWORKS
The Company's Networks business consists principally of domestic and
international basic cable networks, pay television programming services, a
broadcast television network, and sports franchises. The basic cable networks
(collectively, the 'Turner Networks') owned by Turner Broadcasting System, Inc.
('TBS'), a wholly owned subsidiary, constitute the principal component of the
Company's basic cable networks. TBS also operates several large advertiser-
supported online sites, including the CNN family of Internet destinations. Pay
television programming consists of the multichannel HBO and Cinemax pay
television programming services (collectively, the 'Home Box Office Services'),
operated by the Home Box Office division of TWE ('Home Box Office'). The WB
Television Network ('The WB'), a broadcast television network, is operated as a
limited partnership in which WB Communications (a division of TWE) holds a
majority interest in the network and is the network's managing general partner.
The Turner Networks and the Home Box Office Services (collectively, the
'Cable Networks') distribute their programming via cable and other distribution
technologies, including satellite distribution. The Cable Networks generally
enter into separate multi-year agreements, known as affiliation agreements, with
distributors that have agreed to carry them.
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The Turner Networks (other than Turner Classic Movies, which is
commercial-free) generate their revenue principally from the sale of advertising
time and from receipt of monthly per subscriber fees paid by cable system
operators, DTH distribution companies, hotels and other customers (known as
affiliates) that have contracted to receive and distribute such networks. The
Home Box Office Services and Turner Classic Movies, being commercial-free,
generate their revenue from the monthly fees paid by affiliates, which are
generally charged on a per subscriber basis.
Advertising revenue on the basic cable networks and The WB is comprised of
consumer advertising, which is sold primarily on a national basis (The WB sells
time exclusively on a national basis, with local affiliates of The WB selling
local advertising). Advertising contracts generally have terms of one year or
less. Advertising revenue is generated from a wide variety of categories,
including financial and business services, food and beverages, automotive,
entertainment and office supplies and equipment. Advertising revenue is a
function of the size and demographics of the audience delivered, the 'CPM,'
which is the cost per thousand viewers delivered, and the number of units of
time sold. Units sold and CPM's are influenced by the quantitative and
qualitative characteristics of the audience of each network as well as overall
advertiser demand in the marketplace.
TURNER NETWORKS
DOMESTIC NETWORKS
TBS's entertainment networks include two general entertainment networks, TBS
Superstation, with approximately 80.9 million subscribers in the U.S., as of
December 31, 2000, and TNT, with approximately 79.7 million subscribers in the
U.S., as of December 31, 2000; as well as Cartoon Network, with approximately
68.3 million subscribers in the U.S., as of December 31, 2000; and Turner
Classic Movies, a 24-hour, commercial-free network which presents classic films
from TBS's MGM, RKO and pre-1950 Warner Bros. film libraries, which had
approximately 45.9 million subscribers in the U.S., as of December 31, 2000.
Programming for these entertainment networks is derived, in part, from the
Company's film, made-for-television and animation libraries as to which TBS or
other divisions of the Company own the copyrights, licensed programming,
including sports, and original productions. In October 1999, TBS launched Turner
South, a regional entertainment network featuring movies and sitcoms from the
Turner library and original programming targeted to viewers in the Southeast, as
well as regional news and sports. On April 1, 2000, TBS launched Boomerang, a
digital network featuring classic cartoons.
TBS has acquired programming rights from the National Basketball Association
(the 'NBA') to televise a certain number of regular season and playoff games on
TBS Superstation and TNT through the 2001-02 season for which it has agreed to
pay fees, plus a share of the advertising revenues generated in excess of
specified amounts. TBS Superstation also televises a certain number of baseball
games of the Atlanta Braves, a major league baseball club owned by a subsidiary
of TBS, for which rights fee payments are made to Major League Baseball's
central fund for distribution to all Major League Baseball clubs. Through a
joint venture with NBC, TBS has also acquired rights to televise certain NASCAR
Winston Cup and Busch Series races from 2001-2006.
TBS's CNN network is a 24-hour per day cable television news service which
had more than 80 million subscribers in the U.S. as of December 31, 2000.
Together with CNN International ('CNNI'), CNN reached more than 250 million
locations in 212 countries and territories as of December 31, 2000. CNN operates
39 news bureaus, of which 10 are located in the United States and 29 are located
around the world. In addition to Headline News, which provides updated half-hour
newscasts throughout each day, CNN has expanded its brand franchise to include
CNNfn (soon to be renamed and refocused as CNN Money), featuring business and
consumer news; and CNNSI, a venture with Sports Illustrated, an AOL Time Warner
publication, featuring sports news and features. TBS has also expanded into a
number of special market networks.
During 2000, TBS collaborated with several other subsidiaries of the Company
to provide advertisers with marketing opportunities across the Company's
numerous platforms, thereby reaching AOL Time Warner's significant subscriber
base.
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INTERNATIONAL NETWORKS
CNNI is distributed to multiple distribution platforms for delivery to cable
systems, broadcasters, hotels and other viewers around the world on a network of
16 regional satellites. CNN en Espanol, a Spanish language all-news network in
Latin America, as of December 31, 2000, had 10.5 million subscribers. TBS also
distributes region-specific versions of TNT and Cartoon Network, on either a
single channel or combined channel basis, and Turner Classic Movies in
approximately 120 countries around the world.
In a number of regions, TBS has launched international versions of its
channels through joint ventures with local partners. These include CNN+, a
Spanish language 24-hour news network launched for distribution in Spain and
Andorra; CNN Turk, a Turkish language 24-hour news network; and Cartoon Network
Japan. TBS also owns an interest in n-tv, a German language news network
currently reaching nearly 40 million homes in Germany and contiguous countries
in Europe, primarily via cable systems and satellite.
INTERNET SITES
In addition to its cable networks, TBS operates various advertiser-supported
Internet sites. CartoonNetwork.com is a popular advertiser-supported site for
children ages two to eleven. CNN News Group operates multiple sites, such as
CNN.com and allpolitics.com primarily through CNN Interactive. The CNN News
Group also produces two other major news sites: CNNfn.com, a unit of CNN
Financial News; and CNNSI.com, a sports site developed jointly with Sports
Illustrated.
HOME BOX OFFICE
HBO, operated by the Home Box Office division of TWE, is the nation's most
widely distributed pay television service, which together with its sister
service, Cinemax, had approximately 36.9 million subscriptions, as of
December 31, 2000. Both HBO and Cinemax are made available in a multichannel
format. Together with various joint ventures, Home Box Office also distributes
HBO-branded services in Latin America, Asia and Eastern Europe.
A majority of the programming on HBO and Cinemax consists of recently
released, uncut and uncensored theatrical motion pictures. Home Box Office's
practice has been to negotiate licensing agreements of varying duration for such
programming with major motion picture studios, and independent producers and
distributors. These agreements typically grant pay television exhibition rights
to recently released and certain older films owned by the particular studio,
producer or distributor in exchange for a negotiated fee, which may be a
function of, among other things, the films' box office performances.
HBO also defines itself by the exhibition of award-winning pay television
original movies and mini-series, sporting events such as boxing matches, sports
documentaries and sports news programs, as well as dramatic and comedy specials
and series, such as The Sopranos, and Sex and the City, concerts, family
programming and documentaries.
HBO has begun a number of cross-company initiatives with AOL including
promotions of HBO shows like The Sopranos and Sex and the City and AOL's
offering of online sign up for HBO subscriptions through the HBO Express
service.
Home Box Office produces Everybody Loves Raymond, now in its fifth season on
CBS. Divisions of Home Box Office also produce programming for HBO and for other
networks. HBO Sports, a division of Home Box Office, operates TVKO Pay-Per-View
from HBO, an entity that distributes pay-per-view prize fights and other
pay-per-view programming.
THE WB TELEVISION NETWORK
The WB now airs 13 hours of prime time series programming six nights per
week. The network's line-up includes veteran drama series 7th Heaven, Dawson's
Creek, Buffy the Vampire Slayer, Felicity, Roswell, Angel and Charmed, as well
as the new critically acclaimed series Gilmore Girls. Kids' WB!, airs 19 hours
of
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programming per week with strip programming airing weekday mornings and
afternoons, along with a weekend line-up of original programming that includes
the Pokemon series.
As of March 1, 2001, 83 primary and four secondary affiliates provide
coverage for The WB in the top 100 markets. Additional coverage of approximately
6.6 million homes in 101 markets is provided by The WB 100+ Station Group, a
venture between The WB and local broadcasters under which WB programming is
disseminated over the facilities of local cable operators in markets 101-212.
Tribune Broadcasting owns a 22.25% interest in The WB. Key employees of The
WB hold an 11% interest in the network and the balance is owned by a division
of TWE.
OTHER NETWORK INTERESTS
The Company, through the Home Box Office division of TWE, holds a 50%
interest in Comedy Central, an advertiser-supported basic cable television
service, which provides comedy programming. Comedy Central was available in
approximately 68 million homes at December 31, 2000.
The Company, through TWE, also holds a 50% interest in Court TV, which was
available in approximately 53 million homes at December 31, 2000. Court TV is an
advertiser-supported basic cable television service whose programming includes
coverage of live and taped courtroom trials during the day and an expanded
schedule focused on crime and criminal justice genre television series in prime
time.
Through wholly owned subsidiaries, TBS owns the Atlanta Braves of Major
League Baseball, the Atlanta Hawks of the National Basketball Association, and
the Atlanta Thrashers of the National Hockey League. Each sports team is subject
to the team rules and regulations of the league to which it belongs. The teams
derive income from gate receipts, advertising and related sales, suite sales,
local sponsorships and local media, and share pro rata in proceeds from national
media contracts and licensing activities of the relevant league, as well as
expansion fees.
COMPETITION
Each of the Networks competes with other television programming services for
distribution on the limited number of channels available on cable and other
television systems. All of the Networks compete for viewers' attention and
audience share with all other forms of programming provided to viewers,
including broadcast networks, local over-the-air television stations, other pay
and basic cable television services, home video, pay-per-view services, online
activities and other forms of news, information and entertainment. In addition,
the Networks face competition for programming product with those same commercial
television networks, independent stations, and pay and basic cable television
services, some of which have exclusive contracts with motion picture studios and
independent motion picture distributors. The Turner Networks, The WB and TBS's
Internet sites compete for advertising with numerous direct competitors and
other media.
The Cable Networks' production divisions compete with other producers and
distributors of programs for air time on broadcast networks, independent
commercial television stations, and pay and basic cable television networks.
MUSIC
The Company's worldwide recorded music and music publishing businesses are
conducted under the umbrella name, Warner Music Group ('WMG'). In fall 2000, the
Company announced that it had terminated its previously-announced agreement to
combine WMG's global music operations with that of Britain's EMI Group plc.
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RECORDED MUSIC
In the United States, the Company's recorded music business is principally
conducted through WMG's Warner Bros. Records Inc., Atlantic Recording
Corporation, Elektra Entertainment Group Inc. and London-Sire Records Inc. and
their affiliated labels, as well as through the WEA Inc. companies. WMG's
recorded music activities are also conducted in over 70 countries outside the
United States through various subsidiaries, affiliates and non-affiliated
licensees.
The WEA Inc. companies include WEA Manufacturing Inc., which manufactures
compact discs (CDs), audio and videocassettes, CD-ROMs and DVDs for WMG's record
labels, Warner Home Video and outside companies; Ivy Hill Corporation, which
produces printed material and packaging for WMG's recorded music products as
well as for a wide variety of other consumer products; and
Warner-Elektra-Atlantic Corporation ('WEA Corp.'), which markets and distributes
WMG's recorded music products to retailers and wholesale distributors. WMG also
owns a majority interest in Alternative Distribution Alliance ('ADA'), an
independent distribution company specializing in alternative rock, metal, hip
hop and dance music with a focus on new artists.
DOMESTIC
WMG's major record labels in the United States -- Warner Bros., Atlantic,
Elektra and London-Sire -- each with a distinct identity, discover and sign
musical artists. The labels scout and sign talent in many different musical
genres, including pop, rock, jazz, country, hip hop, rap, reggae, latin, folk,
blues, gospel and Christian music. Among the artists that resulted in
significant U.S. sales for WMG during 2000 were: Yolanda Adams, Barenaked
Ladies, Green Day, Don Henley, Faith Hill, Kid Rock, Linkin Park, Madonna,
matchbox twenty, Tim McGraw, Red Hot Chili Peppers and Third Eye Blind.
WMG is a vertically integrated music company. After an artist has entered
into a contract with a WMG label, a master recording of the artist's music is
produced and provided to WMG's manufacturing operation, WEA Manufacturing, which
replicates the music primarily on CDs and audio cassettes. WEA Manufacturing is
also the largest manufacturer of DVDs in the world. Ivy Hill prints material
that is included with CDs, DVDs and audio cassettes and creates packaging for
them. WEA Corp. and ADA, WMG's distribution arms, market and sell product and
deliver it, either directly or through sub-distributors and wholesalers, to
thousands of record stores, mass merchants and other retailers throughout the
country. CDs and audio cassettes are also increasingly being sold directly to
consumers through Internet retailers such as amazon.com and CDnow.
In January 2000, WMG entered into a consent order with the Federal Trade
Commission with respect to the FTC's investigation of the Company's practices
related to minimum advertised prices. Among other things, WMG has agreed that
for seven years it will not make the receipt of any funds for cooperative
advertising of its recorded music product contingent upon the price or price
level at which such product is advertised or promoted.
In addition to newly released records, each of WMG's labels markets and
sells albums from its extensive catalogs of prior releases, in which the labels
generally continue to own the copyright in perpetuity. Rhino Records specializes
in compilations and reissues of previously released music.
WMG also has entered into joint venture arrangements pursuant to which WMG
companies manufacture, distribute and market (in most cases, domestically and
internationally) recordings owned by joint ventures such as Maverick, 143 and
Strictly Rhythm. Through a 50/50 joint venture, WMG and Sony Music Entertainment
Inc. operate The Columbia House Company, a direct marketer of CDs, audio and
videocassettes in North America.
WMG has actively pursued new media opportunities in the physical and digital
arenas. It has been a driving force in establishing the DVD Audio format,
launched in fall 2000, which improves on the CD by providing higher fidelity and
six-channel surround sound. WMG has also made its recordings available for
commercial digital downloading and by licensing its repertoire to Webcasters,
such as Launch, MTV and ARTISTdirect, and digital 'locker' services, such as
Musicbank and MP3.com. WMG's record labels' online sites collectively experience
the second-largest traffic volume among all the major music companies.
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During 2000, WMG and AOL initiated several successful cross-promotional
endeavors. In September, Warner Bros. Records and Spinner teamed up for the
launch of Madonna's latest album, Music. The promotion included a world premier
global listening party followed by Madonna's first-ever live AOL chat with more
than 120,000 fans. The album debuted the following week at No. 1 on the
Billboard top-selling album chart. Earlier in the year, a matchbox twenty
promotion with AOL, Spinner.com and Winamp.com helped drive matchbox twenty's
mad season album to No. 1 on Billboard's Internet sales chart in its first week
and to a No. 3 debut on the SoundScan Top 200. The CD version of this album
contained AOL's registration software as well as software related to AOL-owned
Spinner and Winamp Web sites.
INTERNATIONAL
The Warner Music International ('WMI') division of WMG operates through
various subsidiaries and affiliates and their non-affiliated licensees in over
70 countries around the world. WMI engages in the same activities as WMG's
domestic labels, discovering and signing artists and manufacturing, packaging,
distributing and marketing their recorded music. The artists signed to WMI and
its affiliates number more than a thousand. Significant album sales for WMI in
2000 were generated by the following artists: All Saints, Cher, Eric Clapton,
Enya, Yuki Koyanagi, Luis Miguel, Laura Pausini, Alejandro Sanz and Helene
Segara.
In most cases, WMI also markets and distributes the records of those artists
for whom WMG's domestic record labels have international rights. In certain
countries, WMI licenses to unaffiliated third-party record labels the right to
distribute its records. WMI operates a plant in Germany that manufactures CDs
and DVDs for its affiliated companies, as well as for outside companies and, as
part of a joint venture, operates a plant in Australia that also manufactures
CDs.
MUSIC PUBLISHING
WMG's music publishing companies, Warner/Chappell, own or control the rights
to more than one million musical compositions, including numerous pop music
hits, American standards, folk songs and motion picture and theatrical
compositions. The catalogue includes works from a diverse range of artists and
composers including Madonna, Eric Clapton, Jewel, George and Ira Gershwin,
Radiohead and Cole Porter. Warner/Chappell also administers the music of several
television and motion picture companies, including Lucasfilm, Ltd. and Hallmark
Entertainment.
Warner/Chappell also owns Warner Bros. Publications, one of the world's
largest publishers of printed music, which includes CPP/Belwin, acquired in
1995. Warner Bros. Publications markets publications throughout the world
containing the works of such artists as Shania Twain, The Grateful Dead and Led
Zeppelin and containing works from the Chrysalis, Zomba and Universal music
publishing catalogs.
The principal source of revenues to Warner/Chappell is license fees paid for
the use of its musical compositions on radio, television, in motion pictures and
in other public performances; royalties for the use of its compositions on CDs,
audio cassettes, music videos and in television commercials; and sales of
published sheet music and song books.
COMPETITION
The revenues of a company in the recording industry depend upon public
acceptance of the company's recording artists and their music. Although WMG is
one of the largest recorded music companies in the world, its competitive
position is dependent on its continuing ability to attract and develop talent
that can achieve a high degree of public acceptance. The competition among
record companies for such talent is intense, as is the competition among
companies to sell the recordings created by these artists. The recorded music
business continues to be adversely affected by counterfeiting of both audio
cassettes and CDs, piracy and parallel imports and also by Web sites and
technologies that allow consumers to download quality sound reproductions from
the Internet without authorization from the Company. In response, the recorded
music industry has engaged in a coordinated effort to develop secure
technologies for digital music delivery. Competition in the music publishing
business is also intense. Although WMG's music publishing business is one of the
largest on a worldwide basis,
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it competes with every other music publishing company in acquiring musical
compositions and in having them recorded and performed. In addition, the vast
majority of WMG's music publishing revenues are subject to rate regulation
either by government entities or by collecting societies throughout the world.
PUBLISHING
The Company's Publishing business is conducted primarily by Time Inc., a
wholly owned subsidiary of the Company, either directly or through its
subsidiaries. Time Inc. is one of the world's leading magazine and book
publishers and is one of the largest direct mail marketers.
MAGAZINES
GENERAL
As of March 1, 2001, Time Inc. published 64 magazines, including Time,
People, Sports Illustrated, Fortune, Money, Entertainment Weekly and In Style.
These magazines generally appeal to the broad consumer market.
New business activity during 2000 included the acquisition of Times Mirror
Magazines, which as of March 1, 2001 published 23 magazine titles, including
Golf, Ski, Skiing, Popular Science, Field and Stream and Yachting, and the
launch of four new magazines, including Real Simple, a lifestyle magazine, and
eCompany Now, a business magazine and Web site reporting on the Internet
economy. During 2000, Time Inc. also entered into a joint venture with Essence
Communications, Inc. to publish Essence Magazine and engage in other media
activities. The joint venture will expand Time Inc.'s reach with
African-American women and the African-American community at large.
Time Inc. also continues to expand its core magazine businesses through the
development of product extensions. These are generally managed by the individual
magazines and involve new magazines, specialized editions aimed at particular
audiences, and publication of editorial content through different media, such as
the Internet, books and television.
DESCRIPTION OF MAGAZINES
Each magazine published by Time Inc. 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 production and distribution
activities are generally centralized. Fulfillment activities for Time Inc.'s
magazines are generally administered from a centralized facility in Tampa,
Florida.
Time Inc.'s major magazines and their areas of editorial focus are
summarized below:
Time is a weekly newsmagazine that summarizes the news and interprets the
week's events, both national and international, across a spectrum of topics.
Time also has five weekly English-language editions that circulate outside the
United States. Time for Kids is a current events newsmagazine for children, ages
5-12.
People is a weekly magazine that reports on celebrities and other notable
personalities. People has expanded its franchise in recent years to include
People en Espanol, a Spanish-language edition aimed primarily at Hispanic
readers in the United States, and Teen People, aimed at teenage readers. Who
Weekly is an Australian version of People.
Sports Illustrated is a weekly magazine that covers a variety of competitive
sports. New venues and magazine extensions have also been developed, including
CNNSI, a sports news cable television network and Web site that is operated as a
joint venture between Sports Illustrated and CNN, Sports Illustrated for Women
covering women's sports, and Sports Illustrated for Kids, which is intended
primarily for pre-teenagers.
Time Inc. has other magazines also directed at readers' interests in
celebrities and entertainers. In Style is a monthly magazine that focuses on
fashion, beauty and celebrity lifestyles. In Style Australia was launched in
2000.
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Entertainment Weekly is a weekly magazine that includes reviews and reports
on television, movies, video, music, books and multimedia.
Fortune is a bi-weekly magazine that reports on worldwide economic and
business developments and compiles the annual Fortune 500 list of the largest
U.S. corporations. Money is a monthly magazine that reports primarily on
personal finance. Other business and financial magazines include FSB: Fortune
Small Business, a business magazine covering small business, eCompany Now, a
business magazine covering the Internet economy, and Mutual Funds, a personal
finance magazine covering investing and financial planning.
Through Southern Progress Corporation and other subsidiaries, Time Inc.
publishes several regional magazines including Southern Living; Sunset, The
Magazine of Western Living; and several specialty publishing titles, including
Cooking Light, Health, This Old House and Parenting.
Time Inc. also has management responsibility for most of the American
Express Publishing Corporation's operations, including its core lifestyle
magazines Travel & Leisure, Food & Wine and Departures.
ADVERTISING
Advertising carried in Time Inc. magazines is predominantly consumer
advertising, including computers and technology, domestic and foreign automobile
manufacturers, financial, media and entertainment, toiletries and cosmetics,
food, retail and department stores and pharmaceuticals. In 2000, Time Inc.
magazines (including the Times Mirror magazines) accounted for nearly 25% of the
total advertising revenue in consumer magazines, as measured by the Publishers
Information Bureau (PIB). People, Time, Sports Illustrated and Fortune were
ranked 1, 2, 3 and 5, respectively, by PIB, and Time Inc. had 8 of the 30
leading magazines in terms of advertising dollars.
CIRCULATION
Circulation drives the advertising rate base, which is the guaranteed
minimum paid circulation level on which advertising rates are determined. Time
Inc.'s magazines are primarily sold by subscription and delivered to subscribers
through the mail. Subscriptions are sold by direct mail and online solicitation,
subscription sales agencies, television and telephone solicitation and insert
cards in Time Inc. magazines and other publications. During 2000, Time Inc.
launched a successful cross-promotional campaign on AOL offering subscriptions
to various Time Inc. magazines, generating more than 100,000 gross subscriptions
per month. In return, among other things, Time Inc. enclosed AOL registration
discs in certain of its magazines sent to subscribers.
Single copies of magazines are sold through retail news dealers and other
outlets such as newsstands, supermarkets, and convenience and drug stores, which
are supplied by wholesalers or directly through a Time Inc. subsidiary. Time
Distribution Services Inc. is responsible for the national distribution and
marketing of single copies of Time Inc. magazines and other publications. Warner
Publisher Services Inc. is a major distributor of magazines and paperback books
sold through wholesalers in the United States and Canada.
PAPER AND PRINTING
Lightweight-coated paper constitutes a significant component of physical
costs in the production of magazines. During 2000, Time Inc. purchased its paper
supplies principally from four independent manufacturers. Time Inc. has been
able to obtain an adequate supply of paper to fulfill its needs in the past, but
periodic shortages may occur in the event of strikes or other unexpected
disruptions in the paper industry.
Printing and binding for Time Inc. magazines are performed primarily by
major domestic and international independent printing concerns in approximately
20 locations. Magazine printing contracts are either fixed-term or open-ended at
fixed prices with, in some cases, adjustments based on certain criteria.
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DIRECT MARKETING
Through subsidiaries, Time Inc. conducts world-wide direct mail marketing
businesses. Time Life Inc. is one of the nation's largest direct marketers of
entertainment products such as music and videos. Its products are sold, both as
single products and products in sets, by direct response, including mail order,
television and telephone, through retail channels and catalogs, and in some
markets by independent distributors. Music and video rights are acquired through
outside sources and compiled internally into finished products. Time Life's
domestic direct response fulfillment activities are conducted from a centralized
facility in Richmond, Virginia.
In early 2000, Book-of-the-Month Club, Inc. ('BOMC') formed a 50-50 joint
venture with Bertelsmann AG's Doubleday book clubs business to operate the U.S.
book clubs of BOMC and Doubleday jointly. The joint venture, named Bookspan,
acquires the rights to manufacture and sell books to consumers through clubs.
Multimedia, audio and video products and other merchandise are also offered
through the clubs. Bookspan operates its own fulfillment and warehousing
operations from two locations in Pennsylvania.
BOOKS
Time Inc.'s trade publishing operations are conducted primarily by Time
Warner Trade Publishing Inc. through its two major publishing houses, Warner
Books and Little, Brown. In 2000, Time Warner Trade Publishing placed 37 books
on The New York Times best-seller lists.
Time Warner Trade Publishing handles book distribution for Little, Brown and
Warner Books, as well as other publishers, through its state-of-the-art
distribution center in Indiana. The marketing of trade books is primarily to
retail stores, online outlets and wholesalers throughout the United States,
Canada and the United Kingdom. Through their combined United States and United
Kingdom operations, Little, Brown and Warner Books have the ability to acquire
English-language publishing rights for the distribution of hard and soft-cover
books throughout the world.
Oxmoor House, Inc., Leisure Arts, Inc. and Sunset Books publish and
distribute a variety of how-to books for the cooking, home repair, gardening,
craft, needlework, decorating and travel markets.
POSTAL RATES
Postal costs represent a significant operating expense for the Company's
magazine and book publishing activities. Publishing operations strive 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
Time Inc.'s magazine operations compete for audience and advertising with
numerous other publishers and retailers, as well as other media. These
businesses compete for advertising directed at the general public and also
advertising directed at more focused demographic groups.
Time Inc.'s circulation efforts, as well as those of most other magazine
publishers, have been adversely affected by developments in two principal
distribution channels. The effectiveness of sweepstakes-based subscription
efforts has declined significantly and recent consolidation among independent
magazine wholesalers has resulted in decreased efficiencies for Time Inc. in
retail magazine distribution.
Time Inc.'s direct marketing operations compete with other direct marketers
through all media for the consumer's attention. In addition to the traditional
media sources for product sales, the Internet is becoming a strong vehicle in
the direct marketing business.
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REGULATION AND LEGISLATION
The Company's cable television system, cable and broadcast television
network and original programming businesses are subject, in part, to regulation
by the Federal Communications Commission ('FCC'), and the cable television
system business is also subject to regulation by some state governments and
substantially all local governments in which the Company has cable systems.
In addition, in connection with regulatory clearance of the AOL-Time Warner
merger, the Company's cable system and Internet businesses are subject to
compliance with the terms of the Consent Decree (the 'Consent Decree')
issued by the Federal Trade Commission ('FTC'), the Order to Hold Separate
issued by the FTC, the Memorandum Opinion and Order ('Order') issued by the
FCC, and the Decision issued by the European Commission and the undertakings
thereunder. The Company is also subject to an FTC consent decree (the 'Turner
Consent Decree') as a result of the FTC's approval of Time Warner's acquisition
of Turner Broadcasting System, Inc. in 1996.
The following is a summary of the terms of these orders as well as current
significant federal, state and local laws and regulations affecting the growth
and operation of these businesses. In addition, various legislative and
regulatory proposals under consideration from time to time by Congress and
various federal agencies have in the past materially affected, and may in the
future materially affect, the Company.
FTC CONSENT DECREE
On December 14, 2000, the FTC issued a Consent Decree that imposes certain
requirements that Time Warner Cable must follow in providing its subscribers
with a choice of multiple Internet Service Providers ('ISPs') as part of its
cable modem service. The Consent Decree terminates after five years.
The Consent Decree provides that, in each of Time Warner Cable's 20 largest
divisions, Time Warner Cable cannot make available an 'affiliated broadband ISP'
(e.g., America Online), other than Road Runner, until Earthlink (an unaffiliated
ISP) is made available by Time Warner Cable in that division. Once an affiliated
ISP, such as America Online, is made available in one of these Time Warner Cable
divisions, that division must enter into two additional agreements with
unaffiliated ISPs within 90 days. These agreements must be approved by the FTC.
In the remaining Time Warner Cable divisions, there is no requirement that
Earthlink be made available before Time Warner Cable can begin providing service
from an affiliated broadband ISP. However, once an affiliated broadband ISP is
offered, Time Warner Cable must enter into agreements within 90 days with three
additional unaffiliated broadband ISPs to serve those divisions. These
agreements must be approved by the FTC. Earthlink's agreement with Time Warner
Cable has been approved by the FTC.
The Consent Decree prohibits Time Warner Cable from discriminating against
unaffiliated ISPs on the basis of affiliation in negotiations with unaffiliated
cable broadband ISPs. However, Time Warner Cable may decline either to negotiate
or to enter into agreements with ISPs based on cable broadband capacity
constraints, cable broadband technical considerations or other cable broadband
business considerations. The Consent Decree prohibits Time Warner Cable from
interfering, on the basis of affiliation, with any content passed along
bandwidth used by a non-affiliated ISP pursuant to its ISP agreement with Time
Warner Cable, or from discriminating on the basis of affiliation in the
transmission of content that Time Warner Cable has contracted to deliver to its
subscribers. Furthermore, the Consent Decree prohibits Time Warner Cable from
interfering with any interactive television signals, triggers or content that
Time Warner Cable has agreed to carry.
The Consent Decree requires America Online to continue to offer and promote
digital subscriber line service in areas served by Time Warner Cable on terms
similar to the terms offered in areas not served by Time Warner Cable. America
Online is also prohibited from entering into agreements with cable MSOs that
restrict the ability of that MSO to enter into agreements with other ISPs or
interactive television providers.
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FTC ORDER TO HOLD SEPARATE
On December 14, 2000, the FTC issued an Order to Hold Separate (the 'HSO')
that requires the Company to hold separate and apart the businesses of America
Online and Road Runner and prohibits the use of America Online in any way to
advantage Road Runner and vice-versa. Joint marketing or advertising activities,
cross-links or references to each other's services, the offering of similar
formats or designs, and the hiring of each other's employees are specifically
prohibited. The HSO terminates cable division-by-division as each Time Warner
Cable division satisfies the conditions of the Consent Decree related to
multiple ISPs described above.
FCC MEMORANDUM OPINION AND ORDER
On January 11, 2001, the FCC issued an Order imposing certain requirements
over a five-year period regarding Time Warner Cable's provision of multiple
ISPs. Specifically, the Order requires Time Warner Cable to provide ISP
customers with a list of available ISPs upon request, to allow ISPs to determine
the content on their first screen, and to allow ISPs to have direct billing
arrangements with the subscribers they obtain. The Order prohibits Time Warner
Cable from requiring customers to go through an affiliated ISP (e.g., America
Online) to reach an unaffiliated ISP, from requiring ISPs to include particular
content, and from discriminating on the basis of affiliation with regard to
technical system performance (e.g., caching, quality of service mechanisms).
The FCC's Order also imposes conditions regarding possible future
enhancements to America Online's instant messaging service. The Order prohibits
America Online from offering 'advanced' instant messaging services (which are
defined as streaming video applications that are not upgrades to America
Online's current instant messaging products) that utilize a names and presence
database ('NPD') over Time Warner Cable broadband facilities unless America
Online satisfies one of three conditions: (i) America Online implements an
industry-wide standard for server-to-server interoperability; (ii) America
Online contracts with at least one unaffiliated provider of NPD based instant
messaging services before offering 'advanced' instant messaging and, within 180
days thereafter, enters into two additional such contracts; or (iii) America
Online demonstrates that these conditions no longer serve the public interest
due to materially changed circumstances, e.g., if America Online shows that it
has not been a dominant provider of NPD services for at least four consecutive
months.
In addition, the FCC's Order prohibits the Company from entering into any
agreement with AT&T that gives any ISP affiliated with the Company exclusive
carriage rights on any AT&T cable system for broadband ISP services or that
affects AT&T's ability to offer rates or other carriage terms to ISPs that are
not affiliated with the Company. The Order also requires the Company to notify
the FCC of any increase in ownership interest in General Motors and/or Hughes
Electronics within 30 days of such increase.
EUROPEAN COMMISSION DECISION/UNDERTAKINGS
On October 11, 2000, the European Commission issued a Decision pursuant to
which the Company entered into a series of agreements known as 'undertakings.'
These undertakings include a mechanism that is in place pursuant to which
Bertelsmann AG will progressively exit from AOL Europe SA and AOL Compuserve
France SAS. Until such exit is complete, Bertelsmann cannot exercise operational
control over AOL Europe or AOL Compuserve France, and its relationship with
America Online must be nonexclusive as to its provision and formatting of
online music and as to its promotion of America Online's ISP services.
TURNER FTC CONSENT DECREE
The Company is also subject to the terms of a consent decree (the 'Turner
Consent Decree') entered in connection with the FTC's approval of the
acquisition of Turner Broadcasting System, Inc. ('TBS') by Time Warner in
1996. Certain requirements imposed by the Turner Consent Decree, such as
carriage commitments for Time Warner Cable for the rollout of at least one
independent national news video programming service, have been fully satisfied
by the Company. Various other conditions remain in effect, including certain
restrictions which prohibit the Company from offering programming upon terms
that (1) condition the making available of,
I-25
or the carriage terms for, the HBO service upon whether a multichannel
video programming distributor carries a video programming service affiliated
with TBS; and (2) condition the making available of, or the carriage
terms for, CNN, WTBS and TNT upon whether a multichannel video programming
distributor carries any video programming service affiliated with TWE.
The Turner Consent Decree also imposes certain restrictions on the terms
by which a Turner video programming service may be offered to an
unaffiliated programming distributor that competes in areas served by
Time Warner Cable.
Other conditions of the Turner Consent Decree prohibit Time Warner Cable
from requiring, as a condition of carriage, that any national video programming
vendor provide a financial interest in its programming service or that such
programming vendor provide exclusive rights against any other multichannel
programming distributor. In addition, Time Warner Cable may not discriminate on
the basis of affiliation in the selection, terms or conditions of carriage for
national video programming vendors. The Turner Consent Decree expires in 2006.
CABLE SYSTEM REGULATION
FEDERAL LAWS. The Communications Act of 1934, as amended (the 'Act')
regulates the business of operating cable television systems, including, with
respect to: (i) cable systems rates for basic service, equipment and
installation (cable rates for nonbasic service tiers have not been regulated
since March 31, 1999); (ii) access to cable channels for public, educational and
governmental programming and for leased access; (iii) horizontal and vertical
ownership of cable systems; (iv) consumer protection and customer service
requirements; (v) franchise renewals; (vi) television broadcast signal carriage
requirements and retransmission consent; (vii) technical standards;
(viii) certain restrictions regarding ownership of cable television systems and
(ix) privacy of customer information.
Rate Regulation. The FCC's rate regulations assess the reasonableness of
existing basic service rates, although cable operators can, in some cases,
justify rates above the applicable benchmarks. The regulations also address
future basic service rate increases. Local franchising authorities are
generally empowered to order a reduction of existing rates that exceed the
maximum permitted level for basic service and associated equipment, and
refunds can be required. If a cable operator can establish that it is subject
to 'effective competition' from other multi-channel video providers (e.g.,
DBS) in a community, rate regulation ceases.
Signal Carriage and Retransmission Consent. The Act allows commercial
television broadcast stations that are 'local' to a cable system to elect
every three years either to require the cable system to carry the station,
subject to certain exceptions, or to negotiate for consent to carry the
station. Broadcast stations may seek monetary or non-monetary compensation in
return for granting retransmission consent. Local non-commercial television
stations are also generally given mandatory carriage rights. In addition,
cable systems must obtain retransmission consent for the carriage of all
'distant' commercial broadcast stations, except for certain 'superstations,'
i.e., commercial satellite-delivered independent stations such as WGN. Time
Warner Cable has obtained retransmission consent agreements for the current
three year election cycle, which ends December 31, 2002, with the majority of
broadcasters, but certain broadcasters have only agreed to short-term
arrangements to permit continued negotiations. If Time Warner Cable and a
particular broadcaster cannot agree on retransmission consent terms, the
broadcaster could require Time Warner Cable to cease carriage of the
broadcaster's signal, possibly for an indefinite period.
Ownership. Local exchange telephone companies ('LECs') generally may not
acquire more than a 10% equity interest in an existing cable system operating
within the LEC's service area, although they may operate cable television
systems in those areas. LECs and others also may operate 'open video systems'
('OVS') which are not subject to the full array of regulatory obligations
imposed on traditional cable systems, although OVS operators can be required
to obtain a franchise by a local governmental body and/or to make payments in
lieu of cable franchise fees. A number of separate entities have been
certified to operate open video systems in areas where the Company operates
cable systems, including New York City, Milwaukee, Kansas City and a number
of cities in Texas. Current FCC rules also restrict cable/television station
cross-ownership in a given location. Time Warner Cable is currently a party
to a federal court litigation challenging the validity of this requirement.
Under the Act, cable operators are also generally
I-26
prohibited from having common ownership, control or interest in MMDS
facilities or SMATV systems with overlapping service areas, except in
limited circumstances. There is also an ongoing rulemaking before
the FCC to determine whether cable operators should be restricted from
owning or operating a competing direct broadcast satellite service ('DBS').
Horizontal and Vertical Ownership Limits. Pursuant to the Act, the FCC had
adopted limits on the number of cable subscribers an operator may reach
through systems in which it holds an attributable interest. The FCC's rule
imposes a limit of 30% of all cable, DBS and other multi-channel video
provider subscribers nationwide. Pursuant to the Act, the FCC also adopted
rules that, with certain exceptions, preclude a cable television system from
devoting more than 40% of its first 75 activated channels to national video
programming services in which the cable system owner has an attributable
interest. Those rules have now been invalidated by the Court of Appeals for
the District of Columbia and remanded to the FCC for further consideration.
In addition to the Act, cable television systems are also subject to federal
copyright licensing covering carriage of broadcast signals. In exchange for
making semi-annual payments to a federal copyright royalty pool and meeting
certain other obligations, cable operators obtain a statutory license to
retransmit broadcast signals. The amount of this royalty payment varies,
depending on the amount of system revenues from certain sources, the number of
distant signals carried, and the location of the cable system with respect to
over-the-air television stations.
STATE AND LOCAL REGULATION. Because a cable television system uses local
streets and rights-of-way, cable television systems are subject to local
regulation, typically imposed through the franchising process, and certain
states have also adopted cable television legislation and regulations. Cable
franchises are nonexclusive (and municipalities are entitled to operate
competing systems), granted for fixed terms and usually terminable if the cable
operator fails to comply with material provisions. No Time Warner Cable
franchise has been terminated due to breach. Franchises usually call for the
payment of fees (which are limited under the Act to a maximum of 5% of the
system's gross revenues from cable service) to the granting authority. The terms
and conditions of cable franchises vary materially from jurisdiction to
jurisdiction, and even from city to city within the same state, historically
ranging from reasonable to highly restrictive or burdensome.
RENEWAL OF FRANCHISES. In the renewal process, a franchising authority may
seek to impose new and more onerous requirements, such as upgraded facilities,
increased channel capacity or enhanced services, although protections available
under the Act require the municipality to take into account the cost of meeting
such requirements. Time Warner Cable may be required to make significant
additional investments in its cable television systems as part of the franchise
renewal process. Although Time Warner Cable has been successful in the past in
negotiating new franchise agreements, there can be no assurance as to the
renewal of franchises in the future. The Act contains renewal procedures and
criteria designed to protect incumbent franchisees against arbitrary denials of
renewal.
NETWORK REGULATION
Under the Act and its implementing regulations, vertically integrated cable
programmers like the Turner Networks and the Home Box Office Services, are
generally prohibited from offering different prices, terms, or conditions to
competing unaffiliated multichannel video programming distributors unless the
differential is justified by certain permissible factors set forth in the
regulations. The rules also place certain restrictions on the ability of
vertically integrated programmers to enter into exclusive distribution
arrangements with cable operators. Certain other federal laws also contain
provisions relating to violent and sexually explicit programming, including
relating to the voluntary promulgation of ratings by the industry and requiring
manufacturers to build television sets with the capability of blocking certain
coded programming (the so-called 'V-chip').
I-27
DESCRIPTION OF AGREEMENT WITH
LIBERTY MEDIA CORPORATION
The following description summarizes certain provisions of the Company's
agreement with Liberty Media Corporation (an affiliate of AT&T) and certain of
its subsidiaries (collectively, 'LMC') that was entered into in connection with
the merger of Turner Broadcasting System, Inc. in 1996 (the 'TBS Transaction')
and the Turner Consent Decree. Such description does not purport to be complete
and is subject to, and is qualified in its entirety by reference to, the
provisions of the Second Amended and Restated LMC Agreement dated as of
September 22, 1995 among the Company, Time Warner Companies, Inc. and LMC (the
'LMC Agreement').
OWNERSHIP OF AOL TIME WARNER COMMON STOCK
Pursuant to the LMC Agreement, immediately following consummation of the TBS
Transaction, LMC exchanged the 50.6 million shares of Time Warner common stock,
par value $.01 per share ('Time Warner Common Stock'), received by LMC in the
TBS Transaction on a one-for-one basis for 50.6 million shares of Series LMCN-V
Common Stock. In June 1997, LMC and its affiliates received 6.4 million
additional shares of Series LMCN-V Common Stock pursuant to the provisions of an
option agreement between Time Warner and LMC and its affiliates. In May 1999,
the terms of the Series LMCN-V Common Stock were amended which effectively
resulted in a two-for-one stock split. At the time of the AOL-Time Warner
merger, each share of Series LMCN-V Common Stock was exchanged for one and one
half shares of a substantially identical Series LMCN-V Common Stock of AOL Time
Warner. Each share of Series LMCN-V Common Stock receives the same dividends and
otherwise has the same rights as a share of AOL Time Warner Common Stock except
that (a) holders of Series LMCN-V Common Stock are entitled to 1/100th of a vote
per share on the election of directors and do not have any other voting rights,
except as required by law or with respect to limited matters, including
amendments to the terms of the Series LMCN-V Common Stock adverse to such
holders, and (b) unlike shares of AOL Time Warner Common Stock, shares of Series
LMCN-V Common Stock are not subject to redemption by the Company if necessary to
prevent the loss by the Company of any governmental license or franchise. The
Series LMCN-V Common Stock is not transferable, except in limited circumstances,
and is not listed on any securities exchange.
LMC exchanged its shares of Time Warner Common Stock for Series LMCN-V
Common Stock in order to comply with the Turner Consent Decree, which
effectively prohibits LMC and its affiliates (including TCI) from owning voting
securities of the Company other than securities that have limited voting rights.
Each share of Series LMCN-V Common Stock is convertible into one share of AOL
Time Warner Common Stock at any time when such conversion would no longer
violate the Turner Consent Decree or have a Prohibited Effect (as defined
below), including following a transfer to a third party.
OTHER AGREEMENTS
Under the LMC Agreement, if the Company takes certain actions that have the
effect of (a) making the continued ownership by LMC of the Company's equity
securities illegal under any federal or state law, (b) imposing damages or
penalties on LMC under any federal or state law as a result of such continued
ownership, (c) requiring LMC to divest any such Company equity securities, or
(d) requiring LMC to discontinue or divest any business or assets or lose or
significantly modify any license under any communications law (each a
'Prohibited Effect'), then the Company will be required to compensate LMC for
income taxes incurred by it in disposing of all the Company's equity securities
received by LMC in connection with the TBS Transaction and related agreements
(whether or not the disposition of all such equity securities is necessary to
avoid such Prohibited Effect).
The agreements described in the preceding paragraph may have the effect of
requiring the Company to pay amounts to LMC in order to engage in (or requiring
the Company to refrain from engaging in) activities that LMC would be prohibited
under the federal communications laws from engaging in. Based on the current
businesses of the Company and LMC and based upon the Company's understanding of
applicable law, the Company does not expect these requirements to have a
material effect on its business.
I-28
DESCRIPTION OF CERTAIN PROVISIONS OF THE
TWE PARTNERSHIP AGREEMENT
The following description summarizes certain provisions of the TWE
Partnership Agreement relating to the ongoing operations of TWE. Such
description does not purport to be complete and is subject to, and is qualified
in its entirety by reference to, the provisions of the TWE Partnership
Agreement.
MANAGEMENT AND OPERATIONS OF TWE
PARTNERS. The limited partnership interests in TWE are held by the Class A
Partners consisting of a subsidiary of AT&T, MediaOne TWE Holdings, Inc.
('MediaOne') and wholly owned subsidiaries of the Company and the general
partnership interests in TWE are held by the Class B Partners consisting of
wholly owned subsidiaries of the Company (the "AOLTW General Partners").
BOARD OF REPRESENTATIVES. The business and affairs of TWE are managed under
the direction of a board of representatives (the 'Board of Representatives' or
the 'Board') that is comprised of representatives appointed by subsidiaries of
AOL Time Warner (the 'AOLTW Representatives') and representatives appointed by
AT&T (the 'AT&T Representatives').
The AOLTW Representatives control all Board decisions except for certain
limited, significant matters affecting TWE as a whole, which matters also
require the approval of the AT&T Representatives.
The managing general partners, both of which are wholly owned subsidiaries
of AOL Time Warner, may take any action without the approval or consent of the
Board if such action may be authorized by the AOLTW Representatives without the
approval of the AT&T Representatives.
CABLE MANAGEMENT COMMITTEE. Prior to August 1999, the businesses and
operations of the cable television systems ('Cable Systems') of TWE and the
TWE-A/N Partnership were governed by a Cable Management Committee (the
'Management Committee') comprised of six voting members, three designated by
MediaOne and three designated by TWE. In August 1999, TWE received a notice from
MediaOne concerning the termination of its covenant not to compete with TWE. As
a result of the termination notice and the operation of the TWE partnership
agreement, MediaOne's rights to participate in the management of TWE's
businesses, including its rights to membership on the Management Committee,
terminated immediately and irrevocably. However, MediaOne retains its
representation on the TWE Board of Representatives as described above.
DAY-TO-DAY OPERATIONS. TWE is managed on a day-to-day basis by the officers
of TWE, and each of TWE's principal divisions is managed on a day-to-day basis
by the officers of such division.
CERTAIN COVENANTS
COVENANT NOT TO COMPETE. AT&T ceased to be bound by the covenant not to
compete as of August 2000. For so long as any other partner (or affiliate of any
partner) owns in excess of 5% of TWE and in the case of any AOLTW General
Partner, for one year thereafter, such partner (including its affiliates) is
generally prohibited from competing or owning an interest in the principal lines
of business of TWE -- cable television systems, pay cable programming networks
and filmed entertainment, subject to certain exceptions (which include TBS and
its businesses). The covenant not to compete also does not prohibit (i) any
party from engaging in the cable business in a region in which TWE is not then
engaging in the cable business, subject to TWE's right of first refusal with
respect to such cable business, or (ii) any party from engaging in the telephone
or information services business.
TRANSACTIONS WITH AFFILIATES. Subject to agreed upon exceptions for certain
types of arrangements, TWE has agreed not to enter into transactions with any
partner or any of its affiliates other than on an arm's-length basis.
I-29
REGISTRATION RIGHTS
Within 60 days after June 30, 1999, and within 60 days after the last day of
each 18 month period after June 30, 1999, the Class A Partners holding,
individually or in the aggregate, at least 10% of the residual equity of TWE
will have the right to request that TWE reconstitute itself as a corporation and
register for sale in a public offering an amount of partnership interests held
by such Class A Partners determined by an investment banking firm (appointed
jointly by an investment banking firm chosen by TWE and an investment banking
firm chosen by the Class A Partners) so as to maximize trading liquidity and
minimize the initial public offering discount, if any. Upon any such request,
the parties will cause an investment banker to determine the price at which the
interests to be registered could be sold in a public offering (the 'Appraised
Value'). Upon determination of the Appraised Value, TWE may elect whether or not
to register such interests. If TWE elects to register the interests and the
proposed public offering price (as determined immediately prior to the time the
public offering is to be declared effective) is less than 92.5% of the Appraised
Value, TWE will have a second option to purchase such interests immediately
prior to the time such public offering would otherwise have been declared
effective by the Securities and Exchange Commission at the proposed public
offering price less underwriting fees and discounts. If TWE elects not to
register such interests, the Class A Partners shall have the right to put the
interests to be registered to TWE at their Appraised Value and TWE will be
required to pay the fees and expenses of the underwriters. Upon exercise of
either TWE's purchase option or the Class A Partners put option, TWE may also
elect to purchase the entire partnership interests of the Class A Partners
requesting registration at a relevant price determined by the investment bank
referred to above, subject to certain adjustments.
On February 28, 2001, AT&T delivered to TWE its request that TWE
reconstitute itself as a corporation and register AT&T's partnership interests
for public sale. AT&T has agreed to suspend the process described in the
preceding paragraph until at least March 15, 2001 and, through the date of
this report, no further implementation of this process has subsequently
occurred while the parties have continued their ongoing discussions
regarding AT&T's interest in TWE.
In addition to the foregoing, AT&T will have the right to exercise an
additional demand registration right beginning 18 months following the date on
which TWE reconstitutes itself as a corporation and registers and effects the
sale of securities pursuant to a previously exercised demand registration right.
At the request of any AOLTW General Partner, TWE will effect a public
offering of the partnership interests of the AOLTW General Partners or
reconstitute TWE as a corporation and register the shares held by the
AOLTW General Partners. In any such case, the Class A Partners will have
standard 'piggy-back' registration rights.
Upon any reconstitution of TWE into a corporation, each partner will acquire
preferred and common equity in the corporation corresponding in both relative
value, rate of return and priority to the partnership interests it held prior to
such reconstitution, subject to certain adjustments to compensate the partners
for the effects of converting their partnership interests into capital stock.
CERTAIN PUT RIGHTS OF THE CLASS A PARTNERS
CHANGE IN CONTROL PUT. Upon the occurrence of a change in control of AOL
Time Warner, at the request of AT&T, TWE will be required to elect either to
liquidate TWE within a two-year period or to purchase the interest of AT&T at
fair market value (without any minority discount) as determined by investment
bankers. A 'change in control' of AOL Time Warner shall be deemed to have
occurred:
(x) whenever, in any three-year period, a majority of the members of the
Board of Directors of the Company elected during such three-year period
shall have been so elected against the recommendation of the management of
the Company or the Board of Directors shall be deemed to have been elected
against the recommendation of such Board of Directors of the Company in
office immediately prior to such election; provided, however, that for
purposes of this clause (x) a member of such Board of Directors shall be
deemed to have been elected against the recommendation of such Board of
Directors if his or her initial election occurs as a result of either an
actual or threatened election contest (as such terms are used in
I-30
Rule 14a-11 of Regulation 14A promulgated under the Securities Exchange Act
of 1934, as amended) or other actual or threatened solicitation of proxies
or consents by or on behalf of a person other than such Board of Directors;
or
(y) whenever any person shall acquire (whether by merger, consolidation,
sale, assignment, lease, transfer or otherwise, in one transaction or any
related series of transactions), or otherwise beneficially owns voting
securities of the Company that represent in excess of 50% of the voting
power of all outstanding voting securities of the Company generally entitled
to vote for the election of directors, if such person acquires or publicly
announces its intention to initially acquire ten percent or more of such
voting securities in a transaction that has not been approved by the
management of the Company within 30 days after the date of such acquisition
or public announcement.
The consummation of the AOL-Time Warner merger did not constitute a 'change
in control' of Time Warner under the foregoing provisions.
ASSIGNMENT OF PUT RIGHTS, ETC. TWE, with the consent of such assignee, may
assign to the Company, any general partner or any third party, the obligation to
pay the applicable put price in connection with the exercise of a change in
control put right by AT&T and the right to receive the partnership interests in
payment therefor.
With respect to any of the put rights of AT&T, TWE may pay the applicable
put price in cash or Marketable Securities (defined as any debt or equity
securities that are listed on a national securities exchange or quoted on
NASDAQ) issued by TWE (or if TWE assigns its obligation to pay the put price to
the Company, by the Company). The amount of any Marketable Securities comprising
the applicable put price shall be determined based on the market price of such
securities during the seven months following the closing of such put
transaction.
RESTRICTIONS ON TRANSFER BY AOLTW GENERAL PARTNERS
AOLTW GENERAL PARTNERS. Any AOLTW General Partner is permitted to dispose of
any partnership interest (and any AOLTW General Partner and any parent of any
AOLTW General Partner may issue or sell equity) at any time so long as,
immediately after giving effect thereto, (i) the Company would not own, directly
or indirectly, less than (a) 43.75% of the residual equity of TWE, if such
disposition occurs prior to the date on which the Class A Partners have received
cash distributions of $500 million per $1 billion of investment, and (b) 35% of
the residual equity of TWE if such disposition occurs after such date, (ii) no
person or entity would own, directly or indirectly, a partnership interest
greater than that owned, directly or indirectly, by the Company, and (iii) a
subsidiary of the Company would be a managing general partner of TWE.
No other dispositions are permitted, except that the Company may sell its
entire partnership interest subject to the Class A Partners' rights of first
refusal and 'tag-along' rights pursuant to which the Company must provide for
the concurrent sale of the partnership interests of the Class A Partners so
requesting.
CURRENCY RATES AND REGULATIONS
AOL Time Warner's foreign operations are subject to the risk of fluctuation
in currency exchange rates and to exchange controls. AOL Time Warner cannot
predict the extent to which such controls and fluctuations in currency exchange
rates may affect its operations in the future or its ability to remit dollars
from abroad. For information with respect to America Online, see Note 2,
'Summary of Significant Accounting Policies -- Foreign Currency Translation' to
the consolidated financial statements set forth at page F-28 herein. For a
discussion of revenues of international operations, see Note 7, 'Segment
Information' to the consolidated financial statements set forth on pages F-37
through F-39 herein.
EMPLOYEES
At December 31, 2000, the businesses of AOL Time Warner employed a total of
approximately 88,500 persons, including approximately 32,000 persons employed by
TWE.
I-31
ITEM 2. PROPERTIES
CORPORATE, AMERICA ONLINE, TBS, PUBLISHING AND MUSIC
The following table sets forth certain information as of December 31, 2000
with respect to the Company's principal properties (over 250,000 square feet in
area) that are occupied for corporate offices or used primarily by America
Online, TBS or the Company's publishing and music divisions, 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:
APPROXIMATE
SQUARE FEET TYPE OF OWNERSHIP
LOCATION PRINCIPAL USE FLOOR SPACE EXPIRATION DATE OF LEASE
-------- ------------- ----------- ------------------------
New York, NY Executive and administrative 560,000 Leased by the Company. Lease
75 Rockefeller Plaza offices (Corporate and Music) expires in 2014.
Rockefeller Center Approximately 86,300 sq. ft.
are sublet to outside tenants.
Dulles, VA Executive and administrative and 1,132,000 Owned and occupied by the Company.
22000 AOL Way, business offices
Broderick Dr. (AOL HQ Campus)
Prentice Dr.
Pacific Blvd.
Mt. View, CA Executive, administrative and 802,670 Leased by the Company. (Leases
Middlefield Rd. business offices (Netscape Campus) expire from 2001-2014)
Ellis St. Approximately 88,077 sq. ft. are
Whisman Rd. sublet to outside tenants.
Columbus, OH Executive, administrative and 342,170 Owned and occupied by the Company.
Arlington Centre Blvd, business offices (CompuServe
Wilson Rd. Campus)
Tuller Rd.
Manassas, VA Manassas Tech Center (AOL) 278,000 Owned and occupied by the Company.
New York, NY Business and editorial offices 1,522,400 Leased by the Company. Most leases
Time & Life Bldg. (Publishing) expire in 2017. Approximately
Rockefeller Center 39,800 sq. ft. are sublet to
outside tenants.
Atlanta, GA Executive and administrative 1,570,000 Owned by the Company.
One CNN Center offices, studio (TBS) retail, Approximately 146,000 sq. ft. are
hotel and theatres sublet to outside tenants.
Atlanta, GA Offices and studios (TBS) 436,000 Owned and occupied by the Company.
1050 Techwood Dr.
Atlanta, GA Sales and administrative offices 251,000 Leased by the Company. Lease
101 Marietta St., NW (TBS) expires in 2009.
Lebanon, IN Warehouse space (Publishing) 500,450 Leased by the Company. Lease
121 N. Enterprise Blvd. expires in 2006.
Lebanon, IN Warehouse space 251,350 Leased by the Company.
Lebanon Business (Publishing) Lease expires in 2009.
Park
Olyphant, PA Manufacturing, warehouses, 1,012,000 Owned and occupied by the Company.
East Lackawanna Ave. distribution and office space
(Music)
(table continued on next page)
I-32
(table continued from previous page)
APPROXIMATE
SQUARE FEET TYPE OF OWNERSHIP
LOCATION PRINCIPAL USE FLOOR SPACE EXPIRATION DATE OF LEASE
-------- ------------- ----------- ------------------------
Aurora, IL Offices/warehouse (Music) 602,000 Owned and occupied by the Company.
948 Meridian Lake
Alsdorf, Germany Manufacturing, distribution and 269,000 Owned and occupied by the Company.
Max-Planck Strasse 1-9 office space (Music)
Terre Haute, Indiana Manufacturing and office space 269,000 Leased by the Company. Lease
4025 3rd Pkwy. (Music) expires in 2011.
NETWORKS -- HBO, FILMED ENTERTAINMENT AND CABLE
The following table sets forth certain information as of December 31, 2000
with respect to principal properties (over 250,000 square feet in area) owned or
leased by the Company's Networks -- HBO, Filmed Entertainment and cable
television businesses, all of which the Company considers adequate for its
present needs, and all of which were substantially used by TWE:
APPROXIMATE
SQUARE FEET TYPE OF OWNERSHIP;
LOCATION PRINCIPAL USE FLOOR SPACE/ACRES EXPIRATION DATE OF LEASE
-------- ------------- ----------------- ------------------------
New York, NY Business offices (HBO) 350,000 sq. ft. Leased by TWE.
1100 and 1114 and 244,000 sq. ft. Leases expire in 2018.
Ave. of the
Americas
Burbank, CA Sound stages, administrative, 3,303,000 sq. ft. of Owned by TWE.
The Warner Bros. technical improved space on
Studio and dressing room 158 acres(a)
structures, screening
theaters, machinery and
equipment facilities, back
lot and parking lot and
other Burbank properties
(Filmed Entertainment)
Baltimore, MD Warehouse (Filmed 387,200 sq. ft. Owned by TWE.
White Marsh Entertainment)
Valencia, CA Location filming (Filmed 232 acres Owned by TWE.
Undeveloped Land Entertainment)
---------
(a) Ten acres consist of various parcels adjoining The Warner Bros. Studio,
with mixed commercial, office and residential uses.
I-33
ITEM 3. LEGAL PROCEEDINGS
The Company is a party to various litigation matters, investigations and
proceedings, including:
Following the announcement in January 2000 of the merger of Time Warner
and America Online, several lawsuits were filed naming as defendants one or more
of America Online, directors of America Online, Time Warner and directors of
Time Warner. The complaints purported to be filed on behalf of certain
shareholders of America Online or Time Warner, alleging breach of fiduciary
duty and seeking to enjoin the merger and unspecified compensatory damages.
While a number of these lawsuits remain pending, there has been no recent
activity.
America Online was named during 2000 as a defendant in a number of putative
class action lawsuits filed in state and federal courts nationwide alleging that
consumers and competing Internet service providers have been injured because of
the default selection features and the dial-up networking applications in AOL
versions 5.0 and 6.0 software. Claims include allegations of negligence,
Consumer Protection Act violations and Computer Fraud and Abuse Act violations.
Plaintiffs seek damages, an injunction of the distribution of the AOL versions
5.0 and 6.0 software and disgorgement of monies earned through the distribution
of the software. The federal 5.0 lawsuits have been consolidated in the U.S.
District Court for the Southern District of Florida and the federal 6.0 lawsuits
are expected to be consolidated shortly. There are also four state lawsuits
pending. America Online filed a motion to dismiss the consolidated litigation on
January 19, 2001, which is pending. Although the Company does not believe these
lawsuits have any merit and intends to defend against them vigorously the
Company is unable to predict the outcome of the cases, or reasonably estimate
a range of possible loss at the current status of the matters.
In the Spring of 1999, the Department of Labor ('DOL') began an
investigation of the applicability of the Fair Labor Standards Act ('FLSA') to
America Online's Community Leader program. America Online believes the Community
Leaders are volunteers, not employees, that the Community Leader program
reflects industry practices and that its actions comply with the law. America
Online is cooperating with the DOL's inquiry, but is unable to predict the
outcome of the DOL's investigation. In addition, former volunteers of the
Community Leader program have sued America Online in the U.S. District Court for
the Southern District of New York on behalf of an alleged class of current and
former Community Leader volunteers, alleging violations of the FLSA and
comparable state statutes. America Online filed a motion to dismiss on
December 8, 2000, which is pending. The Company believes the claims have no
merit and intends to defend against them vigorously. The Company is unable to
predict the outcome of the claims, nor can the Company reasonably estimate a
range of possible loss given the current status of the matters.
On June 24, 1997, plaintiffs in Six Flags Over Georgia LLC et al. v. Time
Warner Entertainment Company, L.P. et al., filed an amended complaint in the
Superior Court of Gwinnett County, Georgia, claiming that, inter alia,
defendants, which include TWE, violated their fiduciary duties in operating the
Six Flags Over Georgia amusement park. On December 18, 1998, following a trial,
a jury returned a verdict in favor of plaintiffs. The total awarded to
plaintiffs was approximately $454 million in compensatory and punitive damages.
Interest on the judgment is accruing at the Georgia statutory rate of 12%. The
case was appealed to the Georgia Court of Appeals, which affirmed the trial
court's judgment. TWE filed a motion for reconsideration with the Court of
Appeals, which was denied. Defendants filed a petition for certiorari with the
Supreme Court of Georgia seeking review of the decision of the Court of Appeals,
which was denied on January 18, 2001. A petition for reconsideration of that
decision was also denied, and TWE filed for a stay of the punitive damages with
the U.S. Supreme Court. The Supreme Court granted this stay on March 1, 2001.
Since 1995, several purported class action lawsuits brought by direct
purchasers of compact discs (CDs) were filed against WEA Corp., among other
defendants, alleging that several CD distribution companies affiliated with the
five major record companies violated federal antitrust laws by engaging in a
conspiracy to fix prices. These lawsuits have been consolidated in the U.S.
District Court for the Central District of California. The Court has denied
class status in this matter in a decision dated June 15, 2000. On October 23,
2000, defendants filed a motion for summary judgment, which is pending.
I-34
A related lawsuit, Ottinger & Silvey et al. v. EMI Music Distribution, Inc.
et al., was brought in the Circuit Court of Cocke County, Tennessee in 1998 on
behalf of persons in sixteen states and the District of Columbia who allegedly
indirectly purchased CDs from the same group of record distribution companies.
Plaintiff alleges that defendants are engaged in a conspiracy to fix CD prices,
in violation of the antitrust, unfair trade practices, and consumer protection
statutes. Cases similar to Ottinger were filed subsequently in seven additional
states. In May 1998, defendants filed a motion to dismiss the Ottinger
complaint, which has been denied. Motions to dismiss in the lawsuits in the
seven additional states have been filed and are pending.
A number of lawsuits were brought in 2000 against WEA Corp., along with the
other major record companies, in various state and federal courts by purported
classes of direct and/or indirect purchasers of CDs, including consumers,
alleging that defendants engaged in vertical and/or horizontal conspiracies to
engage in price fixing in violation of state and federal law. Among these
lawsuits is a federal action commenced by the Attorneys General of 42 states and
3 territories. These lawsuits focus on the companies' minimum advertising
pricing ('MAP') programs. The federal lawsuits, as well as the state lawsuits
that were removed to federal court, were consolidated in the U.S. District Court
for the District of Maine. The remaining state court cases are pending in their
respective jurisdictions.
As to each of the music antitrust matters described above, the Company
believes the claims have no merit and intends to defend against them vigorously.
The Company is unable to predict the outcome of the claims, nor can the Company
reasonably estimate a range of possible loss given the current status of
the matters.
On January 25, 2001, the European Commission ('EC') directed a questionnaire
to the Company, along with the other major record companies, as part of an
investigation of the vertical relationship between record companies and
retailers in certain European Union member states. The focus of the
investigation is on the record companies' policies regarding supply, price,
discounting and cooperative advertising. The Company is cooperating with the
investigation, but is unable to predict its outcome.
On February 8, 2001, the United Kingdom Office of Fair Trading announced
that it had initiated an investigation of several record companies in that
country, including Warner Music UK Limited, regarding record companies' policies
in regard to parallel imports of CDs into the United Kingdom. Warner Music UK
Limited is cooperating with the investigation, but is unable to predict its
outcome.
In 2000, several consumer class action lawsuits were brought against a large
number of magazine publishers, including Time Inc., alleging that defendants
violated federal antitrust law by purportedly agreeing to limit the extent to
which they discount the price of subscriptions to their magazines. These
lawsuits have been consolidated in the U.S. District Court for the Southern
District of New York. Plaintiffs filed a motion for partial summary judgment on
November 1, 2000, which is pending. Although the Company does not believe these
lawsuits have any merit and intends to defend against them vigorously, the
Company is unable to predict the outcome of the cases, or reasonably estimate
a range of possible loss due to the preliminary nature of the matters.
In July 1999, the former President of Indonesia, H.M. Suharto, filed a
lawsuit in the Central Jakarta District Court in Indonesia against Time Inc.
Asia and certain individuals, alleging that the May 24, 1999 issue of the Asian
edition of Time Magazine defamed him in violation of Indonesian law. The
complaint sought a public retraction and apology, as well as $27 billion in
compensatory damages for alleged harm to Suharto's reputation. Following the
presentation of oral and written evidence, the district court ruled in Time
Inc.'s favor on all counts on June 6, 2000. Suharto filed an appeal of the
district court's ruling on July 12, 2000, which is pending.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
I-35
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 20, 2001, of
such officer.
NAME AGE OFFICE
---- --- ------
Stephen M. Case...................... 42 Chairman of the Board
Gerald M. Levin...................... 61 Chief Executive Officer
Richard D. Parsons................... 52 Co-Chief Operating Officer
Robert W. Pittman.................... 47 Co-Chief Operating Officer
R. E. Turner......................... 62 Vice Chairman and Senior Advisor
Kenneth J. Novack.................... 59 Vice Chairman
Paul T. Cappuccio.................... 39 Executive Vice President, General Counsel and
Secretary
David M. Colburn..................... 41 Executive Vice President and President of
Business Development for Subscription Services
and Advertising and Commerce Businesses
J. Michael Kelly..................... 44 Executive Vice President and Chief Financial
Officer
Kenneth B. Lerer..................... 49 Executive Vice President
William J. Raduchel.................. 54 Executive Vice President and Chief Technology
Officer
Mayo S. Stuntz, Jr. ................. 51 Executive Vice President
George Vradenburg, III............... 58 Executive Vice President, Global and Strategic
Policy
Set forth below are the principal positions held by each of the executive
officers named above:
Mr. Case............................. Chairman of the Board since the consummation of the
Merger. A co-founder of America Online, Mr. Case had
been Chairman of the Board of Directors of America
Online since October 1995, CEO of America Online since
April 1993, and held various other executive
positions with America Online prior to that.
Mr. Levin............................ Chief Executive Officer since the incorporation of
the Company in February 2000 and continues to serve
in that position; prior to the Merger he was Chairman
of the Board of Directors and Chief Executive Officer
of Time Warner since 1993.
Mr. Parsons.......................... Co-Chief Operating Officer since the consummation of
the Merger; prior to that, he was President of Time
Warner since February 1995. He previously served as
Chairman and Chief Executive Officer of The Dime
Savings Bank of New York, FSB from January 1991.
(table continued on next page)
I-36
(table continued from previous page)
Mr. Pittman.......................... Co-Chief Operating Officer since the consummation of
the Merger; prior to that, Mr. Pittman served as
President and Chief Operating Officer of America
Online since February 1998 and as a director since
1995. He was President and CEO of AOL Networks
from November 1996 until February 1998. Prior to
that, he held the positions of Managing Partner
and CEO of Century 21 Real Estate Corp. from
October 1995 to October 1996 and President and
CEO of Time Warner Enterprises, a division of TWE,
and Chairman and CEO of Six Flags Entertainment
Corporation, the theme park operator, prior to that.
Mr. Turner........................... Vice Chairman since the consummation of the Merger;
prior to that, he was Vice Chairman of Time Warner
since the consummation of the merger of Turner
Broadcasting System, Inc. ('TBS') and Time Warner
in October 1996. Prior to that, he served as
Chairman of the Board and President of TBS from
1970.
Mr. Novack........................... Vice Chairman since the consummation of the Merger;
prior to that, he served as Vice Chairman of America
Online since May 1998 and as a director since
January 2000. Mr. Novack has been Of Counsel to
the Boston-based law firm of Mintz, Levin, Cohn,
Ferris, Glovsky and Popeo, PC, since his
retirement as a member of that firm in August
1998. Mr. Novack had been President and CEO of
the firm from 1991 to 1994.
Mr. Cappuccio........................ Executive Vice President, General Counsel and
Secretary since the consummation of the Merger;
prior to that, he served as Senior Vice President
and General Counsel of America Online since August
1999. Before joining America Online, from 1993 to
1999, Mr. Cappuccio was a partner at the
Washington, D.C. office of the law firm of
Kirkland & Ellis.
Mr. Colburn.......................... Executive Vice President and President of Business
Development for Subscription Services and Advertising
and Commerce Businesses since the consummation of the
Merger; prior to that, he was President of Business
Affairs for America Online since January, 2000, and
Senior Vice President, Business Affairs, from March
1997, having joined America Online in August
1995.
(table continued on next page)
I-37
(table continued from previous page)
Mr. Kelly............................ Executive Vice President and Chief Financial Officer
since the consummation of the Merger; prior to that,
he was Senior Vice President and Chief Financial
Officer of America Online since July 1998. Prior
to joining America Online, he was Executive Vice
President -- Finance and Planning and Chief
Financial Officer of GTE Corporation, a
telecommunications company (now part of Verizon).
Mr. Kelly was appointed GTE's Senior Vice
President -- Finance in 1994, receiving the
responsibility for Corporate Planning and
Development during 1997.
Mr. Lerer............................ Executive Vice President since the consummation of
the Merger, responsible for corporate communications
and investor relations; prior to that, he was
Senior Vice President of America Online since
October 1999. Previously, Mr. Lerer was a founder
and served as President of Robinson Lerer &
Montgomery, a corporate communications and
consulting firm.
Mr. Raduchel......................... Executive Vice President and Chief Technology
Officer since the consummation of the Merger; prior
to that, he was Senior Vice President and Chief
Technology Officer of America Online since
September 1999. Previously, he served as Chief
Strategy Officer and a member of the Executive
Committee of Sun Microsystems, Inc., a provider of
Internet hardware, software and services, from
January 1998 to September 1999, having previously
held a variety of management positions with Sun
Microsystems since 1988.
Mr. Stuntz........................... Executive Vice President since the consummation of
the Merger, with responsibility for coordinating
cross-divisional initiatives within the Company;
prior to that, he had been Chief Operating Officer
of America Online's Interactive Services Group
since March 1999 and President of CompuServe
Interactive Services since February 1998, having
joined America Online in August 1997. He had
previously been Chief Operating Officer and
Executive Vice President of Century 21 Real Estate
Corp. from October 1995 to June 1997.
Mr. Vradenburg....................... Executive Vice President, Global and Strategic
Policy since the consummation of the Merger; prior
to that, he had been Senior Vice President for
Global and Strategic Policy of America Online
since December 1998. Mr. Vradenburg served as
Senior Vice President, General Counsel and
Secretary of America Online from March 1997 to
December 1998. He was a Senior Partner with the
law firm of Latham & Watkins and co-chair of its
Entertainment & Media Practice Group from 1995 to
1997.
I-38
PART II
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. For quarterly price information with respect to America Online's
Common Stock for the two years ended December 31, 2000, see 'Quarterly Financial
Information' at page F-52 herein, which information is incorporated herein by
reference. The number of holders of record of the Company's Common Stock as of
March 1, 2001 was approximately 66,000.
Neither the Company nor America Online has paid any dividends since their
formation.
There is no established public trading market for the Company's Series
LMCN-V Common Stock, which as of March 1, 2001 was held of record by eight
holders.
ITEM 6. SELECTED FINANCIAL DATA.
The selected financial information of the Registrant for the five years
ended December 31, 2000 is set forth at page F-50 herein and is incorporated
herein by reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The information set forth at pages F-2 through F-18 herein is incorporated
herein by reference.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The information set forth at page F-18 herein is incorporated herein by
reference.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The consolidated financial statements of the Registrant and the report of
independent auditors thereon set forth at pages F-19 through F-48 and F-49
herein are incorporated herein by reference.
Quarterly Financial Information set forth at pages F-51 and F-52 herein is
incorporated herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Not applicable.
II-1
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 2001 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.
III-1
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES, AND REPORTS ON FORM 8-K
(a)(1)-(2) Financial Statements and Schedules:
The list of consolidated financial statements set forth in the accompanying
Index to Consolidated Financial Statements at page F-1 herein is incorporated
herein by reference. Such consolidated financial statements are filed as part of
this report.
All financial statement schedules are omitted because the required
information is not applicable, or because the information required is included
in the consolidated financial statements and notes thereto.
(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 10.29 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) Reports on Form 8-K.
(i) Time Warner Inc. filed a Current Report on Form 8-K dated October 5,
2000 in which it reported in Item 5 the termination of its proposed transaction
with EMI Group plc (filing date October 5, 2000).
(ii) The Company filed a Current Report on Form 8-K dated January 11, 2001
in which it reported in Item 2 the closing of the AOL-Time Warner merger (filing
date January 12, 2001).
(iii) The Company filed a Current Report on Form 8-K dated January 18, 2001
setting forth in Item 5 financial statements of America Online as of
September 30, 2000 adjusted to reflect purchase rather than pooling accounting
treatment for three acquisitions (filing date January 26, 2001).
(iv) The Company filed a Current Report on Form 8-K/A dated January 11, 2001
setting forth in Item 7 pro forma financial statements of the Company as of
September 30, 2000 (filing date January 26, 2001).
(v) The Company filed a Current Report on Form 8-K/A dated January 11, 2001
setting forth in Item 7 consolidated financial statements of Time Warner Inc.,
Time Warner Entertainment Company, L.P. ('TWE') and the TWE General partners for
the quarter and year ended December 31, 2000 (filing date February 9, 2001).
IV-1
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.
AOL TIME WARNER INC.
By /s/ J. MICHAEL KELLY
...................................
NAME: J. MICHAEL KELLY
TITLE: EXECUTIVE VICE PRESIDENT AND
CHIEF FINANCIAL OFFICER
Date: March 27, 2001
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
--------- ----- ----
Chairman of the Board March 27, 2001
/s/ STEPHEN M. CASE
.........................................
(STEPHEN M. CASE)
/s/ GERALD M. LEVIN Director and Chief Executive Officer March 27, 2001
......................................... (principal executive officer)
(GERALD M. LEVIN)
/s/ J. MICHAEL KELLY Executive Vice President and Chief March 27, 2001
......................................... Financial Officer (principal
(J. MICHAEL KELLY) financial officer)
/s/ JAMES W. BARGE Vice President and Controller March 27, 2001
......................................... (principal accounting officer)
(JAMES W. BARGE)
/s/ DANIEL F. AKERSON Director March 27, 2001
.........................................
(DANIEL F. AKERSON)
/s/ JAMES L. BARKSDALE Director March 27, 2001
.........................................
(JAMES L. BARKSDALE)
/s/ STEPHEN F. BOLLENBACH Director March 27, 2001
.........................................
(STEPHEN F. BOLLENBACH)
/s/ FRANK J. CAUFIELD Director March 27, 2001
.........................................
(FRANK J. CAUFIELD)
/s/ MILES R. GILBURNE Director March 27, 2001
.........................................
(MILES R. GILBURNE)
/s/ CARLA A. HILLS Director March 27, 2001
.........................................
(CARLA A. HILLS)
IV-2
SIGNATURE TITLE DATE
--------- ----- ----
/s/ REUBEN MARK Director March 27, 2001
.........................................
(REUBEN MARK)
/s/ MICHAEL A. MILES Director March 27, 2001
.........................................
(MICHAEL A. MILES)
/s/ KENNETH J. NOVACK Director March 27, 2001
.........................................
(KENNETH J. NOVACK)
/s/ RICHARD D. PARSONS Director March 27, 2001
.........................................
(RICHARD D. PARSONS)
/s/ ROBERT W. PITTMAN Director March 27, 2001
.........................................
(ROBERT W. PITTMAN)
/s/ FRANKLIN D. RAINES Director March 27, 2001
.........................................
(FRANKLIN D. RAINES)
/s/ R. E. TURNER Director March 27, 2001
.........................................
(R. E. TURNER)
/s/ FRANCIS T. VINCENT, JR. Director March 27, 2001
.........................................
(FRANCIS T. VINCENT, JR.)
IV-3
AMERICA ONLINE, INC. (PREDECESSOR TO AOL TIME WARNER INC.)
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. F-2
Consolidated Balance Sheets as of December 31, 2000 and
1999...................................................... F-19
Consolidated Statements of Operations for the years ended
December 31, 2000, 1999 and 1998.......................... F-20
Consolidated Statements of Cash Flows for the years ended
December 31, 2000, 1999 and 1998.......................... F-21
Consolidated Statements of Changes in Stockholders' Equity
for the years ended December 31, 2000, 1999 and 1998...... F-22
Notes to Consolidated Financial Statements.................. F-23
Report of Independent Auditors.............................. F-49
Selected Financial Information.............................. F-50
Quarterly Financial Information............................. F-51
F-1
AMERICA ONLINE, INC. (PREDECESSOR TO AOL TIME WARNER INC.)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
AMERICA ONLINE-TIME WARNER MERGER
On January 11, 2001, America Online, Inc. ('America Online') and Time Warner
Inc. ('Time Warner') completed their previously announced merger pursuant to the
Second Amended and Restated Agreement and Plan of Merger among the companies and
certain of subsidiaries dated as of January 10, 2000 (the 'Merger'). The
combined company is named AOL Time Warner Inc. ('AOL Time Warner').
The Merger was structured as a stock-for-stock exchange. Prior to the
Merger, America Online and Time Warner formed a new holding company called AOL
Time Warner and the new holding company formed two wholly owned subsidiaries.
Upon the closing of the transaction, one subsidiary merged with and into America
Online and one subsidiary merged with and into Time Warner. As a result, America
Online and Time Warner each became a wholly owned subsidiary of AOL Time Warner.
As part of the merger, each issued and then outstanding share of each class of
common stock of Time Warner was converted into 1.5 shares of an identical series
of common stock of AOL Time Warner. Each issued and then outstanding share of
common stock of America Online was converted into one share of common stock of
AOL Time Warner.
As a result of the Merger, the former shareholders of America Online have an
approximate 55% interest in AOL Time Warner and the former shareholders of Time
Warner have an approximate 45% interest in AOL Time Warner, expressed on a fully
diluted basis. The Merger will be accounted for by AOL Time Warner as an
acquisition of Time Warner under the purchase method of accounting for business
combinations. Under the purchase method of accounting, the estimated cost of
approximately $147 billion to acquire Time Warner, including transaction costs,
will be allocated to its underlying net assets in proportion to their respective
fair values. Any excess of the purchase price over estimated fair values of the
net assets acquired will be recorded as goodwill.
AOL Time Warner classifies its business interests into six fundamental
areas: AOL, consisting principally of interactive services, Web brands, Internet
technologies and electronic commerce services; Cable, consisting principally of
interests in cable television systems; Filmed Entertainment, consisting
principally of interests in filmed entertainment and television production;
Networks, consisting principally of interests in cable television and broadcast
network programming; Music, consisting principally of interests in recorded
music and music publishing; and Publishing, consisting principally of interests
in magazine publishing, book publishing and direct marketing.
Because the Merger was not consummated on or before December 31, 2000, the
following discussion and accompanying consolidated financial statements reflect
only the financial results of America Online, as predecessor of AOL Time Warner.
For additional information on the Merger, see Note 1 of the Notes to the
Consolidated Financial Statements.
OVERVIEW
Founded in 1985, America Online, based in Dulles, Virginia, is the world's
leader in interactive services, Web brands, Internet technologies, and
electronic commerce services.
As of December 31, 2000, America Online had four major lines of businesses:
o the Interactive Services Group
o the Interactive Properties Group
o the AOL International Group
o the Netscape Enterprise Group
The lines of business are described below.
The Interactive Services Group develops and operates branded interactive
services, including:
o the AOL service, a worldwide Internet online service with approximately
26.7 million members as of December 31, 2000
F-2
AMERICA ONLINE, INC. (PREDECESSOR TO AOL TIME WARNER INC.)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED)
o the CompuServe service, a worldwide Internet online service with
approximately 3 million members as of December 31, 2000
o Netscape.com, an Internet portal
o the AOL Anywhere web site
o the Netscape browser software
o the AOLTV service, an interactive television service for mass-market
consumers
o the AOL Mobile services, which deliver features and content of the AOL
service and branded properties to wireless consumers
The Interactive Properties Group is built around branded properties that
operate across multiple services and platforms, such as:
o Digital City, Inc., the leading local online network and community guide on
the AOL service and the Internet based on the number of visitors per month
o ICQ, the world's leading communications portal, based on the number of
registered users, that provides instant communications and chat technology
o AOL Instant Messenger, a Web-based communications service that enables
Internet users to send and respond in real time to private personalized
electronic messages
o Moviefone, Inc., the nation's No. 1 movie guide and ticketing service based
on the number of users
o Internet music brands Spinner.com, Winamp and SHOUTcast
o MapQuest.com, a leader in destination information solutions
o 'AOLbyPhone,' a voice portal that enables AOL members to check their
e-mail and access other popular AOL features conveniently through simple,
spoken commands from any telephone
The AOL International Group oversees the AOL and CompuServe services and
operations outside the United States, as well as the Netscape Online service in
the United Kingdom.
The Netscape Enterprise Group focuses on providing businesses a range of
software products, technical support, consulting and training services. These
products and services enable businesses and users to share information, manage
networks and facilitate electronic commerce. The Netscape Enterprise group
operates primarily through iPlanet E-Commerce Solutions, a strategic alliance
between America Online and Sun Microsystems, Inc. ('Sun Microsystems'), a leader
in network computing products and services, that was formed in November 1998 and
began operating in March 1999.
RESULTS OF OPERATIONS
CONSOLIDATED RESULTS
REVENUES
The following table and discussion highlights the revenues of America Online
for the years ended December 31, 2000, 1999 and 1998.
YEARS ENDED DECEMBER 31,
------------------------------------------------------
2000 1999 1998
-------------- -------------- --------------
(DOLLARS IN MILLIONS)
Revenues:
Subscriptions................................ $4,777 62.0% $3,874 67.6% $2,765 71.4%
Advertising and commerce..................... 2,369 30.8 1,240 21.7 612 15.8
Content and other............................ 557 7.2 610 10.7 496 12.8
------ ----- ------ ----- ------ -----
Total revenues............................... $7,703 100.0% $5,724 100.0% $3,873 100.0%
------ ----- ------ ----- ------ -----
------ ----- ------ ----- ------ -----
F-3
AMERICA ONLINE, INC. (PREDECESSOR TO AOL TIME WARNER INC.)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED)
America Online generates three main types of revenues: subscriptions;
advertising and commerce; and content and other. Subscription revenues are
generated from customers subscribing to America Online's AOL service and,
effective February 1, 1998, the CompuServe service. Additional subscription
revenues are generated from customers subcribing to America Online's custom
solutions services. Advertising and commerce revenues are non-subscription based
and are generated mainly from businesses marketing to America Online's base of
subscribers and users across its multiple brands. Advertising and commerce
revenues mainly consist of advertising and related revenues, the sale of
merchandise and fees associated with electronic commerce. Content and other
revenues consist principally of product licensing fees and fees from technical
support, consulting and training services.
Subscription Revenues
Currently, America Online's Interactive Services Group generates
subscription revenue primarily from subscribers paying a monthly membership fee.
America Online's current pricing options for the AOL service in the United
States are as follows:
o A standard monthly membership fee of $21.95, with no additional hourly
charges (the 'Flat-Rate Plan'). Subscribers can also choose to prepay for
one year in advance at an effective monthly rate of $19.95. America Online
increased the price of its Flat-Rate Plan from $19.95 per month to $21.95
per month, and the effective monthly rate of the annual plan from $17.95
per month to $19.95 per month, effective at the start of each member's
monthly billing cycle in April 1998. Those subscribers who were on the
annual plan at the time of change were not subject to an increase until
their renewal date.
o An alternative offering of three hours for $4.95 per month, with additional
time priced at $2.50 per hour.
o An alternative offering of $9.95 per month for unlimited use -- for those
subscribers who have an Internet connection other than through AOL and use
this connection to access AOL services.
America Online's current pricing options for CompuServe 2000 are as follows:
o A standard monthly membership offering of 20 hours for $9.95 per month,
with additional time priced at $2.95 per hour.
o An alternative monthly membership fee of $19.95, with no additional hourly
charges.
o An incentive rebate program offering a $400 rebate with a 3 year commitment
of $21.95 per month.
At December 31, 2000, America Online had approximately 26.7 million AOL
brand subscribers, of which approximately 21.5 million were in the United
States. Also at that date, America Online had approximately 3 million
CompuServe brand subscribers, of which approximately 2.2 million were in the
United States. At December 31, 1999, America Online had approximately 20.5
million AOL brand subscribers, of which approximately 17.4 million were in the
United States. Also at that date, America Online had approximately 2.5 million
CompuServe brand subscribers, of which approximately 1.6 million were in the
United States. As of December 31, 2000 and 1999, the AOL and CompuServe brands
had approximately 6 million and approximately 4 million subscribers,
respectively, outside of the United States.
For the year ended December 31, 2000, subscription revenues increased from
$3,874 million to $4,777 million, or 23%, over the year ended December 31, 1999.
This increase was primarily attributable to a 32% increase in the average number
of U.S. subscribers in the year ended December 31, 2000, compared to the year
ended December 31, 1999, offset in part by a slight decrease in the average
monthly subscription services revenue per U.S. subscriber. The decrease in the
average monthly subscription revenues per U.S. subscriber is due to the
different brands and services offered by America Online and the mix of multiple
price points offered by these brands and services, as well as certain
promotional bundling programs. Under these bundling programs,
F-4
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED)
customers of America Online's commerce partners typically receive a subscription
to America Online's online services as a result of purchasing a product from a
commerce partner. America Online records subscription revenues under these
bundling programs based upon the net amount received from the commerce partner.
For the year ended December 31, 1999, subscription revenues increased from
$2,765 million to $3,874 million, or 40%, over the year ended December 31, 1998.
This increase was primarily attributable to a 35% increase in the average number
of U.S. subscribers during 1999, compared to 1998, as well as a 4% increase in
the average monthly subscription revenues per U.S. subscriber. This increase in
the average monthly subscription revenues per U.S. subscriber was principally
attributable to the increase in the Flat-Rate Plan membership fee from $19.95 to
$21.95, which became effective in April 1998.
Advertising and Commerce Revenues
An important objective of America Online's business strategy is a continued
emphasis on growing the advertising and commerce revenues. These revenues
consist principally of advertising and related revenues, the sale of merchandise
and fees associated with electronic commerce across America Online's multiple
brands. During the year ended December 31, 2000, utilizing its large, active and
growing user base, America Online continued to build on its industry-leading
advertising and commerce revenue base through a series of major alliances with
leading brands and retailers. The user base not only includes the paying
subscribers of the AOL and CompuServe services, it also includes users of
America Online's other branded portals and services such as MapQuest.com, AOL
Moviefone, AOL Instant Messenger, Netscape.com, AOL.COM, ICQ and Digital City.
The following table summarizes the material components of advertising and
commerce revenues for the years ended December 31, 2000, 1999 and 1998.
YEARS ENDED DECEMBER 31,
------------------------------------------------------
2000 1999 1998
-------------- -------------- --------------
(DOLLARS IN MILLIONS)
Advertising and electronic commerce fees..... $2,115 89.3% $1,071 86.4% $ 519 84.8%
Merchandise.................................. 254 10.7 169 13.6 93 15.2
------ ----- ------ ----- ------ -----
Total advertising and commerce............... $2,369 100.0% $1,240 100.0% $ 612 100.0%
------ ----- ------ ----- ------ -----
------ ----- ------ ----- ------ -----
Advertising and commerce revenues increased by 91%, from $1,240 million
during the year ended December 31, 1999 to $2,369 million during the year ended
December 31, 2000. This increase was primarily attributable to additional
advertising and electronic commerce on America Online's AOL service, as well as
its other branded services and portals. Advertising and electronic commerce fees
increased by 97%, from $1,071 million during the year ended December 31, 1999 to
$2,115 million during the year ended December 31, 2000.
Advertising and commerce revenues increased by 103%, from $612 million
during the year ended December 31, 1998 to $1,240 million during the year ended
December 31, 1999. More advertising on America Online's AOL service and
Netcenter portal, as well as an increase in electronic commerce fees, primarily
drove the increase. Advertising and electronic commerce fees increased by 106%,
from $519 million during the year ended December 31, 1998 to $1,071 million
during the year ended December 31, 1999.
Content and Other Revenues
Content and other revenues consist primarily of product licensing fees and
fees from technical support, consulting and training services generated by
America Online's Netscape Enterprise Group. The Netscape Enterprise Group
focuses on providing businesses a range of software products, technical support,
consulting and training services. These products and services enable businesses
and users to share information, manage
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED)
networks and facilitate electronic commerce on the Internet. In November 1998,
America Online entered into a strategic alliance with Sun Microsystems to
accelerate the growth of electronic commerce. The alliance became effective in
March 1999. The strategic alliance provides that, over a three year period,
America Online and Sun Microsystems will jointly develop and market to business
enterprises, iPlanet client software and network application and server software
for electronic commerce, extended communities and connectivity. These products
will include software incorporating the Netscape code, Sun Microsystems code and
technology and certain America Online services features.
Content and other revenues decreased by 9%, from $610 million in 1999 to
$557 million in 2000. The decrease was primarily due to a decrease in
contractual obligations from Sun Microsystems, offset in part by an increase in
license revenues generated through the alliance with Sun Microsystems. In
addition, as a result of additional products being considered collaborative
(jointly developed by Netscape and Sun Microsystems), when these collaborative
products are sold by Sun Microsystems personnel, America Online records as
revenue the net payments received from Sun Microsystems. This results in lower
reported revenues and thus slower growth of reported revenues, but has not
impacted the gross margin and income from operations which has continued to
grow. See Segment Results of Operations for further discussion on the impact of
the alliance with Sun Microsystems.
Content and other revenues increased by 23%, from $496 million during the
year ended December 31, 1998 to $610 million during the year ended December 31,
1999. The increase was due to an increase in product sales related to server
applications and consulting services coupled with revenues generated from the
alliance with Sun Microsystems.
COSTS AND EXPENSES
The following table and discussion highlights the costs and expenses of
America Online for the years ended December 31, 2000, 1999 and 1998.
YEARS ENDED DECEMBER 31,
------------------------------------------------------
2000 1999 1998
-------------- -------------- --------------
(DOLLARS IN MILLIONS)
Total revenues............................... $7,703 100.0% $5,724 100.0% $3,873 100.0%
------ ----- ------ ----- ------ -----
------ ----- ------ ----- ------ -----
Costs and expenses:
Cost of revenues............................. $3,874 50.3% $3,324 58.1% $2,538 65.5%
Sales, general and administrative............ 1,902 24.7 1,390 24.3 1,034 26.7
Amortization of goodwill and other intangible
assets..................................... 100 1.3 68 1.2 49 1.3
Merger, restructuring and contract
termination charges........................ 10 0.1 123 2.1 50 1.3
Acquired in-process research and
development................................ -- -- -- -- 80 2.1
Settlement charges........................... -- -- -- -- 18 0.4
------ ----- ------ ----- ------ -----
Total costs and expenses..................... $5,886 76.4% $4,905 85.7% $3,769 97.3%
------ ----- ------ ----- ------ -----
------ ----- ------ ----- ------ -----
Cost of Revenues
Cost of revenues includes network-related costs, consisting primarily of
data network costs; personnel and related costs associated with operating the
data centers, data network and providing customer support; billing, consulting
and technical support/training; host computer and network equipment costs; costs
of merchandise sold; and product development costs. Product development costs
include research and development expenses and
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
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other product development costs including support and maintenance of America
Online's multiple interactive products.
America Online continues to experience increases in both subscriber usage,
which is primarily due to the growth of the subscriber base, and average monthly
usage per subscriber. Both of these growth factors have the potential to
increase network costs on an absolute dollar basis, as well as a
percentage-of-revenue basis. While the growth in subscriber usage and related
costs generally are consistent with the increases in subscription revenues, the
increase in usage and related costs per subscriber could impact operating
margins. America Online has minimized, and plans to continue to minimize, the
impact to costs associated with such growth by reducing network costs, on a
relative basis (either on a per-hour basis or as a percentage of total revenues)
and increasing advertising and commerce revenues. An important factor in
reducing network costs is the reduction of the costs of operating America
Online's data network, on a per-hour basis, through volume discounts and more
efficient utilization of AOLnet, America Online's TCP/IP network. America Online
expects the growth in advertising and commerce revenues, assuming such growth
continues, will provide the opportunity and flexibility to fund the costs
associated with the increased usage resulting from growing its subscriber base.
For the year ended December 31, 2000, cost of revenues increased from $3,324
million to $3,874 million, or 17%, over the year ended December 31, 1999, and
decreased as a percentage of total revenues from 58.1% to 50.3%. The increase in
cost of revenues in 2000 was primarily attributable to increases in host
computer and network equipment costs; data network costs and personnel and
related costs associated with operating the data centers and data network and
providing customer support. Additionally, an increase in costs related to
America Online's new custom services contributed to the overall growth of cost
of revenues. Total cost of revenue was partially offset by a decrease in cost of
revenues related to the Enterprise business as a result of the alliance with Sun
Microsystems. Collaborative products (jointly developed by Netscape and Sun
Microsystems) sold are recorded as net revenues by America Online when payments
are received from Sun Microsystems. As a result, America Online records no
expense related to these product sales resulting in lower cost of revenues
reported. Host computer and network equipment costs, consisting of lease,
depreciation and maintenance expenses; data network costs; and personnel and
related costs associated with operating the data centers, data network and
providing customer support increased as a result of the larger member base and
more usage by members, as well as supporting a larger data network. Costs
related to America Online's new custom services are a result of America Online's
agreement with Gateway, Inc., which was entered into in October 1999. Product
development costs increased due to an increase in the number of technical
employees to support additional products across multiple brands. The decrease in
cost of revenues as a percentage of total revenues was primarily attributable to
growth of the higher margin advertising and commerce revenues, as well as a
decrease in network-related costs as a percentage of subscription revenues. The
decrease in network-related costs as a percentage of subscription revenues was
primarily driven by a 19% decrease in the hourly network cost for the year ended
December 31, 2000 compared to the year ended December 31, 1999. The decrease in
the hourly network costs is mainly due to efficiencies America Online continues
to realize as a result of its size and scale, as well as lower negotiated rates
with its network providers. This decrease was partially offset by an increase in
daily member usage, from an average of nearly 55 minutes per day in the year
ended December 31, 1999 to an average of nearly 61 minutes per day in the year
ended December 31, 2000.
For the year ended December 31, 1999, cost of revenues increased from $2,538
million to $3,324 million, or 31%, over the year ended December 31, 1998, and
decreased as a percentage of total revenues from 65.5% to 58.1%. The increase in
cost of revenues during 1999 was primarily attributable to increases in data
network costs; personnel and related costs associated with operating the data
centers and data network and providing customer support, consulting, technical
support/training and billing; host computer and network equipment costs and
royalty expense. Data network costs increased primarily as a result of the
larger member base and more usage per member. Personnel and related costs
associated with operating the data centers, data network,
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED)
providing customer support and billing increased primarily as a result of the
requirements of supporting a larger data network, a larger member base and
increased subscription revenues. Personnel and related costs associated with
consulting and technical support/training increased due to providing additional
customer support and professional services. Host computer and network equipment
costs, consisting of lease, depreciation and maintenance expenses, increased
as a result of additional host computer and network equipment, required to serve
the larger member base and more usage by members. Product development costs
increased due to an increase in the number of technical employees to support
additional products across its multiple brands. The decrease in cost of revenues
as a percentage of total revenues was primarily attributable to growth of the
higher margin advertising and commerce revenues, as well as a decrease in
network-related costs as a percentage of subscription services revenue.
Sales, General and Administrative
Sales, general and administrative expenses include the costs to acquire and
retain subscribers, the operating expenses associated with the sales and
marketing organizations, other general marketing costs to support America
Online's multiple brands, bad debt and other general and administrative costs.
America Online's strategy continues to emphasize brand advertising across
multiple brands, as well as cost-effective bundling agreements, where its
products are widely distributed with new personal computers, the Windows
operating system and other peripheral computer equipment and software.
Additionally, America Online continues to market its products via direct mail
programs. These marketing initiatives coupled with improving subscriber
acquisition and retention rates, continue to create efficiencies in America
Online's marketing costs.
For the year ended December 31, 2000, sales, general and administrative
expenses increased from $1,390 million to $1,902 million, or 37%, over the year
ended December 31, 1999, and remained relatively unchanged as a percentage of
total revenues. The increase in sales, general and administrative expenses for
the year ended December 31, 2000 was mainly attributable to an increase in brand
advertising supporting multiple brands and direct subscriber acquisition costs;
an increase in bad debt expense related to the America Online services and
advertising revenues; and an increase in outside services and fees, primarily
accounting fees, temporary agency fees and legal costs. Brand advertising and
direct subscriber acquisition costs represent $254 million and bad debt expense
represents $155 million of the total increase in sales, general and
administrative costs. The increase in bad debt related to the America Online
services, was primarily the result of extending the collection period for
subscription fees and the CompuServe rebate program which was initiated in the
third quarter of the year ended December 31, 1999. The increase in subscription
revenues during the year ended December 31, 2000 also contributed to the
increase in bad debt. The increase in bad debt related to advertising was a
result of an increased number of advertising contracts entered into and the
overall growth of advertising revenues during the year ended December 31, 2000.
For the year ended December 31, 1999, sales, general and administrative
expenses increased from $1,034 million to $1,390 million, or 34%, over the year
ended December 31, 1998, and decreased as a percentage of total revenues from
26.7% to 24.3%. The increase in sales, general and administrative expenses for
1999 was mainly attributable to an increase in personnel costs, primarily
payroll taxes related to employee stock option exercises and personnel costs
associated with expanding the Netscape Enterprise business, direct subscriber
acquisition costs, and brand advertising across multiple brands. The decrease as
a percentage of total revenues was primarily a result of the substantial growth
in revenues.
Amortization of Goodwill and Other Intangible Assets
Amortization of goodwill and other intangible assets increased to $100
million in 2000 from $68 million in 1999. The increase in amortization expense
during the year ended December 31, 2000 is primarily attributable to
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED)
goodwill associated with the acquisitions of Quack.com, iAmaze, Inc., LocalEyes
Corporation and the remaining 20% interest in Digital City, Inc. during the year
ended December 31, 2000. For further information, refer to Note 6 of the Notes
to the Consolidated Financial Statements. In addition, America Online recognized
an intangible asset associated with the acquisition cost of Gateway.net
subscribers in December 1999. Amortization of goodwill and other intangible
assets increased to $68 million in the year ended December 31, 1999 from $49
million in the year ended December 31, 1998. The increase in amortization
expense during 1999 is primarily attributable to goodwill associated with the
acquisition of Mirabilis, Ltd. ('Mirabilis') in June 1998.
Merger and Restructuring Charges
For the year ended December 31, 2000, America Online recognized net charges
of $10 million primarily related to its merger of MapQuest.com, Inc., consisting
mainly of investment banking, legal and accounting services; contract
termination fees; and severance and other personnel costs. All of these costs
had been paid as of December 31, 2000.
For the year ended December 31, 1999, America Online recognized charges of
$123 million related to restructurings and mergers. All of these costs were paid
as of December 31, 2000.
o In connection with the mergers of Moviefone, Inc., Spinner Networks
Incorporated, NullSoft, Inc. and Tegic Communications, Inc., America Online
recorded direct merger-related costs of $20 million.
o In connection with plans announced and implemented in March 1999, America
Online recorded a charge of $103 million for direct costs related to the
merger with Netscape and America Online's reorganization plans to integrate
Netscape's operations and build on the strengths of the Netscape brand and
capabilities, as well as the merger with When, Inc.
For the year ended December 31, 1998, America Online recognized net charges
of $50 million related to restructurings and mergers. All of these costs had
been paid as of December 31, 2000.
o During the quarter ended December 1998, America Online recognized
approximately $2 million in merger related costs in connection with the
merger of AtWeb, Inc. These expenses were primarily associated with fees
for investment banking, legal and accounting services, severance costs and
other related charges in connection with the transaction.
o In connection with a restructuring plan adopted in the first quarter of the
year ended December 31, 1998, America Online recorded a $35 million
restructuring charge associated with the restructuring of its AOL Studios
brand group. The restructuring included costs of exiting certain business
activities, the termination of approximately 160 employees and the shutdown
of certain subsidiaries and facilities.
o Also, in the first quarter of the year ended December 31, 1998, America
Online recorded a $13 million restructuring charge related to the
implementation of certain restructuring actions mainly related to the
Netscape Enterprise Group. These actions were aimed at reducing its cost
structure, improving its competitiveness and restoring sustainable
profitability. The restructuring plan resulted from decreased demand for
certain Enterprise products and the adoption of a new strategic direction.
The restructuring included a reduction in the workforce (approximately 400
employees), the closure of certain facilities, the write-off of
non-performing operating assets and third-party royalty payment obligations
relating to canceled contracts.
Refer to Note 3 of the Notes to Consolidated Financial Statements for
further information related to restructurings and merger costs.
Acquired In-Process Research and Development
America Online incurred a total of $80 million in acquired in-process
research and development ('IPR&D') charges in 1998 related to the acquisitions
of Mirabilis, Personal Library Software, Inc. ('PLS')
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED)
and NetChannel, Inc. ('NetChannel'). These transactions were accounted for under
the purchase method of accounting.
In June 1998, America Online acquired the assets, including the
developmental ICQ instant communications and chat technology, and assumed
certain liabilities of Mirabilis. The ICQ technology is an enabling technology
for online communication. At the date of acquisition, Mirabilis reported 12
million registered trial users of which approximately half were active. America
Online paid $287 million in cash and may pay up to $120 million in additional
contingent purchase payments based on future performance levels. As a result of
certain performance levels being satisfied, the Company paid $40 million in
August 2000 related to the contingent purchase price. America Online's
Consolidated Statements of Operations reflect a one-time write-off of the amount
of purchase price allocated to IPR&D of approximately $60 million.
In accounting for the acquisition of Mirabilis, America Online allocated the
excess purchase price over the fair value of net tangible assets and identified
intangible assets. In performing this allocation, America Online considered,
among other factors, the attrition rate of the active users of the technology at
the date of acquisition (estimated to be similar to the rate experienced by the
AOL service) and the research and development projects in-process at the date of
acquisition. With regard to the IPR&D projects, America Online considered, among
other factors, the stage of development of each project at the time of
acquisition, the importance of each project to the overall development plan, and
the projected incremental cash flows from the projects when completed and any
associated risks. Associated risks include the inherent difficulties and
uncertainties in completing each project and thereby achieving technological
feasibility and risks related to the impact of potential changes in future
target markets. If these projects are not successfully developed, America Online
may not realize the value assigned to the IPR&D projects. In addition, the value
of the other acquired intangible assets may also become impaired.
America Online acquired PLS, a developer of information indexing and search
technologies in January 1998 and NetChannel, a Web-enhanced television company,
in June 1998. In connection with the purchases of PLS and NetChannel, America
Online recorded charges for acquired IPR&D in the year ended December 31, 1998
of $10 million related to each acquisition.
The technology, market and development risk factors discussed above for the
Mirabilis acquisition are also relevant and should be considered with regard to
the acquisitions of PLS and NetChannel.
Settlement Charges
In the year ended December 31, 1998, America Online recorded a net
settlement charge of $18 million in connection with the settlement of the Orman
v. America Online, Inc. class action lawsuit filed in U.S. District Court for
the Eastern District of Virginia alleging violations of federal securities laws
between August 1995 and October 1996.
OTHER INCOME, NET
Other income, net, consists primarily of net investing activities including
interest income, interest expense and gains and losses recognized on
available-for-sale securities and securities classified as derivatives. America
Online had other income of $67 million, $815 million and $41 million in the
years ended December 31, 2000, 1999 and 1998, respectively. The decrease in
other income, net, in the year ended December 31, 2000 was primarily
attributable to a loss of $465 million on investments as a result of declines in
market values deemed to be other-than-temporary. In addition, America Online
adopted Financial Accounting Standards Board Statement No. 133 'Accounting for
Derivative Instruments and Hedging Activities' ('FAS 133') in the third quarter
of the year ended December 31, 2000. In accordance with the provisions of
FAS 133, America Online incurred a loss of $70 million due to a reduction in
the value of securities that meet the derivative criteria established by
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED)
FAS 133. Including these adjustments, the value of the investments, including
available-for-sale securities was $3,824 million at December 31, 2000. These
losses in the year ended December 31, 2000 were offset by realized gains on
available-for-sale securities of approximately $392 million and net interest
income of approximately $275 million. The increase in other income, net, in
the year ended December 31, 1999 was primarily attributable to realized gains
on investments of $692 million in the year ended December 31, 1999, including
a net gain of $567 million related to the sale of investments in Excite, Inc.,
compared to realized gains of $20 million in 1998, coupled with an increase
in interest income.
America Online's investment portfolio of available-for-sale securities is
primarily invested in Internet and technology companies. These
available-for-sale investments are subject to significant fluctuations in fair
market value due to the volatility of the stock market and the industries in
which it is invested. America Online has realized gains and losses from both the
sale of investments, as well as mergers and acquisitions of companies in which
it is invested. In addition, changes in the value of securities that meet the
derivative criteria established in FAS 133, are recorded in other income. See
Notes 2 and 11 of the Notes to the Consolidated Financial Statements for
additional information on FAS 133. America Online's objective is to minimize the
impact of stock market declines on its earnings and cash flows. Continued market
volatility, as well as mergers and acquisitions, have the potential to have a
material non-cash impact on the operating results of America Online in future
periods.
INCOME TAX PROVISION
The income tax provision was $732 million, $607 million and $30 million in
the years ended December 31, 2000, 1999 and 1998, respectively. The increase in
the provision for income taxes in the year ended December 31, 1999 is a direct
result of America Online's increase in pre-tax income. For additional
information regarding income taxes, refer to Note 12 of the Notes to the
Consolidated Financial Statements.
SEGMENT RESULTS
As of December 31, 2000, America Online had four operating segments, of
which two are reportable segments, that share the same infrastructure. For
further information regarding segments, refer to Note 7 of the Notes to the
Consolidated Financial Statements.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED)
A summary of the segment financial information is as follows:
YEARS ENDED DECEMBER 31,
------------------------
2000 1999 1998
------ ------ ------
(AMOUNTS IN MILLIONS)
Revenues:
Interactive Services Group(1)............................... $6,879 $5,059 $3,441
Netscape Enterprise Group(2)................................ 359 447 357
Other Segments(3)........................................... 465 218 75
------ ------ ------
Total revenues.............................................. $7,703 $5,724 $3,873
------ ------ ------
------ ------ ------
Income (loss) from operations:
Interactive Services Group(1)............................... $1,958 $1,280 $ 616
Netscape Enterprise Group(2)................................ 153 40 (54)
Other Segments(3)........................................... 185 49 (10)
General & Administrative(4)................................. (469) (427) (300)
Other charges............................................... (10) (123) (148)
------ ------ ------
Total income from operations................................ $1,817 $ 819 $ 104
------ ------ ------
------ ------ ------
---------------
(1) For the years ended December 31, 2000, 1999 and 1998, the Interactive
Services Group includes online service revenues of $4,777 million, $3,874
million and $2,765 million, respectively; advertising and commerce revenues
of $2,022 million, $1,116 million and $591 million, respectively; content
and other revenues of $80 million, $69 million and $85 million,
respectively; and goodwill and other intangible assets amortization of $51
million, $39 million and $25 million, respectively.
(2) For the years ended December 31, 2000, 1999 and 1998, the Netscape
Enterprise Group is comprised solely of content and other revenues and
includes goodwill and other intangible assets amortization of $0 million, $0
million and $10 million, respectively.
(3) For the years ended December 31, 2000, 1999 and 1998, Other Segments include
advertising and commerce revenues of $347 million, $124 million and $21
million, respectively; content and other revenues of $118 million, $94
million and $54 million, respectively; and goodwill and other intangible
assets amortization of $49 million, $29 million and $14 million,
respectively.
(4) Bad debt expense has been allocated to the applicable segment.
For an overview of the segment revenues, refer to the consolidated results
of operations discussion earlier in this section.
Interactive Services Group income from operations increased from $616
million in the year ended December 31, 1998 to $1,280 million in the year ended
December 31, 1999 and $1,958 million in the year ended December 31, 2000. These
increases are mainly the result of increases in subscription revenues and
advertising and commerce revenues coupled with increased network efficiencies.
Netscape Enterprise Group income/loss from operations improved from a loss
of $54 million in the year ended December 31, 1998 to income of $40 million in
the year ended December 31, 1999 to income of $153 million in the year ended
December 31, 2000. These improvements were mainly attributable to an increase in
gross margins, as well as a decline in operating expenses, as the Netscape
Enterprise Group began to realize efficiencies from using America Online's
infrastructure. In addition, the Netscape Enterprise Group experienced benefits
from the alliance with Sun Microsystems, which became effective in March 1999.
Other Segments income/loss from operations improved from a loss of $10
million in the year ended December 31, 1998 to income of $49 million in the year
ended December 31, 1999 to income of $185 million in the year ended December 31,
2000. These improvements were mainly attributable to an increase in Interactive
Properties advertising revenues partially offset by an increase in cost of
revenues, selling, general and administrative costs and product development
costs.
LIQUIDITY AND CAPITAL RESOURCES
America Online has financed its operations primarily through cash generated
from operations. In addition, America Online has generated cash from the sale of
its convertible notes, the sale of marketable securities and the sale of its
capital stock. In addition to purchasing telecommunications equipment, America
Online also
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enters into operating leases for the use of this equipment. Net cash provided
by operating activities was $1,958 million, $1,640 million and $554 million
in the years ended December 31, 2000, 1999 and 1998, respectively, and
increased primarily due to America Online's increase in net income. Net cash
used in investing activities was $2,323 million, $2,347 million and $419 million
in the years ended December 31, 2000, 1999 and 1998, respectively. Cash used in
investing activities included approximately $1.9 billion of investments in
available-for-sale securities acquired during the year ended December 31, 2000
and approximately $2.5 billion acquired during the year ended December 31, 1999,
including America Online's $1.5 billion investment in a General Motors equity
security related to the strategic alliance it entered into with Hughes
Electronics Corporation. Cash used in investing activities during the year ended
December 31, 1999 was offset by net proceeds of approximately $567 million
related to the sale of Excite, Inc. investments. Net cash provided by financing
activities was $421 million, $1,729 million and $817 million in the years ended
December 31, 2000, 1999 and 1998, respectively. Included in financing activities
for the year ended December 31, 1999 were approximately $1.2 billion in net
proceeds from the issuance of convertible debt. Included in financing activities
for the year ended December 31, 1998 were $550 million in aggregate net proceeds
from a public offering of its common stock.
America Online has used its working capital to finance ongoing operations
and to fund the marketing and development of its products and services. America
Online plans to continue to invest in subscriber acquisition, retention and
brand marketing to expand its subscriber base, as well as in network, computing
and support infrastructure. Additionally, America Online expects to use a
portion of its cash for the acquisition and subsequent funding of technologies,
content, products or businesses complementary to America Online's current
business.
At December 31, 2000, America Online had working capital of $2,343 million,
compared to working capital of $1,698 million at December 31, 1999. In addition,
America Online had investments including available-for-sale securities of $3,824
million and $4,902 million at December 31, 2000 and 1999, respectively. Current
assets increased by $796 million, from $3,875 million at December 31, 1999 to
$4,671 million at December 31, 2000, while current liabilities increased by $151
million, from $2,177 million to $2,328 million, over this same period. The
increase in current assets was primarily attributable to an increase in cash and
short-term investments resulting from cash generated by operations. The change
in current liabilities was primarily due to an increase in deferred revenues,
partially offset by a reduction in other accrued liabilities and accrued
personnel costs.
On November 15, 2000, America Online exercised its option to redeem in
whole, the 4% Convertible Subordinated Notes due November 15, 2002, (the
'Notes'). Under the redemption prices set forth in the Notes, America Online was
obligated to redeem the outstanding Notes at a price of 101.6% (expressed as a
percentage of principal amount) together with accrued interest at the date of
redemption. At the election of the noteholders the entire outstanding principal
balance of the Notes as of the redemption date was converted into approximately
37.7 million shares of America Online's common stock.
During December 1999, America Online sold $2.3 billion aggregate principal
at maturity of zero-coupon Convertible Subordinated Notes (the 'Zero-Coupon
Notes') due December 6, 2019 and received net proceeds of approximately $1.2
billion. Also, in December 1999, the underwriters exercised the overallotment
option on the Zero-Coupon Notes. As a result, on January 5, 2000, America Online
sold additional Zero-Coupon Notes with aggregate principal at maturity of
approximately $55.6 million for net proceeds of approximately $30 million.
For additional information regarding these notes, refer to Note 10 of the Notes
to the Consolidated Financial Statements.
During July 1998, America Online sold approximately 43.2 million shares of
common stock and raised a total of $550 million in new equity, which was used
for general corporate purposes.
On March 17, 2000, America Online and Bertelsmann AG announced a global
alliance to expand the distribution of Bertelsmann's media content and
electronic commerce properties over America Online's interactive brands
worldwide. America Online and Bertelsmann also announced an agreement to
restructure their interests in the AOL Europe and AOL Australia joint ventures.
This restructuring consists of a put and call
F-13
AMERICA ONLINE, INC. (PREDECESSOR TO AOL TIME WARNER INC.)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED)
arrangement for America Online to purchase, in two installments, Bertelsmann's
50% interest in AOL Europe for consideration ranging from $6.75 billion to
$8.25 billion, payable at America Online's option in cash, AOL Time Warner
stock or a combination of cash and stock. For additional information regarding
these announcements, see Note 6 of the Notes to the Consolidated Financial
Statements.
In June 1998, America Online purchased Mirabilis for $287 million in cash
(and contingent purchase price payments of up to $120 million) and NetChannel
for $16 million in cash. For additional information regarding these
acquisitions, see Note 6 of the Notes to the Consolidated Financial Statements.
In January 1998, America Online consummated a Purchase and Sale Agreement
(the 'Purchase and Sale') by and among America Online, ANS Communications, Inc.
('ANS'), a then wholly-owned subsidiary of America Online, and WorldCom, Inc.
('WorldCom') pursuant to which America Online transferred to WorldCom all of the
issued and outstanding capital stock of ANS in exchange for the online services
business of CompuServe Corporation ('CompuServe'), which was acquired by
WorldCom shortly before the consummation of the Purchase and Sale, and $147
million in cash (excluding $15 million in cash received as part of the
CompuServe online services business and after purchase price adjustments made at
closing). Immediately after the consummation of the Purchase and Sale, America
Online's European partner, Bertelsmann AG, paid $75 million to America Online
for a 50% interest in a newly created joint venture to operate the CompuServe
European online service. Each company invested an additional $25 million in cash
in this joint venture. America Online generated $207 million in net cash as a
result of the aforementioned transactions.
As previously announced, America Online had outstanding at December 31, 2000
commitments to purchase additional ownership in a joint venture and a partner
of a strategic alliance. These commitments total approximately $657 million to
be paid by December 31, 2001. Of this total, approximately $238 million was
paid in February 2001.
America Online enters into multiple-year data communications agreements in
order to support AOLnet. In connection with those agreements, America Online may
commit to purchase certain minimum data communications services. Should America
Online not require the delivery of such minimums, America Online's per hour data
communications costs may increase. For additional information regarding America
Online's commitments, see Note 9 of the Notes to the Consolidated Financial
Statements.
America Online leases the majority of its equipment under non-cancelable
operating leases. America Online is building AOLnet, its data communications
network, as well as expanding its data center capacity. The buildout of AOLnet
and the expansion of data center capacity requires a substantial investment in
telecommunications and server equipment. America Online plans to continue making
significant investments in these areas. America Online is funding these
investments, which are anticipated to total approximately $700 million in the
year ended December 31, 2001, through a combination of leases and cash
purchases.
IMPACT OF THE AMERICA ONLINE-TIME WARNER MERGER ON LIQUIDITY
INCREASED BORROWING CAPACITY
As a combined company, AOL Time Warner's combined borrowing capacity
increased. Significantly adding to this capacity are two revolving credit
facilities (the Bank Credit Agreement and the Stock Options Proceeds Credit
Facility) previously held by Time Warner.
Bank Credit Agreement
The Bank Credit Agreement permits borrowings in an aggregate amount of up to
$7.5 billion, with no scheduled reduction in credit availability prior to
maturity in November 2002. The borrowers under the Bank Credit Agreement are
Time Warner and a number of its consolidated subsidiaries. Borrowings may be
used for general business purposes and unused credit is available to support
commercial paper borrowings. At December 31, 2000, Time Warner's borrowings
under the Bank Credit Agreement were approximately $6.8 billion.
F-14
AMERICA ONLINE, INC. (PREDECESSOR TO AOL TIME WARNER INC.)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED)
Stock Options Proceeds Credit Facility
In connection with a previously existing common stock repurchase program,
Time Warner established a $1.3 billion revolving credit facility that provided
for borrowings against future stock option proceeds. At December 31, 2000 Time
Warner had no outstanding borrowings against future stock option proceeds.
Borrowing availability under the Stock Option Proceeds Facility was
approximately $1.1 billion at December 31, 2000.
$10 BILLION SHELF REGISTRATION STATEMENT
In January 2001, AOL Time Warner filed a shelf registration statement with
the Securities and Exchange Commission, which allows AOL Time Warner to offer
and sell from time to time, debt securities, preferred stock, series common
stock, common stock and/or warrants to purchase debt and equity securities in
amounts up to $10 billion in initial aggregate public offering prices. Proceeds
from any offerings will be used for general corporate purposes including
investments, capital expenditures, repayment of debt and financing acquisitions.
CROSS GUARANTEES OF BANK AND PUBLIC DEBT
During 2001, in connection with the Merger, America Online and AOL Time
Warner were added as guarantors to (i) borrowings drawn against the Bank Credit
Agreement by Time Warner and a number of its consolidated subsidiaries,
consisting of Time Warner Companies, Inc. ('TW Companies'), TWI Cable Inc. ('TWI
Cable') and Turner Broadcasting System, Inc. ('TBS') and (ii) the public debt of
Time Warner, TW Companies and TBS. In addition, AOL Time Warner, Time Warner, TW
Companies, TWI Cable and TBS were added as guarantors to America Online's
zero-coupon convertible subordinated notes.
INCREASED OPERATING CASH FLOW
In addition to the increased borrowing availability, AOL Time Warner will
have increased liquidity generated by the added operating cash flows of Time
Warner's businesses.
COMMON STOCK REPURCHASE PROGRAM
In January 2001 AOL Time Warner's Board of Directors authorized a common
stock repurchase program that allows AOL Time Warner to repurchase, from time to
time, up to $5 billion of common stock over a two-year period.
Management believes that AOL Time Warner's operating cash flows, cash and
equivalents, borrowing capacity and shelf registration are sufficient to fund
its capital and liquidity needs for the foreseeable future.
EARNINGS BEFORE INTEREST, OTHER INCOME, NET, TAXES, DEPRECIATION AND
AMORTIZATION ('EBITDA')
The following table and discussion summarizes America Online's EBITDA for
the years ended December 31, 2000, 1999 and 1998:
YEARS ENDED DECEMBER 31,
------------------------
2000 1999 1998
------ ------ ------
(AMOUNTS IN MILLIONS)
EBITDA...................................................... $2,350 $1,335 $ 535
AOL Time Warner defines EBITDA as operating income, adjusted to exclude
depreciation and amortization. In order to reflect America Online's core
operations, EBITDA discussed herein has also been adjusted to exclude those
corporate expenses that will relate to AOL Time Warner's corporate functions
going forward and special charges, both of which will be shown as separate
components of AOL Time Warner's
F-15
AMERICA ONLINE, INC. (PREDECESSOR TO AOL TIME WARNER INC.)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED)
EBITDA. In 2000, 1999 and 1998, the corporate expenses excluded were $79
million, $77 million and $41 million, respectively, and special charges were
$10 million, $123 million and $148 million, respectively. EBITDA is presented
and discussed because AOL Time Warner and America Online consider EBITDA an
important indicator of the operational strength and performance of its business
including the ability to provide cash flows to service debt and fund capital
expenditures. EBITDA, however, should not be considered an alternative to
operating or net income as an indicator of the performance of AOL Time Warner
or America Online, or as an alternative to cash flows from operating activities
as a measure of liquidity, in each case determined in accordance with generally
accepted accounting principles ('GAAP').
For the year ended December 31, 2000, EBITDA from America Online's core
operations increased from $1,335 million to $2,350 million or 76% over the year
ended December 31, 1999. For the year ended December 31, 1999, EBITDA from
America Online's core operations increased from $535 million to $1,335 million
or 150%. The increase from 1999 to 2000 is mainly due to the significant
increase in income from operations (excluding special charges) from $942 million
in 1999 to $1,827 million in 2000. The increase from 1998 to 1999 is due to the
increase in income from operations (excluding special charges) from $252 million
in 1998 to $942 million in 1999.
SEASONALITY
The number of subscriber acquisitions and amount of usage in America
Online's online services appears to be highest in the first and fourth quarters,
due to the holiday season and following the holiday season, when new computer
and software owners are discovering Internet online services while spending more
time indoors due to winter weather.
Since making advertising revenue a key component of America Online's
strategy, America Online has experienced difficulty in distinguishing
seasonality in advertising sales from the overall market growth. Seasonal
factors seem to be mitigated by advertisers' growing interest in the overall
online medium, as well as gaining access to America Online's large and growing
subscriber/user base across multiple branded distribution channels.
INFLATION
America Online believes that inflation has not had, and will not have in the
future, a material effect on its results of operations.
CAUTION CONCERNING FORWARD-LOOKING STATEMENTS
This document includes certain 'forward-looking statements' within the
meaning of the Private Securities Litigation Reform Act of 1995. These forward-
looking statements are based on management's present expectations or beliefs
about future events. Words such as "anticipates," "estimates," "expects,"
"projects," "intends," "plans," "believes" and words and terms of similar
substance used in connection with any discussion of future operating or
financial performance identify such forward-looking statements. As with any
projection or forecast, they are inherently susceptible to uncertainty and
changes in circumstances, and the Company is under no obligation to (and
expressly disclaims any such obligation to) update or alter its forward-looking
statements whether as a result of such changes, new information, future events
or otherwise. AOL Time Warner operates in highly competitive, consumer driven
and rapidly changing Internet, media and entertainment businesses that are
dependent on government regulation and economic, political and social
conditions in the countries in which they operate, consumer demand for their
products and services, technological developments and (particularly in view of
technological changes) protection of their intellectual property rights. AOL
Time Warner's actual results could differ materially from management's
expectations because of changes in such factors. Other factors could
F-16
AMERICA ONLINE, INC. (PREDECESSOR TO AOL TIME WARNER INC.)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED)
also cause actual results to differ from those contained in the forward-looking
statements, including those identified in AOL Time Warner's, Time Warner's and
America Online's filings with the SEC and the following:
o For AOL Time Warner's America Online businesses, the ability to develop new
products and services to remain competitive; the ability to develop or
adopt new technologies; the ability to continue growth rates of the
subscriber base; the ability to provide adequate server, network and system
capacity; the risk of increased costs for network services; increased
competition from providers of Internet services; the ability to maintain or
enter into new electronic commerce, advertising, marketing or content
arrangements; the ability to maintain and grow market share in the
enterprise software industry; the risks from changes in U.S. and
international regulatory environments affecting interactive services; and
the ability to expand successfully internationally.
o For AOL Time Warner's cable business, more aggressive than expected
competition from new technologies and other types of video programming
distributors, including DBS and DSL; increases in government regulation of
basic cable or equipment rates or other terms of service (such as 'digital
must-carry,' open access or common carrier requirements); government
regulation of other services, such as broadband cable modem service;
increased difficulty in obtaining franchise renewals; the failure of new
equipment (such as digital set-top boxes) or services (such as digital
cable, high-speed online services, telephony over cable or video on demand)
to appeal to enough consumers or to be available at reasonable prices to
function as expected and to be delivered in a timely fashion; fluctuations
in spending levels by businesses and consumers; and greater
than expected increases in programming or other costs.
o For AOL Time Warner's film businesses, their ability to continue to attract
and select desirable talent and scripts at manageable costs; a strike by
screen actors and writers; general increases in production costs;
fragmentation of consumer leisure and entertainment time (and its possible
negative effects on the broadcast and cable networks, which are significant
customers of these businesses); continued popularity of merchandising; and
the uncertain impact of technological developments such as the Internet.
o For AOL Time Warner's network businesses, greater than expected
programming or production costs; a strike by television actors and writers;
public and cable operator resistance to price increases (and the negative
impact on premium programmers of increases in basic cable rates); increased
regulation of distribution agreements; the sensitivity of advertising to
economic cyclicality; the development of new technologies that alter the
role of programming networks and services, and greater than expected
fragmentation of consumer viewership due to an increased number of
programming services or the increased popularity of alternatives to
television.
o For AOL Time Warner's music business, its ability to continue to attract
and select desirable talent at manageable costs; the timely completion of
albums by major artists; the popular demand for particular artists and
albums; its ability to continue to enforce its intellectual property rights
in digital environments; its ability to develop a successful business model
applicable to a digital online environment, and the overall strength of
global music sales.
o For AOL Time Warner's print media and publishing businesses, increases in
paper, postal and distribution costs; the introduction and increased
popularity of alternative technologies for the provision of news and
information, such as the Internet; the ability to continue to develop new
sources of circulation; and fluctuations in spending levels by businesses
and consumers.
o The risks related to the successful integration of the businesses of
America Online and Time Warner, including the costs related to the
integration; the failure of the Company to realize the anticipated benefits
of the combination of these businesses; the difficulty the financial market
may have in valuing the business model of the Company; and fluctuating
market prices that could cause the value of AOL Time Warner's stock to fail
to reflect the historical values of America Online's or Time Warner's
stock.
In addition, the Company's overall financial strategy, including growth in
operations, maintaining its financial ratios and strengthened balance sheet,
could be adversely affected by increased interest rates, failure to
F-17
AMERICA ONLINE, INC. (PREDECESSOR TO AOL TIME WARNER INC.)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- (CONTINUED)
meet earnings expectations, significant acquisitions or other transactions,
economic slowdowns, consequences of the euro conversion and changes in the
Company's plans, strategies and intentions.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the potential loss arising from adverse changes in market
rates and prices, such as foreign currency exchange, interest rates and a
decline in the stock market. America Online does not enter into derivatives or
other financial instruments for trading or speculative purposes. America Online
is exposed to immaterial levels of market risk related to changes in foreign
currency exchange rates and interest rates.
America Online is exposed to market risk as it relates to changes in the
market value of its investments. America Online invests in equity instruments of
public and private companies for business and strategic purposes, most of which
are Internet and technology companies. These securities are subject to
significant fluctuations in fair market value due to the volatility of the stock
market and the industries in which it has invested. These securities, which are
classified in 'Investments including available-for-sale securities,' include
available-for-sale securities, restricted securities and derivatives and hedged
securities. America Online has realized gains and losses from the sale of
investments, declines in market value deemed to be other-than-temporary,
declines in market values of securities classified as derivatives under
FAS 133, as well as mergers and acquisitions of companies it is invested in. As
of December 31, 2000, America Online had securities classified as
available-for-sale debt and equity investments with a fair market value of
$1,206 million and a cost basis of $1,105 million. The gross unrealized gains of
$190 million and gross unrealized losses of $89 million have been recorded net
of deferred taxes of $39 million as a separate component of other comprehensive
income. Also, included in 'Investments including available-for-sale securities'
are certain restricted securities with a cost basis of $1,770 million. In
addition, pursuant to the criteria established in FAS 133, which America Online
adopted as of July 1, 2000, Investments including available-for-sale securities
include equity instruments that are classified as derivatives and equity
securities with associated put options, which are classified as hedges. At
December 31, 2000, these securities had a fair value of $308 million and a cost
basis of $380 million. Changes in the value of these securities are recorded in
other income, net, or for certain of the derivatives classified as cash flow
hedges, in other comprehensive income. See Note 11 of the Notes to the
Consolidated Financial Statements for gains and losses related to
available-for-sale securities, as well as losses on securities classified as
derivatives under FAS 133. America Online's objective in managing its exposure
to stock market fluctuations is to minimize the impact of stock market declines
to its earnings and cash flows. Beyond the control of America Online, however,
continued market volatility, as well as mergers and acquisitions, have the
potential to have a material non-cash impact on the operating results in future
periods. See Note 2 of the Notes to the Consolidated Financial Statements for
additional discussion of America Online's 'Investments including available-
for-sale securities,' the adoption of SFAS 133 and its exposure to stock
market risk.
Since December 31, 2000, there has been a broad decline in the public
equity markets, particularly in technology stocks, including investments
held in the AOL Time Warner portfolio. As a result, as of March 21, 2001, the
fair market value of AOL Time Warner's publicly held investments had declined
approximately $300 million, on a net basis. Similarly, AOL Time Warner has
experienced significant declines in the value of certain privately held
investments and restricted securities. As a matter of policy, management
continually evaluates whether changes in the value of such investments should
be considered to be other-than-temporary. Depending on general market conditions
and the performance of specific investments in AOL Time Warner's portfolio,
AOL Time Warner could record a significant noncash pretax charge in the first
quarter to reduce the carrying value of certain publicly traded and privately
held investments and restricted securities. Any such charge would be
nonoperational in nature, with no corresponding impact on EBITDA, and would be
recorded in other income, net.
F-18
AMERICA ONLINE, INC. (PREDECESSOR TO AOL TIME WARNER INC.)
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
(MILLIONS, EXCEPT PER SHARE AMOUNTS)
2000 1999
------- -------
ASSETS
CURRENT ASSETS
Cash and cash equivalents................................... $ 2,610 $ 2,554
Short-term investments...................................... 886 542
Accounts receivable, less allowances of $97 and $58,
respectively............................................... 464 385
Other receivables, net...................................... 149 111
Prepaid expenses and other current assets................... 562 283
------- -------
Total current assets........................................ 4,671 3,875
Property and equipment at cost, net......................... 1,041 895
Investments including available-for-sale securities......... 3,824 4,902
Product development costs, net.............................. 243 122
Goodwill and other intangible assets, net................... 816 439
Other assets................................................ 232 163
------- -------
$10,827 $10,396
------- -------
------- -------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable............................................ $ 105 $ 68
Accrued expenses and other liabilities...................... 973 1,052
Deferred revenue............................................ 1,063 793
Accrued personnel costs..................................... 111 188
Deferred network services credit............................ 76 76
------- -------
Total current liabilities................................... 2,328 2,177
Notes payable............................................... 1,411 1,581
Deferred revenue............................................ 223 131
Other liabilities........................................... 4 17
Deferred network services credit............................ 83 159
STOCKHOLDERS' EQUITY
Preferred stock, $0.01 par value; 5,000,000 shares
authorized, no shares issued and outstanding at
December 31, 2000 and 1999, respectively................... -- --
Common stock, $0.01 par value; 6,000,000,000 shares
authorized, 2,378,600,806 and 2,290,628,654 shares issued
and outstanding at December 31, 2000 and 1999,
respectively............................................... 24 23
Paid-in capital............................................. 4,966 4,266
Accumulated other comprehensive income -- unrealized gain on
available-for-sale securities and cash flow hedges, net.... 61 1,467
Retained earnings........................................... 1,727 575
------- -------
Total stockholders' equity.................................. 6,778 6,331
------- -------
$10,827 $10,396
------- -------
------- -------
See accompanying notes.
F-19
AMERICA ONLINE, INC. (PREDECESSOR TO AOL TIME WARNER INC.)
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31,
(MILLIONS, EXCEPT PER SHARE AMOUNTS)
2000 1999 1998
------- ------- -------
Revenues:
Subscriptions............................................... $ 4,777 $ 3,874 $ 2,765
Advertising and commerce.................................... 2,369 1,240 612
Content and other........................................... 557 610 496
------- ------- -------
Total revenues.............................................. 7,703 5,724 3,873
Cost of revenues............................................ (3,874) (3,324) (2,538)
Sales, general and administrative........................... (1,902) (1,390) (1,034)
Amortization of goodwill and other intangible assets........ (100) (68) (49)
Merger and, restructuring charges........................... (10) (123) (50)
Acquired in-process research and development................ -- -- (80)
Settlement charges.......................................... -- -- (18)
------- ------- -------
Operating income............................................ 1,817 819 104
Other income, net........................................... 67 815 41
------- ------- -------
Income before income taxes.................................. 1,884 1,634 145
Income tax provision........................................ (732) (607) (30)
------- ------- -------
Net income.................................................. $ 1,152 $ 1,027 $ 115
------- ------- -------
------- ------- -------
Basic net income per common share........................... $ 0.50 $ 0.47 $ 0.06
------- ------- -------
------- ------- -------
Diluted net income per common share......................... $ 0.45 $ 0.40 $ 0.05
------- ------- -------
------- ------- -------
Average basic common shares................................. 2,323 2,199 1,959
------- ------- -------
------- ------- -------
Average diluted common shares............................... 2,595 2,599 2,370
------- ------- -------
------- ------- -------
See accompanying notes.
F-20
AMERICA ONLINE, INC. (PREDECESSOR TO AOL TIME WARNER INC.)
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31,
(MILLIONS)
2000 1999 1998
------- ------- ------
OPERATIONS
Net income.................................................. $ 1,152 $ 1,027 $ 115
Adjustments for noncash and nonoperating items:
Non-cash restructuring charges........................... -- 9 13
Loss on FAS 133 securities............................... 70 -- --
Depreciation and amortization............................ 444 316 242
Amortization of deferred network services credit......... (76) (76) (70)
Charge for acquired in-process research and
development............................................. -- -- 80
Amortization of compensatory stock options............... 13 21 17
Deferred income taxes.................................... 733 608 27
Loss (gain) on sale of investments including
available-for-sale securities........................... 107 (681) (8)
Equity in losses of investees............................ 36 5 12
Changes in operating assets and liabilities, net of the
effects of acquisitions and dispositions:
Trade accounts receivable................................ (84) (134) 43
Other receivables........................................ (7) (1) (82)
Prepaid expenses and other current assets................ (289) (140) (39)
Other assets............................................. (62) (123) (9)
Investments including available-for-sale securities...... (360) (126) (67)
Accrued expenses and other current liabilities........... (81) 564 142
Deferred revenue and other liabilities................... 362 371 138
------- ------- ------
Total adjustments........................................... 806 613 439
------- ------- ------
Cash provided by operations................................. 1,958 1,640 554
INVESTING ACTIVITIES
Purchase of property and equipment.......................... (485) (494) (296)
Product development costs................................... (158) (66) (45)
Proceeds from sale of investments including
available-for-sale securities.............................. 812 733 94
Purchase of investments, including available-for-sale
securities................................................. (1,883) (2,476) (231)
(Purchase of) proceeds from short-term investments, net..... (345) 20 164
Purchase of minority interest in Digital City............... (80) -- --
Net (payments) proceeds for acquisitions/dispositions of
subsidiaries............................................... (40) 16 (73)
Other investing activities.................................. (144) (80) (32)
------- ------- ------
Cash used in investing activities........................... (2,323) (2,347) (419)
FINANCING ACTIVITIES
Proceeds from issuance of common stock, net................. 318 494 742
Principal payments on debt.................................. (8) (22) (5)
Payment of deferred finance costs & other financing
activities, net............................................ 80 (29) 58
Proceeds from issuance of debt.............................. 31 1,286 22
------- ------- ------
Cash provided by financing activities....................... 421 1,729 817
------- ------- ------
INCREASE IN CASH AND EQUIVALENTS............................ 56 1,022 952
CASH AND EQUIVALENTS AT BEGINNING OF YEAR................... 2,554 1,532 580
------- ------- ------
CASH AND EQUIVALENTS AT END OF YEAR......................... $ 2,610 $ 2,554 $1,532
------- ------- ------
------- ------- ------
Supplemental cash flow information
Cash paid during the year for:
Interest (net of amounts capitalized).................... $ 15 $ 16 $ 17
Taxes.................................................... $ 14 $ -- $ --
See accompanying notes.
F-21
AMERICA ONLINE, INC. (PREDECESSOR TO AOL TIME WARNER INC.)
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(MILLIONS, EXCEPT SHARE DATA)
COMPREHENSIVE
ACCUMULATED RETAINED INCOME (LOSS)
PREFERRED STOCK COMMON STOCK OTHER EARNINGS FOR THE
--------------- ---------------------- PAID-IN COMPREHENSIVE (ACCUMULATED YEARS ENDED
SHARES AMOUNT SHARES AMOUNT CAPITAL INCOME, NET DEFICIT) TOTAL DECEMBER 31,
------ ------ ------------- ------ ------- ----------- -------- ----- ------------
BALANCE AT DECEMBER
31, 1997........... 1,000 $ -- 1,860,008,080 $19 $1,278 $ 36 $ (535) $ 798 $ --
Common stock issued:
Exercise of
options and
ESPP............ -- -- 135,650,850 1 175 -- -- 176
Business
acquisitions.... -- -- 2,042,672 -- 12 -- -- 12
Sale of stock,
net............. -- -- 48,004,026 -- 566 -- -- 566
Amortization of
compensatory stock
options............ -- -- -- -- 17 -- -- 17
Unrealized gain on
available-for-sale
securities, net.... -- -- -- -- 59 92 -- 151 92
Conversion of
preferred stock to
common stock....... (1,000) -- 3,136,000 -- -- -- -- --
Tax benefit related
to stock options... -- -- -- -- 27 -- -- 27
Net income.......... -- -- -- -- -- -- 115 115 115
------ ------ ------------- --- ------ ------- ------ ------ -------
BALANCE AT DECEMBER
31, 1998........... -- -- 2,048,841,628 20 2,134 128 (420) 1,862 207
-------
-------
Effect of immaterial
poolings........... -- -- 13,390,986 -- 48 -- (32) 16
Common stock issued:
Exercise of
options, warrant
and ESPP........ -- -- 207,689,168 3 481 -- -- 484
Sale of stock,
net............. -- -- 3,749,918 -- 10 -- -- 10
Amortization of
compensatory stock
options............ -- -- -- -- 21 -- -- 21
Unrealized gain on
available-for-sale
securities, net.... -- -- -- -- 820 1,339 -- 2,159 1,339
Conversion of
debt............... -- -- 15,744,558 -- 101 -- -- 101
Tax benefit related
to stock options... -- -- -- -- 551 -- -- 551
Investment in
Gateway............ -- -- 1,212,396 -- 100 -- -- 100
Net income.......... -- -- -- -- -- -- 1,027 1,027 1,027
------ ------ ------------- --- ------ ------- ------ ------ -------
BALANCE AT DECEMBER
31, 1999........... -- -- 2,290,628,654 23 4,266 1,467 575 6,331 2,366
-------
-------
Effect of immaterial
poolings........... -- -- 291,667 -- 1 -- -- 1
Common stock issued:
Exercise of
options and
ESPP............ -- -- 45,426,369 1 317 -- -- 318
Business
Acquisitions.... -- -- 4,352,440 -- 275 -- -- 275
Amortization of
compensatory stock
options............ -- -- -- -- 13 -- -- 13
Unrealized loss on
available-for-sale
securities and cash
flow hedges, net... -- -- -- -- (861) (1,406) -- (2,267) (1,406)
Conversion of
debt............... -- -- 37,901,676 -- 244 -- -- 244
Tax benefit related
to stock options... -- -- -- -- 711 -- -- 711
Net income.......... -- -- -- -- -- -- 1,152 1,152 1,152
------ ------ ------------- --- ------ ------- ------ ------ -------
BALANCE AT DECEMBER
31, 2000........... -- $ -- 2,378,600,806 $24 $4,966 $ 61 $1,727 $6,778 $ (254)
------ ------ ------------- --- ------ ------- ------ ------ -------
------ ------ ------------- --- ------ ------- ------ ------ -------
See accompanying notes.
F-22
AMERICA ONLINE, INC. (PREDECESSOR TO AOL TIME WARNER INC.)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION
On January 11, 2001, America Online, Inc. ('America Online') and Time Warner
Inc. ('Time Warner') completed their previously announced merger pursuant to the
Second Amended and Restated Agreement and Plan of Merger among the companies and
certain of subsidiaries dated as of January 10, 2000 (the 'Merger'). The
combined company is named AOL Time Warner Inc. ('AOL Time Warner').
The Merger was structured as a stock-for-stock exchange. Prior to the
Merger, America Online and Time Warner formed a new holding company called AOL
Time Warner and the new holding company formed two wholly owned subsidiaries.
Upon the closing of the transaction, one subsidiary merged with and into America
Online and one subsidiary merged with and into Time Warner. As a result, America
Online and Time Warner each became a wholly owned subsidiary of AOL Time Warner.
As part of the merger, each issued and then outstanding share of each class of
common stock of Time Warner was converted into 1.5 shares of an identical series
of common stock of AOL Time Warner. Each issued and then outstanding share of
common stock of America Online was converted into one share of common stock of
AOL Time Warner.
As a result of the Merger, the former shareholders of America Online have an
approximate 55% interest in AOL Time Warner and the former shareholders of Time
Warner have an approximate 45% interest in AOL Time Warner, expressed on a fully
diluted basis. The Merger will be accounted for by AOL Time Warner as an
acquisition of Time Warner under the purchase method of accounting for business
combinations. Under the purchase method of accounting, the estimated cost of
approximately $147 billion to acquire Time Warner, including transaction costs,
will be allocated to its underlying net assets in proportion to their respective
fair values. Any excess of the purchase price over estimated fair values of the
net assets acquired will be recorded as goodwill.
AOL Time Warner classifies its business interests into six fundamental
areas: AOL, consisting principally of interactive services, Web brands, Internet
technologies and electronic commerce services; Cable, consisting principally of
interests in cable television systems; Filmed Entertainment, consisting
principally of interests in filmed entertainment and television production;
Networks, consisting principally of interests in cable television and broadcast
network programming; Music, consisting principally of interests in recorded
music and music publishing; and Publishing, consisting principally of interests
in magazine publishing, book publishing and direct marketing.
Because the Merger was not consummated on or before December 31, 2000, the
accompanying consolidated financial statements and notes reflect only the
financial results of America Online, as predecessor of AOL Time Warner.
America Online was incorporated in the state of Delaware in May 1985. Based
in Dulles, Virginia, America Online is the world's leader in interactive
services, Web brands, Internet technologies and electronic commerce services.
America Online operates: two worldwide Internet services, the AOL service, with
more than 26.7 million members, and the CompuServe service, with approximately 3
million members; several leading Internet brands including ICQ, AOL Instant
Messenger and Digital City, Inc.; Netscape.com and AOL.COM Internet portals; the
Netscape browser software; AOL Moviefone, the nation's number one movie listing
guide and ticketing service; MapQuest.com, a leader in destination information
solutions; and Spinner Networks Incorporated and Nullsoft, Inc., leaders in
Internet music. Through its strategic alliance with Sun Microsystems, Inc. ('Sun
Microsystems'), America Online also develops and offers easy-to-deploy,
end-to-end electronic commerce and enterprise solutions for companies operating
in and doing business on the Internet.
F-23
AMERICA ONLINE, INC. (PREDECESSOR TO AOL TIME WARNER INC.)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of America Online
and its wholly owned subsidiaries. All significant intercompany accounts and
transactions have been eliminated.
The Company has adopted a December 31 calendar-year basis for reporting
purposes. As a result, this report reflects the historical results of America
Online restated on a December 31 calendar-year basis. America Online had
previously reported results on a June 30 fiscal-year basis.
BUSINESS COMBINATIONS
Business combinations which have been accounted for under the purchase
method of accounting include the results of operations of the acquired business
from the date of acquisition. Net assets of the companies acquired are recorded
at their fair value at the date of acquisition. Amounts allocated to acquired
in-process research and development are expensed in the period of acquisition
(Note 6).
Other business combinations have been accounted for under the pooling-of-
interests method of accounting. In such cases, the assets, liabilities and
stockholders' equity of the acquired entities were combined with America
Online's respective accounts at recorded values. Prior period financial
statements have been restated to give effect to the merger unless the effect of
the business combination is not material to the financial statements of America
Online (Note 6).
REVENUE RECOGNITION
Subscription revenues are recognized over the period that services are
provided. In contractual arrangements in which America Online provides services
to third party subscriber accounts, America Online records its subscription
service revenue, net of associated service costs, over the period that services
are provided.
Advertising and commerce revenues and content and other revenues, are
recognized as the services are performed or when the goods are delivered.
America Online generates advertising revenues based on two types of contracts,
standard and non-standard. The revenues derived from standard advertising
contracts in which America Online provides a minimum number of impressions for a
fixed fee, are recognized as the impressions are delivered. The revenues derived
from non-standard advertising contracts, which provide carriage, advisory
services, premier placements and exclusivities, navigation benefits, brand
affiliation and other benefits, are recognized straight-line over the term of
the contract, provided America Online is meeting its obligations under the
contract. Deferred revenue consists primarily of prepaid electronic commerce and
advertising fees and monthly and annual prepaid subscription fees billed in
advance.
America Online enters into rebate and other promotional programs with its
commerce partners. In the year ended December 31, 1999, America Online began to
offer a rebate program whereby there is a contract with the subscriber for a
defined period of time. America Online capitalizes the costs of the rebates and
amortizes the amount as a reduction of revenues over the period in which
services are performed and/or goods are delivered. As of December 31, 2000,
America Online had a short-term and long-term prepaid asset of approximately
$169 million (net of an allowance of $10 million) and $190 million,
respectively. During the year ended December 31, 2000, America Online recorded
provisions (additions) to the allowance of $52 million and write-offs
(deductions) against the allowance of $49 million related to the rebate program.
As of December 31, 1999, America Online had a short-term and long-term prepaid
asset of approximately $58 million (net of an allowance
F-24
AMERICA ONLINE, INC. (PREDECESSOR TO AOL TIME WARNER INC.)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
of $7 million) and $127 million, respectively. During the year ended
December 31, 1999, America Online recorded an allowance of $7 million related to
the rebate program.
For other promotional programs, in which consumers are typically offered a
subscription to America Online's subscription services at no charge as a result
of purchasing a product from the commerce partner, America Online records as
subscription revenue on a straight-line basis, over the term of the service
contract with the subscriber, the amounts received from the commerce partners,
less any amounts paid for marketing to the commerce partners.
In accordance with Statement of Position 97-2, 'Software Revenue
Recognition,' as amended by Statement of Position 98-9, 'Modification of SOP
97-2, Software Revenue Recognition, With Respect to Certain Transactions,'
America Online recognizes the revenue allocable to software licenses upon
delivery of the software product to the end-user, unless the fee is not fixed or
determinable or collectibility is not probable. In software arrangements that
include more than one element, America Online allocates the total arrangement
fee among each deliverable based on the relative fair value of each of the
deliverables determined based on vendor-specific objective evidence ('VSOE').
America Online determines VSOE based on an established price list published by
management having the relevant authority, which reflects the prices at which
those elements are sold separately to third parties.
In December 1999, the Securities and Exchange Commission ('SEC') issued
Staff Accounting Bulletin No. 101, 'Revenue Recognition in Financial Statements'
('SAB 101'), which clarifies certain existing accounting principles for the
timing of revenue recognition and classification of revenues in the financial
statements. While America Online's existing revenue recognition policies are
consistent with the provisions of SAB 101, the new rules have resulted in some
reclassifications between revenues and costs. In the quarter ended December 31,
2000, America Online adopted SAB 101 and restated prior periods to conform to
the current year presentation. The impact was a reduction by equal amounts of
both 'Content and Other' revenues and 'Cost of Revenues' of $107 million, $29
million and $0 million in the years ended December 31, 2000, 1999 and 1998,
respectively.
PROPERTY AND EQUIPMENT
Property and equipment are depreciated or amortized using the straight-line
method over the following estimated useful lives:
Computer equipment and internal software.................... 2 to 5 years
Buildings and related improvements.......................... 15 to 40 years
Leasehold improvements...................................... 4 to 10 years
Furniture and fixtures...................................... 5 years
In accordance with Statement of Position 98-1, 'Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use,' America Online
capitalizes certain costs incurred for the development of internal use software.
These costs include the costs associated with coding, software configuration,
upgrades and enhancements.
In March 2000, the Emerging Issues Task Force issued its consensus on Issue
No. 00-2, 'Accounting for Web Site Development Costs' ('EITF 00-2'). America
Online accounts for the development and maintenance of its website in accordance
with EITF 00-2.
SUBSCRIBER ACQUISITION COSTS AND ADVERTISING
America Online accounts for subscriber acquisition costs pursuant to
Statement of Position 93-7, 'Reporting on Advertising Costs,' by expensing these
costs as they are incurred. Included in sales, general and
F-25
AMERICA ONLINE, INC. (PREDECESSOR TO AOL TIME WARNER INC.)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
administrative expense is both brand and acquisition advertising supporting
America Online's multiple brands which was $829 million, $575 million and $538
million for the three years ended December 31, 2000, 1999 and 1998,
respectively.
INVESTMENTS INCLUDING AVAILABLE-FOR-SALE SECURITIES
Investments including available-for-sale securities is comprised of
available-for-sale securities, restricted securities, derivatives and hedged
securities. America Online has classified all debt and equity securities for
which there is a determinable fair market value and there are no restrictions on
America Online's ability to sell the security within the next 12 months as
available-for-sale. In accordance with the provisions of Financial Accounting
Standards Board ('FASB') Statement No. 115, 'Accounting for Certain Investments
in Debt and Equity Securities,' available-for-sale securities are carried at
fair value, with unrealized gains and losses reported as a separate component of
stockholders' equity net of applicable income taxes. Realized gains and losses
and declines in value deemed to be other-than-temporary on available-for-sale
securities are included in other income (Note 11). The cost basis for realized
gains and losses on available-for-sale securities is determined on a specific
identification basis.
As of December 31, 2000, America Online had available-for-sale investments
with a fair market value of $507 million and a cost basis of $408 million. The
gross unrealized gains of $188 million and gross unrealized losses of $89
million have been recorded, net of deferred taxes of $38 million, as a separate
component of other comprehensive income.
Also, as of December 31, 2000, America Online had certain managed investment
funds with financial institutions. These funds are primarily invested in debt
securities and are classified as 'Investments including available-for-sale
securities.' As of December 31, 2000, the debt securities within these funds had
a fair market value of $699 million and a cost basis of $697 million. The gross
unrealized gains of $2 million have been recorded, net of deferred taxes of
approximately $1 million, as a separate component of other comprehensive income.
All the debt securities included in the investment funds are scheduled to mature
in years 2001 through 2004.
As of December 31, 1999, America Online had available-for-sale debt and
equity investments with a fair market value of $2,911 million and a cost basis
of $545 million. The gross unrealized gains of $2,403 million and gross
unrealized losses of $37 million were recorded, net of deferred taxes of $899
million, as a separate component of other comprehensive income.
Included in 'Investments including available-for-sale securities' at
December 31, 2000 and 1999, were certain restricted securities with a cost basis
of $1,770 million and $1,706 million, respectively. These balances as of
December 31, 2000 and 1999 are primarily made up of an investment of $1,506
million in a General Motors equity security related to the strategic alliance
America Online entered into with Hughes Electronics Corporation.
America Online has various investments, including foreign and domestic
joint ventures, that are accounted for under the equity method of accounting.
All investments in which America Online has the ability to exercise significant
influence over the investee, but less than a controlling voting interest, are
accounted for under the equity method of accounting. Under the equity method
of accounting, America Online's share of the investee's earnings or loss is
included in consolidated operating results. To date, America Online's basis
and current commitments in its investments accounted for under the equity
method of accounting have not been significant. As a result, these investments
have not significantly impacted America Online's results of operations or its
financial position. Investments accounted for under the equity method were
approximately $231 million and $114 million as of December 31, 2000 and
1999, respectively.
F-26
AMERICA ONLINE, INC. (PREDECESSOR TO AOL TIME WARNER INC.)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Other investments, for which America Online does not have the ability to
exercise significant influence and for which there is not a readily determinable
market value, are accounted for under the cost method of accounting. In
addition, for investments in equity securities in which America Online is
restricted from selling the equity securities within 12 months, the
investments are accounted for under the cost method of accounting. When
the restrictions on the sale of such securities lapse, America Online
classifies and accounts for the securities as available-for-sale. Dividends
and other distributions of earnings from investees, if any, are included
in income when declared. America Online periodically evaluates the carrying
value of its investments accounted for under the cost method of accounting
and as of December 31, 2000 and 1999 such investments were recorded at the
lower of cost or estimated net realizable value. Investments accounted under
the cost method were approximately $309 million and $171 million as of
December 31, 2000 and 1999, respectively.
Since December 31, 2000, there has been a broad decline in the public
equity markets, particularly in technology stocks, including investments
held in the AOL Time Warner portfolio. As a result, as of March 21, 2001, the
fair market value of AOL Time Warner's publicly held investments had declined
approximately $300 million, on a net basis. Similarly, AOL Time Warner has
experienced significant declines in the value of certain privately held
investments and restricted securities. As a matter of policy, management
continually evaluates whether changes in the value of such investments should be
considered to be other-than-temporary. Depending on general market conditions
and the performance of specific investments in AOL Time Warner's portfolio,
AOL Time Warner could record a significant noncash pretax charge in the first
quarter to reduce the carrying value of certain publicly traded and privately
held investments and restricted securities. Any such charge would be
nonoperational in nature and would be recorded in other income, net.
DERIVATIVES AND HEDGES
Effective July 1, 2000, America Online adopted FASB Statement No. 133
('FAS 133'), 'Accounting for Derivative Instruments and Hedging Activities.' The
Statement requires America Online to recognize all derivatives on the balance
sheet at fair value. Derivatives that are not cash flow hedges must be adjusted
to fair value through income. If the derivative is a hedge, depending on the
nature of the hedge, changes in the fair value of derivatives will either be
offset against the change in fair value of the hedged assets, liabilities, or
firm commitments through earnings or recognized in other comprehensive income
until the hedged item is recognized in earnings. The ineffective portion of a
derivative's change in fair value will be immediately recognized in earnings.
Pursuant to the derivatives criteria established by FAS 133, investments
including available-for-sale securities include equity instruments that are
classified as derivatives and equity securities with associated put options,
which are classified as hedges. As of December 31, 2000, these securities had
a cost basis of $380 million and a fair market value of $308 million. As a
result, during the year ended December 31, 2000, America Online recorded a
loss in other income of approximately $70 million due to a decline in value of
those securities. As of December 31, 2000, America Online also had gross
unrealized gains on hedges of approximately $9 million and gross unrealized
losses on hedges of approximately $11 million which have been recorded net of
deferred taxes of approximately $1 million as a separate component of other
comprehensive income.
PRODUCT DEVELOPMENT COSTS
America Online's subscription services are comprised of various features
which contribute to the overall functionality of the service. The overall
functionality of the services is delivered primarily through America Online's
four products (the AOL service and the CompuServe service for Windows and
Macintosh). America Online capitalizes costs incurred for the production of
computer software that generates the functionality within its four products.
Capitalized costs include direct labor and related overhead for software
produced by America Online and the cost of software purchased from third
parties. All costs in the software development process which are classified as
research and development are expensed as incurred until technological
feasibility has been established ('beta'). Once technological feasibility has
F-27
AMERICA ONLINE, INC. (PREDECESSOR TO AOL TIME WARNER INC.)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
been established, such costs are capitalized until the software has completed
beta testing and is mass-marketed. To the extent America Online retains the
rights to software development funded by third parties, such costs are
capitalized in accordance with its normal accounting policies. Amortization, a
cost of revenue, is provided on a product-by-product basis, using the greater
of the straight-line method or the current year revenue as a percentage of
total revenue estimates for the related software product, not to exceed five
years, commencing the month after the date of product release. Quarterly,
America Online reviews and expenses the unamortized cost of any feature
identified as being impaired. America Online also reviews recoverability of
the total unamortized cost of all features and software products in relation
to estimated online service and relevant other revenues and, if necessary,
makes an appropriate adjustment to reduce those costs to their net realizable
value.
Capitalized product development costs consist of the following:
YEARS ENDED
DECEMBER 31,
---------------
2000 1999
---- ----
(IN MILLIONS)
Balance, beginning of year.................................. $122 $ 91
Costs capitalized........................................... 156 65
Costs amortized............................................. (35) (34)
---- ----
Balance, end of year........................................ $243 $122
---- ----
---- ----
The accumulated amortization of product development costs related to the
production of computer software totaled $157 million and $122 million at
December 31, 2000 and 1999, respectively.
Included in cost of revenues are research and development costs totaling
$129 million, $131 million and $140 million, and other product development costs
totaling $150 million, $170 million and $129 million in the years ended
December 31, 2000, 1999 and 1998, respectively.
FOREIGN CURRENCY TRANSLATION
Assets and liabilities of America Online's wholly owned foreign subsidiaries
are translated into U.S. dollars at year-end exchange rates, and revenues and
expenses are translated at average rates prevailing during the year. Translation
adjustments are included as a component of stockholders' equity. Foreign
currency transaction gains and losses, which have been immaterial, are included
in results of operations.
GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill and other intangible assets primarily relate to purchase
transactions and are amortized on a straight-line basis over periods ranging
from 2 to 10 years. As of December 31, 2000 and 1999, accumulated amortization
was $225 million and $125 million, respectively. America Online periodically
evaluates whether changes have occurred that would require revision of the
remaining estimated useful life of the assigned goodwill or render the goodwill
not recoverable. If such circumstances arise, America Online would use an
estimate of the undiscounted value of expected future operating cash flows to
determine whether the goodwill is recoverable.
CASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS
America Online considers all highly liquid investments with an original
maturity of three months or less to be cash equivalents. All investments with an
original maturity between three months and one year at the time of
F-28
AMERICA ONLINE, INC. (PREDECESSOR TO AOL TIME WARNER INC.)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
issuance are classified as short-term investments. Short-term investments of
$886 million and $542 million as of December 31, 2000 and 1999, respectively,
are carried at cost which approximates fair market value.
ACCOUNTS RECEIVABLES
The carrying amount of America Online's trade accounts receivables
approximate fair value. America Online recorded provisions (additions) to the
allowance for doubtful accounts of $196 million and $78 million and write-offs
(deductions) against the allowance of $157 million and $66 million during the
years ended December 31, 2000 and 1999, respectively.
America Online sells products and services to customers in diversified
industries, primarily in the Americas, which includes Canada and Latin America,
Europe and the Asia Pacific region. America Online performs ongoing credit
evaluations of its customers' financial condition and generally does not require
collateral on product sales. America Online maintains reserves to provide for
estimated credit losses. Actual credit losses could differ from such estimates.
FINANCIAL INSTRUMENTS
The carrying amounts for America Online's cash and cash equivalents, other
receivables, other assets, trade accounts payable, accrued expenses and
liabilities and other liabilities approximate their fair values. The fair market
value for notes payable (Note 10) and investments including available-for-sale
securities is based on quoted market prices where available.
BARTER TRANSACTIONS
America Online barters advertising for products and services. Such
transactions are recorded at the estimated fair value of the products or
services received or given in accordance with the provisions of the Emerging
Issues Task Force Issue No. 99-17, 'Accounting for Advertising Barter
Transactions.' Revenue from barter transactions is recognized when advertising
is provided, and services received are charged to expense when used. Barter
transactions are immaterial to America Online's statement of operations for all
periods presented.
NET INCOME PER COMMON SHARE
America Online calculates net income per share in accordance with SFAS
No. 128, 'Earnings per Share' (Note 5).
STOCK-BASED COMPENSATION
America Online follows FASB Statement No. 123, 'Accounting for Stock-Based
Compensation' ('FAS 123'). The provisions of FAS 123 allow companies to either
expense the estimated fair value of stock options or to continue to follow the
intrinsic value method set forth in APB Opinion 25, 'Accounting for Stock Issued
to Employees' ('APB 25') but disclose the pro forma effects on net income (loss)
had the fair value of the options been expensed. America Online has elected to
continue to apply APB 25 in accounting for its stock option incentive plans
(Note 14). For awards that generate compensation expense as defined under
APB 25, America Online calculates the amount of expenses and recognizes the
expense over the vesting period of the award.
In March 2000, the FASB issued FASB Interpretation No. 44, 'Accounting for
Certain Transactions involving Stock Compensation' ('FIN 44'), which contains
rules designed to clarify the application of APB 25.
F-29
AMERICA ONLINE, INC. (PREDECESSOR TO AOL TIME WARNER INC.)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FIN 44 became effective on July 1, 2000 at which time America Online adopted
it. The impact of the adoption of FIN 44 was not material to the earnings or
financial position of America Online.
RECLASSIFICATIONS
America Online has reclassified certain prior years revenue and expense
items to conform to the current year presentation which is expected to be used
by AOL Time Warner.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates.
3. MERGER AND RESTRUCTURING CHARGES
2000
In June 2000, America Online recorded a net charge of approximately $10
million of direct costs primarily related to the merger of MapQuest.com, Inc.
('MapQuest.com'). This charge primarily consisted of investment banker fees,
contract termination fees, severance and other personnel costs, fees for legal
and accounting services and other expenses directly related to the transaction.
As part of the merger, approximately 70 positions were eliminated. All of these
costs were paid as of December 31, 2000.
1999
In December 1999, America Online recorded a charge of approximately $5
million of direct costs related to the merger of Tegic Communications, Inc.
('Tegic'). This charge primarily consisted of investment banker fees, fees for
legal and accounting services and other expenses directly related to the
transaction. All of these costs were paid as of December 31, 2000.
During the quarter ended June 1999, America Online recorded a charge of
approximately $15 million of direct costs primarily related to the mergers of
Moviefone, Inc. ('Moviefone'), Spinner Networks Incorporated ('Spinner') and
NullSoft, Inc. ('NullSoft'). These charges primarily consisted of investment
banker fees, severance and other personnel costs, fees for legal and accounting
services, and other expenses directly related to the transaction. All of these
costs were paid as of December 31, 1999.
During the quarter ended March 1999, America Online recorded a charge of
approximately $103 million of direct costs related to the mergers of Netscape
Communications Corporation ('Netscape') and When, Inc. and America Online's
reorganization plans to integrate Netscape's operations and build on the
strengths of the Netscape brand and capabilities. This charge primarily
consisted of investment banker fees, severance and other personnel costs
(related to the elimination of approximately 850 positions), fees for legal and
accounting services, and other expenses directly related to the transaction. As
of December 31, 2000, all of these costs were paid.
1998
During the quarter ended December 1998, America Online recognized
approximately $2 million in merger related costs in connection with the merger
of AtWeb, Inc. ('AtWeb'). These expenses were primarily
F-30
AMERICA ONLINE, INC. (PREDECESSOR TO AOL TIME WARNER INC.)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
associated with fees for investment banking, legal and accounting services,
severance costs and other related charges in connection with the transaction.
As of December 31, 1999, all of these costs were paid.
In connection with a restructuring plan adopted in the first quarter of
1998, America Online recorded a $35 million restructuring charge associated with
the restructuring of its former AOL Studios brand group. The restructuring
included the exiting of certain business activities, the termination of
approximately 160 employees and the shutdown of certain subsidiaries and
facilities. As of December 31, 1999, all of these costs were paid.
During 1998, America Online recorded a $13 million restructuring charge
associated with actions aimed at reducing its cost structure, improving its
competitiveness and restoring sustainable profitability related to the
Netscape Enterprise group. The restructuring plan resulted from decreased demand
for certain Netscape products and the adoption of a new strategic direction. The
restructuring included a reduction in the workforce (approximately 400
employees), the closure of certain facilities, the write-off of non-performing
operating assets, and third-party royalty payment obligations relating to
canceled contracts. As of December 31, 2000, all of these costs were paid.
4. SETTLEMENT CHARGES
During 1998, America Online recorded a net settlement charge of $18 million
in connection with the settlement of the Orman v. America Online, Inc., class
action lawsuit filed in the U.S. District Court for the Eastern District of
Virginia alleging violations of federal securities laws between August 1995 and
October 1996.
5. EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings
per share for the years ended December 31, 2000, 1999 and 1998:
2000 1999 1998
---- ---- ----
(IN MILLIONS EXCEPT
PER SHARE DATA)
BASIC EARNINGS PER SHARE:
Net income available to common shareholders............... $1,152 $1,027 $ 115
Weighted average shares outstanding....................... 2,323 2,199 1,959
------ ------ ------
Basic earnings per share.................................. $ 0.50 $ 0.47 $ 0.06
------ ------ ------
------ ------ ------
DILUTED EARNINGS PER SHARE:
Net income available to common shareholders............... $1,152 $1,027 $ 115
Interest on convertible debt, net of tax.................. 6 8 12
------ ------ ------
Adjusted net income available to common shareholders
assuming conversion..................................... $1,158 $1,035 $ 127
------ ------ ------
------ ------ ------
Weighted average shares outstanding....................... 2,323 2,199 1,959
Effect of dilutive securities:
Employee stock options................................ 244 344 353
Warrants.............................................. -- 12 57
Convertible debt...................................... 28 44 1
------ ------ ------
Adjusted weighted average shares and assumed
conversions............................................. 2,595 2,599 2,370
------ ------ ------
------ ------ ------
Diluted earnings per share................................ $ 0.45 $ 0.40 $ 0.05
------ ------ ------
------ ------ ------
F-31
AMERICA ONLINE, INC. (PREDECESSOR TO AOL TIME WARNER INC.)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The diluted share base for the year ended December 31, 2000 excludes
incremental weighted shares of approximately 13.5 million and approximately 35.6
million related to convertible subordinated notes and stock options,
respectively. The diluted share base for the year ended December 31, 1999
excludes incremental weighted shares of approximately 1 million and 8.8 million
related to convertible subordinated notes and stock options, respectively. The
shares related to the convertible subordinated notes are excluded due to their
antidilutive effect as a result of adjusting net income by $25 million and $2
million for interest expense net of tax for the years ending December 31, 2000
and 1999, respectively, that would be forfeited if the notes were converted to
equity. The shares related to the stock options are excluded due to their
antidilutive effect as a result of the option's exercise prices being greater
than the average market price of the common shares for the years ended
December 31, 2000 and 1999.
6. BUSINESS DEVELOPMENTS
PURCHASE TRANSACTIONS
2000
Quack.com
In August 2000, America Online acquired Quack.com, Inc. ('Quack.com'), a
leading provider of technology for enabling Internet voice portals and web sites
and for developing Internet-hosted voice applications. America Online purchased
all of the outstanding capital stock and debentures and assumed all of the
outstanding stock options in exchange for approximately 3.5 million shares of
America Online's common stock and options. The total purchase price, including
direct acquisition costs, was approximately $201 million and America Online
recognized goodwill of approximately $201 million, which is being amortized over
5 years. The net assets acquired from this purchase transaction were not
material.
Digital City
In May 2000, America Online purchased the 20% interest in Digital City, Inc.
('Digital City') it did not own for approximately $80 million. Approximately $66
million of the purchase price represents goodwill and is being amortized over
10 years. The net results attributable to America Online's non-owned portion of
earnings from Digital City has been previously reflected as earnings allocated
to minority shareholders and included in other income, net. These amounts were
not material for the three years ended December 31, 2000.
Other Purchase Transactions
In August 2000, America Online acquired iAmaze, Inc. ('iAmaze') and
LocalEyes Corporation ('LocalEyes'), software development companies, in separate
transactions for a total aggregate purchase price, including direct acquisition
costs, of approximately $76 million. America Online purchased all the
outstanding capital stock of each of these companies and assumed all of their
outstanding capital stock options in exchange for an aggregate of approximately
1.3 million shares of America Online's common stock and options. As a result of
these purchases, America Online recognized goodwill of approximately $76 million
which is being amortized over 5 years. The net assets acquired from these
purchase transactions were not material.
1998
Acquisition of Mirabilis, Ltd.
In June 1998, America Online purchased the assets, including the
developmental ICQ instant communications and chat technology, and assumed
certain liabilities of Mirabilis, Ltd. ('Mirabilis'), a
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AMERICA ONLINE, INC. (PREDECESSOR TO AOL TIME WARNER INC.)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
development stage enterprise that had generated no revenues, for $287
million in cash. In addition, contingent purchase payments, based on future
performance levels, of up to $120 million may be made over three years
beginning in the year ended December 31, 2000. As a result of certain
performance levels being satisfied, America Online paid $40 million in
August 2000 related to the contingent purchase price, which was recorded as
additional goodwill and is being amortized over the remaining life of the
original goodwill.
The acquisition was accounted for under the purchase method of accounting
and, accordingly, the results of operations are included in the financial
statements as of the date of acquisition, and the assets and liabilities were
recorded based upon their fair values at the date of acquisition. America Online
has allocated the excess purchase price over the fair value of net tangible
assets acquired to goodwill and the following identifiable intangible assets:
strategic value, existing technology, base of trial users, ICQ tradename and
brand and acquired in-process research and development ('IPR&D'). In accounting
for the acquisition of Mirabilis, America Online recorded approximately $228
million in goodwill and other intangible assets, which are being amortized on
a straight-line basis over periods of five to ten years.
Acquisition of CompuServe Online Services Business
In January 1998, America Online consummated a Purchase and Sale Agreement
(the 'Purchase and Sale') by and among America Online, ANS Communications, Inc.
('ANS'), a then wholly-owned subsidiary of America Online, and WorldCom, Inc.
('WorldCom') pursuant to which America Online transferred to WorldCom all of the
issued and outstanding capital stock of ANS in exchange for the online services
business of CompuServe Corporation ('CompuServe'), which was acquired by
WorldCom shortly before the consummation of the Purchase and Sale, and $147
million in cash (excluding $15 million in cash received as part of the
CompuServe online services business and after purchase price adjustments made at
closing). The transaction was accounted for under the purchase method of
accounting and, accordingly, the assets and liabilities were recorded based upon
their fair values at the date of acquisition. As a result of these transactions,
the excess of the cash and the fair value of the CompuServe business received
over the book value of ANS amounted to $381 million. This balance is classified
as current and long-term deferred network services credit and is being amortized
on a straight-line basis over a five-year term (equal to the term of a network
services agreement entered into with WorldCom) as a reduction of network
services expense within cost of revenues.
In connection with the acquisition of CompuServe, America Online recorded
approximately $127 million in goodwill and other intangible assets, which are
being amortized on a straight-line basis over periods of three to seven years.
Immediately after the consummation of the Purchase and Sale, America
Online's European partner, Bertelsmann AG, paid $75 million to America Online
for a 50% interest in a newly created joint venture to operate the CompuServe
European online service. Both America Online and Bertelsmann AG invested an
additional $25 million in cash in this joint venture. America Online accounts
for this transaction under the equity method of accounting in accordance with
the terms of the securities issued in the joint venture.
Other Purchase Transactions
During 1998, America Online acquired Personal Library Software, Inc.
('PLS'), a developer of information indexing and search technologies, and
NetChannel, Inc. ('NetChannel'), a Web-enhanced television company. America
Online purchased all of the outstanding capital stock of each of the companies
and assumed all of their outstanding stock options in exchange for an aggregate
of approximately 2 million shares of America Online's common stock and options
valued at approximately $9 million, approximately $16 million in cash payments
and the assumption of approximately $21 million in liabilities. The total
purchase price for these transactions was approximately $46 million.
F-33
AMERICA ONLINE, INC. (PREDECESSOR TO AOL TIME WARNER INC.)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In connection with the above mentioned purchase transactions, America Online
recorded a charge for acquired IPR&D of approximately $80 million during the
year ended December 31, 1998. Any related purchased IPR&D for each of the above
acquisitions represents the present value of the estimated after-tax cash flows
expected to be generated by the purchased technology, which, at the acquisition
dates, had not yet reached technological feasibility. The cash flow projections
for revenues were based on estimates of relevant market sizes and growth
factors, expected industry trends, the anticipated nature and timing of new
product introductions by America Online and its competitors, individual product
sales cycles and the estimated life of each product's underlying technology.
Estimated operating expenses and income taxes were deducted from estimated
revenue projections to arrive at estimated after-tax cash flows. Projected
operating expenses include cost of goods sold, marketing and selling expenses,
general and administrative expenses, and research and development, including
estimated costs to maintain the products once they have been introduced into
the market and are generating revenue. The remaining identified intangibles,
including goodwill that may result from any future contingent purchase
payments, will be amortized on a straight-line basis over lives ranging from
5 to 10 years.
The following unaudited pro forma information has been prepared assuming
that the purchase of Quack.com, iAmaze, LocalEyes and the 20% interest in
Digital City had occurred at the beginning of the year ended December 31, 1999
through the date of acquisition. In addition, the unaudited pro forma
information for the year ended December 31, 1998 reflects the sale of ANS and
the acquisitions of CompuServe and Mirabilis as if the transactions had occurred
at the beginning of the period. The amount of the aggregate purchase price
allocated to acquired IPR&D for each applicable acquisition has been excluded
from the pro forma information, as it is a non-recurring item. The pro forma
financial information is not necessarily indicative of the combined results that
would have occurred had the acquisitions taken place at the beginning of the
period, nor is it necessarily indicative of results that may occur in the
future. The pro forma effect of the PLS and NetChannel transactions are
immaterial for all periods presented and therefore are not included in the pro
forma information.
PRO FORMA FOR THE YEARS
ENDED DECEMBER 31,
(UNAUDITED)
------------------------------
2000 1999 1998
------ ------ ------
(IN MILLIONS, EXCEPT
PER SHARE DATA)
Revenue................................................... $7,703 $5,724 $3,859
Income from operations.................................... $1,767 $ 754 $ 94
Net income................................................ $1,121 $ 985 $ 105
Income per share -- basic................................. $ 0.48 $ 0.45 $ 0.05
Income per share -- diluted............................... $ 0.43 $ 0.38 $ 0.05
POOLING TRANSACTIONS
2000
In July 2000, America Online completed its merger with Prophead Development,
Inc. ('Prophead'), in which Prophead became a wholly owned subsidiary. In total,
America Online exchanged approximately 292 thousand shares of common stock for
all the outstanding common shares of Prophead in a transaction that was
accounted for as a pooling-of-interests. As Prophead's historical results of
operations were not material in relation to those of America Online, the
financial information prior to the quarter ended June 30, 2000 has not been
restated to reflect this merger.
In June 2000, America Online completed its merger with MapQuest.com, in
which MapQuest.com became a wholly owned subsidiary of America Online. America
Online exchanged approximately 12 million shares of
F-34
AMERICA ONLINE, INC. (PREDECESSOR TO AOL TIME WARNER INC.)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
common stock for all the outstanding common shares of MapQuest.com. The merger
was accounted for under the pooling-of-interests method of accounting and,
accordingly, the accompanying financial statements and footnotes have been
restated to include the operations of MapQuest.com for all periods presented.
For the years ended December 31, 2000 (through the date of the merger), 1999,
and 1998, MapQuest.com's revenues were approximately $22 million, $35 million
and $25 million, respectively. For the years ended December 31, 2000 (through
the date of the merger), 1999 and 1998, MapQuest.com's net loss was
approximately $22 million, $18 million and $3 million, respectively.
1999
In November 1999, America Online completed its merger with Tegic, in which
Tegic became a wholly owned subsidiary of America Online. America Online
exchanged approximately 4.8 million shares of common stock for all the
outstanding common and preferred shares of Tegic in a transaction that was
accounted for as a pooling-of-interests. As Tegic's historical results of
operations were not material in relation to those of America Online, the
financial information prior to the quarter ended December 31, 1999 has not been
restated to reflect the merger.
In May 1999, America Online completed its merger with Moviefone. America
Online exchanged approximately 8.6 million shares of common stock for all the
outstanding common and preferred shares of Moviefone. As Moviefone's historical
results of operations were not material in relation to those of America Online,
the financial information prior to the quarter ended June 30, 1999 has not been
restated to reflect the merger.
In March 1999, America Online completed its merger with Netscape, in which
Netscape became a wholly owned subsidiary of America Online. America Online
exchanged approximately 190 million shares of common stock for all the
outstanding common shares of Netscape. The merger was accounted for under the
pooling-of-interests method of accounting and, accordingly, the accompanying
financial statements and footnotes have been restated to include the operations
of Netscape for all periods presented. For the years ended December 31, 1999
(through the date of the merger) and 1998, Netscape's revenues were
approximately $164 million and $490 million, respectively. For the years ended
December 31, 1999 (through the date of the merger) and 1998, Netscape's net loss
was approximately $47 million and $124 million, respectively.
During 1999, America Online completed mergers with Nullsoft and Spinner,
companies that provide Internet music, and When, Inc. ('When.com'), a company
that provides a personalized event directory and calendar services. America
Online exchanged approximately 8.9 million shares of common stock for all the
outstanding capital stock of these companies. These mergers were accounted for
under the pooling-of-interests method of accounting. The accompanying financial
statements have been restated to include the operations of these companies for
all periods presented. For the year ended December 31, 1999, these companies had
revenues of approximately $1 million through the dates of the mergers and all
prior years were immaterial. For the years ended December 31, 1999 (through the
dates of the mergers) and 1998, the net loss for these companies was
approximately $9 million and $8 million, respectively.
1998
In the quarter ended December 31, 1998, America Online completed mergers
with AtWeb and PersonaLogic, Inc. ('PersonaLogic'). America Online exchanged
approximately 7.5 million shares of common stock for all the outstanding capital
stock of these companies. These mergers were accounted for under the
pooling-of-interests method of accounting. As the combined results of these
companies are material to America Online's net income for the year ended
December 31, 1998, the accompanying financial statements have been restated to
include the operations of these companies for all periods presented. For the
year ended December 31,
F-35
AMERICA ONLINE, INC. (PREDECESSOR TO AOL TIME WARNER INC.)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
1998 (through the dates of the mergers), these companies had revenues of
approximately $2 million and a net loss of approximately $5 million.
OTHER BUSINESS DEVELOPMENTS
On March 17, 2000, America Online and Bertelsmann AG announced a global
alliance to expand the distribution of Bertelsmann's media content and
electronic commerce properties over America Online's interactive brands
worldwide. America Online and Bertelsmann also announced an agreement to
restructure their interests in the AOL Europe and AOL Australia joint ventures.
This restructuring consists of a put and call arrangement for America Online
to purchase, in two installments, Bertelsmann's 49.5% interest in AOL Europe for
consideration ranging from $6.75 billion to $8.25 billion, payable at America
Online's option in cash, AOL Time Warner stock or a combination of cash and
stock. After December 15, 2001 and through January 15, 2002, Bertelsmann has
the right to require America Online to purchase 80% of its 49.5% interest in AOL
Europe with a closing date of January 31, 2002 for $5.3 billion. After March 31,
2002 and through April 30, 2002, Bertelsmann has the right to require America
Online to purchase the remaining 20% of its 49.5% interest in AOL Europe with a
closing date of July 1, 2002 for $1.45 billion. If Bertelsmann fails to
exercise its put rights, America Online has the right to purchase 80% of
Bertelsmann's 49.5% interest in AOL Europe after January 15, 2002 and through
January 15, 2003 for $6.5 billion and the remaining 20% after June 30, 2002
and through June 30, 2003 for $1.75 billion. In addition, the parties agreed
that America Online would take immediate ownership of Bertelsmann's 50%
interest in the parties' AOL Australia joint venture, subject to receipt
of necessary regulatory approvals. Because Bertelsmann's first put option will
not close until January 31, 2002, if exercised, America Online has not
determined yet how it will fund the payment of the purchase price for its
purchases of Bertelsmann's interest in AOL Europe. America Online cannot
predict if Bertelsmann will exercise its put rights, and America Online's
call rights are not exercisable unless Bertelsmann fails to exercise its
put rights. If Bertelsmann does not exercise its put rights, America Online
will consider all pertinent factors at such time and during the
exercisability period of its call rights in determining whether to exercise its
call rights, including the performance and perceived value of AOL Europe at such
time, conditions in the markets where AOL Europe operates, financial market
conditions and America Online's (or AOL Time Warner's) business plans and
financial situation. For the year ended December 31, 2000, AOL Europe's revenues
are less than 10% of America Online's revenues and America Online's pro forma
net income (assuming the potential acquisition was completed at the beginning of
2000) would be reduced by $1.3 billion to $1.8 billion, primarily related to the
amortization of goodwill. Additionally, America Online would incur incremental
financing costs and/or share dilution depending upon the ultimate purchase price
and form of consideration. America Online does not anticipate an adverse impact
from the potential acquisition on America Online's financial position because it
will have the ability to pay the purchase price either in stock or cash, or a
combination of the two, at its option. America Online believes it will have
adequate resources from its cash reserves or from accessing the capital markets
to make the required payment upon exercise of a put or call right, should it
decide to pay in cash, and that as a result of the merger, AOL Time Warner will
be in a stronger position to make such payments than America Online alone would
be.
In November 1998, America Online announced a strategic alliance with Sun
Microsystems to jointly develop a comprehensive suite of easy-to-deploy,
end-to-end solutions to help companies and Internet service providers rapidly
enter the electronic commerce market and scale their electronic commerce
operations. As a result, Sun Microsystems has become a lead systems and service
provider to America Online and America Online is committed to purchase systems
and services worth approximately $400 million at list price from Sun
Microsystems through 2002 for its electronic commerce partners and its own use.
In January 2001, America Online agreed to expand its purchase of hardware from
Sun Microsystems by more than $400 million over two years, in addition to its
previous commitments. As part of the alliance with Sun Microsystems, America
Online will receive more than $350 million in licensing, marketing and
advertising fees from Sun Microsystems, plus
F-36
AMERICA ONLINE, INC. (PREDECESSOR TO AOL TIME WARNER INC.)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
significant minimum revenue commitments of more than $975 million. During
2000, America Online received $123 million in licensing, marketing and
advertising fees and approximately $264 million in minimum revenue commitments.
7. SEGMENT INFORMATION
In accordance with the provisions of SFAS No. 131, certain information is
disclosed based on the way management organizes financial information for making
operating decisions and assessing performance. In determining operating
segments, America Online reviewed the current management structure reporting
to the chief operating decision-maker ('CODM') and analyzed the reporting the
CODM receives to allocate resources and measure performance.
As of December 31, 2000, America Online had four major lines of businesses:
o the Interactive Services Group
o the Interactive Properties Group
o the AOL International Group
o the Netscape Enterprise Group
The lines of business are described below.
The Interactive Services Group develops and operates branded interactive
services, including:
o the AOL service, a worldwide Internet online service with approximately
26.7 million members as of December 31, 2000
o the CompuServe service, a worldwide Internet online service with
approximately 3 million members as of December 31, 2000
o Netscape.com, an Internet portal
o the AOLAnywhere web site
o the Netscape browser software
o the AOLTV service, an interactive television service for mass-market
consumers
o the AOL Mobile services, which deliver features and content of the AOL
service and branded properties to wireless consumers
The Interactive Properties Group is built around branded properties that
operate across multiple services and platforms, such as:
o Digital City, Inc., the leading local online network and community guide on
the AOL service and the Internet based on the number of visitors per month
o ICQ, the world's leading communications portal, based on the number of
registered users, that provides instant communications and chat technology
o AOL Instant Messenger, a Web-based communications service that enables
Internet users to send and respond in real time to private personalized
electronic messages
o Moviefone, Inc., the nation's No. 1 movie guide and ticketing service based
on the number of users
o Internet music brands Spinner.com, Winamp and SHOUTcast
o MapQuest.com, a leader in destination information solutions
o 'AOLbyPhone,' a voice portal that enables AOL members to check their
e-mail and access other popular AOL features conveniently through simple,
spoken commands from any telephone.
F-37
AMERICA ONLINE, INC. (PREDECESSOR TO AOL TIME WARNER INC.)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The AOL International Group oversees the AOL and CompuServe services and
operations outside the United States, as well as the Netscape Online service in
the United Kingdom.
The Netscape Enterprise Group focuses on providing businesses a range of
software products, technical support, consulting and training services. These
products and services enable businesses and users to share information, manage
networks and facilitate electronic commerce. The Netscape Enterprise group
operates primarily through iPlanet E-Commerce Solutions, a Sun Microsystems
alliance. This strategic alliance between America Online and Sun Microsystems
was formed in November 1998 and began operating in March 1999.
The Interactive Services Group and the Netscape Enterprise Group are the
only two reportable segments. The results of the Interactive Properties Group
and the AOL International Group have been combined in the 'Other Segments' row
shown below. Prior period information has been restated to conform to the
current presentation. There are no intersegment revenues between the four
operating segments. Shared support service functions such as human resources,
facilities management and other infrastructure support groups are allocated
based on usage or headcount, where practical, to the four operating segments.
Charges that cannot be allocated are reported as general and administrative
costs and are not allocated to the segments. Special charges determined to be
significant are reported separately in the Consolidated Statements of Operations
and are not assigned or allocated to the segments. All other accounting policies
are applied consistently to the segments, where applicable.
A summary of the segment financial information is as follows:
YEARS ENDED DECEMBER 31,
---------------------------
2000 1999 1998
------- ------- -------
(AMOUNTS IN MILLIONS)
REVENUES:
Interactive Services Group(1)............................... $6,879 $5,059 $3,441
Netscape Enterprise Group(2)................................ 359 447 357
Other Segments(3)........................................... 465 218 75
------ ------ ------
Total revenues.............................................. $7,703 $5,724 $3,873
------ ------ ------
------ ------ ------
INCOME (LOSS) FROM OPERATIONS:
Interactive Services Group(1)............................... $1,958 $1,280 $ 616
Netscape Enterprise Group(2)................................ 153 40 (54)
Other Segments(3)........................................... 185 49 (10)
General & Administrative(4)................................. (469) (427) (300)
Other charges............................................... (10) (123) (148)
------ ------ ------
Total income from operations................................ $1,817 $ 819 $ 104
------ ------ ------
------ ------ ------
---------
(1) For the three years ended December 31, 2000, 1999 and 1998, the Interactive
Services Group includes online service revenues of $4,777 million, $3,874
million and $2,765 million, respectively; advertising and commerce revenues
of $2,022 million, $1,116 million and $591 million, respectively; content
and other revenues of $80 million, $69 million and $85 million,
respectively; and goodwill and other intangible assets amortization of $51
million, $39 million and $25 million, respectively.
(2) For the three years ended December 31, 2000, 1999 and 1998, the Netscape
Enterprise Group is comprised solely of content and other revenues and
includes goodwill and other intangible assets amortization of $0 million, $0
million and $10 million, respectively.
(3) For the three years ended December 31, 2000, 1999 and 1998, Other Segments
include advertising and commerce revenues of $347 million, $124 million and
$21 million, respectively; content and other revenues of $118 million, $94
million, and $54 million, respectively; and goodwill and other intangible
assets amortization of $49 million, $29 million and $14 million,
respectively.
(4) Bad debt expense has been allocated to the applicable segment.
F-38
AMERICA ONLINE, INC. (PREDECESSOR TO AOL TIME WARNER INC.)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
America Online does not have any material revenues and/or assets outside the
United States and no single customer accounts for more than 10% or greater of
total revenues.
8. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
DECEMBER 31,
---------------
2000 1999
------ ------
(IN MILLIONS)
Land........................................................ $ 40 $ 32
Buildings, equipment and related improvements............... 339 195
Leasehold and network improvements.......................... 216 190
Furniture and fixtures...................................... 91 79
Computer equipment and internal software.................... 953 670
Construction in progress.................................... 61 145
Vehicles.................................................... 37 19
------ ------
1,737 1,330
Less accumulated depreciation and amortization.............. 696 435
------ ------
Net property and equipment.................................. $1,041 $ 895
------ ------
------ ------
America Online's depreciation and amortization expense related to property
and equipment for the years ended December 31, 2000, 1999 and 1998 totaled $263
million, $179 million and $142 million, respectively.
9. COMMITMENTS AND CONTINGENCIES
COMMITMENTS
America Online leases facilities and equipment primarily under several
long-term operating leases, certain of which have renewal options. Future
minimum payments under non-cancelable operating leases with initial terms of one
year or more consist of the following:
YEARS ENDING DECEMBER 31,
------------------------- (IN MILLIONS)
2001................................................. $ 367
2002................................................. 305
2003................................................. 159
2004................................................. 69
2005................................................. 59
Thereafter........................................... 157
------
$1,116
------
------
Exclusive of the America Online/Bertelsmann restructuring discussed in Note
6, America Online had outstanding at December 31, 2000, commitments to purchase
additional ownership interest in a joint venture and a partner of a strategic
alliance. These commitments total approximately $657 million and are to be paid
by December 31, 2001. Of this total, approximately $238 million was paid in
February 2001.
America Online's rental expense under operating leases in the years ended
December 31, 2000, 1999 and 1998 totaled approximately $413 million, $324
million and $288 million, respectively.
F-39
AMERICA ONLINE, INC. (PREDECESSOR TO AOL TIME WARNER INC.)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
America Online has guaranteed monthly usage levels of data and voice
communications with some of its network providers and commitments related to the
construction of additional office buildings. The remaining commitments are
$1,732 million, $1,647 million, $724 million and $702 million for the years
ending December 31, 2001, 2002, 2003 and 2004, respectively.
As of December 31, 2000, America Online has guaranteed approximately $11
million in indebtedness of one of its joint ventures. America Online has not had
to make any payments related to this guarantee during the year ended
December 31, 2000.
CONTINGENCIES
America Online is a party to various litigation matters, investigations and
proceedings, including several complaints that have been filed and remain
pending in the Delaware Court of Chancery naming as defendants one or more of
America Online, the directors of America Online, Time Warner and the directors
of Time Warner. The complaints purport to be filed on behalf of holders of
America Online or Time Warner stock, as applicable, and allege breaches of
fiduciary duty by the applicable company and its directors or aiding and
abetting breaches of fiduciary duty by the other company and its directors in
connection with the proposed merger of America Online and Time Warner. The
plaintiffs in each case sought to enjoin completion of the merger and/or
damages, but never took any steps to prosecute their claims beyond filing the
complaints. These cases are, therefore, at a preliminary stage, but America
Online does not believe these lawsuits have any merit and intends to defend
against them vigorously. America Online is unable, however, to predict the
outcome of these cases, or reasonably estimate a range of possible loss given
the current status of the litigation.
Since March 2000, America Online has been named as a defendant in several
class action lawsuits that have been filed in state and federal courts. The
complaints in these lawsuits contend that consumers and competing Internet
service providers have been injured because of the default selection features in
AOL 5.0. Plaintiffs are seeking damages, an injunction enjoining the
distribution of AOL Version 5.0 software, and disgorgement of all monies that
America Online has earned through the distribution of its Version 5.0 software.
These cases are at a preliminary stage, but America Online does not believe they
have merit and intends to contest them vigorously. America Online is unable,
however, to predict the outcome of these cases, or reasonably estimate a range
of possible loss given the current status of the litigation.
Since November 2000, America Online has been named as a defendant in several
lawsuits that have been filed in state courts on behalf of putative classes of
users of the AOL Version 6.0 software. The complaints in these lawsuits contend
that consumers have been injured because of unspecified features in the AOL 6.0
software which cause their computers to 'crash.' The lawsuits seek damages, an
injunction enjoining the distribution of the Version 6.0 software until the
alleged software flaws are rectified, and disgorgement of all monies that
America Online has earned through the distribution of its Version 6.0 software.
These cases are at a preliminary stage, but America Online does not believe they
have merit and intends to defend them vigorously. America Online is unable to
predict the outcome of the cases, however, nor can America Online reasonably
estimate a range of possible loss given the current status of the litigation.
In the spring of 1999, the Department of Labor ('DOL') began an
investigation of the applicability of the Fair Labor Standards Act ('FLSA') to
America Online's Community Leader program. America Online believes the Community
Leaders are volunteers, not employees, that the Community Leader program
reflects industry practices, and that its actions comply with the law. America
Online is cooperating with the DOL's inquiry, but is unable to predict the
outcome of the DOL's investigation and cannot reasonably estimate a range of
possible loss given the current status of the DOL's investigation. Former
volunteers have sued America Online on behalf of an alleged class consisting of
current and former volunteers, alleging violations of the FLSA and comparable
state statutes. America Online believes the claims have no merit and intends to
defend them vigorously. America
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AMERICA ONLINE, INC. (PREDECESSOR TO AOL TIME WARNER INC.)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Online cannot predict the outcome of the claims or whether other former or
current volunteers will file additional actions, nor can America Online
reasonably estimate a range of possible loss given the current status of the
litigation.
The costs and other effects of pending or future litigation, governmental
investigations, legal and administrative cases and proceedings (whether civil or
criminal), settlements, judgments and investigations, claims and changes in
those matters (including those matters described above), and developments or
assertions by or against America Online relating to intellectual property rights
and intellectual property licenses, could have a material adverse effect on
America Online's business, financial condition and operating results.
10. NOTES PAYABLE
During December 1999, America Online sold $2.3 billion principal at maturity
of zero-coupon Convertible Subordinated Notes due December 6, 2019 (the
'Zero-Coupon Notes') and received net proceeds of approximately $1.2 billion.
The Zero-Coupon Notes have a 3% yield to maturity and are convertible into
America Online's common stock at a conversion rate of 5.8338 shares of common
stock for each $1,000 principal amount of the Zero-Coupon Notes (equivalent to a
conversion price of $94.4938 per share based on the initial offering price of
the Zero-Coupon Notes). The Zero-Coupon Notes may be redeemed at the option of
America Online on or after December 6, 2002 at the redemption prices set forth
in the Zero-Coupon Notes. The holders can require America Online to repurchase
the Zero-Coupon Notes on December 6, 2004 at the redemption prices set forth in
the Zero-Coupon Notes. At December 31, 2000, the carrying value of the
Zero-Coupon Notes exceeded the fair value by approximately $215 million as
estimated by using quoted market prices.
On December 31, 1999, the underwriters exercised the overallotment option on
the Zero-Coupon Notes. As a result, on January 5, 2000, America Online sold
additional Zero-Coupon Notes with aggregate principal at maturity of
approximately $55.6 million for net proceeds of approximately $30 million. As of
December 31, 2000 and 1999, the principal amount, net of unamortized discount,
was $1,322 million and $1,245 million, respectively.
During June 1999, America Online borrowed approximately $65 million in the
form of two mortgages on its office buildings and land located in Dulles,
Virginia. The notes are collateralized by the buildings and land and carry
interest rates of 7.7% and 6.75%. The notes amortize over 25 years and are
payable in full at the end of 10 years. As of December 31, 2000 and 1999, the
principal amount outstanding on these mortgages was $64 million and
$65 million, respectively.
During September 1997, America Online borrowed approximately $29 million in
a refinancing of one of its office buildings. The note is collateralized by
America Online's office building and carries interest at a fixed rate of 7.46%.
The note amortizes on a straight-line basis over a term of 25 years and if not
paid in full at the end of 10 years, the interest rate, from that point forward,
is subject to adjustment. As of December 31, 2000 and 1999, the principal amount
outstanding on this note was $27 million and $28 million, respectively.
On November 17, 1997, America Online sold $350 million of 4% Convertible
Subordinated Notes due November 15, 2002 (the 'Notes'). The Notes were
convertible into America Online's common stock at a conversion rate of 153.27504
shares of common stock for each $1,000 principal amount of the Notes (equivalent
to a conversion price of $6.52422 per share), subject to adjustment in certain
events and at the holders option. Interest on the Notes was payable semiannually
on May 15 and November 15 of each year, commencing on May 15, 1998. The Notes
could be redeemed at the option of America Online on or after November 14, 2000,
in whole or in part, at the redemption prices set forth in the Notes.
F-41
AMERICA ONLINE, INC. (PREDECESSOR TO AOL TIME WARNER INC.)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
On November 15, 2000, America Online exercised its option to redeem in
whole, the Notes. Under the redemption prices set forth in the Notes, America
Online was obligated to redeem the outstanding Notes at a price of 101.6%
(expressed as a percentage of principal amount) together with accrued interest
at the date of redemption. At the election of the noteholders the entire
outstanding principal of the Notes as of the redemption date was converted into
approximately 37.7 million shares of America Online's common stock. As of
December 31, 1999, the principal amount, net of unamortized discount, was
$244 million.
Scheduled maturities of total notes payable at December 31, 2000 are:
YEARS ENDING DECEMBER 31,
------------------------- (IN MILLIONS)
2001........................................................ $ 2
2002........................................................ 2
2003........................................................ 2
2004........................................................ 2
2005........................................................ 2
Thereafter.................................................. 2,405
-------
$ 2,415
Less: Unamortized debt discount payable in 2019............. (1,002)
-------
$ 1,413
-------
-------
11. OTHER INCOME, NET
The following table summarizes the components of other income:
YEARS ENDED DECEMBER 31,
-------------------------
2000 1999 1998
----- ---- ----
(IN MILLIONS)
Interest income............................................. $ 330 $161 $ 65
Interest expense............................................ (55) (23) (19)
Equity investment losses.................................... (36) (5) (12)
Gain on investments including available-for-sale
securities................................................ 392 692 20
Loss on investments including available-for-sale
securities................................................ (499) (11) (12)
Loss on SFAS 133 derivatives................................ (70) -- --
Other income (expense)...................................... 5 1 (1)
----- ---- ----
$ 67 $815 $ 41
----- ---- ----
----- ---- ----
The cash portion of net gains on investments including available-for-sale
securities was approximately $205 million, $576 million and $19 million,
respectively, for the years ended December 31, 2000, 1999 and 1998. For the year
ended December 31, 2000 America Online recorded a loss of $481 million on equity
investments, including $123 million on private investments, as a result of
declines in value deemed to be other-than-temporary.
F-42
AMERICA ONLINE, INC. (PREDECESSOR TO AOL TIME WARNER INC.)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
12. INCOME TAXES
The provision for income taxes is comprised of:
YEARS ENDED DECEMBER 31,
--------------------------
2000 1999 1998
----- ----- ----
(IN MILLIONS)
Current -- primarily foreign................................ $ (3) $ (3) $ (2)
Deferred -- primarily US federal and state.................. (5) (53) --
Deferred tax charge attributable to America Online's stock
option plans.............................................. (724) (551) (28)
----- ----- ----
Provision for income taxes.................................. $(732) $(607) $(30)
----- ----- ----
----- ----- ----
The provision for income taxes differs from the amount computed by applying
the statutory federal income tax rate to income before provision for income
taxes. The sources and tax effects of the differences are as follows:
YEARS ENDED DECEMBER 31,
--------------------------
2000 1999 1998
----- ----- ----
(IN MILLIONS)
Income tax provision at the federal statutory rate of 35%... $(659) $(572) $(51)
State income tax, net of federal benefit.................... (56) (51) (7)
Nondeductible charge for purchased research and
development............................................... -- -- (28)
Nondeductible charge for merger related expenses............ (4) (22) --
Benefit of dividends received deduction..................... 23 11 --
Valuation allowance changes affecting the provision for
income taxes.............................................. (8) 48 60
Other....................................................... (28) (21) (4)
----- ----- ----
Provision for income taxes.................................. $(732) $(607) $(30)
----- ----- ----
----- ----- ----
As of December 31, 2000, America Online has net operating loss carryforwards
('NOLs') of approximately $10.6 billion for tax purposes, which will be
available to offset future taxable income. If not used, these carryforwards will
expire between 2002 and 2020. To the extent that net operating loss
carryforwards, when realized, relate to stock option deductions, the resulting
benefits will be credited to stockholders' equity.
America Online's income tax provision was computed based on the federal
statutory rate and the average state statutory rates, net of the related federal
benefit.
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
America Online's deferred tax assets and liabilities are as follows:
F-43
AMERICA ONLINE, INC. (PREDECESSOR TO AOL TIME WARNER INC.)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DECEMBER 31,
-----------------
2000 1999
------- -------
(IN MILLIONS)
Short term:
Short term deferred tax assets:
Deferred revenue............................................ $ 13 $ 17
Accrued expenses and other.................................. 38 26
Valuation allowance......................................... (49) (33)
------- -------
Total....................................................... $ 2 $ 10
------- -------
------- -------
Long term:
Long term deferred tax liabilities:
Capitalized software costs.................................. $ (108) $ (56)
Unrealized gain on available-for-sale securities............ (38) (899)
Unremitted earnings of foreign subsidiaries................. (11) (7)
------- -------
Total....................................................... (157) (962)
Long term deferred tax assets:
Net operating loss carryforwards............................ 4,029 3,883
Deferred network services credit............................ 58 79
Investment in AOL Europe.................................... 187 94
Other....................................................... 261 99
Valuation allowance......................................... (4,370) (3,203)
------- -------
Total....................................................... 165 952
------- -------
Net long term deferred asset (liability).................... $ 8 $ (10)
------- -------
------- -------
The valuation allowance for deferred tax assets increased by $1,183 million
in 2000. The increase in this allowance was primarily due to the benefit
generated from the current year exercise of stock options in excess of the
utilization of $724 million of benefits that reduce 2000 income taxes payable.
The benefit from the 2000 exercise of options will be recorded to stockholders'
equity as it is realized.
America Online has NOLs and other deferred tax benefits that are available
to offset future taxable income. Only a portion of the NOLs are attributable to
operating activities. The remainder of the NOLs are attributable to tax
deductions related to the exercise of stock options. America Online recognized
the tax benefits from current and prior years' stock option deductions after
utilization of NOLs from operations (i.e., NOLs determined without deductions
for exercised stock options) to reduce income tax expense.
America Online's deferred tax asset related to operations and exercised
stock options amounted to:
DECEMBER 31,
---------------
2000 1999
------ ------
(MILLIONS)
Operations.................................................. $ 141 $ 141
Stock options............................................... $4,278 $3,095
When realization of the deferred tax asset is more likely than not to occur,
the benefit related to the deductible temporary differences attributable to
operations will be recognized as a reduction of income tax expense. The benefit
related to the deductible temporary differences attributable to stock option
deductions will be credited to additional paid-in capital when realized.
F-44
AMERICA ONLINE, INC. (PREDECESSOR TO AOL TIME WARNER INC.)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
13. CAPITAL ACCOUNTS
COMMON STOCK
At December 31, 2000 and 1999, America Online's $0.01 par value common stock
authorized was 6 billion shares with approximately 2.4 billion and 2.3 billion
shares issued and outstanding, respectively. At December 31, 2000, approximately
467.6 million shares were reserved for the exercise of issued and unissued
common stock options, and convertible debt, and approximately 15.6 million
shares were reserved for issuance in connection with America Online's Employee
Stock Purchase Plans.
America Online sold approximately 45 million, 211 million and 140 million
shares from the exercise of stock options, warrants and stock purchased through
the employee stock purchase plan in 2000, 1999 and 1998, respectively. Net
proceeds from these sales totaled approximately $318 million, $494 million and
$192 million in the same time periods. In addition, during July 1998, America
Online completed a public offering of common stock. America Online sold
approximately 43.2 million shares of common stock and raised a total of
$550 million in new equity. America Online used the proceeds for general
operating purposes.
PREFERRED STOCK
In February 1992, America Online's stockholders approved an amendment and
restatement of the certificate of incorporation which authorized the future
issuance of 5 million shares of preferred stock, $0.01 par value, with rights
and preferences to be determined by the Board of Directors.
During May 1998, the Board of Directors designated 500,000 shares of America
Online's preferred stock as Series A-1 Junior Participating Preferred Stock in
connection with the establishment of a stockholder rights plan.
During May 1996, America Online sold 1,000 shares of Series B convertible
preferred stock (the 'Preferred Stock') for approximately $28 million. The
Preferred Stock had an aggregate liquidation preference of approximately
$28 million and accrued dividends at a rate of 4% per annum. Accrued dividends
could be paid in the form of additional shares of Preferred Stock. During May
1998, the Preferred Stock, plus accrued but unpaid dividends, automatically
converted into 3.1 million shares of common stock based on the fair market value
of common stock at the time of conversion.
WARRANT
In connection with an agreement with one of America Online's communications
providers, America Online issued a warrant that was exercised in full during
March 1999. The warrant, subject to certain performance standards specified in
the agreement, allowed America Online's communication provider to purchase
57.6 million shares of common stock at a price of $0.2461 per share.
SHAREHOLDER RIGHTS PLAN
America Online adopted a new shareholder rights plan on May 12, 1998 (the
'New Plan'). The New Plan was implemented by declaring a dividend, distributable
to stockholders of record on June 1, 1998, of one preferred share purchase right
(a 'Right') for each outstanding share of common stock. All rights granted under
America Online's former shareholder rights plan adopted in the year ended
December 31, 1993 were redeemed in conjunction with the implementation of the
New Plan and the former plan was terminated. Each Right under the New Plan will
initially entitle registered holders of the common stock to purchase one
one-thousandth of a share of America Online's new Series A-1 Junior
Participating Preferred Stock ('Series A-1 Preferred Stock') at
F-45
AMERICA ONLINE, INC. (PREDECESSOR TO AOL TIME WARNER INC.)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
a purchase price of $900 per one one-thousandth of a share of Series A-1
Preferred Stock, subject to adjustment. The Rights will be exercisable only if a
person or group (i) acquires 15% or more of the common stock or (ii) announces a
tender offer that would result in that person or group acquiring 15% or more of
the common stock. Once exercisable, and in some circumstances if certain
additional conditions are met, the New Plan allows stockholders (other than the
acquirer) to purchase common stock or securities of the acquirer having a then
current market value of two times the exercise price of the Right. The Rights
are redeemable for $0.001 per Right (subject to adjustment) at the option of the
Board of Directors. Until a Right is exercised, the holder of the Right, as
such, has no rights as a stockholder of America Online. The Rights will expire
on May 12, 2008 unless redeemed by America Online prior to that date. On
January 9, 2000, America Online adopted an amendment to the New Plan to exclude
America Online's merger with Time Warner from the actions that would cause the
Rights to become exercisable and to provide that the New Plan would terminate
with the closing of the merger with Time Warner. Consistent with the amendment
to the New Plan, the New Plan terminated as of January 11, 2001, the closing
date of America Online's merger with Time Warner.
STOCK SPLITS
In March 1998, November 1998, February 1999, and November 1999 America
Online effected two-for-one splits of the outstanding shares of common stock.
Accordingly, all data shown in the accompanying consolidated financial
statements and notes has been retroactively adjusted to reflect the stock
splits.
14. STOCK PLANS
Options to purchase America Online's common stock under various stock option
plans have been granted to employees, directors and consultants of America
Online at fair market value on the date of grant. Generally, the options become
exercisable over periods ranging from one to four years and expire ten years
from the date of grant. In certain of these plans, America Online has repurchase
rights upon the individual cessation of employment. Generally, these rights
lapse over a 48-month period. In the years ended December 31, 1996 and 1998, the
Board of Directors authorized approximately 6 million and 16 million options to
be repriced, respectively. The vesting schedules were not materially changed and
no employees owning 3% or more of America Online's common stock nor any senior
executives participated in the repricing.
The effect of applying FAS 123 on the years ended December 31, 2000, 1999
and 1998 pro forma net income (loss) as stated below is not necessarily
representative of the effects on reported net income (loss) for future years
due to, among other things, the vesting period of the stock options and the
fair value of additional stock options in future years. Had compensation cost
for America Online's stock option plans been determined based upon the fair
value at the grant date for awards under the plans consistent with the
methodology prescribed under FAS 123, America Online's net income (loss) in
the years ended December 31, 2000, 1999 and 1998 would have been approximately
$499 million, $553 million and $(55) million, or $0.19 per share, $0.22 per
share and $(0.03) per share, respectively, on a diluted basis. The fair value
of the options granted during the years ended December 31, 2000, 1999 and 1998
are estimated at $21.07 per share, $23.25 per share and $4.57 per share,
respectively, on the date of grant using the Black-Scholes option-pricing
model. The following assumptions (which, for 2000, reflect the impact of the
announced Merger) were used for grants in 2000, 1999 and 1998; no dividend
yield, volatility of 46.3%, 65% and 65%, respectively; a risk-free interest
rate of 6.22%, 5,49% and 5.14%, respectively and an expected life of
.54 years from date of vesting. A summary of stock option activity is as
follows:
F-46
AMERICA ONLINE, INC. (PREDECESSOR TO AOL TIME WARNER INC.)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
WEIGHTED-
AVERAGE
NUMBER OF EXERCISE
SHARES PRICE
------------ ---------
Balance at December 31, 1997................................ 481,566,395 $ 1.74
Granted..................................................... 146,805,238 10.50
Exercised................................................... (140,608,840) 1.00
Forfeited................................................... (36,144,987) 3.77
------------ ------
Balance at December 31, 1998................................ 451,617,806 $ 4.66
Granted..................................................... 102,179,353 51.23
Exercised................................................... (135,021,900) 2.64
Forfeited................................................... (35,699,133) 19.43
------------ ------
Balance at December 31, 1999................................ 383,076,126 $16.42
Granted..................................................... 67,208,815 56.61
Exercised................................................... (44,170,079) 6.10
Forfeited................................................... (23,269,230) 39.94
------------ ------
Balance at December 31, 2000................................ 382,845,632 $23.23
------------ ------
------------ ------
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
---------------------------------------- --------------------------
WEIGHTED-
AVERAGE
REMAINING WEIGHTED- WEIGHTED-
NUMBER CONTRACTUAL AVERAGE NUMBER AVERAGE
RANGE OF OUTSTANDING LIFE EXERCISE EXERCISABLE EXERCISE
EXERCISE PRICE AS OF 12/31/00 (IN YEARS) PRICE AS OF 12/31/00 PRICE
---------------------------------- -------------- ----------- ----- -------------- ---------
$0.01 to $1.08.................... 41,741,214 3.7 $ 0.57 41,099,548 $ 0.57
$1.09 to $1.70.................... 39,396,402 5.5 1.52 38,685,845 1.52
$1.73 to $4.03.................... 52,152,336 6.3 3.52 38,502,927 3.44
$4.15 to $9.08.................... 40,140,953 6.9 6.25 11,490,991 5.83
$9.35 to $14.50................... 61,619,382 7.5 11.21 26,144,605 11.15
$14.63 to $37.39.................. 9,637,440 7.9 25.24 4,001,987 24.43
$37.40 to $47.94.................. 54,688,712 8.6 47.21 13,338,551 47.30
$48.00 to $55.57.................. 15,885,455 9.0 52.92 2,010,186 53.77
$55.60 to $57.38.................. 50,704,260 9.7 57.34 105,793 56.53
$57.44 to $93.94.................. 16,879,478 8.8 65.94 4,329,310 67.71
----------- --- ------ ----------- ------
$0.01 to $93.94................... 382,845,632 7.2 $23.23 179,709,743 $ 9.51
----------- --- ------ ----------- ------
----------- --- ------ ----------- ------
EMPLOYEE STOCK PURCHASE PLAN
In May 1992, America Online's Board of Directors adopted a non-compensatory
Employee Stock Purchase Plan ('the ESPP'). Under the ESPP, employees of America
Online who elect to participate are granted options to purchase common stock at
a 15 percent discount from the market value of such stock. The ESPP permits an
enrolled employee to make contributions to purchase shares of common stock by
having withheld from his or her salary an amount between 1 percent and
15 percent of compensation. The Compensation and Management Development
Committee of the Board of Directors administers the ESPP. The total number of
shares of common stock that may be issued pursuant to options granted under the
ESPP is approximately 28.8 million. A total of approximately 13.2 million
shares of common stock have been issued under the ESPP.
F-47
AMERICA ONLINE, INC. (PREDECESSOR TO AOL TIME WARNER INC.)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In June 1995, America Online adopted a non-compensatory Employee Stock
Purchase Plan ('the Netscape ESPP') under Section 423 of the Internal Revenue
Code and a total of 6.3 million shares of common stock may be issued pursuant to
options under the Netscape ESPP. America Online's Board of Directors in 1998
amended the Netscape ESPP to increase the maximum percentage of payroll
deductions which any participant may contribute from his or her eligible
compensation to 15%; amended the Netscape ESPP from a two-year rolling offering
period to a six-month fixed offering period effective with the offering period
beginning March 1999; amended the limit to the number of shares any employee may
purchase in any purchase period to a maximum of 1,800 shares; and changed the
offering dates for each purchase period to March 1 and September 1 of each year.
Under this plan, qualified employees are entitled to purchase common stock at a
15 percent discount from the market value of such stock. Approximately
4 million shares of common stock have been issued under the Netscape ESPP. The
Netscape ESPP was terminated in September 1999.
15. EMPLOYEE BENEFIT PLAN
SAVINGS PLANS
As of December 31, 2000, America Online has one savings plan that qualifies
as a deferred salary arrangement under Section 401(k) of the Internal Revenue
Code. Under the plan, participating employees may defer a portion of their
pretax earnings. As defined by the plan, America Online matches 50% of each
employee's contributions up to a maximum matching contribution of 3% of the
employee's earnings. Prior to March 2000, America Online had two savings plans.
In one plan, America Online matched 50% of each employee's contributions up to a
maximum matching contribution of 3% of the employee's earnings and in the other
plan, America Online's contributions were discretionary. America Online's
contributions to the plans were approximately $13 million, $9 million and
$5 million in the years ended December 31, 2000, 1999 and 1998, respectively.
F-48
REPORT OF INDEPENDENT AUDITORS
BOARD OF DIRECTORS AND STOCKHOLDERS
AOL TIME WARNER INC.
We have audited the accompanying consolidated balance sheets of America
Online, Inc. (predecessor to AOL Time Warner Inc.) as of December 31, 2000 and
1999, and the related consolidated statements of operations, changes in
stockholders' equity and cash flows for each of the three years in the period
ended December 31, 2000. These financial statements are the responsibility of
America Online's management. Our responsibility is to express an opinion on
these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatements. 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 America Online,
Inc. at December 31, 2000 and 1999, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
December 31, 2000, in conformity with accounting principles generally accepted
in the United States.
/s/ ERNST & YOUNG LLP
January 31, 2001, except for
Note 2, as to which the date
is March 21, 2001
McLean, Virginia
F-49
AMERICA ONLINE, INC. (PREDECESSOR TO AOL TIME WARNER INC.)
SELECTED FINANCIAL INFORMATION
THE FOLLOWING TABLE SETS FORTH THE FIVE YEAR SELECTED DATA FOR AMERICA ONLINE,
INC.
YEARS ENDED DECEMBER 31,
--------------------------------------------
2000 1999 1998 1997 1996
------- ------- ------ ------ ------
(AMOUNTS IN MILLIONS, EXCEPT PER SHARE DATA)
Statement of Operations Data:
Subscription services......................... $ 4,777 $ 3,874 $2,765 $1,715 $1,300
Advertising and commerce...................... 2,369 1,240 612 309 150
Content and other............................. 557 610 496 610 373
------- ------- ------ ------ ------
Total revenues.................................... 7,703 5,724 3,873 2,634 1,823
Income (loss) from operations..................... 1,817 819 104 (28) (219)
Net income (loss)(1).............................. 1,152 1,027 115 1 (244)
Income (loss) per common share:
Net income (loss) per share -- basic.......... $ 0.50 $ 0.47 $ 0.06 $ 0.00 $(0.15)
Net income (loss) per share -- diluted........ $ 0.45 $ 0.40 $ 0.05 $ 0.00 $(0.15)
Weighted average shares outstanding:
Basic......................................... 2,323 2,199 1,959 1,765 1,609
Diluted....................................... 2,595 2,599 2,370 2,066 1,609
AS OF DECEMBER 31,
--------------------------------------------
2000 1999 1998 1997 1996
------- ------- ------ ------ ------
(AMOUNTS IN MILLIONS)
Balance Sheet Data:
Working capital............................... $ 2,343 $ 1,698 $ 885 $ 302 $ 35
Total assets.................................. 10,827 10,396 3,835 2,090 1,137
Total debt.................................... 1,418 1,599 420 375 24
Stockholders' equity.......................... 6,778 6,331 1,862 798 464
---------
(1) Net income in the year ended December 31, 2000 includes gains related to
investments of $275 million, merger expenses of $10 million, investment
losses of $465 million due to the write-down of securities and derivative
losses of $70 million. Net income in the year ended December 31, 1999
includes special charges of $123 million related to mergers and
restructurings and a net gain of $678 million related to the sale of
investments. Net income in the year ended December 31, 1998 includes special
charges of $50 million related to mergers and restructurings, $80 million
related to acquired in-process research and development and $18 million
related to legal settlements. Net income in the year ended December 31, 1997
includes special charges of $27 million related to restructurings,
$24 million related to contract terminations, $23 million related to
acquired in-process research and development and the reversal of $1 million
related to a legal settlement. Net loss in the year ended December 31, 1996
includes special charges of $55 million related to mergers and a
restructuring, $24 million for a legal settlement and $8 million for
the settlement of a class action lawsuit.
F-50
AMERICA ONLINE, INC. (PREDECESSOR TO AOL TIME WARNER INC.)
QUARTERLY FINANCIAL INFORMATION
(UNAUDITED)
THE FOLLOWING TABLE SETS FORTH THE QUARTERLY INFORMATION FOR AMERICA ONLINE,
INC.
QUARTER ENDED
---------------------------------------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
--------- -------- ------------- ------------
(AMOUNTS IN MILLIONS, EXCEPT PER SHARE DATA)
2000(1)
Subscription revenues............................ $1,153 $1,185 $1,206 $1,233
Advertising and commerce......................... 528 561 594 686
Content and other................................ 133 139 145 140
------ ------ ------ ------
Total revenues................................... 1,814 1,885 1,945 2,059
Operating income................................. 376 456 482 503
Net income....................................... 433 338 344 37
Net income per share-basic....................... $ 0.19 $ 0.15 $ 0.15 $ 0.02
Net income per share-diluted..................... $ 0.17 $ 0.13 $ 0.13 $ 0.01
Net cash provided by operating activities........ $ 478 $ 511 $ 398 $ 571
Earnings Before Interest, Other Income, Net,
Taxes, Depreciation and Amortization (EBITDA,
as adjusted)(4)................................ $ 506 $ 583 $ 609 $ 652
1999(2)(3)
Subscription revenues............................ $ 869 $ 943 $ 995 $1,067
Advertising and commerce......................... 247 271 320 402
Content and other................................ 143 170 148 149
------ ------ ------ ------
Total revenues................................... 1,259 1,384 1,463 1,618
Operating Income................................. 44 209 260 306
Net income....................................... 409 157 181 280
Net income per share-basic....................... $ 0.20 $ 0.07 $ 0.08 $ 0.12
Net income per share-diluted..................... $ 0.16 $ 0.06 $ 0.07 $ 0.11
Net cash provided by operating activities........ $ 629 $ 192 $ 466 $ 353
Earnings Before Interest, Other Income, Net,
Taxes, Depreciation and Amortization (EBITDA,
as adjusted)(4)................................ $ 243 $ 322 $ 358 $ 412
---------
(1) Net income in the year ended December 31, 2000 includes gains related to
investments of $275 million in the quarter ended March 31, 2000, merger
expense of $10 million in the quarter ended June 30, 2000 and investment
losses of $465 million due to the write-down of securities and SFAS 133
derivative losses of $70 million in the quarter ended December 31, 2000.
(2) Net income in the year ended December 31, 1999 includes merger and
restructuring expense of $78 million, transition expense of $25 million and
a gain related to an investment of $567 million in the quarter ended March
31, 1999, merger expense of $15 million in the quarter ended June 30, 1999
and gains related to investments of $111 million and merger expense of $5
million in the quarter ended December 31, 1999. Also, in the quarter ended
December 31, 1999, America Online adjusted its accounting to capitalize the
acquisition cost of Gateway.net subscribers and amortize such cost over the
term of the agreement. The effect of the adjustment on the quarter was to
increase net income by $18 million and $.01 per diluted share.
(3) The sum of per share earnings does not equal earnings per share for the year
due to equivalent share calculations which are impacted by fluctuations in
America Online's common stock market prices and the timing (weighting) of
shares issued.
(4) EBITDA is defined as operating income adjusted to exclude: (1) depreciation
and amortization (2) special charges and (3) corporate expenses. In the year
ended December 31, 2000, Corporate expenses excluded from the calculation of
EBITDA were $22 million, $19 million, $17 million and $21 million for the
quarters ended March 31, June 30, September 30, and December 31,
respectively. In the year ended December 31,1999, Corporate expenses
excluded from the calculation of EBITDA were $19 million, $16 million, $19
million and $23 million for the quarters ended March 31, June 30, September
30, and December 31, respectively. America Online considers EBITDA an
important indicator of the operational strength and performance of its
business including the ability to provide cash flows to service debt and
fund capital expenditures. EBITDA, however, should not be considered an
alternative to operating or net income as an indicator of the performance of
America Online, or as an alternative to cash flows from operating activities
as a measure of liquidity, in each case determined in accordance with
generally accepted accounting principles ('GAAP').
F-51
MARKET PRICE OF COMMON STOCK
The following table sets forth the range of high and low sale prices for the
America Online's Common Stock for the periods indicated and reflects all stock
splits effected by America Online:
HIGH LOW
FOR THE QUARTER ENDED: ------ ------
March 31, 1999.............................................. $76.88 $33.50
June 30, 1999............................................... $87.50 $44.75
September 30, 1999.......................................... $64.59 $38.50
December 31, 1999........................................... $95.63 $52.03
March 31, 2000.............................................. $82.88 $48.25
June 30, 2000............................................... $69.38 $48.38
September 30, 2000.......................................... $63.19 $51.06
December 31, 2000........................................... $62.25 $32.90
America Online has never declared, nor has it paid, any cash dividends on
its Common Stock. The Company currently intends to retain its earnings to
finance future growth and, therefore, does not anticipate paying any cash
dividends on its Common Stock in the foreseeable future.
EXCHANGE INFORMATION
The AOL Time Warner Common Stock is traded on the New York Stock Exchange
under the symbol 'AOL.'
Options on the Company's stock are traded on the Chicago Board Options
Exchange, the American Stock Exchange, and the Pacific Stock Exchange.
RECENT SALES OF UNREGISTERED SECURITIES
None
F-52
STATEMENT OF DIFFERENCES
The section symbol shall be expressed as...............................'SS'
EXHIBIT INDEX
Sequential
Exhibit Page
Number Description Number
-----------------------------------------------------------------------------------------
2. Second Amended and Restated Agreement and Plan of Merger dated as of *
January 10, 2000 among the Registrant, America Online, Inc.
("AOL"), Time Warner Inc. ("Time Warner"), America Online Merger
Sub Inc. and Time Warner Merger Sub Inc. (incorporated by
reference to Annex A to the Joint Proxy Statement -- Prospectus
in Part I of Amendment No. 4 to the Registrant's Registration
Statement on Form S-4 filed on May 19, 2000 (File No.)
333-30184)).
3.(i)(a) Restated Certificate of Incorporation of the Registrant as filed *
with the Secretary of State of the State of Delaware on January
11, 2001 (which is incorporated herein by reference to Exhibit
3.1 to the Registrant's Current Report on Form 8-K dated January
11, 2001 (the "January 2001 Form 8-K")).
3.(i)(b) Certificate of the Voting Powers, Designations, Preferences and *
Relative, Participating, Optional or Other Special Rights, and
Qualifications, Limitations or Restrictions Thereof, of Series
LMC Common Stock of the Registrant as filed with the Secretary of
State of the State of Delaware on January 11, 2001 (which is
incorporated herein by reference to Exhibit 3.2 to the
Registrant's January 2001 Form 8-K).
3.(i)(c) Certificate of the Voting Powers, Designations, Preferences and *
Relative, Participating, Optional or Other Special Rights, and
Qualifications, Limitations or Restrictions Thereof, of Series
LMCN-V Common Stock of the Registrant as filed with the Secretary
of State of the State of Delaware on January 11, 2001 (which is
incorporated herein by reference to Exhibit 3.3 to the
Registrant's January 2001 Form 8-K).
3.(ii) By-laws of the Registrant as of January 18, 2001.
4.1 Indenture dated as of June 1, 1998 among Time Warner, Time Warner *
Companies, Inc. ("TWCI"), Turner Broadcasting System, Inc.
("TBS") and The Chase Manhattan Bank, as Trustee ("Chase
Manhattan") (which is incorporated herein by reference to Exhibit
4 to Time Warner's Quarterly Report on Form 10-Q for the Quarter
ended June 30, 1998 (File No. 1-12259)).
4.2 First Supplemental Indenture dated as of January 11, 2001 among
the Registrant, Time Warner, AOL, TWCI, TBS and Chase Manhattan,
as Trustee.
4.3 Indenture dated as of April 30, 1992, as amended by the First *
Supplemental Indenture, dated as of June 30, 1992, among Time
Warner Entertainment Company, L.P. ("TWE"), TWCI, certain of
TWCI's subsidiaries that are parties thereto and The Bank of New
York ("BONY"), as Trustee (which is incorporated herein by
reference to Exhibits 10(g) and 10(h) to TWCI's Current Report on
Form 8-K dated July 14, 1992 (File No. 1-8637) ("TWCI's July 1992
Form 8-K")).
4.4 Second Supplemental Indenture, dated as of December 9, 1992, *
among TWE, TWCI, certain of TWCI's subsidiaries that are
parties thereto and BONY, as Trustee (which is incorporated
herein by reference to Exhibit 4.2 to Amendment No. 1 to TWE's
Registration Statement on Form S-4 (Registration No. 33-67688)
filed with the Commission on October 25, 1993 ("TWE's 1993 Form
S-4")).
4.5 Third Supplemental Indenture, dated as of October 12, 1993, among *
TWE, TWCI, certain of TWCI's subsidiaries that are parties
thereto and BONY, as Trustee (which is incorporated herein by
reference to Exhibit 4.3 to TWE's 1993 Form S-4).
4.6 Fourth Supplemental Indenture, dated as of March 29, 1994, among *
TWE, TWCI, certain of TWCI's subsidiaries that are parties
thereto and BONY, as Trustee (which is incorporated herein by
reference to Exhibit 4.4 to TWE's Annual Report on Form 10-K for
the year ended December 31, 1993 (File No. 1-12878) ("TWE's 1993
Form 10-K")).
4.7 Fifth Supplemental Indenture, dated as of December 28, 1994, *
among TWE, TWCI, certain of TWCI's subsidiaries that are
parties thereto and BONY, as Trustee (which is incorporated
herein by reference to Exhibit 4.5 to TWE's Annual Report on Form
10-K for the year ended December 31, 1994 (File No. 1-12878)).
4.8 Sixth Supplemental Indenture, dated as of September 29, 1997, *
among TWE, TWCI, certain of TWCI's subsidiaries that are
parties thereto and BONY, as Trustee (which is incorporated
herein by reference to Exhibit 4.7 to Time Warner's Annual Report
on Form 10-K for the year ended December 31, 1997 (File No.
1-12259)(the "Time Warner 1997 Form 10-K")).
i
EXHIBIT INDEX
Sequential
Exhibit Page
Number Description Number
-----------------------------------------------------------------------------------------
4.9 Seventh Supplemental Indenture, dated as of December 29, 1997, *
among TWE, TWCI, certain of TWCI's subsidiaries that are
parties thereto and BONY, as Trustee (which is incorporated
herein by reference to Exhibit 4.7 to the Time Warner 1997 Form
10-K).
4.10 Indenture dated as of January 15, 1993 between TWCI and Chase *
Manhattan, as Trustee (which is incorporated herein by
reference to Exhibit 4.11 to TWCI's Annual Report on Form 10-K
for the year ended December 31, 1992 (File No. 1-8637)).
4.11 First Supplemental Indenture dated as of June 15, 1993 between *
TWCI and Chase Manhattan, as Trustee (which is incorporated
herein by reference to Exhibit 4 to TWCI's Quarterly Report on
Form 10-Q for the quarter ended June 30, 1993 (File No. 1-8637)).
4.12 Second Supplemental Indenture dated as of October 10, 1996 among *
Time Warner, TWCI and Chase Manhattan, as Trustee (which is
incorporated herein by reference to Exhibit 4.1 to TWCI's
Quarterly Report on Form 10-Q for the quarter ended September 30,
1996 (File No. 1-8637)).
4.13 Third Supplemental Indenture dated as of December 31, 1996 among *
Time Warner, TWCI and Chase Manhattan, as Trustee (which is
incorporated herein by reference to Exhibit 4.10 to Time Warner's
Annual Report on Form 10-K for the year ended December 31, 1996
(File No. 1-12259) (the "Time Warner 1996 Form 10-K")).
4.14 Fourth Supplemental Indenture dated as of December 17, 1997 among *
Time Warner, TWCI, TBS and Chase Manhattan, as Trustee (which
is incorporated herein by reference to Exhibit 4.4 to Time
Warner's, TWCI's and TBS's Registration Statement on Form S-4
(Registration Nos. 333-45703, 333-45703-02 and 333-45703-01)
filed with the Commission on February 5, 1998 (the "1998 Form
S-4")).
4.15 Fifth Supplemental Indenture dated as of January 12, 1998 among *
Time Warner, TWCI, TBS and Chase Manhattan, as Trustee (which is
incorporated herein by reference to Exhibit 4.5 to Time Warner's,
TWCI's and TBS's 1998 Form S-4).
4.16 Sixth Supplemental Indenture dated as of March 17, 1998 among *
Time Warner, TWCI, TBS and Chase Manhattan, as Trustee (which
is incorporated herein by reference to Exhibit 4.15 to the Time
Warner 1997 Form 10-K).
4.17 Seventh Supplemental Indenture dated as of January 11, 2001 among
the Registrant, Time Warner, AOL, TWCI, TBS and Chase Manhattan,
as Trustee.
4.18 Trust Agreement dated as of April 1, 1998 among Time Warner, as *
Grantor and U.S. Trust Company of California, N.A., as Trustee
(which is incorporated herein by reference to Exhibit 4.16 to the
Time Warner 1997 Form 10-K).
4.19 Indenture dated as of December 6, 1999, between AOL and State
Street Bank and Trust Company ("State Street"), as Trustee.
4.20 Supplemental Indenture No. 1 dated as of December 6, 1999 between
AOL and State Street, as Trustee.
4.21 Supplemental Indenture No. 2 dated as of January 11, 2001 between
the Registrant, AOL, Time Warner, TWCI, TBS and State Street, as
Trustee.
10.1 Time Warner 1986 Stock Option Plan, as amended through March 16, *
2000 (incorporated by reference to Exhibit 10.1 to Time
Warner's Annual Report on Form 10-K for the year ended December
31, 1999 (File No. 1-12259) (the "Time Warner 1999 Form 10-K")).
10.2 1988 Stock Incentive Plan of Time Warner, as amended through *
March 16, 2000 (incorporated by reference to Exhibit 10.2 to
the Time Warner 1999 Form 10-K).
10.3 Time Warner 1989 Stock Incentive Plan, as amended through March 16, *
2000 (incorporated by reference to Exhibit 10.3 to the Time Warner
1999 Form 10-K).
10.4 AOL Time Warner Inc. 1994 Stock Option Plan, as amended through
January 18, 2001.
10.5 Time Warner 1997 Stock Option Plan, as amended through March 16, *
2000 (incorporated by reference to Exhibit 10.7 to the Time
Warner 1999 Form 10-K).
10.6 AOL 1992 Employee, Director and Consultant Stock Option Plan, as *
amended (which is incorporated herein by reference to Exhibit
10.2 to the AOL Annual Report on Form 10-K for the year ended
June 30, 1999 (File No. 1-12143) (the "AOL 1999 Form 10-K")).
10.7 AOL Time Warner 1999 Stock Plan, as amended through January 18,
2001.
10.8 Time Warner 1988 Restricted Stock Plan for Non-Employee
Directors, as amended through January 18, 2001.
ii
EXHIBIT INDEX
Sequential
Exhibit Page
Number Description Number
-----------------------------------------------------------------------------------------
10.9 Time Warner 1996 Stock Option Plan for Non-Employee Directors, as
amended through January 18, 2001.
10.10 Deferred Compensation Plan for Directors of Time Warner, as *
amended through November 18, 1993 (which is incorporated herein
by reference to Exhibit 10.9 to TWCI's Annual Report on Form 10-K
for the year ended December 31, 1993 (File No. 1-8632)).
10.11 Time Warner Retirement Plan for Outside Directors, as amended *
through May 16, 1996 (which is incorporated herein by reference
to Exhibit 10.9 to the Time Warner 1996 Form 10-K).
10.12 Amended and Restated Time Warner Annual Bonus Plan for Executive *
Officers (which is incorporated herein by reference to Annex A
to TWCI's definitive Proxy Statement dated March 30, 1995 used in
connection with TWCI's 1995 Annual Meeting of Stockholders).
10.13 AOL Executive Incentive Plan.
10.14 AOL Time Warner Inc. Deferred Compensation Plan (the "Deferred *
Compensation Plan") (which is incorporated herein by Reference
to Exhibit 4 to Time Warner's Registration Statement on Form S-8
filed with the Commission on December 18, 1998 (Registration No.
333-69161)).
10.15 Amendment No. 2 to the Deferred Compensation Plan, effective on *
September 13, 1999 (which is incorporated herein by reference
to Exhibit 10.15 to the Time Warner 1999 Form 10-K).
10.16 Amendment No. 3 to the Deferred Compensation Plan, effective on *
October 25, 1999 except where otherwise indicated (which is
incorporated herein by reference to Exhibit 10.16 to the Time
Warner 1999 Form 10-K).
10.17 Amendment No. 4 to the Deferred Compensation Plan, effective on *
October 25, 1999 except where otherwise indicated (which is
incorporated herein by reference to Exhibit 10.17 to the Time
Warner 1999 Form 10-K).
10.18 Amendment No. 5 to the Deferred Compensation Plan, effective on *
November 15, 1999, except where otherwise indicated (which is
incorporated herein by reference to Exhibit 10.18 to the Time
Warner 1999 Form 10-K).
10.19 Amendment No. 6 to the Deferred Compensation Plan, effective on *
March 15, 2000, except where otherwise indicated (which is
incorporated herein by reference to Exhibit 10.19 to the Time
Warner 1999 Form 10-K).
10.20 Amendment No. 7 to the Deferred Compensation Plan, approved on *
May 25, 2000, (which is incorporated herein by reference to
Exhibit 10.2 to Time Warner's quarterly report on Form 10-Q for
the quarter ended June 30, 2000 (the "Time Warner June 2000 Form
10-Q").
10.21 Amendment No. 8 to the Deferred Compensation Plan, approved on *
June 28, 2000 (which is incorporated herein by reference to
Exhibit 10.3 to the Time Warner June 2000 Form 10-Q).
10.22 Amendment No. 9 to the Deferred Compensation Plan, effective on *
August 1, 2000 (which is incorporated herein by reference to
Exhibit 10.2 to Time Warner's quarterly report on Form 10-Q for
the quarter ended September 30, 2000 (the "Time Warner September
2000 Form 10-Q").
10.23 Amendment No. 10 to the Deferred Compensation Plan, effective on *
November 1, 2000 (which is incorporated herein by reference to
Exhibit 10.1 to the Time Warner September 2000 Form 10-Q).
10.24 Amendment No. 11 to the Deferred Compensation Plan, effective on
January 11, 2001.
10.25 AOL Time Warner Employee Stock Purchase Plan, as amended (which *
is incorporated herein by reference to Exhibit 10.1 to the AOL
1999 Form 10-K).
10.26 Amended and Restated Employment Agreement effective as of January 1, *
1998, as amended December 2, 1998 between the Registrant and
Gerald M. Levin (which is incorporated herein by reference to
Exhibit 10.13 to the Time Warner Annual Report on Form 10-K for
the year ended December 31, 1998 (File No. 1-12259) (the "Time
Warner 1998 Form 10-K").
iii
EXHIBIT INDEX
Sequential
Exhibit Page
Number Description Number
-----------------------------------------------------------------------------------------
10.27 Amended and Restated Employment Agreement effective as of January 1, *
1998, as amended December 15, 1998 between the Registrant
and R.E. Turner ("Turner") (which is incorporated herein by
reference to Exhibit 10.14 to the Time Warner 1998 Form 10-K).
10.28 Amended and Restated Employment Agreement made as of March 25,
1999, effective as of January 1, 1999, as amended as of October
26, 2000 between the Registrant and Richard D. Parsons.
10.29 Employment Agreement and related agreements entered into with *
Robert W. Pittman (which is incorporated herein by reference to
Exhibit 10.15 to the AOL Annual Report on Form 10-K for the year
ended June 30, 1997 (File No. 1-12143)).
10.30 Agreement Containing Consent Orders, including the Decision and *
Order, between the Registrant and the Federal Trade Commission
signed December 13, 2000 (incorporated herein by reference to
Exhibit 99.2 to the Registrant's January 2001 Form 8-K).
10.31 Order to Hold Separate issued by the Federal Trade Commission *
dated December 14, 2000 (incorporated herein by reference to
Exhibit 99.3 to the Registrant's January 2001 Form 8-K).
10.32 Public Notice issued by the Federal Communications Commission *
dated January 11, 2001 (incorporated herein by reference to
Exhibit 99.4 to the Registrant's January 2001 Form 8-K).
10.33 Second Amended and Restated LMC Agreement dated as of September *
22, 1995 among TWCI, Liberty Media Corporation ("LMC"), TCI
Turner Preferred, Inc. ("TCITP"), Communication Capital Corp.
("CCC") and United Cable Turner Investment, Inc. (which is
incorporated herein by reference to Exhibit 10(a) to TWCI's
Current Report on Form 8-K dated September 6, 1996 ("TWCI's
September 1996 Form 8-K")).
10.34 Agreement Containing Consent Order dated August 14, 1996 among *
TWCI, TBS, Tele-Communications, Inc., LMC and the Federal Trade
Commission (which is incorporated herein by reference to Exhibit
2(b) to TWCI's September 1996 Form 8-K).
10.35 Investors Agreement (No. 1) dated as of October 10, 1996 among *
Time Warner, Turner, Turner Outdoor Inc. and Turner Partners, LP
(which is incorporated herein by reference to Exhibit 10.23 to
the Time Warner 1996 Form 10-K).
10.36 Investors Agreement (No. 2) dated as of October 10, 1996 among *
Time Warner, Turner Foundation, Inc. and Robert E. Turner
Charitable Remainder Unitrust No. 2 (which is incorporated herein
by reference to Exhibit 10.24 to the Time Warner 1996 Form 10-K).
10.37 Credit Agreement dated as of November 10, 1997 among Time Warner, *
TWCI, TWE, TBS, Time Warner Entertainment-Advance/Newhouse
Partnership ("TWE-A/N Partnership") and TWI Cable Inc. ("TWI
Cable"), as Credit Parties, Chase Manhattan, as Administrative
Agent, Bank of America National Trust and Savings Association
("Bank of America"), BONY and Morgan Guaranty Trust Company of
New York ("Morgan"), as Documentation and Syndication Agents and
Chase Securities Inc., as Arranger (which is incorporated herein
by reference to Exhibit 10.26 to Time Warner's 1997 Form 10-K).
10.38 Amendment No. 1 dated as of June 30, 2000 to the Credit Agreement *
dated as of November 10, 1997 among Time Warner, TWCI, TWE,
TBS, TWE-A/N Partnership and TWI Cable, as Credit Parties, Chase
Manhattan, as Administrative Agent, Bank of America, BONY and
Morgan as Documentation and Syndication Agents and Chase
Securities Inc., as Manager (which is incorporated herein by
reference to Exhibit 10.1 to the Time Warner June 2000 Form
10-Q).
10.39 Agreement of Limited Partnership, dated as of October 29, 1991, *
as amended by the Letter Agreement, dated February 11, 1992,
and the Letter Agreement dated June 23, 1992, among TWCI and
certain of its subsidiaries, ITOCHU Corporation ("ITOCHU") and
Toshiba Corporation ("Toshiba") ("TWE Partnership Agreement, as
amended") (which is incorporated herein by reference to Exhibit
(A) to TWCI's Current Report on Form 8-K dated October 29, 1991
(File No. 1-8637) and Exhibit 10(b) and 10(c) to TWCI's July 1992
Form 8-K).
10.40 Admission Agreement, dated as of May 16, 1993, between TWE and US *
WEST, Inc. ("US West") (which is incorporated herein by
reference to Exhibit 10(a) to TWE's Current Report on Form 8-K
dated May 16, 1993 (File No. 1-2878)).
iv
EXHIBIT INDEX
Sequential
Exhibit Page
Number Description Number
-----------------------------------------------------------------------------------------
10.41 Amendment Agreement, dated as of September 14, 1993, among *
ITOCHU, Toshiba, TWCI, US West and certain of their respective
subsidiaries, amending the TWE Partnership Agreement, as amended
(which is incorporated herein by reference to Exhibit 3.2 to
TWE's 1993 Form 10-K (File No. 1-2878)).
10.42 Restructuring Agreement dated as of August 31, 1995 among TWCI, *
ITOCHU and ITOCHU Entertainment Inc. (which is incorporated
herein by reference to Exhibit 2(a) to TWCI's Current Report on
Form 8-K dated August 31, 1995 ("TWCI's August 1995 Form 8-K")).
10.43 Restructuring Agreement dated as of August 31, 1995 between TWCI *
and Toshiba (including Form of Registration Rights Agreement,
between TWCI and Toshiba) (which is incorporated herein by
reference to Exhibit 2(b) to TWCI's August 1995 Form 8-K).
10.44 Option Agreement, dated as of September 15, 1993, between TWE and *
US West (which is incorporated herein by reference to Exhibit
10.9 to TWE's 1993 Form 10-K (File No. 1-2878)).
10.45 Contribution Agreement dated as of September 9, 1994 among TWE, *
Advance Publications, Inc. ("Advance Publications"), Newhouse
Broadcasting Corporation ("Newhouse"), Advance/Newhouse
Partnership ("Advance/Newhouse"), and TWE-AN Partnership (which
is incorporated herein by reference to Exhibit 10(a) to TWE's
Current Report on Form 8-K dated September 9, 1994).
10.46 Amended and Restated Partnership Agreement of TWE-A/N Partnership
entered into as of February 1, 2001 by and between TWE,
Advance/Newhouse and Paragon.
10.47 First Amendment to the Amended and Restated Partnership Agreement
of TWE-A/N Partnership dated as of March 1, 2001 among TWE,
Advance/Newhouse and Paragon.
10.48 Letter Agreement dated April 1, 1995 among TWE, Advance/Newhouse, *
Advance Publications and Newhouse (which is incorporated herein
by reference to Exhibit 10(c) to TWE's Current Report on Form 8-K
dated April 1, 1995).
10.49 Amended and Restated Transaction Agreement, dated as of October 27, *
1997 among Advance Publications, Advance/Newhouse, TWE, TW
Holding Co. and TWE-AN Partnership (which is incorporated herein
by reference to Exhibit 99(c) to Time Warner's Current Report on
Form 8-K dated October 27, 1997).
10.50 Transaction Agreement No. 2 dated as of June 23, 1998 among *
Advance Publications, Newhouse, Advance/Newhouse, TWE, Paragon
Communications ("Paragon") and TWE-AN Partnership (which is
incorporated herein by reference to Exhibit 10.38 to Time
Warner's 1998 Form 10-K).
10.51 Transaction Agreement No. 3 dated as of September 15, 1998 among *
Advance Publications, Newhouse, Advance/Newhouse, TWE, Paragon
and TWE-AN Partnership (which is incorporated herein by reference
to Exhibit 10.39 to Time Warner's 1998 Form 10-K).
10.52 Amended and Restated Transaction Agreement No. 4 dated as of
February 1, 2001 among Advance Publications, Newhouse,
Advance/Newhouse, TWE, Paragon and TWE-AN Partnership.
21. Subsidiaries of the Registrant.
23. Consent of Ernst & Young LLP, Independent Auditors.
99.1 Annual Report on Form 11-K of the AOL Time Warner Savings Plan
for the year ended December 31, 2000 (to be filed by amendment).
99.2 Annual Report on Form 11-K of the AOL Time Warner Thrift Plan for
the year ended December 31, 2000 (to be filed by amendment).
99.3 Annual Report on Form 11-K of the TWC Savings Plan for the year
ended December 31, 2000 (to be filed by amendment).
* Incorporated by reference.
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 outstanding long-term debt that are not required to be
filed herewith.
v