SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
/x / QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT of 1934 for the quarterly period ended SEPTEMBER 30, 1998,
or -------------------
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT of 1934 for the transition period from
--------------- to --------------.
Commission file number 001-12878
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TIME WARNER ENTERTAINMENT COMPANY, L.P.
(Exact name of registrant as specified in its charter)
Delaware 13-3666692
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
American Television and Communications
Corporation Delaware 13-2922502
Warner Communications Inc. Delaware 13-2696809
(Exact name of registrant (State or other (I.R.S. Employer
as specified in its charter) jurisdiction of Identification
incorporation or Number)
organization)
75 Rockefeller Plaza
New York, New York 10019
(212) 484-8000
(Address, including zip code, and telephone number, including
area code, of each registrant's principal executive offices)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
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<PAGE>
TIME WARNER ENTERTAINMENT COMPANY L.P.
AND TWE GENERAL PARTNERS
INDEX TO FORM 10-Q
Page
----
TWE
General
TWE Partners
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PART I. FINANCIAL INFORMATION
Management's discussion and analysis of
results of operations and financial condition............... 1 25
Consolidated balance sheets at September 30, 1998 and
December 31, 1997........................... ................ 13 32
Consolidated statements of operations for the three and nine
months ended September 30,1998 and 1997....................... 14 33
Consolidated statements of cash flows for the nine months
ended September 30, 1998 and 1997............................. 15 35
Consolidated statements of partnership capital and
shareholders' equity for the nine months ended
September 30, 1998 and 1997................................... 16 36
Notes to consolidated financial statements...................... 17 37
PART II. OTHER INFORMATION...................................... 44
<PAGE>
TIME WARNER ENTERTAINMENT COMPANY, L.P.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
Time Warner Entertainment Company, L.P. ("TWE" or the "Company")
classifies its business interests into three fundamental areas: Entertainment,
consisting principally of interests in filmed entertainment, television
production and television broadcasting; Cable Networks, consisting principally
of interests in cable television programming; and Cable, consisting principally
of interests in cable television systems. TWE also manages the cable properties
owned by Time Warner and the combined cable television operations are conducted
under the name of Time Warner Cable. Capitalized terms are as defined and
described in the accompanying consolidated financial statements, or elsewhere
herein.
Use of EBITA
TWE evaluates operating performance based on several factors, of which
the primary financial measure is operating income before noncash amortization of
intangible assets ("EBITA"). Consistent with management's financial focus on
controlling capital spending, EBITA measures operating performance after charges
for depreciation. In addition, EBITA eliminates the uneven effect across all
business segments of considerable amounts of noncash amortization of intangible
assets recognized in business combinations accounted for by the purchase method,
including Time Warner's $14 billion acquisition of Warner Communications Inc. in
1989 and $1.3 billion acquisition of the minority interest in American
Television and Communications Corporation in 1992. The exclusion of noncash
amortization charges is also consistent with management's belief that TWE's
intangible assets, such as cable television franchises, film and television
libraries and the goodwill associated with its brands, are generally increasing
in value and importance to TWE's business objective of creating, extending and
distributing recognizable brands and copyrights throughout the world. As such,
the following comparative discussion of the results of operations of TWE
includes, among other factors, an analysis of changes in business segment EBITA.
However, EBITA should be considered in addition to, not as a substitute for,
operating income, net income and other measures of financial performance
reported in accordance with generally accepted accounting principles.
RESULTS OF OPERATIONS
As more fully described herein, TWE's 1998 operating results have been
affected by certain cable-related transactions, including (i) the transfer of
cable television systems (or interests therein) serving approximately 650,000
subscribers that were formerly owned by subsidiaries of Time Warner to the
TWE-Advance/Newhouse Partnership ("TWE-A/N"), subject to approximately $1
billion of debt, in exchange for common and preferred partnership interests
therein, as well as certain related transactions (collectively, the "TWE-A/N
Transfers"), (ii) the transfer of TWE's and TWE-A/N's direct broadcast satellite
operations and related assets to Primestar, Inc., a separate holding company
(the "Primestar Roll-up Transaction"), (iii) the reorganization of Time Warner
Cable's business telephony operations (the "Business Telephony Reorganization"),
(iv) the formation of a joint venture to operate and expand Time Warner Cable's
and MediaOne's existing high-speed Internet access businesses (the "Road Runner
Joint Venture") and (v) the sale or exchange of certain cable television
systems. The effects of these transactions are described elsewhere herein.
<PAGE>
<TABLE>
TIME WARNER ENTERTAINMENT COMPANY, L.P.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION-(CONTINUED)
EBITA and operating income for TWE for the three and nine months ended
September 30, 1998 and 1997 are as follows:
Three Months Ended September 30, Nine Months Ended September 30,
------------------------------- -------------------------------
Operating Operating
EBITA Income EBITA Income
----- ------ ----- ------
1998 1997 1998 1997 1998 1997 1998 1997
---- ---- ---- ---- ---- ---- ---- ----
(millions)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Filmed Entertainment-Warner Bros..................... $161 $106 $128 $ 75 $ 401 $ 315 $ 302 $223
Broadcasting-The WB Network.......................... (17) (21) (17) (21) (78) (60) (80) (60)
Cable Networks-HBO................................... 117 102 117 102 339 291 339 291
Cable(a)............................................. 336 257 240 179 1,017 759 731 530
---- ---- ---- ---- ----- ----- ---- ----
Total................................................ $597 $444 $468 $335 $1,679 $1,305 $1,292 $984
==== ==== ==== ==== ====== ====== ====== ====
- ---------------
(a) Includes net pretax gains recognized in connection with the sale or
exchange of certain cable television systems of approximately $6 million
and $16 million for the three months ended September 30, 1998 and 1997,
respectively, and approximately $90 million and $40 million for the nine
months ended September 30, 1998 and 1997, respectively.
</TABLE>
Three Months Ended September 30, 1998 Compared to the Three Months Ended
September 30, 1997
TWE had revenues of $3.220 billion and net income of $172 million for
the three months ended September 30, 1998, compared to revenues of $2.855
billion and net income of $81 million for the three months ended September 30,
1997. As discussed more fully below, TWE's net income increased in 1998 as
compared to 1997 principally due to an overall increase in operating income
generated by its business segments (including the positive effect of the TWE-A/N
Transfers), offset in part by an increase in interest expense associated with
the TWE-A/N Transfers, higher losses from certain investments accounted for
under the equity method of accounting and lower gains on foreign exchange
contracts.
As a U.S. partnership, TWE is not subject to U.S. federal and state
income taxation. Income and withholding taxes of $23 million and $27 million for
the three months ended September 30, 1998 and 1997, respectively, have been
provided for the operations of TWE's domestic and foreign subsidiary
corporations.
Filmed Entertainment-Warner Bros. Revenues increased to $1.727 billion,
compared to $1.397 billion in the third quarter of 1997. EBITA increased to $161
million from $106 million. Operating income increased to $128 million from $75
million. Revenues benefited from a significant increase in television production
and distribution operations principally relating to the initial off-network
domestic syndication availability of Friends and the initial off-network basic
cable availability of ER. EBITA and operating income benefited principally from
the revenue gains, offset in part by lower international syndication sales of
library product and film write-offs relating to disappointing results for
certain theatrical releases.
Broadcasting - The WB Network. Revenues increased to $64 million,
compared to $31 million in the third quarter of 1997. EBITA and operating income
improved to a loss of $17 million from a loss of $21 million. Revenues increased
as a result of higher advertising sales relating to improved television ratings
and the addition of a fourth night of prime-time programming in January 1998 and
a fifth night in September 1998. Operating losses improved principally as a
result of the revenue gains, offset in part by higher programming costs
associated with the expanded programming schedule and a lower allocation of
losses to a minority partner in the network. Due to the start-up nature of this
national broadcast operation, losses are expected to continue.
<PAGE>
Cable Networks-HBO. Revenues increased to $505 million, compared to
$482 million in the third quarter of 1997. EBITA and operating income increased
to $117 million from $102 million. Revenues benefited primarily from an increase
in subscriptions. EBITA and operating income increased principally as a result
of the revenue gains, and, to a lesser extent, cost savings and higher income
from Comedy Central, a 50%-owned equity investee.
Cable. Revenues decreased to $1.052 billion, compared to $1.060 billion
in the third quarter of 1997. EBITA increased to $336 million from $257 million.
Operating income increased to $240 million from $179 million. The Cable
division's 1998 operating results were positively affected by the aggregate net
impact of the TWE-A/N Transfers and the deconsolidation of certain of its
operations in connection with each of the Primestar Roll-up Transaction, the
Business Telephony Reorganization and the formation of the Road Runner Joint
Venture. Excluding the effect of these transactions, revenues increased
principally as a result of an increase in basic cable subscribers, increases in
regulated cable rates as permitted under Time Warner Cable's "social contract"
with the Federal Communications Commission ("FCC") and an increase in
advertising revenues. Similarly excluding the effect of these transactions,
EBITA and operating income increased principally as a result of the revenue
gains, offset in part by lower net gains relating to the sale or exchange of
certain cable television systems and higher depreciation related to capital
spending.
Interest and Other, Net. Interest and other, net, was $203 million in
the third quarter of 1998, compared to $145 million in the third quarter of
1997. Interest expense increased to $145 million, compared to $123 million in
the third quarter of 1997, principally due to higher average debt levels
associated with the TWE-A/N Transfers. There was other expense, net, of $58
million in the third quarter of 1998, compared to $22 million in the third
quarter of 1997, principally due to higher losses from certain investments
accounted for under the equity method of accounting, lower gains on foreign
exchange contracts and higher losses associated with TWE's asset securitization
program.
Nine Months Ended September 30, 1998 Compared to the Nine Months Ended
September 30, 1997
TWE had revenues of $8.980 billion and net income of $435 million for
the nine months ended September 30, 1998, compared to revenues of $8.183 billion
and net income of $483 million for the nine months ended September 30, 1997. As
discussed more fully below and as previously described above, TWE's net income
decreased in 1998 as compared to 1997 principally due to significantly lower
aggregate, net pretax gains recognized in connection with the sale or exchange
of certain cable television systems in each year and the 1997 sale of TWE's
interest in E! Entertainment Television, Inc. ("E! Entertainment"). Excluding
the effect of these transactions, TWE's net income increased in 1998 principally
as a result of an overall increase in operating income generated by its business
segments (including the positive effect of the TWE-A/N Transfers), offset in
part by an increase in interest expense associated with the TWE-A/N Transfers,
higher losses from certain investments accounted for under the equity method of
accounting and lower gains on foreign exchange contracts.
As a U.S. partnership, TWE is not subject to U.S. federal and state
income taxation. Income and withholding taxes of $55 million and $64 million for
the nine months ended September 30, 1998 and 1997, respectively, have been
provided for the operations of TWE's domestic and foreign subsidiary
corporations.
Filmed Entertainment-Warner Bros. Revenues increased to $4.364 billion,
compared to $3.823 billion in the first nine months of 1997. EBITA increased to
$401 million from $315 million. Operating income increased to $302 million from
$223 million. Revenues benefited from a significant increase in television
production and distribution operations principally relating to the initial
off-network domestic syndication availability of Friends and the initial
off-network basic cable availability of ER, as well as an increase in revenues
from consumer products licensing operations. EBITA and operating income
benefited principally from the revenue gains, offset in part by lower
international syndication sales of library product and film write-offs relating
to disappointing results for certain theatrical releases. In addition, EBITA and
operating income for each period included certain one-time gains on the sale of
assets that were comparable in amount and therefore, did not have any
significant effect on operating trends.
Broadcasting - The WB Network. Revenues increased to $170 million,
compared to $84 million in the first nine months of 1997. EBITA decreased to a
loss of $78 million from a loss of $60 million. Operating losses increased to
$80 million from $60 million. Revenues increased as a result of higher
advertising sales relating to improved television ratings and the addition of a
fourth night of prime-time programming in January 1998 and a fifth night in
September 1998. Despite the revenue increase, operating losses increased because
of a lower allocation of losses to a minority partner in the network. However,
excluding this minority interest effect, operating losses improved principally
as a result of the revenue gains, which outweighed higher programming costs
associated with the expanded programming schedule. Due to the start-up nature of
this national broadcast operation, losses are expected to continue.
Cable Networks-HBO. Revenues increased to $1.526 billion, compared to
$1.452 billion in the first nine months of 1997. EBITA and operating income
increased to $339 million from $291 million. Revenues benefited primarily from
an increase in subscriptions. EBITA and operating income increased principally
as a result of the revenue gains, and, to a lesser extent, cost savings and
higher income from Comedy Central, a 50%-owned equity investee.
Cable. Revenues increased to $3.289 billion, compared to $3.146 billion
in the first nine months of 1997. EBITA increased to $1.017 billion from $759
million. Operating income increased to $731 million from $530 million. The Cable
division's 1998 operating results were positively affected by the aggregate net
impact of the TWE-A/N Transfers and the deconsolidation of certain of its
operations in connection with each of the Primestar Roll-up Transaction, the
Business Telephony Reorganization and the formation of the Road Runner Joint
Venture. Excluding the effect of these transactions, revenues increased
principally as a result of an increase in basic cable subscribers, increases in
regulated cable rates as permitted under Time Warner Cable's "social contract"
with the FCC and an increase in advertising revenues. Similarly excluding the
effect of these transactions, EBITA and operating income increased principally
as a result of the revenue gains and higher net gains relating to the sale or
exchange of certain cable television systems, offset in part by higher
depreciation related to capital spending.
Interest and Other, Net. Interest and other, net, was $550 million in
the first nine months of 1998, compared to $155 million in the first nine months
of 1997. Interest expense increased to $418 million, compared to $358 million in
1997, principally due to higher average debt levels associated with the TWE-A/N
Transfers. There was other expense, net, of $132 million in the first nine
months of 1998, compared to other income, net, of $203 million in the first nine
months of 1997, principally due to the absence of an approximate $250 million
pretax gain on the sale of an interest in E! Entertainment recognized in 1997,
higher losses from certain investments accounted for under the equity method of
accounting, lower gains on foreign exchange contracts and higher losses
associated with TWE's asset securitization program.
FINANCIAL CONDITION AND LIQUIDITY
September 30, 1998
Financial Condition
TWE had $7.4 billion of debt, $125 million of cash and equivalents
(net debt of $7.3 billion), $221 million of preferred stock of a subsidiary,
$591 million of Time Warner General Partners' Senior Capital and $5.8 billion of
partners' capital at September 30, 1998, compared to $6.0 billion of debt, $322
million of cash and equivalents (net debt of $5.7 billion), $233 million of
preferred stock of a subsidiary, $1.1 billion of Time Warner General Partners'
Senior Capital and $6.3 billion of partners' capital at December 31, 1997. Net
debt increased principally as a result of the TWE-A/N Transfers and cash
distributions paid to Time Warner.
Debt Transactions
In July 1998, TWE borrowed $579 million under its bank credit agreement
and paid a distribution to the Time Warner General Partners relating to their
Senior Capital interests.
In April 1998, TWE consummated two previously announced transactions,
consisting of the sale of TWE's 49% interest in Six Flags Entertainment
Corporation and the Primestar Roll-up Transaction. As a result of these
transactions, TWE reduced debt by approximately $540 million.
In early 1998, TWE-A/N assumed approximately $1 billion of debt from
TWI Cable Inc. ("TWI Cable"), a wholly owned subsidiary of Time Warner, in
connection with the TWE-A/N Transfers. The debt assumed by TWE-A/N has been
guaranteed by TWI Cable and certain of its subsidiaries.
Cash Flows
During the first nine months of 1998, TWE's cash provided by operations
amounted to $1.273 billion and reflected $1.679 billion of EBITA from its Filmed
Entertainment-Warner Bros., Broadcasting-The WB Network, Cable Networks-HBO and
Cable businesses, $698 million of noncash depreciation expense and $131 million
of proceeds from TWE's asset securitization program, less $419 million of
interest payments, $57 million of income taxes, $54 million of corporate
expenses, and $705 million related to an aggregate increase in working capital
requirements, other balance sheet accounts and noncash items. Cash provided by
operations of $918 million in the first nine months of 1997 reflected $1.305
billion of business segment EBITA and $692 million of noncash depreciation
expense, less $394 million of interest payments, $55 million of income taxes,
$54 million of corporate expenses and $576 million related to an aggregate
increase in working capital requirements, other balance sheet accounts and
noncash items.
Cash used by investing activities was $887 million in the first nine
months of 1998, compared to $777 million in the first nine months of 1997,
principally as a result of the effect of deconsolidating approximately $200
million of cash of Paragon Communications in connection with the TWE-A/N
Transfers that has been included as a reduction of cash flows from investments
and acquisitions, offset in part by a $96 million increase in proceeds from the
sale of investments. Capital expenditures were $1.092 billion in the first nine
months of 1998 and $1.117 billion in the first nine months of 1997.
Cash used by financing activities was $583 million in the first nine
months of 1998, compared to $61 million in the first nine months of 1997,
principally as a result of the absence of $243 million of aggregate net proceeds
from the issuance of preferred stock of a subsidiary in the first quarter of
1997 and a $251 million increase in distributions paid to Time Warner, offset in
part by an increase in debt used to fund cash distributions to Time Warner.
Management believes that TWE's operating cash flow, cash and
equivalents and additional borrowing capacity are sufficient to fund its capital
and liquidity needs for the foreseeable future.
Cable Capital Spending
Time Warner Cable has been engaged in a plan to upgrade the
technological capability and reliability of its cable television systems and
develop new services, which it believes will position the business for
sustained, long-term growth. Capital spending by TWE's Cable division amounted
to $991 million in the nine months ended September 30, 1998, compared to $1.013
billion in the nine months ended September 30, 1997. For the full year of 1998,
cable capital spending is expected to be comparable to 1997 levels, with
approximately $400 million budgeted for the remainder of 1998. Capital spending
by TWE's Cable division is expected to continue to be funded by cable operating
cash flow. In exchange for certain flexibility in establishing cable rate
pricing structures for regulated services that went into effect on January 1,
1996 and consistent with Time Warner Cable's long-term strategic plan, Time
Warner Cable agreed with the FCC to invest a total of $4 billion in capital
costs in connection with the upgrade of its cable infrastructure, which is
expected to be substantially completed over a five-year period ending December
31, 2000. The agreement with the FCC covers all of the cable operations of Time
Warner Cable, including the owned or managed cable television systems of TWE,
TWE-A/N and Time Warner. Management expects to continue to finance such level of
investment through cable operating cash flow and the development of new revenue
streams from expanded programming options, high-speed Internet access and other
services.
Cable Financing Strategy
Time Warner's and TWE's cable financing strategy is to continue to use
cable operating cash flow to finance the level of capital spending necessary to
upgrade the technological capability of its cable television systems and develop
new services, while pursuing opportunities to reduce either existing debt and/or
their share of future funding requirements related to the cable television
business and related ancillary businesses. Consistent with this strategy, Time
Warner, TWE and TWE-A/N have completed a series of transactions in 1998, as
discussed more fully below.
Business Telephony Reorganization
In July 1998, Time Warner, TWE and TWE-A/N completed a reorganization
of their business telephony operations (the "Business Telephony Reorganization")
by combining such operations into a single entity that is intended to be
self-financing. This entity, named Time Warner Telecom LLC ("TW Telecom"), is a
competitive local exchange carrier (CLEC) in selected metropolitan areas across
the United States where it offers a wide range of telephony services to business
customers. Time Warner, MediaOne Group, Inc. ("MediaOne," formerly U S WEST,
Inc.) and the Advance/Newhouse Partnership ("Advance/Newhouse"), a limited
partner in TWE-A/N, own interests in TW Telecom of 61.95%, 18.88% and 19.17%,
respectively. As a result of the Business Telephony Reorganization, TWE and
TWE-A/N do not have continuing equity interests in these business telephony
operations.
Road Runner Joint Venture
In June 1998, Time Warner, TWE, TWE-A/N, MediaOne, Microsoft Corp.
("Microsoft") and Compaq Computer Corp. ("Compaq") formed a joint venture to
operate and expand Time Warner Cable's and MediaOne's existing high-speed
Internet access businesses (the "Road Runner Joint Venture"). In exchange for
contributing their existing high-speed Internet access businesses, Time Warner
received an 11.25% common equity interest in the Road Runner Joint Venture, TWE
received a 25% interest, TWE-A/N received a 32.5% interest and MediaOne received
a 31.25% interest. In exchange for Microsoft and Compaq each contributing $212.5
million of cash to the Road Runner Joint Venture, Microsoft and Compaq each
received a preferred equity interest therein that is convertible into a 10%
common equity interest. Accordingly, on a fully diluted basis, the Road Runner
Joint Venture is owned 9% by Time Warner, 20% by TWE, 26% by TWE-A/N, 25% by
MediaOne, 10% by Microsoft and 10% by Compaq. As a result of this transaction,
effective as of June 30, 1998, TWE and TWE-A/N deconsolidated their high-speed
Internet access operations and each of TWE's and TWE-A/N's interest in the Road
Runner Joint Venture is being accounted for under the equity method of
accounting.
The aggregate $425 million of capital contributed by Microsoft and
Compaq is expected to be used by the Road Runner Joint Venture to continue to
expand the roll out of high-speed Internet access services. In addition, as a
result of Time Warner Cable being a retailer of the Road Runner business in its
franchise areas whereby Time Warner Cable's technologically advanced,
high-capacity cable architecture will be used to provide these high-speed
Internet access services, Time Warner Cable will initially retain 70% of the
subscription revenues and 30% of the national advertising and transactional
revenues generated from the delivery of these on-line services to its cable
subscribers. Time Warner Cable's share of these revenues is expected to change
periodically to 75% of subscription revenues and 25% of national advertising and
transactional revenues by 2006.
Primestar Roll-up Transaction
In April 1998, TWE and Advance/Newhouse transferred the direct
broadcast satellite operations conducted by TWE and TWE-A/N (the "DBS
Operations") and the 31% partnership interest in Primestar Partners, L.P. held
by TWE-A/N ("Primestar" and collectively, the "Primestar Assets") to Primestar,
Inc. ("New Primestar"), a separate holding company. New Primestar owns the DBS
Operations and Primestar partnership interests formerly owned by TCI Satellite
Entertainment, Inc. and other previously existing partners of Primestar. In
exchange for contributing its interests in the Primestar Assets, TWE received
approximately 48 million shares of common stock of New Primestar (representing
an approximate 24% equity interest) and realized approximately $240 million of
debt reduction. TWE deconsolidated the DBS Operations effective as of April 1,
1998 and the equity interest in New Primestar received in this transaction is
being accounted for under the equity method of accounting.
TWE-A/N Transfers
In early 1998, Time Warner (through a wholly owned subsidiary)
contributed cable television systems (or interests therein) serving
approximately 650,000 subscribers to TWE-A/N, subject to approximately $1
billion of debt, in exchange for common and preferred partnership interests
therein, and completed certain related transactions. The debt assumed by TWE-A/N
has been guaranteed by TWI Cable and certain of its subsidiaries. TWE-A/N is now
owned 65.3% by TWE, 33.3% by Advance/Newhouse and 1.4% indirectly by Time
Warner.
Warner Bros. Backlog
Warner Bros.' backlog, representing the amount of future revenue not
yet recorded from cash contracts for the licensing of theatrical and television
product for pay cable, basic cable, network and syndicated television
exhibition, amounted to $2.054 billion at September 30, 1998, compared to $2.126
billion at December 31, 1997 (including amounts relating to TWE's cable
television networks of $211 million and $238 million, respectively, and to Time
Warner's cable television networks of $500 million and $481 million,
respectively).
Because backlog generally relates to contracts for the licensing of
theatrical and television product which have already been produced, the
recognition of revenue for such completed product is principally only dependent
upon the commencement of the availability period for telecast under the terms of
the related licensing agreement. Cash licensing fees are collected periodically
over the term of the related licensing agreements or on an accelerated basis
using a $600 million securitization facility. The portion of backlog for which
cash has not already been received has significant off-balance sheet asset value
as a source of future funding. The backlog excludes advertising barter
contracts, which are also expected to result in the future realization of
revenues and cash through the sale of advertising spots received under such
contracts.
Year 2000 Technology Preparedness
TWE, like most large companies, depends on many different computer
systems and other chip-based devices for the continuing conduct of its business.
Older computer programs, computer hardware and chip-based devices may fail to
recognize dates beginning on January 1, 2000 as being valid dates, and as a
result may fail to operate or may operate improperly when such dates are
introduced.
TWE's exposure to potential Year 2000 problems exists in two general
areas: technological operations in the sole control of the Company and
technological operations dependent in some way on one or more third parties.
These technological operations include information technology ("IT") systems and
non-IT systems, including those with embedded technology, hardware and software.
Most of TWE's potential Year 2000 exposures are in the area of technological
operations dependent on one or more third parties. Failure to achieve high
levels of Year 2000 compliance in either area could have a material adverse
impact on TWE and its financial statements.
The Company's Year 2000 initiative is being conducted at the
operational level by divisional project managers and senior technology
executives overseen by senior divisional executives, with assistance internally
as well as from outside professionals. The progress of each division through the
different phases of remediation--inventorying, assessment, remediation planning,
implementation and final testing--is actively overseen and reviewed on a regular
basis by an executive oversight group.
The Company has generally completed the process of identifying
potential Year 2000 difficulties in its technological operations, including IT
applications, IT technology and support, desktop hardware and software, non-IT
systems and important third party operations, and distinguishing those that are
"mission critical" from those that are not. An item is considered "mission
critical" if its Year 2000-related failure would significantly impair the
ability of one of the Company's major business units to (1) produce, market and
distribute the products or services that generate significant revenues for that
business, (2) meet its obligations to pay its employees, artists, vendors and
other obligations or (3) meet its obligations under regulatory requirements and
internal accounting controls. The Company and its divisions have identified
approximately 600 worldwide, "mission critical" potential exposures. Of these,
as of September 30, 1998, approximately 10% have been identified by the
divisions as in the assessment stage, approximately 40% as in the remediation
planning stage, and almost 50% as in the process of implementation or testing or
as Year 2000 compliant. The Company currently expects that the assessment phase
for these potential exposures should be completed by the end of 1998 and that
remediation with respect to technological operations in the sole control of the
Company will be substantially completed in all material respects by the end of
the second quarter of 1999.
In the area of "mission critical" technological operations dependent in
some way on one or more third parties, the situation is much less in TWE's
ability to predict or control. In addition, the Company's business is heavily
dependent on third parties that are themselves heavily dependent on technology.
In some cases, the Company's third party dependence is on vendors of technology
who are themselves working towards solutions to Year 2000 problems. For example,
in a situation endemic to the cable industry, much of the Company's headend
equipment that controls cable set-top boxes is currently not Year 2000
compliant. The box manufacturers are working with cable industry groups and have
recently developed solutions that the Company is beginning to install in its
headend equipment. It is currently expected that these solutions will be
substantially implemented by the end of the second quarter of 1999. In other
cases, the Company's third party dependence is on suppliers of products or
services that are themselves computer-intensive. For example, if a television
broadcaster or cable programmer encounters Year 2000 problems that impede its
ability to deliver its programming, the Company will be unable to provide that
programming to its cable customers. Similarly, because the Company is also a
programming supplier, third-party signal delivery problems could affect its
ability to deliver its programming to its customers. The Company has attempted
to include in its "mission critical" inventory significant service providers,
vendors, suppliers, customers and governmental entities that are believed to be
critical to business operations and is in various stages of attempting to
ascertain their state of Year 2000 readiness through questionnaires, interviews,
on-site visits, industry group participation and other available means.
Moreover, TWE is dependent, like all large companies, on the continued
functioning, domestically and internationally, of basic, heavily computerized
services such as banking, telephony and power, and various distribution
mechanisms ranging from the mail, railroads and trucking to high-speed data
transmission. TWE is taking steps to attempt to ensure that the third parties on
which it is heavily reliant are Year 2000 compliant, but cannot predict the
likelihood of such compliance nor the direct or indirect costs to the Company of
non-compliance by those third parties or of securing such services from
alternate compliant third parties.
The Company currently estimates that the aggregate cost of its Year
2000 remediation program, which started in 1996, will be approximately $50 to
$85 million, of which an estimated 40% to 50% has been incurred through
September 30, 1998. These costs include estimates of the costs of assessment,
replacement, repair and upgrade, both planned and unplanned, of certain IT and
non-IT systems and their implementation and testing. These expenditures have
been and are expected to continue to be funded from the Company's operating cash
flow and have not and are not expected to impact materially the Company's
financial statements.
Management believes that it has established an effective program to
resolve all significant Year 2000 issues in its sole control in a timely manner.
As noted above, however, the Company has not yet completed all phases of its
program and is dependent on third parties whose progress is not within its
control. In the event that the Company did not complete any of its currently
planned additional remediation prior to the Year 2000, management believes that
the Company could experience significant difficulty in producing and delivering
its products and services and conducting its business in the Year 2000 as it has
in the past. In addition, disruptions experienced by third parties with which
the Company does business as well as by the economy generally could also
materially adversely affect the Company. The amount of potential liability and
lost revenue cannot be reasonably estimated at this time.
The Company has been focusing its efforts on identification and
remediation of its Year 2000 exposures and has not yet developed significant
contingency plans in the event it does not successfully complete all phases of
its Year 2000 program. The Company intends to examine its status at the end of
1998, and periodically thereafter, to determine whether such plans are
necessary.
Euro Conversion
Effective January 1, 1999, the "euro" will be established as the common
legal currency of more than two-thirds of the member countries of the European
Union. These member countries will then have a three-year transitional period to
convert their existing sovereign currencies to the euro. By July 1, 2002, all
participating member countries must eliminate their sovereign currencies and
replace their legal tender with euro-denominated bills and coins.
Notwithstanding this transitional period, many commercial transactions are
expected to become euro-denominated well before the July 2002 deadline.
Accordingly, TWE is in the process of evaluating the short-term and long-term
effects of the euro conversion on its businesses, principally consisting of its
international filmed entertainment operations.
TWE believes that its most significant short-term impact relating to
the euro conversion is the need to modify its accounting and information systems
to handle transactions during the transitional period in both the euro and the
existing sovereign currencies of the participating member countries. TWE is in
the process of identifying the accounting and information systems in need of
modification and, based on these findings, will formulate an action plan to
address the nature and timing of remediation efforts. Based on preliminary
information, costs to modify its accounting and information systems are not
expected to be material.
TWE believes that its most significant long-term business risk relating
to the euro conversion may be increased pricing pressures for its products and
services brought about by heightened consumer awareness of possible cross-border
price differences. However, TWE believes that these business risks may be offset
to some extent by lower production costs, other cost savings and marketing
opportunities. Notwithstanding such risks, management does not believe at this
time that the euro conversion will have a material effect on TWE's financial
position, results of operations or cash flows in future periods.
Caution Concerning Forward-Looking Statements
The Securities and Exchange Commission encourages companies to disclose
forward-looking information so that investors can better understand a company's
future prospects and make informed investment decisions. This filing, together
with management's public commentary related thereto, contains such
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995, particularly statements anticipating future
growth in revenues, EBITA and cash flow and forecasting ongoing debt reduction.
Words such as "anticipate", "estimate", "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. Those forward-looking statements are management's
present expectations of future events. As with any projection or forecast, they
are inherently susceptible to changes in circumstances, and TWE is under no
obligation to (and expressly disclaims any such obligation to) update or alter
its forward-looking statements despite such changes.
TWE operates in highly competitive, consumer driven and rapidly
changing 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 and
(particularly in view of technological changes) protection of their intellectual
property rights. TWE's actual results could differ materially from management's
expectations because of changes in such factors. Some of the other factors that
also could cause actual results to differ from those contained in the
forward-looking statements include those identified in TWE's other filings and:
. For TWE's cable business, more aggressive than expected competition
from new technologies and other types of video programming distributors,
including DBS; increases in government regulation of cable or equipment
rates (or any failure to reduce rate regulation as is presently mandated by
statute) or other terms of service (such as "digital must-carry") or
opposition to franchise renewals; the failure of new equipment (such as
digital set-top boxes) or services to function properly, to appeal to
enough consumers or to be delivered in a timely fashion; and greater than
expected increases in programming or other costs.
. For TWE's cable programming and television businesses, greater than
expected programming or production costs; public and cable operator
resistance to price increases to offset higher programming costs (and the
negative impact on premium programmers of increases in basic cable rates);
the sensitivity of advertising to economic cyclicality; and greater than
expected fragmentation of consumer viewership due to an increased number of
programming services or the increased popularity of alternatives to
television.
. For TWE's film and television businesses, their ability to continue
to attract and select desirable talent and scripts at manageable costs;
increases in production costs generally; 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 DVD and the Internet.
. The ability of the Company and its key service providers, vendors,
suppliers, customers and governmental entities to replace, modify or
upgrade computer systems in ways that adequately address the Year 2000
issue, including their ability to identify and correct all relevant
computer codes and embedded chips, unanticipated difficulties or delays in
the implementation of the Company's remediation plans and the ability of
third parties to adequately address their own Year 2000 issues.
In addition, TWE's overall financial strategy, including improved
financial ratios and a strengthened balance sheet, could be adversely affected
by increased interest rates, failure to meet earnings expectations, consequences
of the euro conversion and changes in TWE's plans, strategies and intentions.
<PAGE>
<TABLE>
TIME WARNER ENTERTAINMENT COMPANY, L.P.
CONSOLIDATED BALANCE SHEET
(Unaudited)
September 30, December 31,
1998 1997
---- ----
(millions)
<S> <C> <C>
ASSETS
Current assets
Cash and equivalents........................................................................ $ 125 $ 322
Receivables, including $485 and $385 million due from Time Warner,
less allowances of $407 and $424 million................................................ 2,438 1,914
Inventories................................................................................. 1,310 1,204
Prepaid expenses............................................................................ 173 182
----- -----
Total current assets........................................................................ 4,046 3,622
Noncurrent inventories...................................................................... 2,281 2,254
Loan receivable from Time Warner............................................................ 400 400
Investments................................................................................. 724 315
Property, plant and equipment............................................................... 6,050 6,557
Cable television franchises................................................................. 4,000 3,063
Goodwill.................................................................................... 4,080 3,859
Other assets................................................................................ 826 661
------ -------
Total assets................................................................................ $22,407 $20,731
======= =======
</TABLE>
<TABLE>
<S> <C> <C>
LIABILITIES AND PARTNERS' CAPITAL
Current liabilities
Accounts payable............................................................................ $ 1,077 $ 1,123
Participations and programming costs payable................................................ 1,393 1,176
Debt due within one year.................................................................... 7 8
Other current liabilities, including $353 and $184 million due to Time Warner............... 1,828 1,667
------- -------
Total current liabilities................................................................... 4,305 3,974
Long-term debt.............................................................................. 7,435 5,990
Other long-term liabilities, including $682 and $477 million due to Time Warner............. 2,659 1,873
Minority interests.......................................................................... 1,440 1,210
Preferred stock of subsidiary holding solely a mortgage note of its parent.................. 221 233
Time Warner General Partners' Senior Capital................................................ 591 1,118
Partners' capital
Contributed capital......................................................................... 7,344 7,537
Undistributed partnership earnings (deficit)................................................ (1,588) (1,204)
------ -------
Total partners' capital..................................................................... 5,756 6,333
------ ------
Total liabilities and partners' capital..................................................... $22,407 $20,731
======= =======
</TABLE>
See accompanying notes.
<PAGE>
<TABLE>
TIME WARNER ENTERTAINMENT COMPANY, L.P.
CONSOLIDATED STATEMENT OF OPERATIONS
(Unaudited)
Three Months Nine Months
Ended September 30, Ended September 30,
------------------- -------------------
1998 1997 1998 1997
(millions)
<S> <C> <C> <C> <C>
Revenues (a)....................................................... $3,220 $2,855 $8,980 $8,183
------ ------ ------ ------
Cost of revenues (a)(b)............................................ 2,175 1,905 5,927 5,352
Selling, general and administrative (a)(b)......................... 577 615 1,761 1,847
------ ----- ------ ------
Operating expenses................................................. 2,752 2,520 7,688 7,199
------ ------ ------ ------
Business segment operating income.................................. 468 335 1,292 984
Interest and other, net (a)........................................ (203) (145) (550) (155)
Minority interest.................................................. (52) (64) (198) (228)
Corporate services (a)............................................. (18) (18) (54) (54)
----- ------ ------ ------
Income before income taxes......................................... 195 108 490 547
Income taxes....................................................... (23) (27) (55) (64)
------ ----- ------ ------
Net income......................................................... $ 172 $ 81 $ 435 $ 483
====== ====== ====== ======
- ---------------
(a) Includes the following income (expenses) resulting from transactions with
the partners of TWE and other related companies for the three and nine
months ended September 30, 1998, respectively, and for the corresponding
periods in the prior year: revenues-$227 million and $474 million in 1998,
$103 million and $224 million in 1997; cost of revenues-$(49) million and
$(142) million in 1998, $(11) million and $(47) million in 1997; selling,
general and administrative-$(14) million and $(16) million in 1998, $20
million and $60 million in 1997; interest and other, net-$1 million and $6
million in 1998, $8 million and $25 million in 1997; and corporate
services-$(18) million and $(54) million in 1998, $(18) million and $(54)
million in 1997.
(b) Includes depreciation and amortization expense of:............. $ 358 $ 361 $1,085 $1,013
====== ====== ====== ======
</TABLE>
See accompanying notes.
<PAGE>
<TABLE>
TIME WARNER ENTERTAINMENT COMPANY, L.P.
CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited)
Nine Months
Ended September 30,
-------------------
1998 1997
---- ----
(millions)
<S> <C> <C>
OPERATIONS
Net income.................................................................................. $ 435 $ 483
Adjustments for noncash and nonoperating items:
Depreciation and amortization............................................................... 1,085 1,013
Changes in operating assets and liabilities................................................. (247) (578)
------- -----
Cash provided by operations................................................................. 1,273 918
------ -----
INVESTING ACTIVITIES
Investments and acquisitions................................................................ (335) (104)
Capital expenditures........................................................................ (1,092) (1,117)
Investment proceeds......................................................................... 540 444
------ ------
Cash used by investing activities........................................................... (887) (777)
------ ------
FINANCING ACTIVITIES
Borrowings.................................................................................. 1,515 905
Debt repayments............................................................................. (840) (323)
Issuance of preferred stock of subsidiary................................................... - 243
Capital distributions....................................................................... (1,060) (809)
Other....................................................................................... (198) (77)
------ ------
Cash used by financing activities........................................................... (583) (61)
------ ----
INCREASE (DECREASE) IN CASH AND EQUIVALENTS................................................. (197) 80
CASH AND EQUIVALENTS AT BEGINNING OF PERIOD................................................. 322 216
---- ----
CASH AND EQUIVALENTS AT END OF PERIOD....................................................... $ 125 $ 296
======= ======
</TABLE>
See accompanying notes.
<PAGE>
<TABLE>
TIME WARNER ENTERTAINMENT COMPANY, L.P.
CONSOLIDATED STATEMENT OF PARTNERSHIP CAPITAL
(Unaudited)
Nine Months
Ended September 30,
-------------------
1998 1997
---- ----
(millions)
<S> <C> <C>
BALANCE AT BEGINNING OF YEAR................................................................ $6,333 $6,574
Net income.................................................................................. 435 483
Increase (decrease) in unrealized gains on securities....................................... (2) 5
Foreign currency translation adjustments.................................................... (18) (28)
Increase in realized and unrealized losses on derivative financial instruments.............. (1) -
----- -----
Comprehensive income(a)..................................................................... 414 460
Stock option and tax-related distributions.................................................. (746) (586)
Distribution of business telephony interests................................................ (193) -
Allocation of income to Time Warner General Partners' Senior Capital........................ (52) (88)
----- -----
BALANCE AT SEPTEMBER 30,.................................................................... $5,756 $6,360
====== ======
- ---------------
(a) Comprehensive income for the three months ended September 30, 1998 and 1997 was $167 million and $72 million,
respectively.
</TABLE>
See accompanying notes.
<PAGE>
TIME WARNER ENTERTAINMENT COMPANY, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION
Description of Business
Time Warner Entertainment Company, L.P., a Delaware limited partnership
("TWE"), classifies its businesses into three fundamental areas: Entertainment,
consisting principally of interests in filmed entertainment, television
production and television broadcasting; Cable Networks, consisting principally
of interests in cable television programming; and Cable, consisting principally
of interests in cable television systems.
The operating results of TWE's various business interests are presented
herein as an indication of financial performance (Note 6). Except for start-up
losses incurred in connection with The WB Network, TWE's principal business
interests generate significant operating income and cash flow from operations.
The cash flow from operations generated by such business interests is
considerably greater than their operating income due to significant amounts of
noncash amortization of intangible assets recognized principally in Time Warner
Companies, Inc.'s ("Time Warner") $14 billion acquisition of Warner
Communications Inc. ("WCI") in 1989 and $1.3 billion acquisition of the minority
interest in American Television and Communications Corporation ("ATC") in 1992,
a portion of which cost was allocated to TWE upon the capitalization of the
partnership. Noncash amortization of intangible assets recorded by TWE's
businesses amounted to $129 million and $109 million for the three months ended
September 30, 1998 and 1997, respectively, and $387 million and $321 million for
the nine months ended September 30, 1998 and 1997, respectively.
Time Warner and certain of its wholly owned subsidiaries collectively
own general and limited partnership interests in TWE consisting of 74.49% of the
pro rata priority capital ("Series A Capital") and residual equity capital
("Residual Capital"), and 100% of the senior priority capital ("Senior Capital")
and junior priority capital ("Series B Capital"). The remaining 25.51% limited
partnership interests in the Series A Capital and Residual Capital of TWE are
held by a subsidiary of MediaOne Group, Inc. ("MediaOne"), formerly U S WEST,
Inc. Certain of Time Warner's subsidiaries are the general partners of TWE
("Time Warner General Partners").
Basis of Presentation
The accompanying financial statements are unaudited but, in the opinion
of management, contain all the adjustments (consisting of those of a normal
recurring nature) considered necessary to present fairly the financial position
and the results of operations and cash flows for the periods presented in
conformity with generally accepted accounting principles applicable to interim
periods. The accompanying financial statements should be read in conjunction
with the audited consolidated financial statements of TWE for the year ended
December 31, 1997. Certain reclassifications have been made to the prior year's
financial statements to conform to the 1998 presentation.
Effective July 1, 1998, TWE adopted Financial Accounting Standards
Board Statement No. 133, "Accounting for Derivative Instruments and Hedging
Activities" ("FAS 133"). FAS 133 requires that all derivative financial
instruments, such as foreign exchange contracts, be recognized in the financial
statements and measured at fair value regardless of the purpose or intent for
holding them. The adoption of FAS 133 did not have a material effect on TWE's
financial statements.
<PAGE>
TIME WARNER ENTERTAINMENT COMPANY, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
(UNAUDITED)
2. ACQUISITIONS AND DISPOSITIONS
Cable Transactions
In addition to continuing to use cable operating cash flow to finance
the level of capital spending necessary to upgrade the technological capability
of their cable television systems and develop new services, Time Warner, TWE and
the TWE-Advance/Newhouse Partnership ("TWE-A/N") have completed a series of
transactions in 1998 related to the cable television business and related
ancillary businesses that either reduced existing debt and/or TWE's share of
future funding requirements for such businesses. These transactions are
discussed more fully below.
Business Telephony Reorganization
In July 1998, in an effort to combine their business telephony
operations into a single entity that is intended to be self-financing, Time
Warner, TWE and TWE-A/N completed a reorganization of their business telephony
operations (the "Business Telephony Reorganization"), whereby (i) the operations
conducted by Time Warner, TWE and TWE-A/N were each contributed to a new holding
company named Time Warner Telecom LLC ("TW Telecom"), and then (ii) TWE's and
TWE-A/N's interests in TW Telecom were distributed to their partners, Time
Warner, MediaOne and Advance/Newhouse. TW Telecom is a competitive local
exchange carrier (CLEC) in selected metropolitan areas across the United States
where it offers a wide range of telephony services to business customers. As a
result of the Business Telephony Reorganization, Time Warner, MediaOne and
Advance/Newhouse own interests in TW Telecom of 61.95%, 18.88% and 19.17%,
respectively. TWE and TWE-A/N do not have continuing equity interests in these
business telephony operations. TWE and TWE-A/N recorded the distribution of
their business telephony operations to their respective partners based on the
$244 million historical cost of the net assets, of which $193 million was
recorded as a reduction in partners' capital and $51 million was recorded as a
reduction in minority interest in TWE's consolidated balance sheet.
Road Runner Joint Venture
In June 1998, Time Warner, TWE, TWE-A/N, MediaOne, Microsoft Corp.
("Microsoft") and Compaq Computer Corp. ("Compaq") formed a joint venture to
operate and expand Time Warner Cable's and MediaOne's existing high-speed
Internet access businesses (the "Road Runner Joint Venture"). In exchange for
contributing their existing high-speed Internet access businesses, Time Warner
received a common equity interest in the Road Runner Joint Venture of 11.25%,
TWE received a 25% interest, TWE-A/N received a 32.5% interest and MediaOne
received a 31.25% interest. In exchange for Microsoft and Compaq each
contributing $212.5 million of cash to the Road Runner Joint Venture, Microsoft
and Compaq each received a preferred equity interest therein that is convertible
into a 10% common equity interest. Accordingly, on a fully diluted basis, the
Road Runner Joint Venture is owned 9% by Time Warner, 20% by TWE, 26% by
TWE-A/N, 25% by MediaOne, 10% by Microsoft and 10% by Compaq. As a result of
this transaction, effective as of June 30, 1998, TWE and TWE-A/N deconsolidated
their high-speed Internet access operations and each of TWE's and TWE-A/N's
interest in the Road Runner Joint Venture is being accounted for under the
equity method of accounting.
Primestar
In April 1998, TWE and Advance/Newhouse, a limited partner in TWE-A/N,
transferred the direct broadcast satellite operations conducted by TWE and
TWE-A/N (the "DBS Operations") and the 31% partnership interest in Primestar
Partners, L.P. held by TWE-A/N ("Primestar" and collectively, the "Primestar
Assets") to Primestar, Inc. ("New Primestar"), a separate holding company. New
Primestar owns the DBS Operations and Primestar partnership interests formerly
owned by TCI Satellite Entertainment, Inc. and other previously existing
partners of Primestar. In exchange for contributing its interests in the
Primestar Assets, TWE received approximately 48 million shares of common stock
of New Primestar (representing an approximate 24% equity interest) and realized
approximately $240 million of debt reduction. In partial consideration for
contributing its indirect interest in certain of the Primestar Assets,
Advance/Newhouse received an approximate 6% equity interest in New Primestar. As
a result of this transaction, effective as of April 1, 1998, TWE deconsolidated
the DBS Operations and the 24% equity interest in New Primestar received in the
transaction is being accounted for under the equity method of accounting.
This transaction is referred to herein as the "Primestar Roll-up Transaction."
In a related transaction, Primestar also entered into an agreement in
June 1997 with The News Corporation Limited ("News Corp."), MCI WorldCom, Inc.
("MCI") and American Sky Broadcasting LLC ("ASkyB"), pursuant to which New
Primestar would acquire certain assets relating to the high-power, direct
broadcast satellite business of ASkyB (the "Primestar ASkyB Transaction"). In
May 1998, the U.S. Department of Justice brought a civil action against
Primestar, each of its cable owners, including TWE, and News Corp. and MCI, to
enjoin on antitrust grounds the Primestar ASkyB Transaction. Although the
parties had discussions with the U.S. Department of Justice in an attempt to
restructure the transaction, no resolution was reached and the parties
terminated their agreement in October 1998.
TWE-A/N Transfers
In early 1998, Time Warner (through a wholly owned subsidiary)
contributed cable television systems (or interests therein) serving
approximately 650,000 subscribers to TWE-A/N, subject to approximately $1
billion of debt, in exchange for common and preferred partnership interests
therein, and completed certain related transactions (collectively, the "TWE-A/N
Transfers"). The cable television systems transferred to TWE-A/N were formerly
owned by TWI Cable Inc. ("TWI Cable"), a wholly owned subsidiary of Time Warner,
and Paragon Communications ("Paragon"), a partnership formerly owning cable
television systems serving approximately 1 million subscribers that was wholly
owned by subsidiaries of Time Warner, with 50% beneficially owned in the
aggregate by TWE and TWE-A/N. The debt assumed by TWE-A/N has been guaranteed by
TWI Cable and certain of its subsidiaries, including Paragon.
As part of the TWE-A/N Transfers, TWE and TWE-A/N exchanged
substantially all of their respective beneficial interests in Paragon for an
equivalent share of Paragon's cable television systems (or interests therein)
serving approximately 500,000 subscribers, resulting in wholly owned
subsidiaries of Time Warner owning 100% of the restructured Paragon entity, with
less than 1% beneficially held for TWE. Accordingly, effective as of January 1,
1998, Time Warner has consolidated Paragon. Because this transaction represented
an exchange of TWE's and TWE-A/N's beneficial interests in Paragon for an
equivalent amount of its cable television systems, it did not have a significant
economic impact on Time Warner, TWE or TWE-A/N.
In connection with the TWE-A/N Transfers, Advance/Newhouse made a
capital contribution to TWE-A/N in order to maintain its 33.3% common
partnership interest therein. Accordingly, TWE-A/N is now owned 65.3% by TWE,
33.3% by Advance/Newhouse and 1.4% indirectly by Time Warner. The TWE-A/N
Transfers were accounted for effective as of January 1, 1998. Time Warner did
not recognize a gain or loss on the TWE-A/N Transfers. TWE has continued to
consolidate TWE-A/N and Time Warner has accounted for its interest in TWE-A/N
under the equity method of accounting.
On a pro forma basis, giving effect to the TWE-A/N Transfers as if they
had occurred at the beginning of 1997, TWE would have reported for the three and
nine months ended September 30, 1997, respectively, revenues of $2.869 billion
and $8.227 billion, depreciation expense of $253 million and $696 million,
operating income before noncash amortization of intangible assets of $473
million and $1.393 billion, operating income of $347 million and $1.023 billion,
and net income of $79 million and $479 million.
Sale or Exchange of Cable Television Systems
In 1998 and 1997, in an effort to enhance their geographic clustering
of cable television properties, TWE sold or exchanged various cable television
systems. As a result of these transactions, TWE recognized net pretax gains of
approximately $6 million and $16 million for the three months ended September
30, 1998 and 1997, respectively, and approximately $90 million and $40 million
for the nine months ended September 30, 1998 and 1997, respectively. Such
amounts have been included in operating income in the accompanying consolidated
statement of operations.
Six Flags
In April 1998, TWE sold its remaining 49% interest in Six Flags
Entertainment Corporation ("Six Flags") to Premier Parks Inc. ("Premier"), a
regional theme park operator, for approximately $475 million of cash. TWE used
the net, after-tax proceeds from this transaction to reduce debt by
approximately $300 million. As part of the transaction, TWE will continue to
license its animated cartoon and comic book characters to Six Flags's theme
parks and will similarly license such rights to Premier's theme parks in the
United States and Canada under a long-term agreement covering an aggregate of
twenty-five existing and all future locations. A substantial portion of the gain
on this transaction has been deferred principally as a result of TWE's
continuing guarantees of certain significant long-term obligations of Six Flags
relating to the Six Flags Over Texas and Six Flags Over Georgia theme parks.
E! Entertainment Television, Inc.
In March 1997, TWE sold its 58% interest in E! Entertainment
Television, Inc. A pretax gain of approximately $250 million relating to this
sale has been included in the accompanying consolidated statement of operations
for the nine months ended September 30, 1997.
<PAGE>
3. INVENTORIES
TWE's inventories consist of:
<TABLE>
September 30, 1998 December 31, 1997
------------------ -----------------
Current Noncurrent Current Noncurrent
------- ---------- ------- ----------
(millions)
<S> <C> <C> <C> <C>
Film costs:
Released, less amortization..................................... $ 555 $ 662 $ 545 $ 658
Completed and not released...................................... 263 93 170 50
In process and other............................................ 51 600 27 595
Library, less amortization...................................... - 573 - 612
Programming costs, less amortization............................... 352 353 382 339
Merchandise........................................................ 89 - 80 -
------ ------ ------ -------
Total.............................................................. $1,310 $2,281 $1,204 $2,254
====== ====== ====== ======
</TABLE>
4. PARTNERS' CAPITAL
TWE is required to make distributions to reimburse the partners for
income taxes at statutory rates based on their allocable share of taxable
income, and to reimburse Time Warner for stock options granted to employees of
TWE based on the amount by which the market price of Time Warner Inc. common
stock exceeds the option exercise price on the exercise date or, with respect to
options granted prior to the TWE capitalization on September 30, 1992, the
greater of the exercise price and the $27.75 market price of Time Warner Inc.
common stock at the time of the TWE capitalization. TWE accrues a stock option
distribution and a corresponding liability with respect to unexercised options
when the market price of Time Warner Inc. common stock increases during the
accounting period, and reverses previously accrued stock option distributions
and the corresponding liability when the market price of Time Warner Inc. common
stock declines.
During the nine months ended September 30, 1998, TWE accrued $264
million of tax-related distributions and $482 million of stock option
distributions, based on closing prices of Time Warner common stock of $87.56 at
September 30, 1998 and $62.00 at December 31, 1997. During the nine months ended
September 30, 1997, TWE accrued $232 million of tax-related distributions and
$354 million of stock option distributions as a result of an increase at that
time in the market price of Time Warner Inc. common stock. In the nine months
ended September 30, 1998, TWE paid cash distributions to the Time Warner General
Partners in the amount of $1.060 billion, consisting of $264 million of
tax-related distributions, $217 million of stock option related distributions
and a $579 million distribution to the Time Warner General Partners relating to
their Senior Capital interests. In the nine months ended September 30, 1997, TWE
paid the Time Warner General Partners cash distributions in the amount of $809
million, consisting of $232 million of tax-related distributions, $42 million of
stock option related distributions and a $535 million distribution to the Time
Warner General Partners relating to their Senior Capital interests.
In addition, in connection with the Business Telephony Reorganization,
TWE recorded a $193 million noncash distribution to its partners based on the
historical cost of the net assets (Note 2).
5. DERIVATIVE FINANCIAL INSTRUMENTS
TWE uses derivative financial instruments principally to manage the
risk that changes in exchange rates will affect the amount of unremitted or
future license fees to be received from the sale of U.S.
copyrighted products abroad. The following is a summary of TWE's foreign
currency risk management strategy and the effect of this strategy on TWE's
consolidated financial statements.
Foreign Currency Risk Management
Foreign exchange contracts are used primarily by Time Warner to hedge
the risk that unremitted or future license fees owed to TWE domestic companies
for the sale or anticipated sale of U.S. copyrighted products abroad may be
adversely affected by changes in foreign currency exchange rates. As part of its
overall strategy to manage the level of exposure to the risk of foreign currency
exchange rate fluctuations, Time Warner hedges a portion of its foreign currency
exposures anticipated over the ensuing twelve month period, including those
related to TWE. At September 30, 1998, Time Warner had effectively hedged
approximately half of TWE's estimated foreign currency exposures that
principally relate to anticipated cash flows to be remitted to the U.S. over the
ensuing twelve month period, using foreign exchange contracts that generally
have maturities of three months or less, which generally are rolled over to
provide continuing coverage throughout the year. Time Warner often closes
foreign exchange sale contracts by purchasing an offsetting purchase contract.
Time Warner reimburses or is reimbursed by TWE for contract gains and losses
related to TWE's foreign currency exposure. Foreign exchange contracts are
placed with a number of major financial institutions in order to minimize credit
risk.
TWE records these foreign exchange contracts at fair value in its
consolidated balance sheet and the related gains or losses on these contracts
are deferred in partners' capital (as a component of comprehensive income).
These deferred gains and losses are recognized in income in the period in which
the related license fees being hedged are received and recognized in income.
However, to the extent that any of these contracts are not considered to be
perfectly effective in offsetting the change in the value of the license fees
being hedged, any changes in fair value relating to the ineffective portion of
these contracts are immediately recognized in income. Gains and losses on
foreign exchange contracts are generally included as a component of interest and
other, net, in TWE's consolidated statement of operations.
At September 30, 1998, Time Warner had contracts for the sale of $608
million and the purchase of $267 million of foreign currencies at fixed rates.
Of Time Warner's $341 million net sale contract position, none of foreign
exchange purchase contracts and $96 million of the foreign exchange sale
contracts related to TWE's foreign currencies exposure, primarily Japanese yen
(32% of net contract position related to TWE), English pounds (5%), German marks
(13%), Canadian dollars (7%) and French francs (9%), compared to a net sale
contract position of $105 million of foreign currencies at December 31, 1997.
TWE had deferred approximately $1 million of net losses on foreign exchange
contracts at September 30, 1998, which is all expected to be recognized in
income over the next twelve months.
6. SEGMENT INFORMATION
TWE classifies its businesses into three fundamental areas:
Entertainment, consisting principally of interests in filmed entertainment,
television production and television broadcasting; Cable Networks, consisting
principally of interests in cable television programming; and Cable, consisting
principally of interests in cable television systems.
Information as to the operations of TWE in different business segments
is set forth below based on the nature of the products and services offered. TWE
evaluates performance based on several factors, of which the primary financial
measure is business segment operating income before noncash amortization of
intangible assets ("EBITA"). The operating results of TWE's cable segment
reflect the TWE-A/N Transfers effective as of January 1, 1998, the Primestar
Roll-up Transaction effective as of April 1, 1998, the formation of the Road
Runner Joint Venture effective as of June 30, 1998 and the Business Telephony
Reorganization effective as of July 1, 1998.
Information as to the operations of TWE in different business segments
is set forth below.
<TABLE>
Three Months Nine Months
Ended September 30, Ended September 30,
------------------- -------------------
1998 1997 1998 1997
---- ---- ---- ----
(millions)
<S> <C> <C> <C> <C>
Revenues
Filmed Entertainment-Warner Bros................................... $1,727 $1,397 $4,364 $3,823
Broadcasting-The WB Network........................................ 64 31 170 84
Cable Networks-HBO................................................. 505 482 1,526 1,452
Cable.............................................................. 1,052 1,060 3,289 3,146
Intersegment elimination........................................... (128) (115) (369) (322)
------ ------ ------ ------
Total.............................................................. $3,220 $2,855 $8,980 $8,183
====== ====== ====== ======
Three Months Nine Months
Ended September 30, Ended September 30,
------------------- -------------------
1998 1997 1998 1997
---- ---- ---- ----
(millions)
EBITA(1)
Filmed Entertainment-Warner Bros................................... $ 161 $ 106 $ 401 $ 315
Broadcasting-The WB Network........................................ (17) (21) (78) (60)
Cable Networks-HBO................................................. 117 102 339 291
Cable(2)........................................................... 336 257 1,017 759
----- ----- ------ -----
Total.............................................................. $ 597 $ 444 $1,679 $1,305
====== ====== ====== ======
- ---------------
(1)EBITA represents business segment operating income before noncash
amortization of intangible assets. After deducting amortization of intangible
assets, TWE's business segment operating income for the three and nine months
ended September 30, 1998, respectively, and for the corresponding periods in
the prior year was $468 million and $1.292 billion in 1998, and $335 million
and $984 million in 1997.
(2)Includes net pretax gains recognized in connection with the sale or exchange
of certain cable television systems of approximately $6 million and $16
million for the three months ended September 30, 1998 and 1997, respectively,
and approximately $90 million and $40 million for the nine months ended
September 30, 1998 and 1997, respectively.
<PAGE>
Three Months Nine Months
Ended September 30, Ended September 30,
------------------- -------------------
1998 1997 1998 1997
---- ---- ---- ----
(millions)
Depreciation of Property, Plant and Equipment
Filmed Entertainment-Warner Bros................................... $ 48 $ 50 $126 $131
Broadcasting-The WB Network........................................ 1 - 1 1
Cable Networks-HBO................................................. 6 5 16 15
Cable.............................................................. 174 197 555 545
---- ---- ---- ----
Total.............................................................. $229 $252 $698 $692
==== ==== ==== ====
Three Months Nine Months
Ended September 30, Ended September 30,
-------------------- ---------------------
1998 1997 1998 1997
---- ---- ---- ----
(millions)
Amortization of Intangible Assets (1)
Filmed Entertainment-Warner Bros................................... $ 33 $ 31 $ 99 $ 92
Broadcasting-The WB Network........................................ - - 2 -
Cable Networks-HBO................................................. - - - -
Cable.............................................................. 96 78 286 229
---- ---- ---- ----
Total.............................................................. $129 $109 $387 $321
==== ==== ==== ====
(1)Amortization includes amortization relating to all business combinations
accounted for by the purchase method, including Time Warner's $14 billion
acquisition of WCI in 1989 and $1.3 billion acquisition of the minority
interest in ATC in 1992.
7. COMMITMENTS AND CONTINGENCIES
Pending legal proceedings are substantially limited to litigation
incidental to the businesses of TWE. In the opinion of management, the ultimate
resolution of these matters will not have a material effect on the consolidated
financial statements of TWE.
8. ADDITIONAL FINANCIAL INFORMATION
Additional financial information with respect to cash flows is as
follows:
Nine Month
Ended September 30,
-------------------
1998 1997
---- ----
(millions)
Interest expense............................................................................ $418 $358
Cash payments made for interest............................................................. 419 394
Cash payments made for income taxes, net.................................................... 57 55
Noncash capital distributions............................................................... 675 354
Noncash investing and financing activities in the first nine months of
1998 included the Business Telephony Reorganization, the TWE-A/N Transfers, the
Primestar Roll-up Transaction and the exchange of certain cable television
systems (Note 2). During the nine months ended September 30, 1998, TWE received
$131 million of proceeds under its asset securitization program.
</TABLE>
<PAGE>
TWE GENERAL PARTNERS
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
On June 30, 1992, thirteen direct or indirect subsidiaries of Time
Warner Companies, Inc. ("TW Companies") contributed the assets and liabilities
or the rights to the cash flows of substantially all of TW Companies's Filmed
Entertainment-Warner Bros., Cable Networks-HBO and Cable businesses to Time
Warner Entertainment Company, L.P., a Delaware limited partnership ("TWE"), for
general partnership interests, and each general partner guaranteed a pro rata
portion of substantially all of TWE's debt and accrued interest at that time
based on the relative fair value of the net assets each contributed to TWE (the
"General Partner Guarantees"). In 1997, two of the original general partners,
Warner Cable Communications Inc. ("WCCI") and Time Warner Operations Inc.
("TWOI"), were merged into another original general partner, Warner
Communications Inc. (the "WCCI Merger" and the "TWOI Merger," respectively, and
collectively, the "1997 General Partner Mergers"). After the 1997 General
Partner Mergers, eleven of the thirteen original general partners have now been
merged or dissolved into the other two. Warner Communications Inc. ("WCI") and
American Television and Communications Corporation ("ATC" ) are the two
remaining general partners of TWE. They have succeeded to the general
partnership interests and have assumed the General Partner Guarantees of the
eleven former general partners.
The WCCI Merger had no effect on the consolidated results of operations
and financial condition of WCI because WCCI was a consolidated subsidiary of WCI
prior to the merger and, as such, WCCI's net assets, operating results and cash
flows were already included in the consolidated financial statements of WCI. The
TWOI Merger has been accounted for as a merger of entities under common control,
similar to the pooling-of-interests method of accounting for business
combinations. Accordingly, the 1997 consolidated financial statements of WCI
have been restated to reflect the TWOI Merger effective as of January 1, 1997.
Set forth below is a discussion of the results of operations and
financial condition of WCI, the only General Partner with independent business
operations. WCI conducts substantially all of TW Companies's Music operations,
which include copyrighted music from many of the world's leading recording
artists that is produced and distributed by a family of established record
labels such as Warner Bros. Records, Atlantic Records, Elektra Entertainment and
Warner Music International. The financial position and results of operations of
ATC are principally derived from its investments in TWE, TW Companies, Turner
Broadcasting System, Inc. and Time Warner Telecom LLC, and its revolving credit
agreement with TW Companies. Capitalized terms are as defined and described in
the accompanying consolidated financial statements, or elsewhere herein.
Use of EBITA
WCI evaluates operating performance based on several factors, of which
the primary financial measure is operating income before noncash amortization of
intangible assets ("EBITA"). Consistent with management's financial focus on
controlling capital spending, EBITA measures operating performance after charges
for depreciation. The exclusion of noncash amortization charges is consistent
with management's belief that WCI's intangible assets, such as music catalogues
and copyrights and the goodwill associated with its brands, are generally
increasing in value and importance to WCI's business objective of creating,
extending and distributing recognizable brands and copyrights throughout the
world. As such, the following comparative discussion of the results of
operations of WCI includes, among other factors, an analysis of changes in
business segment EBITA. However, EBITA should be considered in addition to, not
as a substitute for, operating income, net income and other measures of
financial performance reported in accordance with generally accepted accounting
principles.
RESULTS OF OPERATIONS
Three Months Ended September 30, 1998 Compared to the Three Months Ended
September 30, 1997
WCI had revenues of $938 million and net income of $66 million for the
three months ended September 30, 1998, compared to revenues of $866 million and
net income of $11 million for the three months ended September 30, 1997. EBITA
increased to $97 million from $89 million. Operating income increased to $31
million from $20 million. Revenues benefited from an increase in domestic and
international recorded music sales principally relating to higher compact disc
sales of a broad range of popular releases from new and established artists and
movie soundtracks, as well as lower returns of product. At the end of September
1998, WCI had a leading domestic market share of 20%, as measured by SoundScan.
EBITA and operating income increased principally as a result of the revenue
gains.
WCI's equity in the pretax income of TWE was $115 million for the three
months ended September 30, 1998, compared to $64 million for the three months
ended September 30, 1997. TWE's pretax income increased in 1998 as compared to
1997 principally due to an overall increase in operating income generated by its
business segments (including the positive effect of the TWE-A/N Transfers),
offset in part by an increase in interest expense associated with the TWE-A/N
Transfers, higher losses from certain investments accounted for under the equity
method of accounting and lower gains on foreign exchange contracts. As used
herein, the TWE-A/N Transfers refer to the transfer of cable television systems
(or interests therein) serving approximately 650,000 subscribers that were
formerly owned by subsidiaries of Time Warner to the TWE-Advance/Newhouse
Partnership ("TWE-A/N"), subject to approximately $1 billion of debt, in
exchange for common and preferred partnership interests therein, as well as
certain related transactions (collectively, the "TWE-A/N Transfers").
Interest and other, net was $3 million of expense for the three months
ended September 30, 1998, compared to $15 million of expense for the three
months ended September 30, 1997. Interest expense decreased to $4 million from
$6 million. There was other income, net, of $1 million in 1998, compared to
other expense, net, of $9 million in 1997, principally because of an increase in
interest income relating to a $610 million note receivable from TW Companies
(the "TW Companies Note Receivable") received in connection with the 1997
disposal of WCI's interest in Hasbro, Inc.
Nine Months Ended September 30, 1998 Compared to the Nine Months Ended
September 30, 1997
WCI had revenues of $2.731 billion and net income of $185 million for
the nine months ended September 30, 1998, compared to revenues of $2.635 billion
and net income of $172 million for the nine months ended September 30, 1997.
EBITA decreased to $283 million from $289 million. Operating income increased to
$85 million from $84 million. Revenues benefited from an increase in domestic
and international recorded music sales principally relating to higher compact
disc sales of a broad range of popular releases from new and established artists
and movie soundtracks, as well as lower returns of product. At the end of
September 1998, WCI had a leading domestic market share of 20%, as measured by
SoundScan. Despite the revenue increase, EBITA declined principally as a result
of the negative effect of changes in foreign currency exchange rates on
international recorded music operations and the absence of certain one-time
gains recognized in 1997. Operating income similarly was affected by these
factors, although it increased marginally due to lower amortization of
intangible assets.
WCI's equity in the pretax income of TWE was $290 million for the nine
months ended September 30, 1998, compared to $324 million for the nine months
ended September 30, 1997. TWE's pretax income decreased in 1998 as compared to
1997 principally due to significantly lower aggregate, net pretax gains
recognized in connection with the sale or exchange of certain cable television
systems in each year and the 1997 sale of TWE's interest in E! Entertainment
Television, Inc. Excluding the effect of these transactions, TWE's pretax income
increased in 1998 principally as a result of an overall increase in operating
income generated by its business segments (including the positive effect of the
TWE-A/N Transfers), offset in part by an increase in interest expense associated
with the TWE-A/N Transfers, higher losses from certain investments accounted for
under the equity method of accounting and lower gains on foreign exchange
contracts.
Interest and other, net was $12 million of income for the nine months
ended September 30, 1998, compared to $15 million of income for the nine months
ended September 30, 1997. Interest expense decreased to $14 million from $17
million. There was other income, net, of $26 million in 1998, compared to other
income, net, of $32 million in 1997, principally because of lower gains on
foreign exchange contracts, offset in part by an increase in interest income
relating to the TW Companies Note Receivable.
The relationship between income before income taxes and income tax
expense for the General Partners is principally affected by the amortization of
goodwill and certain other financial statement expenses that are not deductible
for income tax purposes. Income tax expense for each of the General Partners
includes all income taxes related to its allocable share of partnership income
and its equity in the income tax expense of corporate subsidiaries of TWE.
FINANCIAL CONDITION AND LIQUIDITY
September 30, 1998
WCI had $8 billion of equity at September 30, 1998, compared to $8.5
billion of equity at December 31, 1997. WCI's equity decreased principally due
to higher dividends paid to Time Warner. Cash and equivalents increased to $196
million at September 30, 1998, compared to $102 million at December 31, 1997.
WCI had no long-term debt due to TW Companies under its revolving credit
agreement at the end of either period.
ATC had $1.7 billion of equity at September 30, 1998, compared to $2.1
billion at December 31, 1997. ATC's equity decreased principally due to higher
dividends paid to Time Warner. Although ATC has no independent operations, it is
expected that additional tax-related and other distributions from TWE, as well
as availability under ATC's revolving credit agreement with TW Companies, will
continue to be sufficient to satisfy ATC's obligations with respect to its tax
sharing agreement with TW Companies for the foreseeable future.
Cash Flows
In the first nine months of 1998, WCI's cash provided by operations
amounted to $382 million and reflected $283 million of EBITA, $54 million of
noncash depreciation expense and $358 million of distributions from TWE
(excluding $270 million representing the return of a portion of the General
Partners' Senior Capital interests that has been classified as a source of cash
from investing activities), less $7 million of interest payments, $174 million
of income taxes ($121 million of which was paid to TW Companies under a tax
sharing agreement) and $132 million related to an aggregate reduction in working
capital requirements, other balance sheet accounts and noncash items. Cash
provided by WCI's operations of $176 million in the first nine months of 1997
reflected $289 million of EBITA, $62 million of noncash depreciation expense,
$210 million of distributions from TWE (similarly, excluding $270 million
representing the return of a portion of the General Partners' Senior Capital
interests that has been classified as a source of cash from investing
activities), less $10 million of interest payments, $254 million of income taxes
($151 million of which was paid to TW Companies under a tax sharing agreement)
and $121 million related to an aggregate reduction in working capital
requirements, other balance sheet accounts and noncash items.
Cash provided by investing activities was $296 million in the first
nine months of 1998, compared to $246 million in the first nine months of 1997,
principally as a result of a decrease in investment spending and an increase in
investment proceeds.
Cash used by financing activities was $584 million in the first nine
months of 1998, compared to $349 million in the first nine months of 1997,
principally as a result of an increase in advances to TW Companies and increased
dividend payments of $133 million.
Management believes that WCI's operating cash flow and borrowing
availability under its revolving credit agreement with TW Companies are
sufficient to meet its capital and liquidity needs for the foreseeable future
without cash distributions from TWE above those permitted by existing
agreements.
WCI and ATC have no claims on the assets and cash flows of TWE except
through the payment of certain reimbursements and cash distributions. During the
nine months of 1998, the General Partners received an aggregate $1.060 billion
of distributions from TWE, consisting of $579 million of Senior Capital
distributions (representing the return of $455 million of contributed capital
and the distribution of $124 million of priority capital return), $264 million
of tax-related distributions and $217 million of stock option related
distributions. During the nine months ended September 30, 1997, the General
Partners received an aggregate $809 million of distributions, consisting of $535
million of Senior Capital distributions (representing the return of $455 million
of contributed capital and the distribution of $80 million of priority capital
return), $232 million of tax-related distributions and $42 million of stock
option related distributions. Of such aggregate distributions in the first nine
months of 1998 and 1997, WCI received $628 million and $480 million,
respectively, and ATC received $432 million and $329 million, respectively.
Year 2000 Technology Preparedness
WCI, together with TWE and like most large companies, depends on many
different computer systems and other chip-based devices for the continuing
conduct of its business. Older computer programs, computer hardware and
chip-based devices may fail to recognize dates beginning on January 1, 2000 as
being valid dates, and as a result may fail to operate or may operate improperly
when such dates are introduced.
WCI's exposure to potential Year 2000 problems exists in two general
areas: technological operations in the sole control of WCI and technological
operations dependent in some way on one or more third parties. These
technological operations include information technology ("IT") systems and
non-IT systems, including those with embedded technology, hardware and software.
Most of WCI's potential Year 2000 exposures are in the area of technological
operations dependent on one or more third parties. Failure to achieve high
levels of Year 2000 compliance in either area could have a material adverse
impact on WCI and its financial statements.
WCI's Year 2000 remediation project has several phases: inventory,
assessment, remediation planning, implementation and final testing. The progress
of its operational project managers through these phases is actively overseen by
a senior technology executive who reports on a regular basis to the senior
financial executive. Assistance is obtained, when appropriate, from both
internal and outside professional sources.
WCI has generally completed the process of identifying potential Year
2000 difficulties in its technological operations, including IT applications, IT
technology and support, desktop hardware and software, non-IT systems and
important third party operations, and distinguishing those that are "mission
critical" from those that are not. An item is considered "mission critical" if
its Year 2000-related failure would significantly impair the ability of one of
WCI's major business units to (1) produce, market and distribute the products or
services that generate significant revenues for that business, (2) meet its
obligations to pay its employees, artists, vendors and other obligations or (3)
meet its obligations under regulatory requirements and internal accounting
controls. WCI has identified approximately 200 worldwide, "mission critical"
potential exposures. Of these, as of September 30, 1998, approximately 7% have
been identified by the divisions as in the assessment stage, approximately 13%
as in the remediation planning stage, and almost 80% as in the process of
implementation or testing or as Year 2000 compliant. WCI currently expects that
the assessment phase for these potential exposures should be completed by the
end of 1998 and that remediation with respect to technological operations in
WCI's sole control will be substantially completed in all material respects by
the end of the second quarter of 1999.
In the area of "mission critical" technological operations dependent in
some way on one or more third parties, the situation is much less in WCI's
ability to predict or control. In addition, WCI's business is dependent on third
parties that are themselves dependent on technology. In some cases, WCI's third
party dependence is on vendors of technology who are themselves working towards
solutions to Year 2000 problems. WCI has attempted to include in its "mission
critical" inventory significant service providers, vendors, suppliers, customers
and governmental entities that are believed to be critical to business
operations and is in various stages of attempting to ascertain their state of
Year 2000 readiness through questionnaires, interviews, on-site visits, industry
group participation and other available means. Moreover, WCI is dependent, like
all large companies, on the continued functioning, domestically and
internationally, of basic, heavily computerized services such as banking,
telephony and power, and various distribution mechanisms ranging from the mail,
railroads and trucking to high-speed data transmission. WCI is taking steps to
attempt to ensure that the third parties on which it is heavily reliant are Year
2000 compliant, but cannot predict the likelihood of such compliance nor the
direct or indirect costs to WCI of non-compliance by those third parties or of
securing such services from alternate compliant third parties.
WCI currently estimates that the aggregate cost of its Year 2000
remediation program, which started in 1996, will be approximately $25 to $40
million, of which an estimated 40% to 50% has been incurred through September
30, 1998. These costs include estimates of the costs of assessment, replacement,
repair and upgrade, both planned and unplanned, of certain IT and non-IT systems
and their implementation and testing. These expenditures have been and are
expected to continue to be funded from WCI's operating cash flow and have not
and are not expected to impact materially WCI's financial statements.
In addition to the foregoing areas, WCI is also exposed to potential
Year 2000 problems encountered by TWE in technological operations under its sole
control and in TWE's technological operations dependent in some way on one or
more third parties. ATC, while not having any independent operations, is
similarly exposed to potential Year 2000 problems encountered by TWE. Although
WCI and ATC anticipate that TWE will successfully complete its efforts to be
Year 2000 compliant in all material respects in advance of January 1, 2000,
failure by TWE to achieve high levels of Year 2000 compliance could have a
material adverse impact on WCI and ATC. For a discussion of TWE's Year 2000
technology preparedness, see TWE's Management's Discussion and Analysis of
Results of Operations and Financial Condition included elsewhere herein.
Management believes that it has established an effective program to
resolve all significant Year 2000 issues in its sole control in a timely manner.
As noted above, however, WCI has not yet completed all phases of its program and
is dependent on third parties whose progress is not within its control. In the
event that WCI did not complete any of its currently planned additional
remediation prior to the Year 2000, management believes that WCI could
experience significant difficulty in producing and delivering its products and
services and conducting its business in the Year 2000 as it has in the past. In
addition, disruptions experienced by third parties with which WCI does business
as well as by the economy generally could also materially adversely affect WCI.
The amount of potential liability and lost revenue cannot be reasonably
estimated at this time.
WCI has been focusing its efforts on identification and remediation of
its Year 2000 exposures and has not yet developed significant contingency plans
in the event it does not successfully complete all phases of its Year 2000
program. WCI intends to examine its status at the end of 1998, and periodically
thereafter, to determine whether such plans are necessary.
The discussion of WCI's expectations with respect to its Year 2000
remediation plans is based on management's current expectations of future
events. As with any projection, it is inherently susceptible to changes in
circumstances. WCI's actual results could differ materially from management's
expectations as a result of such factors as the ability of WCI and its key
service providers, vendors, suppliers, customers and governmental entities to
replace, modify or upgrade computer systems in ways that adequately address the
Year 2000 issue, including their ability to identify and correct all relevant
computer codes and embedded chips, unanticipated difficulties or delays in the
implementation of WCI's remediation plans and the ability of third parties to
adequately address their own Year 2000 issues.
Euro Conversion
Effective January 1, 1999, the "euro" will be established as the common
legal currency of more than two-thirds of the member countries of the European
Union. These member countries will then have a three-year transitional period to
convert their existing sovereign currencies to the euro. By July 1, 2002, all
participating member countries must eliminate their sovereign currencies and
replace their legal tender with euro-denominated bills and coins.
Notwithstanding this transitional period, many commercial transactions are
expected to become euro-denominated well before the July 2002 deadline.
Accordingly, WCI is in the process of evaluating the short-term and long-term
effects of the euro conversion on its businesses.
WCI believes that its most significant short-term impact relating to
the euro conversion is the need to modify its accounting and information systems
to handle transactions during the transitional period in both the euro and the
existing sovereign currencies of the participating member countries. WCI is in
the process of identifying the accounting and information systems in need of
modification and, based on these findings, will formulate an action plan to
address the nature and timing of remediation efforts. Based on preliminary
information, costs to modify its accounting and information systems are not
expected to be material.
WCI believes that its most significant long-term business risk relating
to the euro conversion may be increased pricing pressures for its products and
services brought about by heightened consumer awareness of possible cross-border
price differences. However, WCI believes that these business risks may be offset
to some extent by lower production costs, other cost savings and marketing
opportunities. Notwithstanding such risks, management does not believe at this
time that the euro conversion will have a material effect on WCI's financial
position, results of operations or cash flows in future periods.
<PAGE>
TWE GENERAL PARTNERS
CONSOLIDATED BALANCE SHEETS
(Unaudited)
<TABLE>
WCI ATC
--- ---
September 30, December 31, September 30, December 31,
1998 1997 1998 1997
---- ---- ---- ----
(millions)
<S> <C> <C> <C> <C>
ASSETS
Current assets
Cash and equivalents.................................. $ 196 $ 102 $ - $ -
Receivables, less allowances of $252 and
$264 million....................................... 709 866 - -
Inventories........................................... 160 140 - -
Prepaid expenses...................................... 713 651 - -
----- ------ ----- ------
Total current assets.................................. 1,778 1,759 - -
Investments in and amounts due to and from TWE........ 1,967 2,423 1,565 1,861
Investments in TW Companies........................... 103 103 62 62
Other investments..................................... 1,359 1,259 403 352
Music catalogues, contracts and copyrights............ 867 928 - -
Goodwill.............................................. 3,541 3,554 - -
Other assets, primarily property, plant and
equipment.......................................... 432 464 - -
------ ------ ----- ------
Total assets.......................................... $10,047 $10,490 $2,030 $2,275
======= ======= ====== ======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Accounts and royalties payable........................ $ 955 $ 978 $ - $ -
Other current liabilities............................. 386 464 - 1
----- ------ ------ ------
Total current liabilities............................. 1,341 1,442 - 1
Long-term liabilities, including $404, $251, $295
and $187 million due to TW Companies............... 754 527 295 187
Shareholders' equity
Common stock.......................................... 1 1 1 1
Preferred stock of WCI, $.01 par value, 90,000 shares
outstanding, $90 million liquidation preference.... - - - -
Paid-in capital....................................... 10,196 10,465 2,522 2,708
Retained earnings (accumulated deficit)............... 257 450 (140) (4)
------ ------- ------ ------
10,454 10,916 2,383 2,705
Due from TW Companies, net............................ (1,916) (1,809) (312) (282)
Reciprocal interest in TW Companies stock............. (586) (586) (336) (336)
------- ------ ------ ------
Total shareholders' equity............................ 7,952 8,521 1,735 2,087
------- ------- ------ ------
Total liabilities and shareholders' equity............ $10,047 $10,490 $2,030 $2,275
======= ======= ====== ======
See accompanying notes.
</TABLE>
<PAGE>
<TABLE>
TWE GENERAL PARTNERS
CONSOLIDATED STATEMENTS OF OPERATIONS
Three Months Ended September 30,
(Unaudited)
WCI ATC
------------------ ------------------
1998 1997 1998 1997
---- ---- ---- ----
(millions)
<S> <C> <C> <C> <C>
Revenues (a)....................................................... $938 $866 $ - $ -
---- ---- ----- -----
Cost of revenues (a)(b)............................................ 601 573 - -
Selling, general and administrative (a)(b)......................... 306 273 - -
---- ---- ----- -----
Operating expenses................................................. 907 846 - -
---- ---- ----- -----
Business segment operating income.................................. 31 20 - -
Equity in pretax income of TWE (a)................................. 115 64 80 44
Interest and other, net (a)........................................ (3) (15) 3 9
---- ----- ----- ----
Income before income taxes......................................... 143 69 83 53
Income taxes (a)................................................... (77) (58) (39) (28)
---- ----- ----- ----
Net income......................................................... $ 66 $ 11 $ 44 $ 25
==== ==== ===== ====
- ------------------
(a) Includes the following income (expenses) resulting from transactions with
Time Warner, TW Companies, TWE or equity investees of the General
Partners:
Revenues........................................................... $ 93 $ 28 $ - $ -
Cost of revenues................................................... (7) (10) - -
Selling, general and administrative................................ (10) 17 - -
Equity in pretax income of TWE..................................... (13) (7) - -
Interest and other, net............................................ 16 15 - -
Income taxes....................................................... (50) (31) (30) (17)
(b) Includes depreciation and amortization expense of:.......... $ 82 $ 90 $ - $ -
==== ==== ===== =====
See accompanying notes.
<PAGE>
TWE GENERAL PARTNERS
CONSOLIDATED STATEMENTS OF OPERATIONS
Nine Months Ended September 30,
(Unaudited)
WCI ATC
------------------- ------------------
1998 1997 1998 1997
---- ---- ---- ----
(millions)
Revenues (a)....................................................... $2,731 $2,635 $ - $ -
------ ------ ---- -----
Cost of revenues (a)(b)............................................ 1,732 1,724 - -
Selling, general and administrative (a)(b)......................... 914 827 - -
------ ----- ----- -----
Operating expenses................................................. 2,646 2,551 - -
------ ------ ----- -----
Business segment operating income.................................. 85 84 - -
Equity in pretax income of TWE (a)................................. 290 324 200 223
Interest and other, net (a)........................................ 12 15 17 20
------ ----- ---- -----
Income before income taxes......................................... 387 423 217 243
Income taxes (a)................................................... (202) (251) (99) (116)
------ ------- ---- -----
Net income......................................................... $ 185 $ 172 $ 118 $ 127
====== ====== ===== =====
- ------------------
(a) Includes the following income (expenses) resulting from transactions with
Time Warner, TW Companies, TWE or equity investees of the General
Partners:
Revenues........................................................... $ 139 $ 93 $ - $ -
Cost of revenues................................................... (18) (30) - -
Selling, general and administrative................................ (12) 42 - -
Equity in pretax income of TWE..................................... (25) (12) - -
Interest and other, net............................................ 54 49 - -
Income taxes....................................................... (121) (151) (77) (90)
(b) Includes depreciation and amortization expense of:.......... $ 252 $ 267 $ - $ -
===== ===== ===== =====
See accompanying notes.
<PAGE>
TWE GENERAL PARTNERS
CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended September 30,
(Unaudited)
WCI ATC
------------------- ------------------
1998 1997 1998 1997
---- ---- ---- ----
(millions)
OPERATIONS
Net income......................................................... $ 185 $ 172 $ 118 $ 127
Adjustments for noncash and nonoperating items:
Depreciation and amortization...................................... 252 267 - -
Deficiency (excess) of equity in pretax income of TWE
over distributions............................................ 68 (114) 47 (79)
Equity in (income) loss of other investee companies, net
of distributions.............................................. 63 17 (1) -
Changes in operating assets and liabilities........................ (186) (166) 5 5
----- ----- ----- -----
Cash provided by operations........................................ 382 176 169 53
----- ----- ----- -----
INVESTING ACTIVITIES
Investments and acquisitions....................................... (26) (54) - -
Capital expenditures............................................... (73) (78) - -
Investment proceeds................................................ 125 108 - -
Proceeds received from distribution of Senior Capital
contributed to TWE............................................ 270 270 185 185
----- ---- --- ---
Cash provided by investing activities.............................. 296 246 185 185
----- ----- ----- -----
FINANCING ACTIVITIES
Dividends.......................................................... (477) (344) 324) (235)
Increase in amounts due from TW Companies, net..................... (107) (5) (30) (3)
----- ----- ----- -----
Cash used by financing activities.................................. (584) (349) (354) (238)
----- ----- ----- -----
INCREASE IN CASH AND EQUIVALENTS................................... 94 73 - -
CASH AND EQUIVALENTS AT BEGINNING OF PERIOD........................ 102 91 - -
----- ----- ----- -----
CASH AND EQUIVALENTS AT END OF PERIOD.............................. $ 196 $ 164 $ - $ -
===== ===== ====== =====
See accompanying notes.
<PAGE>
TWE GENERAL PARTNERS
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Nine Months Ended September 30,
(Unaudited)
WCI ATC
----------------- -----------------
1998 1997 1998 1997
---- ---- ---- ----
(millions)
BALANCE AT BEGINNING OF YEAR....................................... $8,521 $9,541 $2,087 $2,331
Net income......................................................... 185 172 118 127
Increase (decrease) in unrealized gains on securities, net of $7
million and $(1) million tax benefit (expense) in 1997.......... (1) (10) (1) 2
Foreign currency translation adjustments........................... (12) (38) (7) (11)
Increase in realized and unrealized losses on derivative financial
instruments, net of $3 million tax benefit...................... (4) - - -
------ ----- ----- -----
Comprehensive income (loss)(a)..................................... 168 124 110 118
Increase in stock option distribution liability to
TW Companies(b)................................................. (286) (210) (196) (144)
Dividends.......................................................... (349) (319) (235) (218)
Transfers to TW Companies, net..................................... (107) (5) (30) (3)
Other.............................................................. 5 - (1) (1)
------ ------ ------ ------
BALANCE AT SEPTEMBER 30,........................................... $7,952 $9,131 $1,735 $2,083
====== ====== ====== ======
- ------------------
(a)Comprehensive income (loss) for the three months ended September 30, 1998 and
1997 was $68 million and $(4) million, respectively, for WCI and $43 million
and $22 million, respectively, for ATC.
(b)The General Partners record distributions to TW Companies and a corresponding
receivable from TWE as a result of the stock option related distribution
provisions of the TWE partnership agreement. Stock option distributions of
$286 million and $210 million for WCI and $196 million and $144 million for
ATC were accrued in the first nine months of 1998 and 1997, respectively,
because of an increase in the market price of Time Warner common stock (Note
2).
</TABLE>
See accompanying notes.
<PAGE>
TWE GENERAL PARTNERS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION
Description of Business
On June 30, 1992, thirteen direct or indirect subsidiaries of Time
Warner Companies, Inc. ("TW Companies") contributed the assets and liabilities
or the rights to the cash flows of substantially all of TW Companies's Filmed
Entertainment-Warner Bros., Cable Networks-HBO and Cable businesses to Time
Warner Entertainment Company, L.P., a Delaware limited partnership ("TWE"), for
general partnership interests, and each general partner guaranteed a pro rata
portion of substantially all of TWE's debt and accrued interest at that time
based on the relative fair value of the net assets each contributed to TWE (the
"General Partner Guarantees," see Note 3). In 1997, two of the original general
partners, Warner Cable Communications Inc. ("WCCI") and Time Warner Operations
Inc. ("TWOI"), were merged into another original general partner, Warner
Communications Inc. (the "WCCI Merger" and the "TWOI Merger," respectively, and
collectively, the "1997 General Partner Mergers"). After the 1997 General
Partner Mergers, eleven of the thirteen original general partners have now been
merged or dissolved into the other two. Warner Communications Inc. ("WCI") and
American Television and Communications Corporation ("ATC") are the two remaining
general partners of TWE. They have succeeded to the general partnership
interests and have assumed the General Partner Guarantees of the eleven former
general partners. WCI, ATC and, where appropriate, the former general partners
are referred to herein as the "General Partners."
The WCCI Merger had no effect on the consolidated financial statements
of WCI because WCCI was a consolidated subsidiary of WCI prior to the merger
and, as such, WCCI's net assets, operating results and cash flows were already
included in the consolidated financial statements of WCI. The TWOI Merger has
been accounted for as a merger of entities under common control, similar to the
pooling-of-interests method of accounting for business combinations.
Accordingly, the 1997 consolidated financial statements of WCI have been
restated to reflect the TWOI Merger effective as of January 1, 1997.
WCI conducts substantially all of TW Companies's Music operations,
which include copyrighted music from many of the world's leading recording
artists that is produced and distributed by a family of established record
labels such as Warner Bros. Records, Atlantic Records, Elektra Entertainment and
Warner Music International. ATC does not conduct operations independent of their
ownership interests in TWE and certain other investments.
Basis of Presentation
The accompanying financial statements are unaudited but, in the opinion
of management, contain all the adjustments (consisting of those of a normal
recurring nature) considered necessary to present fairly the financial position
and the results of operations and cash flows for the periods presented in
conformity with generally accepted accounting principles applicable to interim
periods. The accompanying financial statements should be read in conjunction
with the audited consolidated financial statements of the General Partners for
the year ended December 31, 1997. Certain reclassifications have been made to
the prior year's financial statements to conform to the 1998 presentation.
Effective July 1, 1998, WCI adopted Financial Accounting Standards
Board Statement No. 133, "Accounting for Derivative Instruments and Hedging
Activities" ("FAS 133"). FAS 133 requires that all derivative financial
instruments, such as foreign exchange contracts, be recognized in the financial
statements and measured at fair value regardless of the purpose or intent for
holding them. The adoption of FAS 133 did not have a material effect on WCI's
financial statements.
<PAGE>
2. TWE
The General Partners' investment in and amounts due to and from TWE at
September 30, 1998 and December 31, 1997 consists of the following:
<TABLE>
SEPTEMBER 30, 1998 WCI ATC
- ------------------ --- ---
(millions)
<S> <C> <C>
Investment in TWE........................................................................... $1,830 $1,287
Stock option related distributions due from TWE............................................. 404 278
Other net liabilities due to TWE, principally related to home video distribution............ (267) -
----- ------
Total....................................................................................... $1,967 $1,565
====== ======
DECEMBER 31, 1997 WCI ATC
- ----------------- --- ---
(millions)
Investment in TWE........................................................................... $2,418 $1,691
Stock option related distributions due from TWE............................................. 247 170
Other net liabilities due to TWE, principally related to home video distribution............ (242) -
----- -------
Total....................................................................................... $2,423 $1,861
====== ======
</TABLE>
Partnership Structure and Allocation of Income
TWE was capitalized on June 30, 1992 to own and operate substantially
all of the Filmed Entertainment-Warner Bros., Cable Networks-HBO and Cable
businesses previously owned by the General Partners. The General Partners in the
aggregate hold, directly or indirectly, 63.27% of the pro rata priority capital
("Series A Capital") and residual equity capital ("Residual Capital") of TWE and
100% of the senior priority capital ("Senior Capital") and junior priority
capital ("Series B Capital") of TWE. TW Companies acquired the 11.22% of the
Series A Capital and Residual Capital limited partnership interests previously
held by subsidiaries of each of ITOCHU Corporation and Toshiba Corporation in
1995. The remaining 25.51% limited partnership interests in the Series A Capital
and Residual Capital of TWE are held by a subsidiary of MediaOne Group, Inc.
("MediaOne"), formerly U S WEST, Inc.
The TWE partnership agreement provides for special allocations of
income, loss and distributions of partnership capital, including priority
distributions in the event of liquidation. No portion of TWE's net income has
been allocated to the limited partnership interests.
Summarized Financial Information of TWE
Set forth below is summarized financial information of TWE, which
reflects the TWE-A/N Transfers effective as of January 1, 1998, the Primestar
Roll-up Transaction effective as of April 1, 1998, the formation of the Road
Runner Joint Venture effective as of June 30, 1998 and the Business Telephony
Reorganization effective as of July 1, 1998 (each as defined hereinafter).
<PAGE>
<TABLE>
Three Months Nine Months
Ended September 30, Ended September 30,
------------------- -------------------
1998 1997 1998 1997
---- ---- ---- ----
(millions)
<S> <C> <C> <C> <C>
Operating Statement Information
Revenues........................................................... $3,220 $2,855 $8,980 $8,183
Depreciation and amortization...................................... (358) (361) (1,085) (1,013)
Business segment operating income (1).............................. 468 335 1,292 984
Interest and other, net (2)........................................ (203) (145) (550) (155)
Minority interest.................................................. (52) (64) (198) (228)
Income before income taxes......................................... 195 108 490 547
Net income......................................................... 172 81 435 483
- ------------------
(1) Includes net pretax gains recognized in connection with the sale or
exchange of certain cable television systems of approximately $6 million
and $16 million for the three months ended September 30, 1998 and 1997,
respectively, and approximately $90 million and $40 million for the nine
months ended September 30, 1998 and 1997, respectively.
(2) Includes a pretax gain of approximately $250 million recognized in the
first quarter of 1997 related to the sale of an interest in
E! Entertainment Television, Inc.
Nine Months
Ended September 30,
------------------
1998 1997
---- ----
(millions)
Cash Flow Information
Cash provided by operations................................................................. $1,273 $ 918
Capital expenditures........................................................................ (1,092) (1,117)
Investments and acquisitions................................................................ (335) (104)
Investment proceeds......................................................................... 540 444
Borrowings.................................................................................. 1,515 905
Debt repayments............................................................................. (840) (323)
Issuance of preferred stock of subsidiary................................................... - 243
Capital distributions....................................................................... (1,060) (809)
Other financing activities, net............................................................. (198) (77)
Increase (decrease) in cash and equivalents................................................. (197) 80
September 30, December 31,
1998 1997
---- ----
(millions)
Balance Sheet Information
Cash and equivalents.................................................................... $ 125 $ 322
Total current assets.................................................................... 4,046 3,622
Total assets............................................................................ 22,407 20,731
Total current liabilities............................................................... 4,305 3,974
Long-term debt ......................................................................... 7,435 5,990
Minority interests...................................................................... 1,440 1,210
Preferred stock of subsidiary........................................................... 221 233
General Partners' Senior Capital........................................................ 591 1,118
Partners' capital....................................................................... 5,756 6,333
</TABLE>
Capital Distributions
The assets and cash flows of TWE are restricted by the TWE partnership
and credit agreements and are unavailable for use by the partners except through
the payment of certain fees, reimbursements, cash distributions and loans, which
are subject to limitations. At September 30, 1998 and December 31, 1997, the
General Partners had recorded $682 million and $417 million, respectively, of
stock option related distributions due from TWE, based on closing prices of Time
Warner common stock of $87.56 and $62.00, respectively. The General Partners are
paid when the options are exercised. The General Partners also receive
tax-related distributions from TWE on a current basis. During the nine months
ended September 30, 1998, the General Partners received cash distributions from
TWE in the amount of $1.060 billion, consisting of $579 million of Senior
Capital distributions (representing the return of $455 million of contributed
capital and the distribution of $124 million of priority capital return), $264
million of tax-related distributions and $217 million of stock option related
distributions. During the nine months ended September 30, 1997, the General
Partners received cash distributions from TWE in the amount of $809 million,
consisting of $535 million of Senior Capital distributions (representing the
return of $455 million of contributed capital and the distribution of $80
million of priority capital return), $232 million of tax-related distributions
and $42 million of stock option related distributions. Of such aggregate
distributions in 1998 and 1997, WCI received $628 million and $480 million,
respectively and ATC received $432 million and $329 million, respectively.
In addition, in connection with the Business Telephony Reorganization,
TWE recorded a $193 million noncash distribution to its partners, of which WCI
and ATC received an interest in TW Telecom valued at $72 million and $50
million, respectively, based on TWE's historical cost of the net assets.
Acquisitions and Dispositions
Time Warner, TWE and the TWE-Advance/Newhouse Partnership ("TWE-A/N")
have completed a series of transactions in 1998 relating to the cable television
business and related ancillary businesses, as well as the theme park business.
These transactions are summarized below. For a more comprehensive description of
these transactions, see Note 2 to the accompanying TWE consolidated financial
statements.
Business Telephony Reorganization
In July 1998, Time Warner, TWE and TWE-A/N completed a reorganization
of their business telephony operations (the "Business Telephony Reorganization")
by combining such operations into a single entity that is intended to be
self-financing. This entity, named Time Warner Telecom LLC ("TW Telecom"), is a
competitive local exchange carrier (CLEC) in selected metropolitan areas across
the United States where it offers a wide range of telephony services to business
customers. Subsidiaries of Time Warner (including WCI and ATC), MediaOne and the
Advance/Newhouse Partnership ("Advance/Newhouse"), a limited partner in TWE-A/N,
own interests in TW Telecom of 61.95%, 18.88% and 19.17%, respectively. Of Time
Warner's 61.95% interest in TW Telecom, WCI and ATC directly own interests of
27.76% and 19.08%, respectively. As a result of the Business Telephony
Reorganization, TWE and TWE-A/N do not have continuing equity interests in these
business telephony operations.
Road Runner Joint Venture
In June 1998, Time Warner, TWE, TWE-A/N, MediaOne, Microsoft Corp.
("Microsoft") and Compaq Computer Corp. ("Compaq") formed a joint venture to
operate and expand Time Warner Cable's and MediaOne's existing high-speed
Internet access businesses (the "Road Runner Joint Venture"). In exchange for
contributing their existing high-speed Internet access businesses, Time Warner
received an 11.25% common equity interest in the Road Runner Joint Venture, TWE
received a 25% interest, TWE-A/N received a 32.5% interest and MediaOne received
a 31.25% interest. In exchange for Microsoft and Compaq each contributing $212.5
million of cash to the Road Runner Joint Venture, Microsoft and Compaq each
received a preferred equity interest therein that is convertible into a 10%
common equity interest. Accordingly, on a fully diluted basis, the Road Runner
Joint Venture is owned 9% by Time Warner, 20% by TWE, 26% by TWE-A/N, 25% by
MediaOne, 10% by Microsoft and 10% by Compaq. As a result of this transaction,
effective as of June 30, 1998, TWE and TWE-A/N deconsolidated their high-speed
Internet access operations and each of TWE's and TWE-A/N's interest in the Road
Runner Joint Venture is being accounted for under the equity method of
accounting.
Primestar Roll-up Transaction
In April 1998, TWE and Advance/Newhouse transferred the direct
broadcast satellite operations conducted by TWE and TWE-A/N (the "DBS
Operations") and the 31% partnership interest in Primestar Partners, L.P. held
by TWE-A/N ("Primestar" and collectively, the "Primestar Assets") to Primestar,
Inc. ("New Primestar"), a separate holding company. New Primestar owns the DBS
Operations and Primestar partnership interests formerly owned by TCI Satellite
Entertainment, Inc. and other previously existing partners of Primestar. In
exchange for contributing its interests in the Primestar Assets, TWE received
approximately 48 million shares of common stock of New Primestar (representing
an approximate 24% equity interest) and realized approximately $240 million of
debt reduction. TWE deconsolidated the DBS Operations effective as of April 1,
1998 and the equity interest in New Primestar received in this transaction is
being accounted for under the equity method of accounting.
In a related transaction, Primestar also entered into an agreement in
June 1997 with The News Corporation Limited ("News Corp."), MCI WorldCom, Inc.
("MCI") and American Sky Broadcasting LLC ("ASkyB"), pursuant to which New
Primestar would acquire certain assets relating to the high-power, direct
broadcast satellite business of ASkyB (the "Primestar ASkyB Transaction"). In
May 1998, the U.S. Department of Justice brought a civil action against
Primestar, each of its cable owners, including TWE, and News Corp. and MCI, to
enjoin on antitrust grounds the Primestar ASkyB Transaction. Although the
parties had discussions with the U.S. Department of Justice in an attempt to
restructure the transaction, no resolution was reached and the parties
terminated their agreement in October 1998.
TWE-A/N Transfers
In early 1998, TW Companies (through a wholly owned subsidiary)
contributed cable television systems (or interests therein) serving
approximately 650,000 subscribers to TWE-A/N, subject to approximately $1
billion of debt, in exchange for common and preferred partnership interests
therein, and completed certain related transactions (collectively the "TWE-A/N
Transfers"). The debt assumed by TWE-A/N has not been guaranteed by the General
Partners, but has been guaranteed by TWI Cable Inc., a wholly owned subsidiary
of TW Companies, and certain of its subsidiaries.
Six Flags
In April 1998, TWE sold its remaining 49% interest in Six Flags
Entertainment Corporation ("Six Flags") to Premier Parks Inc., a regional theme
park operator, for approximately $475 million of cash. TWE used the net,
after-tax proceeds from this transaction to reduce debt by approximately $300
million. A substantial portion of the gain on this transaction has been deferred
principally as a result of TWE's continuing guarantees of certain significant
long-term obligations of Six Flags relating to the Six Flags Over Texas and Six
Flags Over Georgia theme parks.
3. GENERAL PARTNER GUARANTEES
Each General Partner has guaranteed a pro rata portion of approximately
$6.4 billion of TWE's debt and accrued interest at September 30, 1998, based on
the relative fair value of the net assets each General Partner (or its
predecessor) contributed to TWE. Such indebtedness is recourse to each General
Partner only to the extent of its guarantee. There are no restrictions on the
ability of the General Partner guarantors to transfer assets, other than TWE
assets, to parties that are not guarantors.
The portion of TWE debt and accrued interest at September 30, 1998
that was guaranteed by each General Partner is set forth below:
<TABLE>
Total Guaranteed by
Each General Partner
--------------------
GENERAL PARTNER % Amount
- --------------- - ------
(dollars in millions)
<S> <C> <C>
WCI ........................................................................... 59.27 $3,809
ATC ........................................................................... 40.73 2,618
------ ------
Total........................................................................... 100.00 $6,427
====== ======
</TABLE>
4. DERIVATIVE FINANCIAL INSTRUMENTS
Derivative financial instruments are used principally to manage the
risk that changes in exchange rates will affect the amount of unremitted or
future royalties to be received by WCI domestic companies from the sale of U.S.
copyrighted products abroad. The following is a summary of WCI's risk management
strategy and the effect of this strategy on WCI's consolidated financial
statements.
Foreign Currency Risk Management
Foreign exchange contracts are used primarily by Time Warner to hedge
the risk that unremitted or future royalties owed to WCI domestic companies for
the sale or anticipated sale of U.S. copyrighted products abroad may be
adversely affected by changes in foreign currency exchange rates. As part of its
overall strategy to manage the level of exposure to the risk of foreign currency
exchange rate fluctuations, Time Warner hedges a portion of its, TWE's and WCI's
combined foreign currency exposures anticipated over the ensuing twelve month
period. At September 30, 1998, Time Warner had effectively hedged approximately
half of WCI's total estimated foreign currency exposures that principally relate
to anticipated cash flows to be remitted to the U.S. over the ensuing twelve
month period, using foreign exchange contracts that generally have maturities of
three months or less, which generally are rolled over to provide continuing
coverage throughout the year. Time Warner often closes foreign exchange sale
contracts by purchasing an offsetting purchase contract. Time Warner reimburses
or is reimbursed by WCI for Time Warner contract gains and losses related to
WCI's foreign currency exposure. Foreign exchange contracts are placed with a
number of major financial institutions in order to minimize credit risk.
WCI records these foreign exchange contracts at fair value in its
consolidated balance sheet and the related gains or losses on these contracts
are deferred in shareholders' equity (as a component of comprehensive income).
These deferred gains and losses are recognized in income in the period in which
the related royalties being hedged are received and recognized in income.
However, to the extent that any of these contracts are not considered to be
perfectly effective in offsetting the change in the value of the royalties being
hedged, any changes in fair value relating to the ineffective portion of these
contracts are immediately recognized in income. Gains and losses on foreign
exchange contracts are generally included as a component of interest and other,
net, in WCI's consolidated statement of operations.
At September 30, 1998, WCI had contracts for the sale of $475 million and
the purchase of $255 million of foreign currencies at fixed rates, primarily
German marks (60% of contract value) and French francs (21%), compared to
contracts for the sale of $380 million and the purchase of $139 million of
foreign currencies at December 31, 1997. WCI had deferred approximately $4
million of net losses on foreign exchange contracts at September 30, 1998, which
is all expected to be recognized in income over the next twelve months.
5. CONTINGENCIES
Pending legal proceedings are substantially limited to litigation
incidental to the businesses of the General Partners. In the opinion of
management, the ultimate resolution of these matters will not have a material
effect on the consolidated financial statements of the General Partners.
6. ADDITIONAL FINANCIAL INFORMATION
Additional financial information with respect to cash flows is as
follows:
<TABLE>
Nine Months Ended September 30,
-------------------------------
1998 1997
---- ----
WCI ATC WCI ATC
--- --- --- ---
(millions)
<S> <C> <C> <C> <C>
Cash payments made for interest.......................................... $ 7 $ - $ 10 $ -
Cash payments made for income taxes, net................................. 174 77 254 90
Tax-related distributions received from TWE.............................. 156 108 138 94
Noncash capital distributions, net....................................... 286 196 210 144
Noncash investing activities in the first nine months of 1998 included
the Business Telephony Reorganization (Note 2).
</TABLE>
<PAGE>
Part II. Other Information
Item 1. Legal Proceedings.
Reference is made to the litigation entitled Six Flags Over Georgia,
Inc., et al. v. Six Flags Fund, Ltd., et al. commenced in Superior Court in
Gwinnett County, Georgia in connection with the management of the Six Flags Over
Georgia Theme Park described on pages I-28 and I-29 of TWE's Annual Report on
Form 10-K (the "1997 Form 10-K") for the year ended December 31, 1997. TWE and
its former 51% partner in Six Flags retained financial responsibility for this
litigation following completion of the sale of Six Flags. Discovery has now
concluded, although a number of motions relating to discovery and
discovery-related practices are still pending. Plaintiffs in the action moved on
October 22, 1998 to amend their complaint so as to drop their claim for fraud
and to modify their claim for breach of contract. Trial on the remaining claims
seeking damages in excess of $250 million is scheduled to commence November 16,
1998.
Reference is made to the civil action brought by the U.S. Department of
Justice in the United States District Court for the District of Columbia against
Primestar, Inc. ("Primestar") to enjoin on antitrust grounds Primestar's
proposed acquisition of certain assets described on page 38 of TWE's Quarterly
Report on Form 10-Q for the quarter ended June 30, 1998 (the "June 30, 1998 Form
10-Q"). Abandonment of the proposed acquisition was announced on October 15,
1998 and it is expected that such abandonment will moot the litigation.
Reference is made to the litigation entitled Coppola v. Warner Bros.
described on page 38 of the June 30, 1998 Form 10-Q. On October 15, 1998, the
Court vacated the jury award against Warner Bros. for $60 million in punitive
damages but affirmed the award of $20 million in compensatory damages and denied
Warner Bros.' motion for a new trial. Both sides have stated they will appeal
the Court's ruling.
Reference is made to the litigation entitled Samuel D. Moore, et al. v.
American Federation of Television and Radio Artists, et al., described on page
I-27 of the 1997 Form 10-K and on page 38 of the June 30, 1998 Form 10-Q. By
Order dated October 6, 1998, the 11th Circuit Court of Appeals has accepted
interlocutory review of the District Court's Order dated June 22, 1998, denying
class certification. This appeal will now proceed to briefing and argument.
Item 6. Exhibits and Reports on Form 8-K.
(a)......EXHIBITS.
The exhibits listed on the accompanying Exhibit Index are
filed or incorporated by reference as a part of this report and such Exhibit
Index is incorporated herein by reference.
(b) ....REPORTS ON FORM 8-K.
No Current Report on Form 8-K was filed by TWE during the
quarter ended September 30, 1998.
<PAGE>
TIME WARNER ENTERTAINMENT COMPANY, L.P.
AND TWE GENERAL PARTNERS
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, each
of the registrants has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Time Warner Entertainment Company, L.P.
By: Warner Communications Inc.,
as General Partner
By: /s/ Richard J. Bressler
Name: Richard J. Bressler
Title: Executive Vice President and
Chief Financial Officer
American Television and Communications Corporation
Warner Communications Inc.
By: /s/ Richard J. Bressler
Name: Richard J. Bressler
Title: Executive Vice President and
Chief Financial Officer
Dated: November 12, 1998
<PAGE>
EXHIBIT INDEX
PURSUANT TO ITEM 601 OF REGULATIONS S-K
EXHIBIT NO........DESCRIPTION OF EXHIBIT
27 Financial Data Schedule.
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
financial statements of Time Warner Entertainment Company, L.P. for the nine
months ended September 30, 1998 and is qualified in its entirety by reference to
such financial statements.
</LEGEND>
<CIK> 0000893657
<NAME> TIME WARNER ENTERTAINMENT COMPANY, L.P.
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 125
<SECURITIES> 0
<RECEIVABLES> 2,845
<ALLOWANCES> 407
<INVENTORY> 3,591
<CURRENT-ASSETS> 4,046
<PP&E> 10,315
<DEPRECIATION> 4,265
<TOTAL-ASSETS> 22,407
<CURRENT-LIABILITIES> 4,305
<BONDS> 7,435
<COMMON> 0
591
0
<OTHER-SE> 5,756
<TOTAL-LIABILITY-AND-EQUITY> 22,407
<SALES> 8,980
<TOTAL-REVENUES> 8,980
<CGS> 5,927
<TOTAL-COSTS> 5,927
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 418
<INCOME-PRETAX> 490
<INCOME-TAX> 55
<INCOME-CONTINUING> 435
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 435
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
