<PAGE>   1
 
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                            ------------------------
 
                                   FORM 10-K
                ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
                      THE SECURITIES EXCHANGE ACT OF 1934
 
                  FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998.
                         COMMISSION FILE NUMBER 1-12259
                            ------------------------
 
                                TIME WARNER INC.
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
                            ------------------------
 
<TABLE>
<S>                                            <C>
                   DELAWARE                                      13-3527249
       (STATE OR OTHER JURISDICTION OF                        (I.R.S. EMPLOYER
        INCORPORATION OR ORGANIZATION)                      IDENTIFICATION NO.)
 
     75 ROCKEFELLER PLAZA, NEW YORK, N.Y.                          10019
   (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)                      (ZIP CODE)
</TABLE>
 
                            ------------------------
 
       REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (212) 484-8000
                            ------------------------
 
          SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
 
<TABLE>
<CAPTION>
                                                               NAME OF EACH EXCHANGE
                    TITLE OF EACH CLASS                         ON WHICH REGISTERED
                    -------------------                        ---------------------
<S>                                                           <C>
COMMON STOCK, $.01 PAR VALUE                                  NEW YORK STOCK EXCHANGE
RIGHTS TO PURCHASE SERIES A PARTICIPATING CUMULATIVE          NEW YORK STOCK EXCHANGE
PREFERRED STOCK
</TABLE>
 
          SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
                                      NONE
 
     Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months, and (2) has been subject to such filing
requirements for the past 90 days.  Yes [X]  No [ ]
 
     Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.  [ ]
 
     As of March 15, 1999, there were 1,133,899,660 shares of registrant's
Common Stock and 57,061,942 shares of registrant's Series LMCN-V Common Stock
outstanding. The aggregate market value of the registrant's voting securities
held by non-affiliates of the registrant (based upon the closing price of such
shares on the New York Stock Exchange Composite Tape on March 15, 1999) was
approximately $70.65 billion.
 
                      DOCUMENTS INCORPORATED BY REFERENCE:
 
<TABLE>
<CAPTION>
           DESCRIPTION OF DOCUMENT                         PART OF THE FORM 10-K
           -----------------------                         ---------------------
<S>                                            <C>
Portions of the Definitive Proxy Statement to        Part III (Item 10 through Item 13)
 be used in connection with the registrant's
     1999 Annual Meeting of Stockholders.
</TABLE>
 
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
<PAGE>   2

                                Time Warner Inc.
                          Corporate Organization Chart


Included in the Form 10-K for Time Warner Inc. is a chart illustrating Time
Warner Inc.'s corporate organization, providing the following information:

Time Warner Inc. owns 100% of Turner Broadcasting System, Inc. and Time
Warner Companies, Inc.

Turner Broadcasting System, Inc. owns 100% of Cable Networks-TBS and Filmed
Entertainment-TBS.

Time Warner Companies, Inc. owns 100% of the Publishing division, TWI Cable
and the Time Warner General and Limited Partners.(1)

Time Warner General and Limited Partners own 100% of the Music division and
74.49% of Time Warner Entertainment Company, L.P. ("TWE"). TWE is also
25.51%-owned by MediaOne Limited Partner.(2)

TWE owns 100% of Time Warner Cable, Cable Networks - HBO and Filmed
Entertainment-Warner Bros., and 64.8% of the TWE - A/N Partnership (Cable). The
TWE - A/N Partnership is also 1.9%-owned by TWI Cable and 33-1/3% - owned by
Advance/Newhouse.(3)

----------
(1)   Time Warner Companies, Inc. directly or indirectly owns 100% of the
      capital stock of each of the Time Warner General and Limited Partners.

(2)   Pro rata priority capital and residual equity interests. In addition, the
      Time Warner General Partners own 100% of the priority capital interests
      senior and junior to the pro rata priority capital interests. (See Note 4
      to the Company's consolidated statements.)

(3)   Direct or indirect common equity interests. In addition, TWI Cable
      indirectly owns preferred partnership interests.
<PAGE>   3
 
                                     PART 1
 
ITEM 1.  BUSINESS
 
     Time Warner Inc. (the "Company"), together with its consolidated and
unconsolidated subsidiaries, is the world's leading media and entertainment
company. The Company classifies its business interests into four fundamental
areas:
 
     - CABLE NETWORKS, consisting principally of interests in cable television
       programming;
 
     - PUBLISHING, consisting principally of interests in magazine publishing,
       book publishing and direct marketing;
 
     - ENTERTAINMENT, consisting principally of interests in filmed
       entertainment, television production, television broadcasting, recorded
       music and music publishing; and
 
     - CABLE, consisting principally of interests in cable television systems.
 
     The Company is a holding company that derives its operating income and cash
flow from its investments in its subsidiaries.
 
     In October 1996, the Company completed the merger of Turner Broadcasting
System, Inc. ("TBS") thereby acquiring the remaining approximately 80% interest
in TBS that the Company did not already own (the "TBS Transaction"). As a result
of the TBS Transaction, a new parent company with the name "Time Warner Inc."
replaced the old parent company of the same name and the old parent company,
which changed its name to Time Warner Companies, Inc. ("TWCI"), and TBS became
separate, wholly owned subsidiaries of the new parent company. Information on
the TBS Transaction is set forth in Note 3, "TBS Transaction," to the Company's
consolidated financial statements, at pages F-38 and F-39 herein. The assets of
TWCI consist primarily of investments in its consolidated and unconsolidated
subsidiaries, including Time Warner Entertainment Company, L.P. ("TWE"). For
convenience, the terms the "Registrant," "Company" and "Time Warner" are used in
this report to refer to both the old and new parent company and collectively to
the parent company and the subsidiaries through which its various businesses are
conducted, unless the context otherwise requires.
 
TWE
 
     TWE is a Delaware limited partnership that was formed in 1992 to own and
operate substantially all of the business of Warner Bros., Home Box Office and
the cable television businesses owned and operated by the Company prior to such
date. Currently, the Company, through its wholly owned subsidiaries, owns
general and limited partnership interests in 74.49% of the pro rata priority
capital ("Series A Capital") and residual equity capital ("Residual Capital") of
TWE and 100% of the senior priority capital and junior priority capital of TWE.
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"). The Company does not consolidate TWE and certain related companies
(the "Entertainment Group") for financial reporting purposes. Two Time Warner
subsidiaries are the general partners of TWE. See also "Description of Certain
Provisions of the TWE Partnership Agreement" for additional information about
the organization of TWE.
 
     In 1995, TWE formed a cable television joint venture with the
Advance/Newhouse Partnership ("Advance/Newhouse") known as TWE-A/N. As of
December 31, 1998, TWE-A/N owned cable television systems (or interests) serving
6.3 million subscribers. TWE is the managing partner of TWE-A/N, which is owned
64.8% by TWE, 33.3% by Advance/Newhouse and 1.9% by TWI Cable Inc. For
information about certain transactions affecting TWE-A/N during 1998, see Note
2, "Cable Transactions," to the Company's consolidated financial statements on
pages F-35 through F-38 herein.
 
RECENT EVENTS
 
     On February 1, 1999, the Company announced that it intended to form a joint
venture with AT&T Corp. ("AT&T") pursuant to which the joint venture will have
the right for up to a 20-year term to offer AT&T-
                                       I-1
<PAGE>   4
 
branded cable telephone service to residential and small business customers over
Time Warner Cable's existing cable network. Under the preliminary terms
announced by the parties, the joint venture will be 77.5% owned by AT&T and
22.5% owned by TWE, TWE-A/N and TWI Cable, Inc., collectively. The joint venture
is expected to make payments to Time Warner Cable initially based on the number
of homes included in the cable network that have been upgraded to fiber optic
capacity and will pay a monthly fee during the term per telephony subscriber,
subject to guaranteed minimums, and is expected to make future revenue sharing
payments if the joint venture surpasses targeted monthly subscriber revenue
levels. The joint venture is also expected to purchase telephony equipment and
fund Time Warner Cable's expenses of installing and maintaining such equipment.
It is expected that AT&T will fund all of the joint venture's negative cash
flow. See also "Management's Discussion and Analysis of Results of Operations
and Financial Condition -- Cable Strategy" at pages F-16 through F-18 herein.
 
     The joint venture is subject to the negotiation and execution of definitive
agreements, approval of the final terms by MediaOne and Advance/Newhouse and
certain regulatory and other approvals. No assurances can be given that such
agreements and approvals will be completed or obtained.
 
CAUTION CONCERNING FORWARD-LOOKING STATEMENTS
 
     This Annual Report on Form 10-K includes certain "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995. These statements are based on management's current expectations and are
naturally subject to uncertainty and changes in circumstances. Actual results
may vary materially from the expectations contained herein due to changes in
economic, business, competitive, technological and/or regulatory factors. More
detailed information about those factors is set forth on pages F-22 and F-23 of
"Management's Discussion and Analysis of Results of Operations and Financial
Condition." Time Warner is under no obligation to (and expressly disclaims any
such obligation to) update or alter its forward-looking statements whether as a
result of new information, future events or otherwise.
 
                                       I-2
<PAGE>   5
 
                                 CABLE NETWORKS
 
     The Company's Cable Networks business consists principally of domestic and
international basic cable networks and pay television programming services and
the operation of World Championship Wrestling and sports franchises. TBS's
networks (collectively, the "Turner Networks") constitute the principal
component of the Company's basic cable networks: Cable News Network ("CNN"), CNN
International, Headline News, CNN Financial News Network ("CNNfn"), TBS
Superstation, Turner Network Television ("TNT"), Turner Classic Movies, Cartoon
Network, CNN/Sports Illustrated and CNN en Espanol, all operated by TBS, which
is wholly owned by the Company. TBS also operates several large advertiser-
supported online sites, including the CNN family of Internet sites. Pay
television programming consists of the multichannel HBO and Cinemax pay
television programming services (collectively, the "Home Box Office Services"),
operated by the Home Box Office division of TWE ("Home Box Office").
 
GENERAL
 
     The Company, through TBS, is the leading supplier of programming for the
basic cable industry in the United States. The Turner Networks provide a wide
variety of movies, sports, general entertainment, all-news and all-sports news
programming. Through TWE's Home Box Office division, the Company distributes
HBO, the leading domestic pay-TV service, as well as Cinemax. HBO and Cinemax
offer uncut, commercial-free motion pictures and high-quality documentaries. In
addition, HBO offers sporting and special entertainment events (such as concerts
and comedy shows), and feature motion pictures, mini-series and television
series produced specifically by or for HBO.
 
     The Turner Networks and the Home Box Office Services (collectively, the
"Networks") distribute their programming via cable and other distribution
technologies, including satellite distribution. A separate distribution
subsidiary handles the sales and marketing of all of TBS's domestic basic cable
networks to cable, satellite master antenna television ("SMATV") and
multichannel MDS ("MMDS") systems and direct-to-home satellite ("DTH")
distribution companies in the United States. The Networks generally enter into
separate multi-year agreements, known as affiliation agreements, with operators
of cable television systems, SMATV, MMDS and DTH distribution companies that
have agreed to carry such Networks. With the proliferation of new cable networks
and services, competition for cable carriage on the limited available channel
capacity has intensified.
 
     The programming produced for the Company's Networks is generally
transmitted via C-band or Ku-band communications satellites from an uplinking
terminus and received on receivers located at local operations centers for each
affiliated cable company, or on home satellite dish receivers. Individual dish
owners wishing to receive programming from one of the satellite distribution
companies must purchase a consumer decoder from a local source and arrange for
its activation.
 
     The Turner Networks (other than Turner Classic Movies, which is commercial
free) generate their revenue principally from the sale of advertising time and
from receipt of monthly per subscriber fees paid by cable system operators, DTH
distribution companies, hotels and other customers (known as affiliates) that
have contracted to receive and distribute such networks. The Home Box Office
Services and Turner Classic Movies, being commercial free, generate their
revenue principally from the monthly fees paid by affiliates, which are
generally charged on a per subscriber basis. Individual subscribers to the Home
Box Office Services are generally billed monthly by their local cable company or
DTH packager for each service purchased and are free to cancel a service at any
time.
 
     As a result of acquisitions and mergers in the cable television industry in
recent years, the percentage of the Networks' revenue from affiliates that are
large DTH distribution companies or multiple system cable operators, such as
Tele-Communications, Inc., a subsidiary of AT&T ("TCI") or Time Warner Cable,
has increased. The Networks attempt to assure continuity in their relationships
with affiliates and have entered into multi-year contracts with affiliates,
whenever possible. Although TBS and Home Box Office believe the prospects of
continued carriage and marketing of their respective Networks by the larger
affiliates are good, the loss of one or more of them as distributors of any
individual network or service could have a material adverse effect on their
respective businesses.
                                       I-3
<PAGE>   6
 
     Advertising revenue on basic cable networks is a function of the number of
advertising spots sold, the "CPM," which is the average cost per thousand homes
charged for such advertising, and market conditions. The CPM applicable to each
network program varies depending upon its ratings (which measure the numbers of
viewers delivered), the type of program and its time slot, which latter factors
influence the demographics of such viewers, which are important to an
advertiser. To evaluate the level of its viewing audiences, TBS utilizes the
metered method of audience measurement as provided by A.C. Nielsen. Cable
networks which have not achieved widespread cable system distribution are not
able to achieve significant viewing levels and, as a result, do not command a
high CPM for their advertising time.
 
                                TURNER NETWORKS
 
DOMESTIC NETWORKS
 
     Effective at year-end 1997, TBS Superstation converted to a copyright-paid
cable network from an independent UHF television station whose signal was
retransmitted by a third party common carrier via satellite. The network, while
still transmitted over-the-air in the Atlanta market, is now retransmitted by
TBS and delivered via satellite to cable systems in all 50 states, Puerto Rico
and the Virgin Islands, and has approximately 76 million subscribers. Its
programming includes movies, sports, original productions and classic television
comedies. As a broadcast television station, TBS Superstation relied principally
on advertising revenue and received no direct compensation for its signal from
cable systems. As a cable network, TBS Superstation also receives subscription
revenue directly from cable and other distribution systems that carry the
service.
 
     Other entertainment networks produced and distributed by TBS are TNT, which
as of December 31, 1998 had approximately 75 million subscribers in the United
States; Cartoon Network, with approximately 55 million subscribers in the United
States; and Turner Classic Movies, a 24-hour, commercial-free network which
presents classic films from TBS's MGM, RKO and pre-1950 Warner Bros. film
libraries and which has approximately 31 million subscribers. Programming for
these entertainment networks is derived, in part, from the Company's film,
made-for-television and animation libraries as to which TBS or other divisions
of the Company own the copyrights, licensed programming, including sports, and
original productions. In February, TBS announced that it will launch a new
regional entertainment network, Turner South, in the fall of 1999. Targeting the
Southeast, Turner South will feature movies and sitcoms from the Turner library
and original regional programming such as performance shows, regional news and
sports.
 
     TBS has acquired programming rights from the National Basketball
Association (the "NBA") to televise a certain number of regular season and
playoff games on TBS Superstation and TNT through the 2001-02 season for which
it has agreed to pay fees plus a share of the advertising revenues generated in
excess of specified amounts. TBS Superstation also televises a certain number of
baseball games of the Atlanta Braves, a major league baseball club owned by a
subsidiary of TBS, for which rights fee payments are paid to Major League
Baseball's central fund for distribution to all Major League Baseball clubs.
 
     CNN is a 24-hour per day cable television news service which has more than
75 million subscribers. Together with CNN International, which is distributed
outside the United States, CNN reaches more than 200 million homes in 212
countries and territories as of December 31, 1998. In addition to Headline News,
which provides updated half-hour newscasts throughout each day, CNN has expanded
its brand franchise to include CNNfn, launched in December 1995, featuring
business and consumer news; and CNN/Sports Illustrated, a venture with Sports
Illustrated, a Time Warner publication, which was launched in December 1996,
featuring sports news and features. The Company has also expanded into a number
of special market networks.
 
     CNN owns and operates 34 permanent news bureaus, of which ten are in the
United States and 24 are located around the world. In addition, a network of
satellite newsgathering trucks, portable satellite uplinks and a network of
approximately 600 domestic and 200 international broadcast television affiliates
on six continents permit CNN to report live from virtually anywhere in the
world. These affiliate arrangements, from
 
                                       I-4
<PAGE>   7
 
which CNN obtains substantial news coverage, are generally pursuant to contracts
having terms of one or more years.
 
INTERNATIONAL NETWORKS
 
     CNN International ("CNNI") is a television news service which is
distributed to multiple distribution platforms for delivery to cable systems,
broadcasters, hotels and other viewers around the world on a network of 16
regional satellites. In 1997, TBS launched CNN en Espanol, a Spanish language
all-news network in Latin America which, as of December 31, 1998, had 7.6
million subscribers.
 
     Each of CNNI and CNN en Espanol derives its revenues primarily from fees
charged to cable operators, fees paid by other recipients of the CNNI and CNN en
Espanol signals, including hotels and over-the-air television stations, and the
sale of advertising time.
 
     TBS also distributes region specific versions of TNT and Cartoon Network,
on either a single channel basis or a combined channel basis, in approximately
120 countries in Latin America and the Caribbean, Europe, the Middle East,
Africa and Asia. Each such network features all or a portion of its schedule in
more than one language through dubbing or subtitling. Revenues from these
services are derived both from subscription fees and advertising sales.
 
     CNN+, a Spanish language 24-hour news network, was launched for
distribution in Spain and Andorra on January 27, 1999. This new network is a
50/50 joint venture between TBS and Sogecable, S.A., an affiliate of Canal Plus.
CNN+ will derive revenues from cable and satellite subscription fees and
advertising sales.
 
     Cartoon Network Japan, a Japanese-language, all animation (including a
significant amount of locally sourced, Japanese product) 24-hour network, was
launched in Japan in 1997. Cartoon Network Japan is a joint venture owned 40% by
TBS, 40% by ITOCHU and 20% by Time Warner Entertainment Japan Inc. ("TWE
Japan"), which is 37.5% owned by Time Warner. Revenue sources for this network
include both subscription and advertising sales.
 
     n-tv, a German language news network currently reaching nearly 40 million
homes in Germany and contiguous countries in Europe, primarily via cable systems
and satellite, is 49.8%-owned, in the aggregate, by TBS and a division of TWE
and managed by TBS. n-tv relies principally on advertising revenues and receives
no compensation for its signal from cable systems. TBS also manages the
Company's interest in music video channels in Germany, Hungary and Asia.
 
INTERNET SITES
 
     In addition to its cable networks, TBS operates various
advertiser-supported Internet sites. CNN News Group operates multiple sites,
primarily through CNN Interactive. CNN Interactive operates CNN.com as its
general news service and online companion to CNN and six additional web sites,
including AllPolitics.com, a U.S. political newssite produced in conjunction
with TIME magazine and Congressional Quarterly; CNN CustomNews, a personalized
news site operated by Oracle technology; and additional online services in
Spanish, Portuguese, Swedish and Norwegian. The CNN News Group also produces two
other major news sites: CNNfn.com, a unit of CNN Financial News, and CNNSI.com,
a sports site developed jointly with Sports Illustrated. The CNN News Group
sites received 4.4 billion page impressions during 1998, more than double the
aggregate traffic of the CNN News Group sites during 1997.
 
     In addition to producing content for the Internet, CNN Interactive produces
and distributes CNN digital content for different platforms and technologies,
including pagers, push technology, European teletext and certain mobile
telephone technologies.
 
     In the entertainment field, as of November 1998, TBS's advertiser-supported
CartoonNetwork.com was ranked by Media Metrix (based on audience composition) as
one of the top three information and entertainment sites for children ages two
to eleven.
 
                                       I-5
<PAGE>   8
 
                                HOME BOX OFFICE
 
     HBO, operated by the Home Box Office division of TWE, is the nation's most
widely distributed pay television service, which together with its sister
service, Cinemax, had approximately 34.6 million subscriptions as of December
31, 1998. Both HBO and Cinemax are available in multichannel format.
 
PROGRAMMING
 
     A majority of HBO's programming and a large portion of that on Cinemax
consists of recently released, uncut and uncensored theatrical motion pictures.
Home Box Office's practice has been to negotiate licensing agreements of varying
duration for such programming with major motion picture studios and independent
producers and distributors. These agreements typically grant pay television
exhibition rights to recently released and certain older films owned by the
particular studio, producer or distributor in exchange for a negotiated fee,
which may be a function of, among other things, HBO and Cinemax subscription
levels and the films' box office performances.
 
     Home Box Office attempts to ensure access to future movies in a number of
ways. In addition to its exhibition of movies distributed by Warner Bros. and
its regular licensing agreements with numerous distributors, it has agreements
with DreamWorks SKG, Regency Entertainment, Sony Pictures Entertainment, Inc.
("Sony Pictures"), and Twentieth Century Fox Film Corporation ("Fox") pursuant
to which the Home Box Office Services have acquired exclusive and non-exclusive
rights to exhibit all or a substantial portion of the films produced, acquired
and/or released by these entities during the term of each agreement. Home Box
Office has also entered into non-exclusive license agreements with Fox,
Paramount Pictures Corporation, Sony Pictures and Walt Disney Pictures for
older, library films.
 
     HBO also defines itself by the exhibition of contemporary and sometimes
controversial pay television original movies and mini-series, sporting events
such as boxing matches and Wimbledon, sports documentaries and the sports news
program "Real Sports," dramatic and comedy specials and series, concert events,
family programming, and documentaries that are produced by independent
production companies for initial exhibition on HBO.
 
OTHER INTERESTS
 
     Time Warner Sports, a division of Home Box Office, operates TVKO
Pay-Per-View from HBO, an entity that distributes pay-per-view prize fights and
other pay-per-view programming.
 
     In 1998, Home Box Office's own production company, HBO Independent
Productions, produced "Everybody Loves Raymond," in its third season on CBS.
Divisions of Home Box Office also produce comedy programming for HBO, Comedy
Central, broadcast networks and syndication. Home Box Office is also co-owner of
a U.K. television production company and of a separate joint venture for the
international distribution of programming.
 
     When it controls the rights, Home Box Office also distributes theatrical
films and made-for-pay television programming to other cable television or
pay-per-view services and for home video and distributes its original
programming into domestic syndication and abroad for television and home video
viewing.
 
INTERNATIONAL
 
     HBO Ole, a 33.46%-owned partnership comprised of TWE (acting through its
Home Box Office and Warner Bros. divisions), a Venezuelan company and two other
motion picture companies, operates two Spanish-language pay television motion
picture services, HBO Ole and Cinemax, which are currently distributed in
Central and South America, Mexico and the Caribbean. TWE also has interests in
several advertiser-supported television services distributed by HBO Ole in Latin
America. HBO Brasil, another partnership in which TWE has an interest,
distributes Portuguese-language pay television movie services in Brazil. TWE
also has a 40% interest in HBO Asia, a movie-based pay television service which,
together with Cinemax, is distributed to various countries in Southeast Asia.
 
                                       I-6
<PAGE>   9
 
     In addition to the Latin American and Asian ventures, Home Box Office has
interests in pay television services in Hungary, the Czech Republic, the Slovak
Republic, Poland and Romania.
 
                      OTHER BASIC CABLE NETWORK INTERESTS
 
     The Company, through TWE, holds a 50% interest in Comedy Central, an
advertiser-supported basic cable television service, which provides comedy
programming. Comedy Central was available in approximately 56 million homes at
year-end 1998.
 
     The Company, through TWE, also holds a 50% interest in Court TV, which was
available in approximately 32 million homes at year-end 1998. Court TV is an
advertiser-supported basic cable television service providing coverage of live
and taped legal proceedings during the day and a mix of fictional and real crime
stories in the evening.
 
                                  COMPETITION
 
     The Networks all face strong competition. Each of the Networks competes
with other television programming services for distribution on the limited
number of channels available on cable and other television systems. All of the
Networks compete for viewers' attention with all other forms of programming
provided to viewers, including broadcast networks, local over-the-air television
stations, other pay and basic cable television services, home video,
pay-per-view services, online activities and other forms of news, information
and entertainment. In addition, the Networks face competition for programming
product with those same commercial television networks, independent stations,
and pay and basic cable television services, some of which have exclusive
contracts with motion picture studios and independent motion picture
distributors. The Turner Networks and TBS's Internet sites compete for
advertising with numerous direct competitors and other media, as well.
 
     The Networks' production divisions compete with other producers and
distributors of programs for air time on broadcast networks, independent
commercial television stations, and pay and basic cable television networks.
 
                           OTHER CABLE NETWORK ASSETS
 
WORLD CHAMPIONSHIP WRESTLING
 
     Through World Championship Wrestling ("WCW"), TBS produces wrestling
programming for TBS Superstation and TNT, the domestic syndication markets and
pay-per-view television. In addition to television programming, WCW is involved
in ancillary businesses such as licensing and merchandising from which it
derives revenues worldwide.
 
SPORTS FRANCHISES
 
     Through wholly owned subsidiaries, TBS owns the Atlanta Braves major league
baseball club and the Atlanta Hawks basketball team and has been conditionally
granted a National Hockey League expansion franchise team to be known as the
Atlanta Thrashers that will begin play in the 1999-2000 hockey season. TBS must
meet certain sales and other objectives applicable to all other hockey expansion
teams prior to a formal grant of right to operate the hockey team. Each national
sports team is subject to the rules and regulations of the league to which it
belongs.
 
     The teams derive income from gate receipts, advertising and related sales,
suite sales, local sponsorships and local media, and share pro rata in proceeds
from national media contracts and licensing activities of the relevant league,
as well as expansion fees.
 
     A new, state-of-the-art arena adjacent to CNN Center is under construction
and will be the future home of the Hawks and the Thrashers. The arena is being
developed by a TBS subsidiary and the cost of the arena is being funded
primarily with the proceeds from bonds issued by the City of Atlanta-Fulton
County Recreation Authority.
 
                                       I-7
<PAGE>   10
 
                                   PUBLISHING
 
     The Company's Publishing business is conducted primarily by Time Inc., a
wholly owned subsidiary of the Company, either directly or through its
subsidiaries. Time Inc. is one of the world's leading magazine and book
publishers and is one of the largest direct mail marketers in the world.
 
                                   MAGAZINES
 
GENERAL
 
     Time Inc. publishes some of the world's best-known magazines, including
TIME, PEOPLE, SPORTS ILLUSTRATED, FORTUNE, MONEY, ENTERTAINMENT WEEKLY and
InSTYLE. These magazines are generally aimed at a broad consumer market. They
cover a broad range of topics of interest to potential readers, including
current events, prominent personalities, sports, entertainment, business and
personal finance, and lifestyle.
 
     Each magazine published by Time Inc. has an editorial staff under the
general supervision of a managing editor and a business staff under the
management of a president or publisher. Many of the magazines have numerous
regional and demographic editions which contain the same basic editorial
material but permit advertisers to direct their advertising to specific markets.
Through the use of selective binding and ink-jet technology, magazines can
create special custom editions targeted towards specific groups of readers.
 
     Magazine production and distribution activities are generally managed by
centralized staffs of Time Inc. Fulfillment activities for Time Inc.'s magazines
are generally administered from a centralized facility in Tampa, Florida. Some
of the development properties and overseas operations employ independent
fulfillment services and make their own arrangements for production and
distribution.
 
     Time Inc. has expanded its core magazine businesses through the development
of product extensions. These are generally managed by the individual magazines
and involve specialized editions aimed at particular readership groups,
publication of editorial content developed by the magazine staffs through
different media, such as the Internet, hardcover books and television, and use
of the brand name and reach of the core publications to expand into related
products, such as merchandise. In June 1998, CNN and Time Inc. launched CNN
Newstand, a collaboration between CNN and TIME, FORTUNE and ENTERTAINMENT WEEKLY
which airs four nights a week on CNN.
 
DESCRIPTION OF MAGAZINES
 
     The Company's magazines and their areas of interest are summarized below:
 
     TIME, which celebrated its 75th anniversary in 1998, summarizes the news
and brings original interpretation and insight to the week's events, both
national and international, and across the spectrum of politics, business,
entertainment, sports, societal trends, health, and other areas of general
consumer interest. TIME has also developed additional publications aimed at
particular reader segments such as TIME FOR KIDS, an in-school weekly news
magazine, and TIME DIGITAL, a supplement to TIME which covers technology-related
issues. TIME also has five weekly English-language editions which circulate
outside the United States: TIME Asia, TIME Atlantic, TIME Canada, TIME Latin
America, and TIME South Pacific.
 
     SPORTS ILLUSTRATED is a weekly news magazine that covers virtually all
forms of recreational and competitive sports. In addition, SPORTS ILLUSTRATED
has developed SPORTS ILLUSTRATED FOR KIDS, a monthly sports-oriented magazine
geared to children, and a special edition, GOLF PLUS. New venues for its
editorial content have also been developed, including CNN/Sports Illustrated, a
sports news cable television network and web site that is operated as a joint
venture between SPORTS ILLUSTRATED and CNN.
 
     PEOPLE is a weekly magazine which reports on celebrities and other notable
personalities in the fields of politics, sports and entertainment, or who
otherwise come to prominent public attention due to acts of heroism, tragedy or
other aspects of general human interest. PEOPLE has recently developed two
PEOPLE
                                       I-8
<PAGE>   11
 
offspring: PEOPLE en Espanol, a Spanish-language edition aimed primarily at
Hispanic readers in the United States launched in 1997, and TEEN PEOPLE, aimed
at teenage readers, launched in 1998. WHO WEEKLY is an Australian version of
PEOPLE.
 
     Time Inc. has other magazines also directed at readers' interests in
celebrities and entertainers. InSTYLE is a monthly magazine which focuses on
celebrity lifestyles and includes reports and advice on beauty and fashion.
ENTERTAINMENT WEEKLY is a weekly magazine which includes reviews and reports on
television, movies, video, music, books, and multimedia and also offers
entertainment-related merchandise directly to consumers.
 
     FORTUNE is a bi-weekly magazine which reports on worldwide economic and
business developments. FORTUNE also provides extensive coverage of the
activities of major or noteworthy corporations and business personalities, and
compiles the annual FORTUNE 500 list of the largest U.S. corporations. MONEY is
a monthly magazine which reports primarily on personal finance and provides
information on topics such as investing, planning for retirement and financing
children's college educations. Time Inc. also publishes YOUR COMPANY, a
bi-monthly magazine focusing on success stories, growth advice and operational
issues for small businesses, and in 1998 acquired MUTUAL FUNDS, a monthly
magazine featuring extensive reports on mutual funds, including stories about
retirement and college planning.
 
     LIFE is a monthly magazine which features photographic essays of important
news events, prominent personalities and meaningful vignettes of the lives of
ordinary people. LIFE also publishes hardcover books that include contemporary
and historical photographs of note from its extensive collection.
 
     Time Inc. also publishes several regional magazines including SOUTHERN
LIVING, a monthly regional home, garden, food and travel magazine focused on the
South, published by Southern Progress Corporation ("Southern Progress"), and
SUNSET, The Magazine of Western Living, a monthly focused on western lifestyles
published by Sunset Publishing Corporation ("Sunset Publishing"). COOKING LIGHT
is published ten times a year and promotes health and fitness through active
lifestyles and good nutrition. Southern Progress also publishes SOUTHERN
ACCENTS, a bi-monthly magazine that features architecture, fine homes and
gardens, arts and travel, COASTAL LIVING, a bi-monthly magazine for people who
"love the coast," PROGRESSIVE FARMER, a monthly regional farming magazine and
WEIGHT WATCHERS, a magazine published nine times a year under a license from
Weight Watchers International, Inc.
 
     Time Publishing Ventures, Inc. ("TPV") manages Time Inc.'s specialty
publishing titles. Parents and families are addressed by PARENTING and BABY
TALK, both of which are published ten times a year. In 1998, TPV acquired First
Moments, Inc., a sampling company that targets newlyweds and new mothers. HEALTH
is a women's consumer magazine about health and fitness published eight times in
1998 and HIPPOCRATES is a monthly trade magazine targeted at primary care
physicians. TPV also publishes THIS OLD HOUSE magazine ten times a year pursuant
to a licensing arrangement with public television station WGBH in Boston based
on the popular home renovation television series.
 
     Time Inc.'s international operations include both regional versions of some
of its core magazines, including TIME, PEOPLE and FORTUNE, as well as
publications whose editorial content and focus are outside the United States.
Such magazines include WALLPAPER, PRESIDENT, DANCYU, and ASIAWEEK.
 
     Time Inc. also has management responsibility for most of the American
Express Publishing Corporation's operations, including its core lifestyle
magazines TRAVEL & LEISURE and FOOD & WINE, as well as DEPARTURES magazine,
which is a controlled circulation magazine distributed to holders of the
Platinum Card issued by American Express. In 1998, American Express Publishing
launched TRAVEL & LEISURE GOLF magazine. Time Inc. receives a fee for managing
these properties.
 
     Time Inc. Custom Publishing is a marketing division of Time Inc. producing
magazines and newsletters for corporate clients utilizing content from Time Inc.
magazines and archival photography from the Time Inc. photography collection, as
well as original content.
 
                                       I-9
<PAGE>   12
 
CIRCULATION
 
     Time Inc.'s magazines are sold primarily by subscription and delivered to
subscribers through the mail. Subscriptions are sold by direct mail and online
solicitation, subscription sales agencies, television and telephone solicitation
and insert cards in Time Inc. magazines and other publications. Single copies of
magazines are sold through retail news dealers and other consumer magazine
retailers, such as supermarkets, drug stores, and discount stores, which are
supplied by wholesalers or directly from a Time Inc. subsidiary.
 
     Circulation drives the advertising rate base, which is the guaranteed
minimum paid circulation level on which advertising rates are based. The Time
Inc. titles with the 10 highest rate bases on December 31, 1998 were:
 
<TABLE>
<CAPTION>
TITLE                                                         RATE BASE
-----                                                         ---------
<S>                                                           <C>
TIME........................................................  4,000,000
PEOPLE......................................................  3,250,000
SPORTS ILLUSTRATED..........................................  3,150,000
SOUTHERN LIVING.............................................  2,450,000
MONEY.......................................................  1,900,000
LIFE........................................................  1,500,000
SUNSET......................................................  1,425,000
COOKING LIGHT...............................................  1,350,000
ENTERTAINMENT WEEKLY........................................  1,350,000
PARENTING...................................................  1,350,000
</TABLE>
 
     Time Distribution Services Inc. ("TDS") is a national distribution company
responsible for the retail sales, distribution, marketing and merchandising of
single copies of periodicals for Time Inc. and other publishers. TDS distributes
periodicals either through a magazine wholesaler network which services retail
outlets such as newsstands, supermarkets, convenience and drug stores or in some
cases directly to retailers.
 
     Warner Publisher Services Inc. ("WPS") is a major distributor of magazines
and paperback books sold through wholesalers in the United States and Canada.
WPS is the sole national distributor for MAD magazine, the publications of DC
Comics, and certain publications and paperback books published by other
publishers, including Conde Nast, Petersen and Ziff-Davis.
 
ADVERTISING
 
     Advertising carried in Time Inc. magazines is predominantly consumer
advertising. In 1998, Time Inc. magazines accounted for 21% of the total
advertising revenue in consumer magazines, as measured by the Publishers
Information Bureau ("PIB"), which measures advertising placed in consumer
magazines. Time Inc. had the three leading magazines in terms of advertising
dollars and seven of the top 25:
 
<TABLE>
<CAPTION>
TITLE                                                         PIB RANK
-----                                                         --------
<S>                                                           <C>
PEOPLE......................................................      1
TIME........................................................      2
SPORTS ILLUSTRATED..........................................      3
FORTUNE.....................................................     10
ENTERTAINMENT WEEKLY........................................     18
MONEY.......................................................     21
SOUTHERN LIVING.............................................     25
</TABLE>
 
     The five leading categories of advertising carried in Time Inc. magazines
in 1998, according to PIB were, in descending order, domestic automobile
manufacturers, toiletries and cosmetics, food, computers and financial. Time
Inc. places local advertising for local and national advertisers through its
subsidiary, Media Networks, Inc. ("MNI"). MNI partners with some of the
country's leading national magazines, including
 
                                      I-10
<PAGE>   13
 
several Time Inc. magazines, to offer local marketers the opportunity to
advertise to select targeted areas defined by sectional postal centers.
 
PAPER AND PRINTING
 
     Lightweight coated paper constitutes a significant component of physical
costs in the production of magazines. Time Inc. has contractual commitments to
ensure an adequate supply of paper, but periodic shortages may occur in the
event of strikes or other unexpected disruptions in the paper industry. During
1998, Time Inc. purchased paper principally from six independent manufacturers,
with the larger relationships under contracts that, for the most part, are
either fixed-term or open-ended at prices determined on a market price or
formula price basis.
 
     Printing and binding for Time Inc. magazines are accomplished primarily by
major domestic and international independent printing concerns in approximately
20 locations. Magazine printing contracts are either fixed-term or open-ended at
fixed prices with, in some cases, adjustments based on certain criteria.
 
                                  ONLINE MEDIA
 
     Time Inc. New Media ("New Media"), the online unit of Time Inc., is one of
the largest creators of online digital content, producing electronic versions of
TIME, PEOPLE, FORTUNE, MONEY, ENTERTAINMENT WEEKLY and LIFE. New Media also
develops and manages new brands that are accessible only on the Internet, such
as "Ask Dr. Weil" and "ParentTime". New Media launched the Pathfinder online
network in November 1994 to provide easy access and simple navigation to Time
Inc.'s websites. The sites generate revenue from advertising, subscription-based
access and fee-based downloads to premium content, selected e-commerce
offerings, and the licensing of digital content. In 1998, New Media agreed to
make its heavily trafficked PEOPLE online content available exclusively on AOL's
proprietary network starting in early 1999. TEEN PEOPLE has also entered into an
exclusive arrangement with AOL. Also in 1999, Time Inc. announced that it will
direct a major expansion of Time Warner's e-commerce effort.
 
                                DIRECT MARKETING
 
TIME LIFE
 
     Time Life Inc. is one of the nation's largest direct marketers of
continuity series of books, music and videos. In addition to continuity series,
it sells single products and products in sets. Its products are sold by direct
response, including mail order, television and telephone, through retail,
institutional and learning channels, catalogs, and in some markets by
independent distributors. Time Life products are currently sold in over 25
languages worldwide.
 
     Editorial material for its books is created by in-house staffs as well as
through outside publishers. Music and video rights are acquired through outside
sources and compiled internally into finished products. Time Life's domestic
direct response fulfillment activities are conducted from a centralized facility
in Richmond, Virginia. Fulfillment of other business lines is done through a
combination of in-house and outside fulfillment companies.
 
BOOK-OF-THE-MONTH CLUB
 
     Book-of-the-Month Club, Inc. ("BOMC") currently operates eleven distinct
book clubs and two continuity businesses with a combined membership of more than
4.5 million. Two of the clubs, Book-of-the-Month Club and Quality Paperback Book
Club, are general interest clubs; other clubs specialize in history, business,
children's books, women's lifestyle, spiritual, self-help and health topics, or
the books of a particular author. In addition, multimedia, audio and video
products and other merchandise are offered through the clubs. BOMC operates in
over 40 countries worldwide.
 
                                      I-11
<PAGE>   14
 
     BOMC acquires the rights from publishers to manufacture and distribute
books and then has them printed by independent printing concerns. BOMC operates
its own fulfillment and warehousing operations in Mechanicsburg, Pennsylvania.
 
AMERICAN FAMILY PUBLISHERS
 
     A wholly-owned subsidiary of Time Inc. is a 50% partner in the parent
entity of American Family Publishers ("AFP"), whose principal business is
selling magazine subscriptions through the use of sweepstakes promotions. Time
Inc. has no management role in the day-to-day operation of AFP's business.
During 1998, a number of state attorneys general launched investigations of
AFP's sweepstakes business, while other atttorneys general and private
plaintiffs filed lawsuits that alleged AFP's mailings were misleading. AFP has
entered into an assurance of voluntary compliance ("AVC") with a number of
states, and has substantially revised the wording of its sweepstakes mailings to
conform with the AVC. These matters have had a significant adverse impact on
AFP's business. See also Item 3, "Legal Proceedings" for additional information
about the AFP matters.
 
                                     BOOKS
 
TRADE PUBLISHING
 
     Time Inc.'s trade publishing operations are conducted primarily by Time
Warner Trade Publishing Inc. through its two major publishing houses, Warner
Books and Little, Brown. In 1998, Time Warner Trade Publishing placed 31 books
on The New York Times best-seller lists.
 
WARNER BOOKS
 
     Warner Books primarily publishes hardcover, mass market and trade paperback
books. Among its best selling hardcover books in 1998 were "Simple Abundance,"
by Sarah Ban Breathnach; "The Weaver," by David Baldacci and "The Celestine
Vision," by James Redfield. Best selling mass market paperbacks in 1998 included
"Jack & Jill," by James Patterson; "The Notebook," by Nicholas Sparks and "Blood
Work," by Michael Connelly.
 
     Time Warner Audiobooks develops and markets audio versions of books and
other materials published by both Warner Books and Little, Brown.
 
LITTLE, BROWN
 
     Little, Brown publishes general and children's trade books. Through its
subsidiary, Little, Brown and Company (U.K.) Ltd., it also publishes general
hardcover and mass market paperback books in the United Kingdom. Among the trade
hardcover best-sellers published by Little, Brown in 1998 were: "Cat & Mouse,"
by James Patterson; "Making Faces," by Kevyn Aucoin and "The Dark Side of
Camelot," by Seymour M. Hersh.
 
     Little, Brown handles book distribution for itself and Warner Books as well
as other publishers through its new state-of-the-art distribution center in
Indiana. The marketing of trade books is primarily to retail stores and
wholesalers throughout the United States, Canada and the United Kingdom. Through
their combined United States and United Kingdom operations, Little, Brown and
Warner Books have the ability to acquire English-language publishing rights for
the distribution of hard and soft-cover books throughout the world.
 
OXMOOR HOUSE AND SUNSET BOOKS
 
     Oxmoor House, Inc., a subsidiary of Southern Progress, markets how-to books
on a wide variety of topics including food and crafts, and Leisure Arts, Inc.,
also a subsidiary of Southern Progress, is a well-established publisher and
distributor of instructional leaflets, continuity books series and magazines for
the needlework and crafts markets. Sunset Books, the book publishing division of
Sunset Publishing, markets books on topics
 
                                      I-12
<PAGE>   15
 
such as building and decorating, cooking, gardening and landscaping, and travel.
Sunset Books' unique marketing formula includes an extensive distribution
network of home repair and garden centers.
 
                                  POSTAL RATES
 
     Postal costs represent a significant operating expense for the Company's
publishing activities. In January 1999, the United States post office raised
postal rates for all classes of mail.
 
     Publishing operations strive to minimize postal expense through the use of
certain cost-saving measures, including the utilization of contract carriers to
transport books and magazines to central postal centers. It has been the
Company's practice in selling books and other products by mail to include a
charge for postage and handling, which is adjusted from time to time to
partially offset any increased postage or handling costs.
 
                                  COMPETITION
 
     Time Inc.'s magazine and Internet media operations compete for audience and
advertising with numerous other publishers and retailers, as well as other
media. These businesses compete for advertising directed at the general public
and also advertising directed at more focused demographic groups.
 
     Time Inc.'s book publishing operations compete for sales with numerous
other publishers and retailers as well as other media. In addition, the
acquisition of publication rights to important book titles is highly
competitive, and Warner Books and Little, Brown compete with numerous other book
publishers. TDS and WPS compete directly with other distributors operating
throughout the United States and Canada in the distribution of magazines and
paperback books.
 
     Time Inc.'s direct marketing operations compete with other direct marketers
through all media for the consumer's attention. In addition to the traditional
media sources for product sales, the Internet is becoming a strong vehicle in
the direct marketing business.
 
                                 ENTERTAINMENT
 
     The Company's Entertainment businesses produce and distribute theatrical
motion pictures, television shows, animation and other programming, distribute
home video product, operate The WB Television Network, maintain
advertiser-supported entertainment sites on the Internet, license rights to the
Company's characters, operate retail stores featuring consumer products based on
the Company's characters and brands, operate theme parks and motion picture
theaters internationally and also produce and distribute recorded music. All of
the foregoing businesses are principally conducted by Warner Bros., which is a
division of TWE, except the recorded music business which is wholly owned by the
Company and is not part of TWE.
 
     The filmed entertainment business also includes New Line Cinema Corporation
("New Line") and Castle Rock Entertainment ("Castle Rock"), as well as the
Turner libraries, which include Hanna-Barbera, MGM, RKO and classic Warner Bros.
films and animated shorts. These businesses are wholly owned by the Company and
are not a part of TWE, although TWE performs and is compensated for certain
distribution and other services for many of these businesses.
 
     The Company, through its wholly owned Warner Music Group division ("WMG"),
is in the business of discovering and signing musical artists and manufacturing,
packaging, distributing and marketing their recorded music. WMG also operates
Warner/Chappell, a wholly owned music publishing business with offices around
the world, and is a joint venture partner of music and video clubs in North
America through its 50% ownership of The Columbia House Company.
 
     The Company's Entertainment operations are conducted in the United States
and around the world. During 1998, approximately 42% of worldwide theatrical
revenues and more than 52% of WMG's recorded music revenues were generated
outside the United States.
 
                                      I-13
<PAGE>   16
 
                      FILMED ENTERTAINMENT -- WARNER BROS.
 
WARNER BROS. FEATURE FILMS
 
     Warner Bros. produces feature films both wholly on its own and under
co-financing arrangements with other motion picture companies. Warner Bros. also
acquires for distribution completed films produced by others. Acquired
distribution rights may be limited to specified territories, media and/or
periods of time. The terms of Warner Bros.' agreements with independent
producers and other entities are separately negotiated and vary depending upon
the production, the amount and type of financing by Warner Bros., the media and
territories covered, the distribution term and other factors. In some cases,
producers, directors, actors, writers and others participate in the proceeds
generated by the motion pictures in which they are involved.
 
     Feature films are licensed to exhibitors under contracts that provide for
the length of the engagement, rental fees, which may be either a percentage of
box office receipts, with or without a guarantee of a fixed minimum, or a flat
sum and other relevant terms. The number of feature films that a particular
theater exhibits depends upon its policy of program changes, the competitive
conditions in its area and the quality and appeal of the feature films available
to it. Warner Bros. competes with all other distributors for playing time in
theaters.
 
     In response to the rising cost of producing theatrical films, Warner Bros.
has signed joint venture agreements with several companies to co-finance films,
decreasing its financial risk while retaining substantially all worldwide
distribution rights. Warner Bros. and Canal Plus have formed a joint venture,
known as Bel-Air Entertainment, to co-finance on primarily a 50/50 basis the
production, overhead and development costs of a total of approximately 10 to 20
motion pictures through 2003. Warner Bros. acquired all distribution rights in
the U.S. and Canada and substantially all international distribution rights to
these pictures. Warner Bros. will advance marketing and distribution costs in
the territories where it distributes and will receive a distribution fee in
connection with the exploitation of the pictures. "Message in a Bottle" was
released under a separate arrangement with Bel-Air in the first quarter of 1999.
 
     In 1998 Warner Bros. entered into an agreement with Village Roadshow
Pictures ("VRP") to co-finance under a cost sharing arrangement the production
of up to 20 motion pictures over a five-year period. Approximately 50% of the
production costs of those pictures will be provided by Warner Bros. and the
balance will be provided by VRP. Warner Bros. will acquire all distribution
rights in the U.S. and Canada and substantially all international distribution
rights to the co-financed pictures. Warner Bros. will advance marketing and
distribution costs in the territories in which it distributes and will receive a
distribution fee in connection with the exploitation of the pictures. "Practical
Magic" was co-financed under this arrangement and distributed by Warner Bros.
during 1998. Among others, "Analyze This," "Gossip," "Three Kings" and "The
Matrix" are scheduled for release in 1999.
 
     Warner Bros. and Polygram Filmed Entertainment ("Polygram") have agreed to
co-finance on a 50/50 basis through 2000 the production, overhead and
development costs of motion pictures produced or acquired by Castle Rock, a
subsidiary of Time Warner. Warner Bros. and Polygram (now Universal Studios)
will each acquire distribution rights in the U.S. and Canada to half of the
Castle Rock pictures and international distribution rights to the other half on
an alternating basis. Warner Bros. and Polygram will each advance marketing and
distribution costs in connection with the exploitation of the Castle Rock
pictures. During l998, Warner Bros. distributed "The Last Days of Disco,"
internationally, under this arrangement. Among the Castle Rock releases
anticipated for l999 are "Mickey Blue Eyes" and "The Green Mile," which will be
distributed by Warner Bros. domestically.
 
     Warner Bros. has extended the term of its distribution servicing agreements
with Morgan Creek Productions Inc. ("Morgan Creek") through up to June 2003
pursuant to which, among other things, Warner Bros. provides domestic
distribution services for all Morgan Creek pictures for a period of ten years
from delivery of a picture, and certain foreign distribution services for
selected pictures. Under this arrangement, Warner Bros. released "Wrongfully
Accused," "Incognito" and "Major League 3" in l998.
 
                                      I-14
<PAGE>   17
 
     Warner Bros.' co-financing and distribution agreement with Monarchy
Enterprises C.V. and Regency Entertainment U.S.A. ("Monarchy/Regency") expired
in 1998. Warner Bros. distributed "Dangerous Beauty" and "The Negotiator" for
Monarchy/Regency and released "City of Angels" as a co-financed picture with
them in 1998.
 
     During 1998, Warner Bros. released 27 motion pictures for theatrical
exhibition, of which 15 were produced by or with others and four were released
solely in international markets. The following motion pictures, among others,
were released by Warner Bros. in 1998: "City of Angels," "Lethal Weapon 4,"
"Practical Magic," "A Perfect Murder" and "You've Got Mail."
 
     During 1999, Warner Bros. expects to release approximately 22 motion
pictures, of which 14 are expected to be produced by or with others. In addition
to the co-financed pictures mentioned above, during 1999 Warner Bros. will
release "True Crime," "Wild, Wild West" and "Eyes Wide Shut."
 
HOME VIDEO
 
     Warner Home Video ("WHV") distributes for home video use pre-recorded
videocassettes and digital video discs ("DVDs") containing the filmed
entertainment product of (i) Warner Bros., (ii) Home Box Office, (iii)
WarnerVision Entertainment, (iv) Castle Rock and (v) New Line Cinema. In March
1999, WHV and MGM agreed to terminate the parties' video distribution agreement.
WHV will receive $225 million plus, effective January 1, 1999, video
distribution rights in the Turner Entertainment library, which includes all of
the classic pre-1948 Warner Bros. and pre-1986 MGM films. In return, MGM was
granted early termination, effective January 31, 2000, of WHV's rights with
respect to the United Artists film library and post-1986 MGM video product. WHV
also distributes other companies' product for which it has acquired home video
distribution or servicing rights. In l998, WHV commenced distributing DVDs on
behalf of Disney in Europe, the Middle East and Africa.
 
     WHV sells its product in the United States and in major international
territories to retailers and wholesalers through its own sales force, with
warehousing and fulfillment handled by divisions of Warner Music Group and third
parties. In some international countries, WHV's product is distributed through
licensees. Videocassette product is generally manufactured under contract with
independent duplicators. DVD product is replicated by Warner Music Group
companies and third parties.
 
     During 1998, WHV released five titles in North America for home rental with
sales and licensed units exceeding 400,000 units each: "Lethal Weapon 4," "L.A.
Confidential," "Devil's Advocate," "City of Angels" and "U.S. Marshals." WHV
entered into revenue sharing license agreements with rental customers, including
distributors, in l998. Under such agreements, WHV licenses video product and
shares in revenues generated by its customers. Additionally, WHV released nine
titles in the North American sell-through market which generated sales of more
than one million units each. Internationally, the following titles generated
substantial home video revenue in 1998: "Tomorrow Never Dies," "Conspiracy
Theory," "Contact," "L.A. Confidential" and the first four seasons of the
television series "Friends."
 
     DVDs, capable of storing large volumes of digitized information -- enough
storage capacity for two full-length feature films on a double-sided or
dual-layered disc -- increased their presence in North American markets during
1998. The DVD technology offers picture quality significantly superior to
existing home video technology as well as premium features such as multiple
language soundtracks. WHV is currently benefiting by releasing in DVD format
both first-run feature motion pictures and titles from WHV's extensive
catalogue. At year-end l998, WHV had DVD distribution in major international
territories.
 
TELEVISION
 
     Warner Bros. is the leading supplier of television programming in the
world. Warner Bros. both develops and produces new television series,
made-for-television movies, mini-series, reality-based entertainment shows and
animation programs and also distributes television programming for exhibition on
all national networks, syndicated domestic television, cable syndication and a
growing array of international television distribution outlets. The distribution
library owned or managed by Warner Bros. currently has some 5,700 feature films,
 
                                      I-15
<PAGE>   18
 
32,000 television titles, 12,000 animated titles and 1,500 classic animated
shorts, including classic MGM and RKO titles such as "The Wizard of Oz" and
"Gone With The Wind," as well as animation from Hanna-Barbera and MGM. Warner
Bros. acts as distributor of the programming owned by subsidiaries of TBS.
 
     Warner Bros.' television programming is primarily produced by Warner Bros.
Television, which produces dramatic and comedy programming, and Telepictures
Productions ("Telepictures"), which specializes in reality-based and
talk/variety series. During the 1998-1999 season, Warner Bros. Television
launched several new network primetime series, including "Jesse," "Whose Line is
it Anyway" and "Two of a Kind." Returning network primetime series included,
among others, the top-rated series "ER" and "Friends," "The Parent Hood" and
"The Wayans Bros." (each in its fifth season); "The Drew Carey Show" (in its
fourth season); "Suddenly Susan" (in its third season); and "Veronica's Closet"
and "For Your Love" (in their second season).
 
     Telepictures is responsible for the development and production of original
programming primarily for syndicated television. In this capacity, Telepictures
has successfully launched "The Rosie O'Donnell Show" (third season), "The Jenny
Jones Show" (eighth season), "EXTRA" (fifth season), and "Change of Heart"
(first season).
 
     Warner Bros. Television Animation ("WBTA") is responsible for the creation,
development and production of contemporary television animation, as well as for
the creative use and production of classic animated characters from Warner
Bros.', TBS's and DC Comic's libraries, including "Looney Tunes" and the
Hanna-Barbera and MGM libraries. Animation programming is important to the
Company as a foundation for various product merchandising and marketing revenue
streams as well as being an important source of initial and on- going
programming for various distribution outlets, including those owned by the
Company (including Cartoon Network and Kids' WB!).
 
     WBTA continues to be a leading producer of original children's animation
programming and direct-to-video projects, with such programs as "Steven
Spielberg Presents Pinky, Elmyra & The Brain," "The New Batman/Superman
Adventures" and "Batman Beyond." WBTA also distributes "Pokemon" in the U.S. and
manages production of, among others, the Cartoon Network series "Cow and
Chicken," "Johnny Bravo," "Powerpuff Girls" and "I Am Weasel." Direct-to-video
projects for 1999 include "Steven Spielberg Presents Animaniacs: Wakko's Wish"
and a second Scooby-Doo feature-length video.
 
     The expansion of off-network, pay-per-view, pay and basic cable and
satellite broadcasting has increased the distribution opportunities for feature
films and television programming of all varieties from the Warner Bros. and TBS
libraries. A typical sale of a new program series produced by or for Warner
Bros. Television to a major domestic network grants that network an option to
carry such program series for four years, after which time Warner Bros.
Television can enter into a new license agreement with that or any other network
as well as license the already-broadcast episodes into off-network syndication
(broadcast and/or cable). New series are also licensed concurrently into the
international marketplace and can, after a short period of time, be sold in part
or in whole on home video. Warner Bros.' domestic distribution operation handles
the launching and supporting of first-run series produced directly for
syndication, as well as the sale of movie packages, off-network syndication
strips (in which shows originally produced for weekly broadcast on a network are
aired five days a week), and reruns of classic television series for cable and
satellite broadcasting.
 
     The top-rated series "ER" and "Friends" debuted in syndication in September
1998. Other television programs currently in off-network syndication include,
among others, "Murphy Brown," "Full House," "The Fresh Prince of Bel Air" and
"Family Matters."
 
     Warner Bros. International Television Distribution ("WBITD") is the world's
largest distributor of feature and television programming for television
exhibition outside of the United States. WBITD distributes programming in more
than 175 countries and in more than 40 languages. The introduction of new
technologies and programming services throughout the world has created many new
opportunities for WBITD. In conjunction with these new services seeking Warner
Bros.' programming, WBITD has formed strategic alliances with some of the
world's leading satellite, cable and over-the-air television broadcasters, and
has also commenced the development and production of television programming with
international partners. In 1998,
 
                                      I-16
<PAGE>   19
 
Warner Bros. formed a joint venture with Nippon Television Network, Toshiba and
TWE Japan to produce and distribute movies and television programs in Japan and
worldwide.
 
     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, network, basic cable and syndicated television
exhibition, amounted to $2.298 billion at December 31, 1998 (including amounts
relating to the licensing of product to Time Warner's and TWE's cable television
networks of $769 million as of December 31, 1998). The backlog excludes
advertising barter contracts. See also "Management's Discussion and Analysis of
Results of Operations and Financial Condition -- Filmed Entertainment Backlog"
at page F-18 herein.
 
CONSUMER PRODUCTS AND WARNER BROS. STUDIO STORES
 
     Warner Bros. Consumer Products licenses rights in both domestic and
international markets to the names, photographs, logos and other representations
of characters and copyrighted material from the films and television series
produced or distributed by Warner Bros., including the superhero characters of
DC Comics, Hanna-Barbera characters and Turner classic films.
 
     At December 31, 1998, Warner Bros. Studio Stores was operating more than
180 stores in the United States and in 15 countries or territories throughout
the world, including 44 stores owned by international franchisees.
 
THEATERS
 
     Through joint ventures, Warner Bros. International Theaters operates
approximately 90 multi-screen cinema complexes with approximately 800 screens in
seven foreign countries, including 30 theaters in Australia, 22 in the United
Kingdom, 20 in Japan, eight in Portugal, four in Italy and four in Spain. During
l999, Warner Bros. International Theaters plans to open more than 15 cinemas
with over 150 screens.
 
                          FILMED ENTERTAINMENT -- TBS
 
     Theatrical films are also produced by New Line and Castle Rock, which are
wholly owned subsidiaries of TBS and not a part of TWE. New Line is a leading
independent producer and distributor of theatrical motion pictures. During 1998,
through its two film divisions, New Line Cinema and Fine Line Features, New Line
releases included "Rush Hour," "The Wedding Singer," "Lost in Space," "Blade"
and "Pleasantville." For 1999, New Line anticipates that it will release, among
others, "Austin Powers: The Spy Who Shagged Me," "Town & Country" and "The
Bachelor."
 
     Castle Rock's films are currently being co-financed and distributed under
an arrangement with Warner Bros. and Polygram (see also, "Filmed
Entertainment -- Warner Bros." above). Castle Rock Television produced the
critically acclaimed and highly rated Emmy award winning series "Seinfeld" for
the past ten years. The series, which is distributed by a third party for a fee,
began its first domestic syndication cycle in September 1995 and also continues
to be aired throughout the world. In 1998 it was successfully sold to broadcast
television stations for a second syndication cycle commencing in 2001 as well as
to TBS Superstation for basic cable exhibition commencing in 2002.
 
     TBS's filmed entertainment business also includes the Hanna-Barbera, MGM
and RKO libraries, which include classic films such as "The Wizard of Oz" and
"Gone With the Wind" and cartoons such as the "Flintstones," "Yogi Bear,"
"Huckleberry Hound" and "Tom & Jerry." Distribution of these libraries is
managed by Warner Bros.
 
     TBS's backlog, representing the amount of future revenue not yet recorded
from cash contracts for the licensing of theatrical and television product for
pay cable, network, basic cable and syndicated television exhibition, amounted
to $636 million at December 31, 1998 (including amounts relating to the
licensing of film product to Time Warner's and TWE's cable television networks
of $226 million). The backlog excludes advertising barter contracts. See also
"Management's Discussion and Analysis of Results of Operations and Financial
Condition - Filmed Entertainment Backlog" at page F-18 herein.
 
                                      I-17
<PAGE>   20
 
                           THE WB TELEVISION NETWORK
 
     The WB Television Network ("The WB") completed its fourth year of broadcast
operations in January l999. During the l998/99 broadcast season, The WB expanded
its prime time program line-up to five nights and is now airing ll hours of
series programming from Sunday to Thursday nights. The network's line-up
includes the family series "7th Heaven," as well as programming aimed at a teen
and young adult audience, such as "Dawson's Creek," "Charmed," "Buffy the
Vampire Slayer," and the Golden Globe award winning "Felicity."
 
     During 1998, The WB's broadcast coverage (with 88 over-the-air affiliates)
grew to approximately 90% of U.S. TV households with the addition of key
affiliates in Pittsburgh, Cincinnati, Baltimore, San Antonio and Oklahoma City.
The WeB, a distribution alliance for The WB, was launched in September 1998 in
smaller broadcast markets. WeB programming is distributed to local broadcast
affiliates who then disseminate WeB programming via local cable systems.
 
     The WB's children's network, Kids' WB!, airs l9 hours of programming per
week with programming on weekday mornings, weekday afternoons and Saturday
mornings.
 
     Tribune Broadcasting owns a 22.25% interest in The WB. Key employees of The
WB hold an ll% interest in the network.
 
                              WARNER BROS. ONLINE
 
     Warner Bros. Online, established in l995, is responsible for all of Warner
Bros. commercial advertiser-supported online initiatives and, according to Media
Metrix, has established itself as one of the most-visited studio sites on the
Internet. The division recently entered into a joint venture with
FortuneCity.com, called ACMEcity.com, to create a global advertiser-supported
community network which will enable fans of Warner Bros. movies, music and
television shows to build personal home pages. In connection with the formation
of this joint venture, Warner Bros. received equity in FortuneCity.com equal to
approximately 13% of its outstanding shares.
 
     In the second quarter of l999, Warner Bros. Online plans to launch a
vertical advertiser-supported entertainment portal called "Entertaindom" to be
co-branded and distributed in partnership with computer manufacturers, Internet
service providers and portal sites. Entertaindom will offer entertainment
information and services, as well as a mix of content, community sites and
e-commerce, featuring video-based entertainment, animation, music and
multiplayer games.
 
     Warner Bros. Online is currently producing broadband interactive
entertainment in the form of WebDVD shows and content for broadband networks.
 
                                 RECORDED MUSIC
 
     In the United States, WMG's recorded music business is principally
conducted through WMG's Warner Bros. Records, Inc., Atlantic Recording
Corporation, Elektra Entertainment Group Inc. and Sire Records Group Inc. and
their affiliated labels, as well as through the WEA Inc. companies. The WEA Inc.
companies include WEA Manufacturing Inc., which manufactures compact discs
(CDs), audio and videocassettes, CD-ROMs and DVDs for WMG's record labels,
Warner Home Video and for outside companies; Ivy Hill Corporation, which
produces printed material and packaging for WMG's recorded music products as
well as for a wide variety of other consumer products; and
Warner-Elektra-Atlantic Corporation ("WEA Corp."), which markets and distributes
WMG's recorded music products to retailers and wholesale distributors. WMG also
owns a majority interest in Alternative Distribution Alliance ("ADA"), a
so-called "independent" distribution company specializing in alternative rock
music with a focus on new artists and smaller retailers.
 
     WMG's recorded music activities are conducted in more than 60 countries
outside the United States by Warner Music International and its subsidiaries,
affiliates and non-affiliated licensees.
 
                                      I-18
<PAGE>   21
 
DOMESTIC
 
     WMG's record labels in the United States -- Warner Bros., Atlantic, Elektra
and Sire -- each with a distinct identity, discover and sign musical artists.
The labels scout and sign talent in many different musical genres, including
pop, rock, jazz, country, hip hop, reggae, folk, blues, gospel and Christian
music. Artists generally receive royalties based upon the sales of their
recordings and music videos, and many receive non-refundable advance payments
recoupable from such royalties.
 
     WMG is a vertically-integrated music company. After an artist has entered
into a contract with a WMG label, a master recording of the artist's music is
produced and provided to WMG's manufacturing operation, WEA Manufacturing, which
replicates the music primarily on CDs and audio cassettes. Ivy Hill prints
material that is included with CDs and audio cassettes and creates packaging for
them. WEA Corp. and ADA, WMG's distribution arms, sell product and deliver it,
either directly or through sub-distributors and wholesalers, to thousands of
record stores, mass merchants and other retailers throughout the country. CDs
and tapes are also beginning to be sold directly to consumers through online
retailers on the Internet, such as CD Now, Amazon.com and Columbia House's Total
E. WMG, working with IBM and several other music companies, has announced a test
of the digital distribution of music, named the Madison Project, which will seek
to evaluate consumer interest in purchasing electronically distributed music via
the Internet.
 
     At the same time a recording is being distributed, the label's promotion,
marketing, advertising and publicity departments place advertisements in print
and electronic media, work to get the new album played on the radio, reviewed
and mentioned in publications and the artist booked for appearances on radio and
television. If a music video featuring an artist has been produced, the video is
distributed and promoted to music video outlets. Label personnel may also help
organize a concert tour that will further promote a new album.
 
     In addition to newly released records, each of WMG's labels markets and
sells albums from their extensive catalogues of prior releases, in which the
labels generally continue to own the copyright in perpetuity. Rhino Records,
which became wholly owned by WMG during 1998, specializes in compilations and
reissues of previously released music.
 
     WMG also has entered into joint venture arrangements pursuant to which WMG
companies manufacture, distribute and market (in most cases, domestically and
internationally) recordings owned by the joint ventures. Such agreements
typically provide a WMG label with an equity interest and a profit participation
in the venture, with financing furnished either solely by the WMG label or by
both parties. Included among these arrangements are the labels Maverick, Tommy
Boy, Sub Pop, Qwest and 143 Records. WMG labels also enter into agreements with
unaffiliated third-party record labels such as Curb Records to manufacture and
distribute recordings that are marketed under the owner's proprietary label.
 
     Through a 50/50 joint venture, WMG and Sony Music Entertainment operate The
Columbia House Company, the leading direct marketer of CDs, audio and
videocassettes in the United States and Canada. According to Media Metrix, The
Columbia House Internet sites are among the top 15 most visited retail sites on
the Internet.
 
     Among the albums resulting in significant U.S. sales for WMG during 1998
were the City of Angels soundtrack and releases from matchbox20, Brandy,
Madonna, Barenaked Ladies, Jewel, Alanis Morissette, Third Eye Blind and
Metallica.
 
INTERNATIONAL
 
     Operating in more than 60 countries around the world, Warner Music
International ("WMI") engages in the same activities as WMG's domestic labels,
discovering and signing artists and manufacturing, packaging, distributing and
marketing their recorded music. The artists signed to WMI and its affiliates
number more than a thousand. In most cases, WMI also markets and distributes the
recordings of those artists for whom WMG's domestic record labels have
international rights. In certain countries, WMI licenses to unaffiliated
third-party record labels the right to distribute its recordings.
 
                                      I-19
<PAGE>   22
 
     WMI operates a plant in Germany that manufactures CDs, laser discs and
vinyl records for its affiliated companies, as well as for outside companies
and, as part of a joint venture, operates a plant in Australia that also
manufactures CDs. WMI operates two video companies that coordinate the
international release of music and non-music video titles.
 
     Among the artists whose albums resulted in significant sales for WMI in
1998 were Madonna, Enya, Alejandro Sanz, Eric Clapton and Tatsuro Yamashita.
 
                                MUSIC PUBLISHING
 
     WMG's music publishing companies own or control the rights to more than one
million musical compositions, including numerous pop music hits, American
standards, folk songs, and motion picture and theatrical compositions. The
catalogue includes works from a diverse range of artists and composers,
including Phil Collins, Comden & Green, George and Ira Gershwin, Michael
Jackson, Madonna and Cole Porter. Warner/Chappell also administers the music of
several television and motion picture companies, including Lucasfilm, Ltd. and
Samuel Goldwyn Productions.
 
     Warner/Chappell also owns Warner Bros. Publications and CPP/Belwin, two of
the world's largest publishers of printed music. These two companies market
publications throughout the world containing the works of such artists as
Alabama, The Grateful Dead, Led Zeppelin, Madonna, Bob Seger and many others.
 
     The principal source of revenues to Warner/Chappell is license fees paid
for the use of its musical compositions on radio, television, in motion pictures
and in other public performances; royalties for the use of its compositions on
CDs, audio cassettes, music videos and in television commercials; and sales of
published sheet music and song books.
 
                           OTHER ENTERTAINMENT ASSETS
 
THEME PARKS
 
     With local partners, Warner Bros. has developed movie-related theme parks
in Australia and Germany which feature Warner Bros.' movie, cartoon and
superhero characters. Warner Bros. has announced that it is studying the
feasibility of operating the first movie-based theme park in Spain.
 
     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. 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 25 existing and
all future locations. See also Item 3, "Legal Proceedings" for information about
certain litigation involving Six Flags.
 
DC COMICS AND MAD MAGAZINE
 
     TWE and Warner Communications Inc. ("WCI"), which is wholly owned by Time
Warner, each own a 50% interest in DC Comics. DC Comics publishes more than 60
regularly issued comics magazines, among the most popular of which are
"Superman," "Batman," "Wonder Woman" and "The Sandman," as well as collections
sold as books. DC Comics also derives revenues from motion pictures, television,
product licensing, books for juvenile and adult markets and foreign publishing.
 
     Time Warner wholly owns E.C. Publications, Inc., the publisher of MAD, a
magazine featuring articles of humorous and satirical interest, which is
regularly published 12 times a year and also in periodic special editions.
 
                                      I-20
<PAGE>   23
 
                                  COMPETITION
 
     The production and distribution of theatrical motion pictures, television
and animation product and videocassettes/videodiscs/DVDs are highly competitive
businesses, as each competes with the other for viewers' attention, as well as
with other forms of entertainment and leisure time activities, including video
games, the Internet and other computer-related activities. Furthermore, there is
increased competition in the television industry evidenced by the increasing
number and variety of broadcast networks and basic cable and pay television
services now available. There is active competition among all production
companies in these industries for the services of producers, directors, actors
and others and for the acquisition of literary properties. With respect to the
distribution of television product, there is significant competition from
independent distributors as well as major studios. Revenues for filmed
entertainment product depend in part upon general economic conditions, but the
competitive position of a producer or distributor is still greatly affected by
the quality of, and public response to, the entertainment product it makes
available to the marketplace. Network television is extremely competitive as
networks seek to attract audience share, television stations for affiliation,
advertisers and broadcast rights to television programming. Warner Bros.
competes in its character merchandising and other licensing and retail
activities with other licensors and retailers of character, brand and celebrity
names. Warner Bros.' operation of theaters is subject to varying degrees of
competition with respect to obtaining films and attracting patrons.
 
     The recorded music business is highly competitive. The revenues of a
company in the recording industry depend upon public acceptance of the company's
recording artists and their music. Although WMG is one of the largest recorded
music companies in the world, its competitive position is dependent on its
continuing ability to attract and develop talent that can achieve a high degree
of public acceptance. Overexpansion of retail recorded music outlets in the U.S.
over the past several years led to the closing of many such stores during 1996
and 1997, which has resulted in further increased competition among recorded
music companies. The recorded music business continues to be adversely affected
by counterfeiting of both audio cassettes and CDs, piracy and parallel imports
and may be affected by consumers' ability to download quality sound
reproductions from the Internet in sound files without authorization from the
Company. In response, the recorded music industry is engaged in a coordinated
effort to develop a secure technology for digital music delivery. In addition,
the recorded music business also has competition from other forms of
entertainment, such as television, pre-recorded videocassettes, the Internet and
computer and video games. Competition in the music publishing business is
intense. Although WMG's music publishing business is one of the largest on a
worldwide basis, it competes with every other music publishing company in
acquiring musical compositions and in having them recorded and performed.
 
                                      I-21
<PAGE>   24
 
                                     CABLE
 
     The Company's Cable business consists principally of interests in cable
television systems that, in general, are managed by Time Warner Cable, a
division of TWE. Of the approximately 12.6 million subscribers served by the
Company at December 31, 1998, approximately 1.8 million are in systems owned by
TWI Cable Inc. ("TWI Cable"), a wholly owned subsidiary of Time Warner which is
not a part of TWE, and approximately 10.8 million are in systems owned or
managed by TWE. TWE's cable systems include approximately 6.3 million
subscribers in a joint venture between TWE and Advance/Newhouse known as
TWE-A/N. Time Warner Cable generally manages all such systems and receives a fee
for management of the systems owned by TWI Cable and TWE-A/N. As of March 1,
1999, TWE-A/N was owned 33.3% by Advance/Newhouse, 64.8% by TWE and 1.9% by TWI
Cable.
 
                               SYSTEMS OPERATIONS
 
     Time Warner Cable is the largest operator of cable television systems in
the United States. As of December 31, 1998, 82% of Time Warner Cable customers
were served by clustered cable systems (as described below) with 100,000
subscribers or more, and approximately 70% of Time Warner Cable's systems have
been upgraded for higher channel capacity and new and advanced services.
 
     Over the past several years, Time Warner Cable has pursued a strategic goal
of upgrading its cable systems generally to 750 MHz capability, based on a
hybrid fiber optic/coaxial cable architecture. Those systems not upgraded to 750
MHz will be upgraded to a level of 550 MHz. Upgraded systems can deliver
increased channel capacity and provide two-way transmission capability, with
improved network management systems. The system architecture is also flexible,
in that system capacity for future needs can be expanded by various means
without major additional capital expenditures.
 
     Approximately 70% of Time Warner Cable's systems had completed upgrades by
December 31, 1998. These upgrades have enabled Time Warner Cable to expand its
core cable programming, so that average channel capacity of Time Warner Cable
systems has generally increased from approximately 50 channels to approximately
70 channels at the end of 1998. Over time, the upgrading will also permit Time
Warner Cable to roll out new and advanced services, including digital and
high-definition television ("HDTV") programming, high-speed Internet access,
telephony and other services including video-on-demand. See "Cable -- New Cable
Services" below.
 
     Time Warner Cable entered into a Social Contract with the Federal
Communications Commission ("FCC") in 1996 that required upgrades of generally
all domestic systems managed by Time Warner Cable by December 31, 2000. The
total capital investment to be made by Time Warner Cable for the upgrades is
estimated to be approximately $4 billion of which, by the end of 1998,
approximately $3 billion had been spent.
 
     Time Warner Cable believes that its clustering strategy has enabled, among
other things, significant cost and marketing efficiencies, more effective
pursuit of local and regional cable advertisers, the development of local news
channels and the roll-out of advanced services over a geographically
concentrated customer base. Several transactions entered into or completed in
1998 or scheduled to close in 1999 will further Time Warner Cable's clustering
strategy. As of December 31, 1998, Time Warner Cable had 33 distinct geographic
system groupings, each serving more than 100,000 subscribers.
 
     During 1998, TWE-A/N and subsidiaries of TCI Communications Inc. ("TCIC")
formed a new 50-50 joint venture (the "Texas Venture") to provide cable
television to the Houston area and to certain other communities in south and
west Texas. The two partners each contributed systems serving approximately
550,000 subscribers to the Texas Venture, which is managed by Time Warner Cable.
TCIC also contributed a cable television system serving approximately 95,000
subscribers to the existing Kansas City Cable Partners joint venture. In
November 1998, Time Warner Cable entered into a series of asset exchange
agreements with certain subsidiaries of TCIC under which TCIC will receive
systems serving approximately 575,000 subscribers in areas not strategic to Time
Warner Cable and Time Warner Cable will receive systems serving approximately
625,000 subscribers adjacent to or near major clusters in Florida, Hawaii,
Maine, New York,
                                      I-22
<PAGE>   25
 
Ohio, Texas and Wisconsin. These trades are expected to close periodically
throughout 1999, subject to obtaining required regulatory approvals.
 
FRANCHISES
 
     Cable systems are constructed and operated under non-exclusive franchises
granted by state or local governmental authorities. Franchises typically contain
many conditions, such as time limitations on commencement or completion of
construction; conditions of service, including number of channels, provision of
free services to schools and other public institutions; and the maintenance of
insurance and indemnity bonds. Cable franchises are subject to various federal,
state and local regulations. See "Regulation and Legislation" below.
 
PROGRAMMING
 
     Programming is generally made available to customers through programming
tiers, which are packages of different programming services provided for
prescribed monthly fees. The available analog channel capacity of Time Warner
Cable's systems has been expanding as system upgrades are completed. Digital
services will further increase the number of channels of video programming a
customer may elect to receive.
 
     Video programming available to customers includes local and distant
broadcast television signals, cable programming services like CNN, TNT and ESPN,
and premium cable services like HBO, Cinemax, Showtime and Starz! The terms and
conditions of carriage of programming services are generally established through
programming affiliation agreements with Time Warner Cable. Many programming
services impose a monthly license fee per subscriber upon the cable operator.
Programming costs generally have been increasing sharply in recent years and
depending on the terms of any specific agreement, the cost of providing any
cable programming service may continue to rise. While Time Warner Cable
sometimes has the right to cancel contracts, and can in any event refuse to
renew them, it is unknown whether the loss of any one popular supplier would
have a material adverse effect on Time Warner Cable's operations.
 
SERVICE CHARGES AND ADVERTISING
 
     Subscribers to the Company's cable systems are charged monthly fees based
on the level of service selected. The monthly prices for various levels of cable
television services (excluding services offered on a per-channel or per-program
basis) range generally from $8 to $30 for residential customers. Other services
offered include equipment rentals, for an additional monthly fee. A one-time
installation fee is generally charged for connecting subscribers to the cable
television system. Although regulation of certain cable programming rates is
scheduled to "sunset" on March 31, 1999, rates for "basic" programming and for
equipment and installation will continue to be regulated pursuant to federal
law. See "Regulation and Legislation" below.
 
     Subscribers may purchase premium programming services and, in certain
systems, other per-channel services, for an additional monthly fee for each such
service, with discounts generally available for the purchase of more than one
service. Pay-per-view programming offers movies and special events, such as
boxing, for a separate charge. Systems offering pay-per-view movies generally
charge between $3 and $4 per movie, and systems offering pay-per-view events
charge between $6 and $50, depending on the event. Time Warner Cable's systems
increasingly offer pay-per-view services on an "impulse" basis, permitting a
subscriber to place an order over the cable system through his or her remote
control or cable set-top box.
 
     Subscription revenues continue to account for most of Time Warner Cable's
revenues, with pay-per-view and premium services contributing additional
revenues. Subscribers may discontinue purchasing services at any time.
 
     Time Warner Cable also generates revenue by selling advertising time to
national, regional and local businesses. Cable television operators receive an
allocation of advertising time availabilities on certain cable programming
services into which commercials can be inserted at the local system level. In
this regard, Time Warner Cable competes against broadcast TV stations, radio
stations and newspapers for a share of local media revenues. The clustering of
Time Warner Cable's systems expands the reach of viewers to cable
 
                                      I-23
<PAGE>   26
 
programs over the local area and helps local ad sales personnel to compete more
effectively. In addition, in many localities, contiguous cable system operators
have formed advertising interconnects to deliver locally inserted commercials
across wider geographic areas, replicating the reach of the broadcast stations
as much as possible. Fifteen of Time Warner Cable's 43 field divisions
participate in a cable advertising interconnect.
 
LOCAL NEWS CHANNELS
 
     Time Warner Cable operates 24-hour local news channels in New York City
(NY1 News), Tampa Bay (Bay News 9), Orlando (Central Florida News 13) and
Rochester, NY (R/News) and has announced that its fifth local news channel will
launch in Austin, Texas in the summer of 1999. Local news programming increases
local advertising revenues. Further, Time Warner Cable believes that providing
news programming specifically focused on a local region strengthens its ability
to compete with other multichannel video providers operating in the region.
 
                               NEW CABLE SERVICES
 
ROAD RUNNER
 
     In June 1998, TWE, TWE-A/N, TWI Cable, MediaOne, and subsidiaries of
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 online service business (the "Road Runner Joint Venture"). The Road
Runner cable service provides high-speed Internet access and also offers
original content for broadband-capable networks. Road Runner affiliates with
local cable television system operators, principally Time Warner Cable and
MediaOne, in exchange for a percentage of the cable operator's retail revenue
from subscribers for the Road Runner service. Customers who elect to subscribe
connect their personal computers to the Road Runner service for access at high
speeds to the Internet and to Road Runner's content.
 
     The ownership of the equity in the Road Runner Joint Venture is presently
as follows: TWI Cable -- 10.7%, TWE -- 25%, TWE-A/N -- 32.9%, and
MediaOne -- 31.4%. In exchange for Microsoft and Compaq contributing $425
million to the Road Runner Joint Venture, Microsoft and Compaq each received a
preferred equity interest in the Venture that is convertible into a 10% common
equity interest. Accordingly, on a fully diluted basis, the Road Runner Joint
Venture is owned 8.6% by TWI Cable, 20% by TWE, 26.3% by TWE-A/N, 25.1% by
MediaOne, 10% by Microsoft and 10% by Compaq. See also Note 2, "Cable
Transactions -- Road Runner Joint Venture" to the Company's consolidated
financial statements at page F-36 herein.
 
     As of December 31, 1998, the Road Runner Joint Venture had affiliations in
24 locations with access to 7 million cable homes and the service had
approximately 180,000 subscribers. The Road Runner service has been launched by
Time Warner Cable in the following areas: Albany, Austin, Binghamton, Charlotte,
Columbus and Northeast Ohio, El Paso, Hawaii, Memphis, Portland, Rochester, San
Diego, Syracuse and Tampa Bay. Roll-outs will continue during 1999.
 
DIGITAL CABLE SERVICES
 
     Following testing in 1998 and early 1999, Time Warner Cable will begin a
roll-out of digital cable service for certain of its cable systems, including
Austin, Texas, Tampa, Florida and Columbus, Ohio. The digital format of the
signals allows compression of the signals so that they occupy less bandwidth.
This substantially increases the number of channels that can be provided over a
system, when compared to standard analog signals. Time Warner Cable's digital
cable service will present customers with the option to subscribe to a new
digital programming service providing up to 100 digital program networks and
music services for a separate monthly fee. The programming on the digital
set-top boxes delivered to subscribing customers will also offer more
pay-per-view options, more channels of multiplexed premium services, a digital
interactive program guide, a digital programming tier, CD-quality music and
other features such as parental lockout options. Digital service roll-outs are
expected to increase over time as additional set-top equipment becomes
available.
                                      I-24
<PAGE>   27
 
HDTV
 
     Pursuant to FCC order, each television broadcast station has been granted
additional over-the-air spectrum to provide, under a prescribed roll-out
schedule, high definition and digital television signals to the public.
Depending on the speed with which HDTV and digital signals are developed, it can
be expected that such signals will vie with the many other sources of
programming for cable carriage. In 1998, Time Warner Cable agreed to carry the
high-definition television signals and other digital signals that will be
broadcast by television stations owned and operated by the CBS network.
 
                                 RECENT EVENTS
 
PROPOSED AT&T JOINT VENTURE
 
     On February 1, 1999, the Company announced that it intended to form a joint
venture with AT&T pursuant to which the joint venture will have the right for up
to a 20-year term to offer AT&T-branded cable telephone service to residential
and small business customers over Time Warner Cable's existing cable network.
Under the preliminary terms announced by the parties, the joint venture will be
77.5% owned by AT&T and 22.5% owned by TWE, TWE-A/N and TWI Cable, collectively.
The joint venture is expected to make payments to Time Warner Cable initially
based on the number of homes included in the cable network that have been
upgraded to fiber optic capacity and will pay a monthly fee during the term per
telephony subscriber, subject to guaranteed minimums, and is expected to make
future revenue sharing payments if the joint venture surpasses targeted monthly
subscriber revenue levels. The joint venture is also expected to purchase
telephony equipment and fund Time Warner Cable's expenses of installation and
maintenance. It is expected that AT&T will fund all of the joint venture's
negative cash flow. For additional information, see also "Management's
Discussion and Analysis of Results of Operations and Financial
Condition -- Cable Strategy" at pages F-16 through F-18 herein.
 
     The joint venture is subject to the negotiation and execution of definitive
agreements, approval of the final terms by MediaOne and Advance/Newhouse and
certain regulatory and other approvals.
 
PRIMESTAR
 
     In April 1998, TWE and Advance/Newhouse transferred the direct broadcast
satellite ("DBS") operations conducted by TWE and TWE-A/N and the 31%
partnership interest in Primestar Partners, L.P. held by TWE-A/N to Primestar,
Inc., a separate holding company ("Primestar"). Following Primestar's decision
to abandon its proposed acquisition of certain high-power satellite assets from
a joint venture between The News Corporation Ltd. and MCI Telecommunications
Corp., due to inability to obtain regulatory approvals, Primestar recently
entered into an agreement to sell Primestar's medium-power DBS business and
assets to DirecTV, a competitor of Primestar owned by Hughes Electronics Corp.
Also, Primestar, Primestar Partners, the stockholders of Primestar and Tempo
Satellite, Inc. ("Tempo"), a wholly owned subsidiary of TCI Satellite
Entertainment, Inc., entered into a second agreement with DirecTV, pursuant to
which DirecTV will purchase high-power satellites from Tempo and Primestar and
Primestar Partners will relinquish their respective rights to acquire or use
such high-power satellites.
 
     The ultimate disposition of the medium-power assets of Primestar is subject
to Primestar bondholders' and regulatory approvals and the disposition of
certain of Tempo's high-power satellites is subject to regulatory approvals.
There can be no assurance that such approvals will be obtained. For further
information with respect to Primestar, see Note 2, "Cable
Transactions -- Primestar" to the Company's consolidated financial statements at
pages F-36 and F-37 herein.
 
                                 INTERNATIONAL
 
     In France, TWE and TWE-A/N own 100% of Cite Reseau and 49.9% of Rhone
Vision Cable, both of which were established to acquire new franchises, build
and operate cable systems in France. In Japan, TWE and TWE-A/N beneficially own,
directly or indirectly, 25% of Titus Communications Corporation, which
                                      I-25
<PAGE>   28
 
provides cable, telephony and Internet access service primarily in the Tokyo
area, and 19.2% of Chofu Cable Television Company, which provides cable service
in the suburban Tokyo area.
 
                               BUSINESS TELEPHONY
 
     In July 1998, TWE, TWE-A/N and TWI Cable combined the business telephony
operations formerly owned by them into a new entity named Time Warner Telecom
LLC ("Time Warner Telecom") that is intended to be self-financing. Time Warner
Telecom is a facilities-based competitive local exchange carrier ("CLEC") that
offers a wide range of business telephony services in selected metropolitan
markets across the United States. The equity interests of Time Warner Telecom
are owned 61.98% by Time Warner, 18.85% by MediaOne and 19.17% by
Advance/Newhouse. In connection with its formation in July 1998, Time Warner
Telecom raised approximately $400 million in a public debt offering, the
proceeds of which are being used by Time Warner Telecom to further develop and
expand its telephony networks and services and for general corporate and working
capital purposes. In January 1999, Time Warner Telecom updated a previously
filed, preliminary registration statement with the Securities and Exchange
Commission to conduct an initial public offering of a minority interest of its
common stock, subject to market and other conditions.
 
     Time Warner Telecom's customers are principally medium and large-sized
telecommunications-intensive business end-users, long distance carriers,
Internet service providers, wireless communications companies and governmental
entities. Such customers are offered a wide range of integrated
telecommunications services, including dedicated transmission, local switched
data and video transmission services and certain Internet services. As of
December 31, 1998, Time Warner Telecom had deployed switches in 16 of its 19
metropolitan markets. Its networks have been constructed primarily through
licensing the use of fiber capacity from Time Warner Cable.
 
                                  COMPETITION
 
     Cable television systems face strong competition for viewer attention and
subscriptions from a wide variety of news, information and entertainment
providers. These include multichannel video providers like DTH, MMDS, SMATV
systems and telephone companies, other sources of video programs (such as
broadcast television and videocassettes) and additional sources for news,
entertainment and information, including the Internet. Cable television systems
also face strong competition from all media for advertising dollars.
 
     DTH.  The FCC has awarded permits to several companies for orbital slots
from which medium- or high-power Ku-Band DTH service can be provided. DTH
services offer pre-packaged programming services that can be received by
relatively small and inexpensive receiving dishes. As of June 1998,
satellite-delivered DTH services were reported to be serving over 7.2 million
subscribers. Echostar has announced that, unlike other DTH services, it will
deliver some local broadcast stations in some areas. In addition to DTH, most
cable programming is available to owners of larger, more expensive C-Band
satellite dishes ("TVROs"), either directly from the programmers or through
third-party packagers. Legislation has been introduced in Congress to include
carriage of local signals by DTH providers under the copyright compulsory
license now granted to cable television operators. The ability of DTH services
to deliver local signals on an equal economic basis will eliminate a significant
advantage that cable operators currently have over DTH providers.
 
     MMDS/Wireless Cable.  Wireless cable operators, including digital wireless
operators, use microwave technology to distribute video programming. Wireless
cable has grown rapidly, reportedly servicing over 1.0 million subscribers
nationwide as of June 1998. In recent years, the FCC has adopted rules to
facilitate the use of greater numbers of channels by wireless cable operators.
 
     SMATV.  Additional competition comes from private cable television systems
servicing condominiums, apartment complexes and certain other multiple unit
residential developments. The operators of these private systems, known as SMATV
systems, often enter into exclusive agreements with apartment building owners or
homeowners' associations which preclude franchised cable television operators
from serving residents of such private complexes. Under the 1996
Telecommunications Act, a SMATV system is not a cable system as long
                                      I-26
<PAGE>   29
 
as it uses no public right-of-way. SMATV systems offer both improved reception
of local television stations and many of the same satellite-delivered program
services as offered by franchised cable television systems.
 
     Overbuilds.  Under the 1992 Cable Act, franchising authorities are
prohibited from unreasonably refusing to award additional franchises. There are
an increasing number of overlapping cable systems operating in Time Warner Cable
franchise areas. Municipalities themselves are authorized to operate cable
systems without a franchise. One municipally-owned system is presently in
operation in a Time Warner Cable franchise area and several other municipalities
have indicated an interest in operating a cable system.
 
     Telephone Companies.  The 1996 Telecommunications Act eliminated the
restriction against ownership and operation of cable systems by local telephone
companies within their local exchange service areas (subject to the restriction
against acquisition of greater than 10% of existing cable systems described
under "Regulation and Legislation -- Ownership," below). Telephone companies are
now free to enter the retail video distribution business through any means, such
as DTH, MMDS, SMATV or as traditional franchised cable system operators.
Alternatively, the 1996 Telecommunications Act authorizes local telephone
companies to operate "open video systems" subject to certain local
authorizations, including payments to local governmental bodies in lieu of cable
franchise fees.
 
     Additional Competition.  In addition to multichannel video providers, cable
television systems compete with all other sources of news, information and
entertainment for viewer attention and for subscription revenues. This includes
over-the-air television broadcast signals which a viewer is able to receive
directly using the viewer's own television set and antenna. Cable systems also
face competition from alternative methods of distributing and receiving
television signals and from other sources of entertainment such as live sporting
events, movie theaters and home video products, including videocassette
recorders, and the Internet. In recent years, the FCC has adopted policies
providing for authorization of new technologies and a more favorable operating
environment for certain existing technologies that provide, or may provide,
substantial additional competition for cable television systems.
 
                           REGULATION AND LEGISLATION
 
     The Company's cable television systems, cable network, television network
and original programming businesses are subject, in part, to regulation by the
FCC, and the cable television systems business is also subject to regulation by
some state governments and substantially all local governments. The following is
a summary of current federal laws and regulations affecting the growth and
operation of these businesses and a description of certain state and local laws.
In addition, various legislative and regulatory proposals under consideration
from time to time by Congress and various federal agencies have in the past
materially affected, and may in the future materially affect, the Company.
 
                         PROGRAMMING AND CABLE NETWORKS
 
     The Telecommunications Competition and Deregulation Act of 1996 (the "1996
Telecommunications Act") eliminated the restrictions on the number of television
stations that one entity may own and increased the national audience reach
limitation by one entity from 25% to 35% of U.S. television households. As
required by the 1996 Telecommunications Act, the FCC revised its dual network
rule to allow a TV station to affiliate with an entity maintaining two or more
networks, unless certain limited circumstances pertain.
 
     The FCC rules currently prohibit an entity from having an attributable
interest in two local TV stations with overlapping specified signal contours. In
an ongoing rulemaking proceeding, the FCC has proposed to relax this rule in
certain circumstances and sought comment on a possible waiver mechanism. In
another rulemaking, the FCC has sought comment on possible changes to its
attribution rules, which define the type of interests in television stations
that are recognizable for purposes of its ownership rules. Under one such
proposal, certain currently nonattributable debt or passive equity interests
would become attributable if held in conjunction with certain other interests in
or relationships with the TV licensee, such as the provision of programming.
Such a proposal, if adopted, could adversely affect The WB's efforts to add new
television stations as affiliates.
                                      I-27
<PAGE>   30
 
     Under the 1992 Cable Act, the FCC has issued regulations which generally
prohibit vertically integrated programmers, which currently include the Turner
Networks and the Home Box Office Services, from offering different prices,
terms, or conditions to competing multichannel video programming distributors
unless the differential is justified by certain permissible factors set forth in
the regulations. The rules also place certain restrictions on the ability of
vertically integrated programmers to enter into exclusive distribution
arrangements with cable operators.
 
     The 1996 Telecommunications Act also contains certain provisions relating
to violent and sexually explicit programming. First, the statute requires
manufacturers to build television sets with the capability of blocking certain
coded programming (the so-called "V-chip"). The FCC has adopted rules requiring
television manufacturers to include blocking technology in at least half of
their new product models with a picture screen of 13 inches or greater by July
1, 1999; the remaining such models will be required to contain blocking
technology by January 1, 2000. Second, the 1996 Telecommunications Act gave the
cable and broadcasting industries one year to develop voluntary ratings for
video programming containing violent, sexually explicit or other indecent
content and to agree voluntarily to transmit signals containing such ratings. In
March 1998, the FCC determined that the system of voluntary parental guidelines
adopted by television broadcasters, networks and program producers, and cable
systems and networks, was acceptable and in compliance with the 1996
Telecommunications Act.
 
                                     CABLE
 
     The following discussion summarizes the significant federal, state and
local laws and regulations affecting the Company's cable television systems
operations.
 
     Federal Laws.  The Cable Communications Policy Act of 1984 ("1984 Cable
Act"), the 1992 Cable Act and the 1996 Telecommunications Act are the principal
federal statutes governing the cable industry. These statutes regulate the cable
industry, among other things, with respect to: (i) cable system rates for both
basic and certain nonbasic services; (ii) programming access and exclusivity
arrangements; (iii) access to cable channels for public, educational and
governmental programming; (iv) leased access terms and conditions; (v)
horizontal and vertical ownership of cable systems; (vi) consumer protection and
customer service requirements; (vii) franchise renewals; (viii) television
broadcast signal carriage requirements and retransmission consent; (ix)
technical standards; and (x) privacy of customer information.
 
     Federal Regulations.  The FCC, the principal federal regulatory agency with
jurisdiction over cable television, has promulgated regulations implementing the
federal statutes.
 
     Rate Regulation.  Under federal laws, nearly all cable television systems
are subject to local rate regulation of basic service pursuant to a formula
established by the FCC and enforced by local franchising authorities.
Additionally, the 1992 Cable Act required the FCC to review rates for nonbasic
service tiers, known as "cable programming service tiers" ("CPST"), comprised of
cable programming services other than per-channel or per-program services, in
response to complaints filed by franchising authorities; prohibited cable
television systems from requiring subscribers to purchase service tiers above
basic service in order to purchase premium service if the system is technically
capable of doing so; required the FCC to adopt regulations to establish, on the
basis of actual costs, the price for installation of cable service and rental of
cable equipment; and allowed the FCC to impose restrictions on the retiering and
rearrangement of basic and CPST services under certain limited circumstances.
 
     Under the 1996 Telecommunications Act, regulation of CPST rates is
scheduled to terminate on March 31, 1999. Regulation of both basic and CPST
rates also ceases for any cable system subject to "effective competition." The
1996 Telecommunications Act expanded the definition of "effective competition"
to cover situations where a local telephone company or its affiliate, or any
multichannel video provider using telephone company facilities, offers
comparable video service by any means except direct-to-home ("DTH"). The FCC has
found Time Warner Cable to be subject to "effective competition" in certain
jurisdictions.
 
                                      I-28
<PAGE>   31
 
     The FCC's rate regulations employ a benchmark system for measuring the
reasonableness of existing basic and CPST service rates. Alternatively, cable
operators have the opportunity to make cost-of-service showings which, in some
cases, may justify rates above the applicable benchmarks. The regulations also
provide that future rate increases may not exceed an inflation-indexed amount,
plus increases in certain costs beyond the cable operator's control, such as
taxes, franchise fees and programming costs. Cost-based adjustments to these
capped rates can also be made in the event a cable operator adds or deletes
channels or significantly upgrades its system. In addition, new product tiers
consisting of services new to the cable system can be created free of rate
regulation as long as certain conditions are met, e.g., services may not be
moved from existing tiers to the new product tier. The rules also require that
charges for cable-related equipment (e.g., converter boxes and remote control
devices) and installation be unbundled from the provision of cable service and
based upon actual costs plus a reasonable profit.
 
     Local franchising authorities and/or the FCC are empowered to order a
reduction of existing rates that exceed the maximum permitted level for either
basic and/or CPST services and associated equipment, and refunds can be
required.
 
     In 1996, the FCC adopted a Social Contract with Time Warner Cable which
resolved all of the cable television rate complaints then pending against Time
Warner Cable and requires Time Warner Cable to upgrade its domestic cable
television systems. The Social Contract was negotiated in accordance with the
FCC's authority to consider and adopt "social contracts" as alternatives to
other regulatory approaches applicable to cable television rates. Specifically,
the Social Contract provides for an estimated $4.7 million plus interest in
refunds in the form of bill credits to subscribers of certain designated Time
Warner Cable systems, a commitment by Time Warner Cable to establish a lifeline
basic service priced at 10% below Time Warner Cable's benchmark regulated rates
with an adjustment to the nonbasic tier to recoup the reduced basic service tier
revenue; and a commitment by Time Warner Cable to upgrade its domestic systems
by December 31, 2000. Time Warner Cable is allowed to increase the non-basic
service tier by $1.00 per year over the term of the Social Contract. At Time
Warner Cable's election, the Social Contract's limitation on non-basic service
tier rates would no longer be effective after March 31, 1999. Court appeals that
were filed seeking review of the FCC decision adopting the Social Contract have
all been resolved. An appeal filed by Middletown Township, PA in 1999 remains
pending but is limited to the question whether Time Warner Cable owes refunds to
subscribers in that Township.
 
     Carriage of Broadcast Television Signals.  The 1992 Cable Act allows
commercial television broadcast stations that are "local" to a cable system to
elect every three years either to require the cable system to carry the station,
subject to certain exceptions, or to negotiate for "retransmission consent" to
carry the station. Broadcast stations may seek monetary compensation or the
carriage of additional programming in return for granting retransmission
consent. Local non-commercial television stations are also given mandatory
carriage rights, subject to certain exceptions. Unlike commercial stations,
non-commercial stations are not given the option to require negotiation of
retransmission consent. In addition, cable systems must obtain retransmission
consent for the carriage of all "distant" commercial broadcast stations, except
for certain "superstations," i.e., commercial satellite-delivered independent
stations such as WGN. Time Warner Cable has obtained any necessary
retransmission consents from all stations carried, which consents have varying
expiration dates. In those cases where the expiration date of particular
agreements has not been contractually varied from the original schedule set up
by the 1992 Act, the next three-year election between mandatory carriage and
retransmission consent for local commercial television stations will occur on
October 1, 1999.
 
     Deletion of Certain Programming.  Cable television systems that serve 1,000
or more customers must delete the simultaneous or nonsimultaneous network
programming of a distant station upon the appropriate request of a local
television station holding local exclusive rights to such programming. FCC
regulations also enable television broadcast stations that have obtained
exclusive distribution rights for syndicated programming in their market to
require a cable system to delete or "black out" such programming from non-local
television stations which are carried by the cable system.
 
                                      I-29
<PAGE>   32
 
     Public and Leased Access Channels.  The 1984 Cable Act permits local
franchising authorities to require operators to set aside certain channels for
public, educational and governmental access programming. The 1984 Cable Act
further requires cable television systems with thirty-six or more activated
channels to designate a portion of their channel capacity for commercial leased
access by unaffiliated third parties. The 1992 Cable Act requires leased access
rates to be set according to a formula determined by the FCC.
 
     Ownership.  The 1996 Telecommunications Act repealed the 1984 Cable Act's
restrictions on local exchange telephone companies ("LECs") from providing video
programming directly to customers within their local exchange telephone service
areas. With certain limited exceptions, a LEC may not acquire more than a 10%
equity interest in an existing cable system operating within the LEC's service
area. The 1996 Telecommunications Act also authorized LECs and others to operate
"open video systems" ("OVS") which are not subject to the full array of
regulatory obligations imposed on traditional cable systems, although OVS
operators can be required to obtain a franchise by a local governmental body
and/or to make payments in lieu of cable franchise fees. A number of separate
entities have been certified to operate open video systems in areas where the
Company operates cable systems, including New York City.
 
     The 1996 Telecommunications Act eliminated the FCC rule prohibiting common
ownership between a cable system and a national broadcast television network,
and the statutory ban covering certain common ownership interests, operation or
control between a television station and cable system within the station's Grade
B signal coverage area. However, the parallel FCC rule against cable/television
station cross-ownership remains in place, subject to the outcome of a pending
review by the FCC. Time Warner Cable obtained a temporary waiver from this rule,
and has sought a permanent waiver, so that it could continue to own certain
Atlanta area cable systems located within the Grade B signal coverage area of
television station WTBS. The FCC denied the permanent waiver request, but that
denial is presently stayed pending resolution of a petition for reconsideration.
This matter will be rendered moot upon consummation of a proposed exchange of
cable systems with MediaOne. Finally, the 1992 Cable Act prohibits common
ownership, control or interest in cable television systems and MMDS facilities
or SMATV systems having overlapping service areas, except in limited
circumstances. The 1996 Telecommunications Act exempts cable systems facing
"effective competition" from the MMDS and SMATV cross-ownership restrictions.
 
     The FCC has initiated a rulemaking proceeding in which it asks what
restrictions, if any, should be placed on a cable operator's ownership of a DTH
service. This could affect Time Warner, in that TWE has an ownership interest in
Primestar, a DTH service. This concern would no longer exist if the proposed
sale of Primestar to DirectTV is consummated. See "Cable -- Primestar," above.
 
     The 1992 Cable Act directed the FCC to adopt so-called subscriber-limit
rules, establishing reasonable limits on the number of cable subscribers an
operator may reach through systems in which it holds an attributable interest.
The FCC has promulgated a rule imposing a limit of 30% of homes passed, but it
is currently conducting further rulemaking proceedings in which it may revisit
the substance of that rule. Pursuant to the 1992 Cable Act, the FCC has also
adopted so-called channel-occupancy rules that, with certain exceptions,
preclude a cable television system from devoting more than 40% of its first 75
activated channels to national video programming services in which the cable
system owner has an attributable interest. Time Warner Cable is a party to a
federal-court challenge to the validity of both the channel-occupancy rules and
the subscriber-limit rules. Pending this challenge, the FCC has voluntarily
stayed the effectiveness of the subscriber-limit rules (with the exception of
certain reporting requirements) but not the channel-occupancy rules.
 
     Other FCC Regulations. Additional FCC regulations relate to a cable
system's carriage of local sports programming; privacy of customer information;
equipment compatibility; franchise transfers; franchise fees; closed captioning;
equal employment opportunity; pole attachments; restrictions on origination and
cablecasting by cable system operators; application of the rules governing
political broadcasts; customer service; technical standards; home wiring; and
limitations on advertising contained in nonbroadcast children's programming.
Pursuant to the 1996 Telecommunications Act, the FCC changed the formula for
pole attachment fees which will result in substantial increases in payments by
cable operators to utilities for pole
 
                                      I-30
<PAGE>   33
 
attachment rights when telecommunications services are delivered by cable
systems. This new higher rate formula will be phased in beginning in February
2001.
 
     Copyright.  Cable television systems are subject to federal copyright
licensing covering carriage of broadcast signals. In exchange for making
semi-annual payments to a federal copyright royalty pool and meeting certain
other obligations, cable operators obtain a statutory license to retransmit
broadcast signals. The amount of this royalty payment varies, depending on the
amount of system revenues from certain sources, the number of distant signals
carried, and the location of the cable system with respect to over-the-air
television stations.
 
     State and Local Regulation.  Because a cable television system uses local
streets and rights-of-way, cable television systems are subject to local
regulation, typically imposed through the franchising process, and certain
states have also adopted cable television legislation and regulations. Cable
franchises are nonexclusive, granted for fixed terms and usually terminable if
the cable operator fails to comply with material provisions. No Time Warner
Cable franchise has been terminated due to breach. Franchises usually call for
the payment of fees (which are limited under the 1984 Cable Act to 5% of the
system's gross revenues from cable service) to the granting authority. The terms
and conditions of cable franchises vary materially from jurisdiction to
jurisdiction, and even from city to city within the same state, historically
ranging from reasonable to highly restrictive or burdensome.
 
     The 1992 Cable Act prohibits exclusive franchises and allows franchising
authorities to operate their own multichannel video distribution system without
having to obtain a franchise.
 
     The 1996 Telecommunications Act provides that local franchising authorities
may not condition the grant or renewal of a cable franchise on the provision of
telecommunications service or facilities (other than institutional networks) and
clarifies that the calculation of franchise fees is to be based solely on
revenues derived from the provision of cable services, not revenues derived from
telecommunications services.
 
     Renewal of Franchises.  The 1984 Cable Act established renewal procedures
and criteria designed to protect incumbent franchisees against arbitrary denials
of renewal. While these formal procedures are not mandatory unless timely
invoked by either the cable operator or the franchising authority, they can
provide substantial protection to incumbent franchisees. The 1992 Cable Act
makes several changes to the renewal process which could make it easier in some
cases for a franchising authority to deny renewal.
 
     In the renewal process, a franchising authority may seek to impose new and
more onerous requirements, such as upgraded facilities, increased channel
capacity or enhanced services, although the municipality must take into account
the cost of meeting such requirements. Time Warner Cable may be required to make
significant additional investments in its cable television systems as part of
the franchise renewal process. Of Time Warner Cable's franchises, as of January
1, 1999, approximately 180 franchises serving approximately 580,000 subscribers
expire during the period ending December 31, 2001. Although Time Warner Cable
has been successful in the past in negotiating new franchise agreements, there
can be no assurance as to the renewal of franchises in the future.
 
     The foregoing does not describe all present and proposed federal, state and
local regulations and legislation relating to the cable television industry.
Other existing federal regulations, copyright licensing and, in many
jurisdictions, state and local franchise requirements, currently are the subject
of a variety of judicial proceedings, legislative hearings and administrative
and legislative proposals which could change, in varying degrees, the manner in
which cable television systems operate.
 
                               FTC CONSENT DECREE
 
     As a result of the TBS Transaction, the Company is subject to a Consent
Decree (the "FTC Consent Decree") entered into with the Federal Trade Commission
("FTC"), certain provisions of which impose limitations on the Company's
business conduct with respect to the sale of certain of its cable programming
services. These provisions, among other things, prohibit the Company from
increasing the pre-TBS Transaction pricing ratios which existed between large
and small distributors in geographic areas also served by Time
 
                                      I-31
<PAGE>   34
 
Warner Cable. In addition, under the terms of the FTC Consent Decree, Time
Warner Cable is required to carry on a significant number of its cable systems a
24-hour per day news and information channel that is not owned, controlled by or
affiliated with the Company. Compliance with the FTC Consent Decree is not
expected to cause an undue financial burden on the Company.
 
                           NEW COPYRIGHT LEGISLATION
 
     In 1998 two important pieces of federal legislation were enacted that will
benefit the Company's businesses: The Sonny Bono Copyright Term Extension Act
extends the term of copyright protection in the United States by 20 years, and
the Digital Millennium Copyright Act ("DMCA") prohibits the circumvention of
copy protection technologies and establishes rules with respect to the liability
of online service providers for copyright infringements when users or
subscribers transmit or provide infringing material.
 
                                      I-32
<PAGE>   35
 
                         DESCRIPTION OF AGREEMENT WITH
                           LIBERTY MEDIA CORPORATION
 
     The following description summarizes certain provisions of the Company's
agreement with Liberty Media Corporation (an affiliate of TCI) and certain of
its subsidiaries (collectively, "LMC") that was entered into in connection with
the TBS Transaction and the FTC Consent Decree. Such description does not
purport to be complete and is subject to, and is qualified in its entirety by
reference to, the provisions of the Second Amended and Restated LMC Agreement
dated as of September 22, 1995 among the Company, Time Warner Companies, Inc.
and LMC (the "LMC Agreement").
 
OWNERSHIP OF TIME WARNER COMMON STOCK
 
     Pursuant to the LMC Agreement, immediately following consummation of the
TBS Transaction, LMC exchanged the 50.6 million shares of Time Warner common
stock, par value $.01 per share ("Time Warner Common Stock"), received by LMC in
the TBS Transaction on a one-for-one basis for 50.6 million shares of Series
LMCN-V Common Stock. In June 1997, LMC and its affiliates received 6.4 million
additional shares of Series LMCN-V Common Stock pursuant to the provisions of an
option agreement between the Company and LMC and its affiliates. Each share of
Series LMCN-V Common Stock receives the same dividends and otherwise has the
same rights as two shares of Time Warner Common Stock except that (a) holders of
Series LMCN-V Common Stock are entitled to 1/50th of a vote per share on the
election of directors and do not have any other voting rights, except as
required by law or with respect to limited matters, including amendments to the
terms of the Series LMCN-V Common Stock adverse to such holders, and (b) unlike
shares of Time Warner Common Stock, shares of Series LMCN-V Common Stock are not
subject to redemption by the Company if necessary to prevent the loss by the
Company of any governmental license or franchise. The Series LMCN-V Common Stock
is not transferable, except in limited circumstances, and is not listed on any
securities exchange.
 
     LMC exchanged its shares of Time Warner Common Stock for Series LMCN-V
Common Stock in order to comply with the FTC Consent Decree, which effectively
prohibits LMC and its affiliates (including TCI) from owning voting securities
of the Company other than securities that have limited voting rights. Each share
of Series LMCN-V Common Stock is convertible into two shares of Time Warner
Common Stock at any time when such conversion would no longer violate the FTC
Consent Decree or have a Prohibited Effect (as defined below), including
following a transfer to a third party.
 
OTHER AGREEMENTS
 
     Under the LMC Agreement, if the Company takes certain actions that have the
effect of (a) making the continued ownership by LMC of the Company's equity
securities illegal under any federal or state law, (b) imposing damages or
penalties on LMC under any federal or state law as a result of such continued
ownership, (c) requiring LMC to divest any such Company equity securities, or
(d) requiring LMC to discontinue or divest any business or assets or lose or
significantly modify any license under any communications law (each a
"Prohibited Effect"), then the Company will be required to compensate LMC for
income taxes incurred by it in disposing of all the Company's equity securities
received by LMC in connection with the TBS Transaction and related agreements
(whether or not the disposition of all such equity securities is necessary to
avoid such Prohibited Effect).
 
     The agreements described in the preceding paragraph may have the effect of
requiring the Company to pay amounts to LMC in order to engage in (or requiring
the Company to refrain from engaging in) activities that LMC would be prohibited
under the federal communications laws from engaging in. Based on the current
businesses of the Company and LMC and based upon the Company's understanding of
applicable law, the Company does not expect these requirements to have a
material effect on its business.
 
                                      I-33
<PAGE>   36
 
                    DESCRIPTION OF CERTAIN PROVISIONS OF THE
                           TWE PARTNERSHIP AGREEMENT
 
     The following description summarizes certain provisions of the TWE
Partnership Agreement relating to the ongoing operations of TWE. Such
description does not purport to be complete and is subject to, and is qualified
in its entirety by reference to, the provisions of the TWE Partnership
Agreement.
 
MANAGEMENT AND OPERATIONS OF TWE
 
     Partners.  Upon the capitalization of TWE in June 1992, certain
subsidiaries of the Company became the general partners (the "Class B Partners"
or the "Time Warner General Partners") of TWE and subsidiaries of Itochu
Corporation ("ITOCHU") and Toshiba Corporation ("Toshiba") became limited
partners of TWE (the "Class A Partners"). A subsidiary of MediaOne (formerly US
West) was admitted as a Class A Partner in September 1993. In 1995, Time Warner
acquired the limited partnership interests of Itochu and Toshiba. Consequently,
the limited partnership interests in TWE are held by the Class A Partners
consisting of MediaOne and wholly owned subsidiaries of the Company and the
general partnership interests in TWE are held by the Class B Partners consisting
of wholly owned subsidiaries of the Company.
 
     Board of Representatives.  Subject to the authority of the Cable Management
Committee (as described below) with respect to the Cable division, the business
and affairs of TWE are managed under the direction of a board of representatives
(the "Board of Representatives" or the "Board") that is comprised of
representatives appointed by subsidiaries of Time Warner (the "Time Warner
Representatives") and representatives appointed by MediaOne (the "MediaOne
Representatives").
 
     The Time Warner Representatives control all Board decisions except for
certain matters including (i) the merger or consolidation of TWE; (ii) the sale
or other disposition of assets of TWE generating in excess of 10% of the
consolidated revenues of TWE during the previous fiscal year or representing in
excess of 10% of the fair market value of the total assets of TWE (in each case,
other than in connection with certain joint ventures and "cable asset swaps" as
to which the thresholds are greater); (iii) any acquisition by TWE, other than
in the ordinary course of business, if the consideration paid by TWE in
connection with such acquisition would exceed the greater of (1) $750 million
and (2) 10% of the consolidated revenues of TWE for the most recently ended
fiscal year of TWE; (iv) the engagement by TWE in any business other than the
businesses then being conducted by TWE, as they may evolve from time to time and
any business related to such businesses (provided that TWE may not engage in the
manufacturing, sale or servicing of hardware, other than as may be incidental to
TWE's businesses); (v) the incurrence by TWE of indebtedness for money borrowed
if, after giving effect to such incurrence, the ratio of total indebtedness for
money borrowed to cash flow would exceed the greater of (x) 5.00 to 1.00 and (y)
 .5 over the analogous ratio in the TWE credit agreement as in effect from time
to time; (vi) cash distributions other than as provided in the TWE Partnership
Agreement; (vii) the dissolution or voluntary bankruptcy of TWE; and (viii) any
amendment to the TWE Partnership Agreement, which matters also require the
approval of the MediaOne Representatives.
 
     The managing general partners, both of which are wholly owned subsidiaries
of Time Warner, may take any action without the approval or consent of the Board
if such action may be authorized by the Time Warner Representatives without the
approval of the MediaOne Representatives. However, see "Cable Management
Committee," below.
 
     Cable Management Committee.  Subject to obtaining necessary franchise and
other approvals, the businesses and operations of the cable television systems
("Cable Systems") of TWE and the TWE-A/N Partnership are governed by a Cable
Management Committee (the "Management Committee"). The Management Committee is
comprised of six voting members, three designated by MediaOne and three
designated by TWE. Advance/Newhouse has the right to designate a non-voting
member to the Management Committee. If MediaOne at any time owns less than 50%
of the partnership interest which it owned, directly or indirectly, as of
September 15, 1993 or if a "change in control" of MediaOne occurs, MediaOne's
right to designate or maintain any members of the Management Committee will
terminate. The Cable Systems are managed on a day-to-day basis by Time Warner
Cable. The approval of a majority of the members of the Management Committee is
required for certain significant transactions relating to the Cable Systems,
                                      I-34
<PAGE>   37
 
including, among other things, the sale, pledge or encumbrance of assets of any
Cable System, the acquisition of cable assets, the making of commitments or
expenditures relating to any Cable System, in each case subject to agreed upon
thresholds, certain decisions with respect to design, architecture and
designation of cable systems for upgrade and the adoption of the annual business
plan.
 
     Day-to-Day Operations.  TWE is managed on a day-to-day basis by the
officers of TWE, and each of TWE's three principal divisions is managed on a
day-to-day basis by the officers of such division. The officers of Time Warner
are also officers of TWE.
 
CERTAIN COVENANTS
 
     Covenant Not to Compete.  For so long as any partner (or affiliate of any
partner) owns in excess of 5% of TWE and in the case of any Time Warner General
Partner, for one year thereafter, such partner (including its affiliates) is
generally prohibited from competing or owning an interest in the three principal
lines of business of TWE -- cable, cable programming and filmed entertainment
(including the ownership and operation of theme parks) -- as such businesses may
evolve, subject to certain agreed upon exceptions (including TBS), limited
passive investments and inadvertent violations. The covenant not to compete does
not prohibit (i) MediaOne from conducting cable and certain regional programming
businesses in the 14-state region in which US WEST, Inc. provides telephone
service, (ii) any party from engaging in the cable business in a region in which
TWE is not then engaging in the cable business, subject to TWE's right of first
refusal with respect to such cable business, or (iii) any party from engaging in
the telephone or information services business. ITOCHU and Toshiba continue to
be bound by and benefit from the non-compete provisions but only as they relate
to Japan.
 
     Transactions with Affiliates.  Subject to agreed upon exceptions for
certain types of arrangements, TWE has agreed not to enter into transactions
with any partner or any of its affiliates other than on an arm's-length basis.
 
REGISTRATION RIGHTS
 
     Beginning on June 30, 2002 (or as early as June 30, 1999 if certain
threshold cash distributions are not made to the Class A Partners), the Class A
Partners holding, individually or in the aggregate, at least 10% of the residual
equity of TWE will have the right to request that TWE reconstitute itself as a
corporation and register for sale in a public offering an amount of partnership
interests held by such Class A Partners determined by an investment banking firm
so as to maximize trading liquidity and minimize the initial public offering
discount, if any. Upon any such request, the parties will cause an investment
banker to determine the price at which the interests sought to be registered
could be sold in a public offering (the "Appraised Value"). Upon determination
of the Appraised Value, TWE may elect either to register such interests or
purchase such interests at the Appraised Value, subject to certain adjustments.
If TWE elects to register the interests and the proposed public offering price
(as determined immediately prior to the time the public offering is to be
declared effective) is less than 92.5% of the Appraised Value, TWE will have a
second option to purchase such interests immediately prior to the time such
public offering would otherwise have been declared effective by the Securities
and Exchange Commission at the proposed public offering price less underwriting
fees and discounts. If TWE exercises its purchase option, it will be required to
pay the fees and expenses of the underwriters. Upon exercise of either purchase
option, TWE may also elect to purchase the entire partnership interests of the
Class A Partners requesting registration at the relevant price, subject to
certain adjustments.
 
     In addition to the foregoing, MediaOne will have the right to exercise an
additional demand registration right (in which the other Class A Partners would
be entitled to participate) beginning 18 months following the date on which TWE
reconstitutes itself as a corporation and registers the sale of securities
pursuant to a previously exercised demand registration right.
 
     At the request of any Time Warner General Partner, TWE will effect a public
offering of the partnership interests of the Time Warner General Partners or
reconstitute TWE as a corporation and register the shares held by the Time
Warner General Partners. In any such case, the Class A Partners will have
standard "piggy-back" registration rights.
                                      I-35
<PAGE>   38
 
     Upon any reconstitution of TWE into a corporation, each partner will
acquire preferred and common equity in the corporation corresponding in both
relative value, rate of return and priority to the partnership interests it held
prior to such reconstitution, subject to certain adjustments to compensate the
partners for the effects of converting their partnership interests into capital
stock.
 
CERTAIN PUT RIGHTS OF THE CLASS A PARTNERS
 
     Change in Control Put.  Upon the occurrence of a change in control of Time
Warner, at the request of any Class A Partner, TWE will be required to elect
either to liquidate TWE within a two-year period or to purchase the interest of
such partner at fair market value (without any minority discount) as determined
by investment bankers. A "change in control" of Time Warner shall be deemed to
have occurred:
 
     (x) whenever, in any three-year period, a majority of the members of the
Board of Directors of the Company elected during such three-year period shall
have been so elected against the recommendation of the management of the Company
or the Board of Directors shall be deemed to have been elected against the
recommendation of such Board of Directors of the Company in office immediately
prior to such election; provided, however, that for purposes of this clause (x)
a member of such Board of Directors shall be deemed to have been elected against
the recommendation of such Board of Directors if his or her initial election
occurs as a result of either an actual or threatened election contest (as such
terms are used in Rule 14a-11 of Regulation 14A promulgated under the Securities
Exchange Act of 1934, as amended) or other actual or threatened solicitation of
proxies or consents by or on behalf of a person other than such Board of
Directors; or
 
     (y) whenever any person shall acquire (whether by merger, consolidation,
sale, assignment, lease, transfer or otherwise, in one transaction or any
related series of transactions), or otherwise beneficially owns voting
securities of the Company that represent in excess of 50% of the voting power of
all outstanding voting securities of the Company generally entitled to vote for
the election of directors, if such person acquires or publicly announces its
intention to initially acquire ten percent or more of such voting securities in
a transaction that has not been approved by the management of the Company within
30 days after the date of such acquisition or public announcement.
 
     Assignment of Put Rights, etc.  TWE, with the consent of such assignee, may
assign to the Company, any general partner or any third party, the obligation to
pay the applicable put price in connection with the exercise of a change in
control put right by a Class A Partner and the right to receive the partnership
interests in payment therefor.
 
     With respect to any of the put rights of the Class A Partners, TWE may pay
the applicable put price in cash or Marketable Securities (defined as any debt
or equity securities that are listed on a national securities exchange or quoted
on NASDAQ) issued by TWE (or if TWE assigns its obligation to pay the put price
to the Company, by the Company). The amount of any Marketable Securities
comprising the applicable put price shall be determined based on the market
price of such securities during the seven months following the closing of such
put transaction.
 
RESTRICTIONS ON TRANSFER BY TIME WARNER GENERAL PARTNERS
 
     Time Warner General Partners.  Any Time Warner General Partner is permitted
to dispose of any partnership interest (and any Time Warner General Partner and
any parent of any Time Warner General Partner may issue or sell equity) at any
time so long as, immediately after giving effect thereto, (i) the Company would
not own, directly or indirectly, less than (a) 43.75% of the residual equity of
TWE, if such disposition occurs prior to the date on which the Class A Partners
have received cash distributions of $500 million per $1 billion of investment,
and (b) 35% of the residual equity of TWE if such disposition occurs after such
date, (ii) no person or entity would own, directly or indirectly, a partnership
interest greater than that owned, directly or indirectly, by the Company, and
(iii) a subsidiary of the Company would be a managing general partner of TWE.
 
                                      I-36
<PAGE>   39
 
     No other dispositions are permitted, except that the Company may sell its
entire partnership interest subject to the Class A Partners' rights of first
refusal and "tag-along" rights pursuant to which the Company must provide for
the concurrent sale of the partnership interests of the Class A Partners so
requesting.
 
                         CURRENCY RATES AND REGULATIONS
 
     The Company's foreign operations are subject to the risk of fluctuation in
currency exchange rates and to exchange controls. The Company cannot predict the
extent to which such controls and fluctuations in currency exchange rates may
affect its operations in the future or its ability to remit dollars from abroad.
See Note 1 "Organization and Summary of Significant Accounting Policies
-- Foreign Currency" and Note 15 "Financial Instruments -- Foreign Currency Risk
Management" to the consolidated financial statements set forth at pages F-29 and
F-56, respectively, herein. For the revenues of international operations, see
Note 16 "Segment Information" to the consolidated financial statements set forth
on page F-58 herein.
 
                                   EMPLOYEES
 
     At December 31, 1998, the Company employed a total of approximately 67,500
persons, including approximately 29,400 persons employed by TWE.
 
                                      I-37
<PAGE>   40
 
ITEM 2.  PROPERTIES
 
CORPORATE, TBS, PUBLISHING AND MUSIC
 
     The following table sets forth certain information as of December 31, 1998
with respect to the Company's principal properties (over 250,000 square feet in
area) that are used primarily by TBS and the Company's publishing and music
divisions or occupied for corporate offices, all of which the Company considers
adequate for its present needs, and all of which were substantially used by the
Company or were leased to outside tenants:
 
<TABLE>
<CAPTION>
                                                          APPROXIMATE
                                                          SQUARE FEET       TYPE OF OWNERSHIP
       LOCATION                   PRINCIPAL USE           FLOOR SPACE    EXPIRATION DATE OF LEASE
       --------                   -------------           -----------    ------------------------
<S>                      <C>                              <C>          <C>
New York, New York       Executive and administrative         560,000  Leased by the Company. Lease
  75 Rockefeller Plaza   offices (Corporate and Music)                 expires in 2014.
  Rockefeller Center                                                   Approximately 94,368 sq. ft.
                                                                       are sublet to outside
                                                                       tenants.
 
New York, New York       Business and editorial offices     1,506,000  Leased by the Company. Most
  Time & Life Bldg.      (Publishing and Corporate)                    leases expire in 2007.
  Rockefeller Center                                                   Approximately 33,000 sq. ft.
                                                                       are sublet to outside
                                                                       tenants.
 
New York, New York       Offices (Music)                      273,800  Leased by the Company.
  1290 Ave. of the                                                     Leases expire 2000-2012.
  Americas                                                             Approximately 30,850 sq. ft.
                                                                       are sublet to outside
                                                                       tenants.
 
Atlanta, Georgia         Executive and administrative       1,570,000  Owned by the Company.
  One CNN Center         offices, studio (TBS) retail,                 Approximately 131,140 sq.
                         hotel and theatres                            ft. are sublet to outside
                                                                       tenants.
 
Atlanta, Georgia         Offices and studios (TBS)            311,000  Owned and occupied by the
  1050 Techwood Dr.                                                    Company.
 
Lebanon, Indiana         Warehouse space (Publishing)         500,450  Leased by the Company. Lease
  121 N. Enterprise                                                    expires in 2006.
  Blvd.
 
Mechanicsburg,           Office and warehouse space           358,000  Owned and occupied by the
  Pennsylvania           (Publishing)                                  Company.
  1225 S. Market St.
 
Indianapolis, Indiana    Warehouse space (Publishing)         253,000  Owned and occupied by the
  4200 N. Industrial                                                   Company.
  Street
 
Olyphant, Pennsylvania   Manufacturing, warehouses,         1,012,000  Owned and occupied by the
  1400 and 1444 East     distribution and office space                 Company.
  Lackawanna Avenue      (Music)
 
Nortorf, Germany         Manufacturing, distribution and      550,000  Owned and occupied by the
  Niedernstrasse 3-7     office space (Music)                          Company.
 
Alsdorf, Germany         Manufacturing, distribution and      269,000  Owned and occupied by the
  Max-Planck Strasse     office space (Music)                          Company.
  1-9
 
Terre Haute, Indiana     Manufacturing and office space       269,000  Leased by the Company. Lease
  4025 3rd Parkway       (Music)                                       expires in 2001.
</TABLE>
 
                                      I-38
<PAGE>   41
 
CABLE NETWORKS -- HBO, FILMED ENTERTAINMENT AND CABLE
 
     The following table sets forth certain information as of December 31, 1998
with respect to principal properties (over 250,000 square feet in area) owned or
leased by the Company's Cable Networks -- HBO, Filmed Entertainment and cable
television businesses, all of which the Company considers adequate for its
present needs, and all of which were substantially used by TWE:
 
<TABLE>
<CAPTION>
                                                              APPROXIMATE
                                                              SQUARE FEET        TYPE OF OWNERSHIP;
        LOCATION                   PRINCIPAL USE           FLOOR SPACE/ACRES  EXPIRATION DATE OF LEASE
        --------                   -------------           -----------------  ------------------------
<S>                       <C>                              <C>                <C>
New York, New York        Business offices (HBO)           335,000 sq. ft.    Leased by TWE.
  1100 and 1114 Avenue                                     and 241,390 sq.    Leases expire in 2004 and
  of the Americas                                          ft.                2006.
 
Burbank, California       Sound stages, administrative,    3,303,000 sq. ft.  Owned by TWE.
  The Warner Bros.        technical and dressing room      of improved space
  Studio                  structures, screening theaters,  on 158 acres(a)
                          machinery and equipment
                          facilities, back lot and
                          parking lot and other Burbank
                          properties (Filmed
                          Entertainment)
 
Baltimore, Maryland       Warehouse (Filmed                387,000 sq. ft.    Owned by TWE.
  White Marsh             Entertainment)
 
West Hollywood,           Sound stages, administrative,    350,000 sq. ft.    Owned by TWE.
  California              technical and dressing room      of improved space
  The Warner Hollywood    structures, screening theaters,  on 11 acres
  Studio                  machinery and equipment
                          facilities (Filmed
                          Entertainment)
 
Valencia, California      Location filming (Filmed         232 acres          Owned by TWE.
  Undeveloped Land        Entertainment)
</TABLE>
 
---------------
 
(a) Ten acres consist of various parcels adjoining The Warner Bros. Studio, with
    mixed commercial, office and residential uses.
 
ITEM 3.  LEGAL PROCEEDINGS
 
     In the matter of Six Flags Fund, Ltd., Six Flags Over Georgia, LLC and
George DeRay v. Time Warner Entertainment Company, L.P., Six Flags Entertainment
Corporation, Six Flags Theme Parks Inc., and Six Flags Over Georgia, Inc., which
has been pending in the Superior Court for Gwinnett County, Georgia and which is
described further in the Form 10-K filed by the Company for the year ended
December 31, 1997, plaintiffs sought imposition of a constructive trust,
compensatory damages in excess of $250 million and unspecified punitive damages
for alleged breaches of fiduciary duty, conversion, fraud and conspiracy
allegedly committed by the defendants in connection with the management of the
Six Flags Over Georgia theme park. On October 22, 1998, following the close of
discovery, plaintiffs amended their complaint so as to drop their claim for
fraud and to modify their claim for breach of contract. Following trial, on
December 18, 1998, the jury returned a verdict in favor of the plaintiffs and
awarded the two plaintiffs a total of approximately $197 million in compensatory
damages on their claims for breach of fiduciary duty. On December 21, 1998, the
same jury awarded plaintiffs an additional $257 million in punitive damages.
Defendants moved on February 1, 1999, for judgment notwithstanding the verdict,
for a new trial and for the remittur of all or part of the damages awarded by
the jury based on defendants' assertion that the trial court committed legal
error. Among other grounds, defendants argue that defendants complied with all
fiduciary duties as are defined by the operative legal agreement between the
parties; that defendants' conduct in the context of arm's length negotiations
was not a breach of fiduciary duty as a matter of law; that defendants cannot be
held liable for their good-faith business judgments; that as a matter of law the
defendants did not have a fiduciary duty to make capital expenditures in amounts
that exceeded those that were otherwise contractually agreed to by the
 
                                      I-39
<PAGE>   42
 
parties; that the Court improperly prevented defendants from introducing
relevant and important evidence; and that the Court improperly commented on
evidence received during the trial. Defendants' papers also argue that the Court
provided a number of erroneous instructions to the jury or, in other cases,
failed to provide any instruction to the jury on pertinent legal issues,
including the application of law with respect to alleged fiduciary duties in
matters specifically addressed by contract. With respect to damages, defendants
argue that the evidence presented concerning compensatory damages was unduly
speculative and excessive as a matter of law, and that the evidence and
applicable law cannot support the award of punitive damages. TWE and its 51%
partner in Six Flags retained financial responsibility for this litigation
following completion of the sale of the Six Flags companies to Premier Parks,
Inc.
 
     On September 13, 1995, Francis Ford Coppola, Fred Fuchs and FFC, Inc.
("Coppola") filed a lawsuit in the Superior Court of California, County of Los
Angeles against Warner Bros., alleging that Warner Bros. unlawfully interfered
with Coppola's efforts to develop with another film studio a previously
undeveloped film project based on "Pinocchio." Among other things, Coppola asked
that the Court declare that any prior agreement between Coppola and Warner Bros.
to produce the film was void or that it be rescinded. In 1997, the Court granted
the plaintiffs' motion to declare that any alleged agreement between Warner
Bros. and Coppola was void under the Copyright Act's statute of frauds
provision. On June 1, 1998, the case went to trial and on July 2, 1998, the jury
found in Coppola's favor with respect to the interference claims and awarded $20
million in compensatory damages; on July 9, 1998, the jury awarded an additional
$60 million in punitive damages for these claims. Warner Bros. subsequently
filed motions for judgment notwithstanding the verdict, for a new trial and to
set aside the damages awarded, as a result of which, on October 15, 1998, the
Court vacated the $60 million punitive damages award. Both sides have taken
appeals from the Court's rulings.
 
     On February 4, 1999, the Department of Justice served a Civil Investigative
Demand ("CID") on various motion picture studios including Warner Bros., calling
for the production of certain information and documents about distribution
licenses and relationships between the studios and movie theaters. The CID
served upon Warner Bros. also calls for responsive information about the
operations of New Line.
 
     In October 1993, 15 music performers or representatives of deceased
performers, on behalf of an alleged similarly-situated class, filed suit in the
United States District Court for the Northern District of Georgia against
approximately 50 record companies, including four WMG record labels. (Samuel D.
Moore, et al. v. American Federation of Television and Radio Artists, et al.,
No. 93-Civ-2358). Plaintiffs claimed that the recording companies under-reported
and under-contributed to the Fund, in violation of ERISA, in breach of contract
and fiduciary duty, through fraud and embezzlement, and in violation of RICO,
and that the American Federation of Television and Radio Artists ("AFTRA")
(their union), and the AFTRA Health and Retirement Fund (the "Fund") had
breached their fiduciary duties and acted in violation of ERISA in failing to
enforce the recording companies' obligations. Plaintiffs sought substantial, but
unquantified, monetary damages, treble damages, attorneys' fees and costs and
the imposition of a constructive trust over their master recordings. The Court
has dismissed all claims against AFTRA. The Court also consolidated with this
action a second, similar lawsuit, commenced by the same plaintiffs in the United
States District Court for the Southern District of New York. Through various
Orders during this litigation, the Court has granted the record company
defendants' motion to dismiss the ERISA claims but denied the defendants' motion
to dismiss state law claims for breach of contract and fraud and a motion for
summary judgment on the RICO claims. The Court has also declined to dismiss the
claims against the Fund and the Fund Trustees. On January 20, 1998, the Court
denied plaintiffs' motions for class certification of the remaining claims
against the record company defendants and against the Fund and Fund Trustees.
Accordingly, the case is now limited to the individual remaining claims of the
15 named plaintiffs. By Order dated June 22, 1998, the Court granted plaintiffs'
motion to certify its order denying class certification for appeal to the
Eleventh Circuit Court of Appeals, and granted plaintiffs' motion for entry of
judgment pursuant to Rule 54(b) in favor of the recording company defendants on
the ERISA claims. On October 6, 1998, the Eleventh Circuit accepted
interlocutory review of the District Court's Order denying class certification
and consolidated that appeal with the appeal on the plaintiffs' ERISA claims.
 
     On May 30, 1995, a purported class action was filed with the United States
District Court for the Central District of California, entitled Digital
Distribution Inc. d/b/a Compact Disc Warehouse v. CEMA Distribu-
                                      I-40
<PAGE>   43
 
tion, Sony Music Entertainment, Inc., Warner Elektra Atlantic Corporation, UNI
Distribution Corporation, Bertelsmann Music Group, Inc. and PolyGram Group
Distribution, Inc., No. 95-3536. The plaintiff, representing a class of direct
purchasers of recorded music compact discs ("CDs"), alleged that Warner Elektra
Atlantic Corporation ("WEA"), along with five other distributors of CDs,
violated the federal antitrust laws by engaging in a conspiracy to fix the
prices of CDs, and sought an injunction and treble damages (the "CD Price-Fixing
Class Action"). On January 9, 1996, the defendants' motion to dismiss the
amended complaint was granted and the action was dismissed, with prejudice.
Plaintiff appealed the dismissal to the United States Court of Appeals for the
Ninth Circuit, No. 96-55264. On July 3, 1997, the United States Court of Appeals
for the Ninth Circuit reversed the dismissal of the amended complaint and
remanded the case to the District Court, holding that the amended complaint was
sufficient to meet the pleading requirements of the Federal Rules and that the
action should proceed. On October 29, 1997, the District Court stayed
proceedings in the action due to the filing on May 12, 1997 of a Chapter 7
Petition under the U.S. Bankruptcy Code by plaintiff. Subsequently, the
Bankruptcy Court permitted plaintiff to proceed and the stay was lifted. On
April 22, 1998, the Judicial Panel on Multidistrict Litigation consolidated for
pretrial purposes various other actions, including Chandu Dani d/b/a Compact
Disc Warehouse and Record Revolution v. EMI Music Distribution, Sony Music
Entertainment, Inc., Warner Elektra Atlantic Corporation, Universal Music and
Video Distribution, Bertelsmann Music Group, Inc. and Polygram Group
Distribution, Inc., No. 97-7226 (C.D. Cal. 1997); Obie, inc. d/b/a Chestnut Hill
Compact Disc v. EMI Music Distribution, Sony Music Entertainment, Inc., Warner
Elektra Atlantic Corporation, Universal Music and Video Distribution,
Bertelsmann Music Group, Inc. and PolyGram Group Distribution, Inc., No. 97-8864
(S.D.N.Y. 1997); Third Street Jazz and Rock Holding Corporation v. EMI Music
Distribution, Sony Music Entertainment, Inc., Warner Elektra Atlantic
Corporation, Universal Music and Video Distribution, Bertelsmann Music Group,
Inc. and PolyGram Group Distribution, Inc., No. 97-8864 (C.D. Cal. 1997) and
Nathan Muchnick, Inc. v. Sony Music Entertainment, Inc., PolyGram Group
Distribution, Inc., Bertelsmann Music Group, Inc., Universal Music and Video
Distribution, Warner Elektra Atlantic Corporation and EMI Music Distribution,
No. 98 Civ. 0612(S.D.N.Y.1998). The consolidated actions are captioned In re
Compact Disc Antitrust Litigation. The Court has outlined certain pretrial
procedures and discovery is proceeding pursuant to those procedures.
 
     On February 17, 1998, a purported class action was commenced in the Circuit
Court of Cocke County, Tennessee at Newport, entitled Ottinger & Silvey, et.
al., v. EMI Music Distribution, Inc., Sony Music Entertainment, Inc., Warner
Elektra Atlantic Corporation, UNI Distribution Corporation, Bertelsmann Music
Group, Inc., and Polygram Group Distribution, Inc. The action is brought on
behalf of persons who from January 29, 1993 to the present, purchased CDs
indirectly from the defendants in Alabama, Arizona, California, the District of
Columbia, Florida, Kansas, Maine, Michigan, Minnesota, Mississippi, New Mexico,
North Carolina, North Dakota, South Dakota, Tennessee, West Virginia and
Wisconsin, and alleges that the defendants are engaged in a conspiracy to fix
the prices of CDs, in violation of the antitrust, unfair trade practices and
consumer protection statutes of each of those jurisdictions. On May 11, 1998,
WEA and the other defendants filed a motion to dismiss the complaint for failure
to state a cause of action. Plaintiffs have not yet responded to the motion.
 
     On April 11, 1997, the Washington and Dallas offices of the Federal Trade
Commission notified WEA that they had commenced a preliminary investigation into
whether WEA and others may be violating or have violated laws against unfair
competition by the adoption, implementation or maintenance of minimum advertised
pricing programs. On September 23, 1997, Warner Communications Inc. was served
by the Federal Trade Commission with a subpoena duces tecum calling for the
production of documents in connection with a nonpublic investigation into
whether the recorded music distribution companies and others may be engaging or
may have engaged in unfair methods of competition through the adoption,
implementation and maintenance of cooperative advertising programs that included
minimum advertised price provisions. WEA has produced documents in response to
the subpoena.
 
     On July 25, 1996, WEA was served with an antitrust civil investigative
demand from the Office of the Attorney General of the State of Florida that
calls for the production of documents in connection with an investigation to
determine whether there is, has been or may be a conspiracy to fix the prices of
CDs or
 
                                      I-41
<PAGE>   44
 
conduct consisting of unfair methods of competition or unfair trade practices in
the sale and marketing of CDs. WEA produced documents in compliance with the
investigative demand. By letter dated January 8, 1998, WEA was notified by the
Office of the Attorney General of the State of Florida that certain documents
that WEA had produced to its office were shared under a confidentiality
provision in the Florida statutes with the Office of the Attorney General of the
State of Illinois and the Office of the Attorney General of the State of New
York.
 
     Litigation relating to the 1990 merger of Time Inc. and WCI has either been
dismissed or has been dormant for years. The litigation is described in previous
reports on Form 10-K filed by the Company.
 
     A subsidiary of Time Inc. holds a 50% interest in the parent entity of
American Family Publishers ("AFP"). AFP's principal business is direct mail
magazine solicitation based on sweepstakes promotions. On February 2, 1998,
Florida's Attorney General filed a lawsuit which charged that AFP's mailings
were false and deceptive. The publicity surrounding this lawsuit quickly led to
additional suits, filed by other attorneys general as well as private
plaintiffs. To date, 54 actions have been filed against AFP and other defendants
in various state and federal courts; 23 of these actions name as a party AFP's
processing and customer service vendor, Time Customer Service Inc., a wholly
owned subsidiary of Time Inc. Of the 54 cases, 26 are class actions, and five
are brought by State Attorneys General; 37 cases are in Federal court and the
remaining 17 cases are in State court. These actions allege, among other things,
that AFP's sweepstakes magazine solicitations misrepresent that the recipient
has won the grand prize in AFP's sweepstakes. The actions seek damages,
attorney's fees and injunctive relief. On March 16, 1998, AFP entered into an
"assurance of voluntary compliance" with the Attorneys General of 32 states and
the District of Columbia. AFP admitted no wrongdoing but agreed to a payment in
reimbursement of investigative expenses. Subsequently, AFP entered into a
settlement with the New York Attorney General. AFP admitted no wrongdoing but
agreed to contribute towards a special fund created by the New York Attorney
General and also agreed to pay investigative costs.
 
     On March 29, 1996, Bartholdi Cable f/k/a Liberty Cable Co., Inc, and LVE,
LLC filed suit against TWI, TWE, various cable division subsidiaries and Gerald
Levin in the Eastern District of New York. The action alleges claims for
monopolization; attempted monopolization; conspiracy to monopolize in violation
of the antitrust laws; violations of the Lanham Act for purportedly misleading
advertising and deceptive trade practices. Defendants answered the complaint and
filed counterclaims on June 18, 1997, against Bartholdi and certain individuals.
The Court has declined motions to dismiss plaintiffs' claims or defendants'
counterclaims. On September 25, 1998, defendants filed a motion for summary
judgment, which was denied by the Court on November 17, 1998, with leave for
resubmission after six months. Discovery is now ongoing. Plaintiffs Andrew
Parker and Eric DeBrauwere, on behalf of a purported nationwide class, brought
this action on June 16, 1998, against defendants TWE and Time Warner Cable in
the Eastern District of New York. After defendants filed a motion to dismiss on
August 6, 1998, plaintiffs filed an amended complaint, which claims violations
of the Cable Act's privacy provisions, 47 U.S.C. sec. 551, related to the
alleged disclosure by defendants of personally identifiable information about
plaintiffs through sales of customer lists. Plaintiffs also have asserted claims
for violation of New York law for deceptive trade practices, negligent
misrepresentation and unjust enrichment. The lawsuit seeks damages under the
Cable Act, restitution of profits from the sale of such information, interest,
costs and attorney's fees. On December 18, 1998, defendants filed a motion to
dismiss the Amended Complaint.
 
ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
 
     Not applicable.
 
                                      I-42
<PAGE>   45
 
                       EXECUTIVE OFFICERS OF THE COMPANY
 
     Pursuant to General Instruction G (3), the information regarding the
Company's executive officers required by Item 401(b) of Regulation S-K is hereby
included in Part 1 of this report.
 
     The following table sets forth the name of each executive officer of the
Company, the office held by such officer and the age, as of March 12, 1999, of
such officer:
 
<TABLE>
<CAPTION>
                   NAME                     AGE                          OFFICE
                   ----                     ---                          ------
<S>                                         <C>   <C>
Gerald M. Levin...........................  59    Chairman of the Board and Chief Executive Officer
R.E. Turner...............................  60    Vice Chairman of the Board
Richard D. Parsons........................  50    President
Richard J. Bressler.......................  41    Executive Vice President and Chief Financial Officer
Peter R. Haje.............................  64    Executive Vice President, General Counsel and
                                                  Secretary
Timothy A. Boggs..........................  48    Senior Vice President
Andrew J. Kaslow..........................  49    Senior Vice President
John A. LaBarca...........................  56    Senior Vice President and Controller
</TABLE>
 
     Set forth below are the principal positions held by each of the executive
officers named above since March 1, 1994:
 
Mr. Levin.....................   Chairman of the Board of Directors and Chief
                                   Executive Officer since January 1993.
 
Mr. Turner....................   Vice Chairman since the consummation of the TBS
                                   Transaction in October 1996. Prior to that,
                                   he served as Chairman of the Board and
                                   President of TBS from 1970.
 
Mr. Parsons...................   President since February 1995. Prior to that,
                                   he served as Chairman and Chief Executive
                                   Officer of The Dime Savings Bank of New York,
                                   FSB from January 1991.
 
Mr. Bressler..................   Executive Vice President and Chief Financial
                                   Officer since January 1998. Prior to that, he
                                   served as Senior Vice President and Chief
                                   Financial Officer from March 1995; as Senior
                                   Vice President, Finance from January 1995;
                                   and as a Vice President prior to that.
 
Mr. Haje......................   Executive Vice President and General Counsel
                                   since October 1990 and Secretary since May
                                   1993.
 
Mr. Boggs.....................   Senior Vice President since November 1992.
 
Mr. Kaslow....................   Senior Vice President since January 1999. Prior
                                   to that, he served as Senior Vice President,
                                   Human Resources at Becton Dickinson and
                                   Company (medical supplies and devices) from
                                   April 1996 and prior to that he served as
                                   Vice President, Human Resources at Pepsico
                                   Inc. (beverages and snack foods), from
                                   September 1994; and Vice President of
                                   Pepsico's KFC International division prior to
                                   that.
 
Mr. LaBarca...................   Senior Vice President and Controller since May
                                   1997. Prior to that, he served as Vice
                                   President and Controller from January 1995;
                                   Vice President, Director of Internal Audit
                                   from May 1993; and Senior Partner at Ernst &
                                   Young LLP prior to that.
 
                                      I-43
<PAGE>   46
 
                                    PART II
 
ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
 
     The principal market for the Company's Common Stock is the New York Stock
Exchange. For quarterly price information with respect to the Company's Common
Stock for the two years ended December 31, 1998, see "Quarterly Financial
Information" at page F-69 herein, which information is incorporated herein by
reference. The approximate number of holders of record of the Company's Common
Stock as of February 28, 1999 was 25,000.
 
     For information on the frequency and amount of dividends paid with respect
to the Company's Common Stock during the two years ended December 31, 1998, see
"Quarterly Financial Information" at page F-69 herein, which information is
incorporated herein by reference.
 
     There is no established public trading market for the Company's Series
LMCN-V Common Stock, which as of February 28, 1999 was held of record by nine
holders.
 
ITEM 6.  SELECTED FINANCIAL DATA.
 
     The selected financial information of the Company for the five years ended
December 31, 1998 is set forth at pages F-67 and F-68 herein and is incorporated
herein by reference.
 
ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
 
     The information set forth under the caption "Management's Discussion and
Analysis" at pages F-2 through F-23 herein is incorporated herein by reference.
 
ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
 
     The information set forth under the caption "Interest Rate and Foreign
Currency Risk Management" at page F-19 herein is incorporated herein by
reference.
 
ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
 
     The consolidated financial statements and supplementary data of the Company
and the report of independent auditors thereon set forth at pages F-24 through
F-64, F-70 through F-77 and F-66 herein are incorporated herein by reference.
 
     Quarterly Financial Information set forth at page F-69 herein is
incorporated herein by reference.
 
ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
 
     Not Applicable.
 
                                      II-1
<PAGE>   47
 
                                    PART III
 
ITEMS 10, 11, 12 AND 13. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT;
                         EXECUTIVE COMPENSATION; SECURITY OWNERSHIP OF CERTAIN
                         BENEFICIAL OWNERS AND MANAGEMENT; CERTAIN RELATIONSHIPS
                         AND RELATED TRANSACTIONS
 
     Information called for by PART III (Items 10, 11, 12 and 13) is
incorporated by reference from the Company's definitive Proxy Statement to be
filed in connection with its 1999 Annual Meeting of Stockholders pursuant to
Regulation 14A, except that the information regarding the Company's executive
officers called for by Item 401(b) of Regulation S-K has been included in PART I
of this report and the information called for by Items 402(k) and 402(l) of
Regulation S-K is not incorporated by reference.
 
                                      III-1
<PAGE>   48
 
                                    PART IV
 
ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
 
     (a)(1)-(2) Financial Statements and Schedules:
 
     The list of consolidated financial statements and schedules set forth in
the accompanying Index to Consolidated Financial Statements and Other Financial
Information at page F-1 herein is incorporated herein by reference. Such
consolidated financial statements and schedules are filed as part of this
report.
 
     All other financial statement schedules are omitted because the required
information is not applicable, or because the information required is included
in the consolidated financial statements and notes thereto.
 
     (3) Exhibits:
 
     The exhibits listed on the accompanying Exhibit Index are filed or
incorporated by reference as part of this report and such Exhibit Index is
incorporated herein by reference. Exhibits 10.1 through 10.20 listed on the
accompanying Exhibit Index identify management contracts or compensatory plans
or arrangements required to be filed as exhibits to this report, and such
listing is incorporated herein by reference.
 
     (b) Reports on Form 8-K.
 
          (i) The Company filed a Current Report on Form 8-K dated November 19,
     1998 in which it reported in Item 5 that the Company had declared a
     two-for-one split of the Company's common stock and set forth restated
     historical earnings per share data reflecting such stock split.
 
          (ii) The Company filed a Current Report on Form 8-K dated December 18,
     1998 in which it reported in Item 5 the jury verdict with respect to the
     litigation entitled Six Flags Over Georgia, Inc., et al, v. Six Flags Fund,
     Ltd., et al. described on pages I-39 and I-40 herein.
 
                                      IV-1
<PAGE>   49
 
                                   SIGNATURES
 
     Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
 
                                          TIME WARNER INC.
 
                                          By        /s/ PETER R. HAJE
 
                                            ------------------------------------
                                                       Peter R. Haje
                                                 Executive Vice President,
                                               General Counsel and Secretary
 
Date: March 26, 1999
 
     Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
 
<TABLE>
<CAPTION>
                  SIGNATURE                                   TITLE                         DATE
                  ---------                                   -----                         ----
<C>                                            <S>                                     <C>
 
             /s/ GERALD M. LEVIN               Director, Chairman of the Board and     March 26, 1999
---------------------------------------------    Chief Executive Officer (principal
              (Gerald M. Levin)                  executive officer)
 
           /s/ RICHARD J. BRESSLER             Executive Vice President and Chief      March 26, 1999
---------------------------------------------    Financial Officer (principal
            (Richard J. Bressler)                financial officer)
 
             /s/ JOHN A. LABARCA               Senior Vice President and Controller    March 26, 1999
---------------------------------------------    (principal accounting officer)
              (John A. LaBarca)
 
              /s/ MERV ADELSON                 Director                                March 26, 1999
---------------------------------------------
               (Merv Adelson)
 
             /s/ J. CARTER BACOT               Director                                March 26, 1999
---------------------------------------------
              (J. Carter Bacot)
 
          /s/ STEPHEN F. BOLLENBACH            Director                                March 26, 1999
---------------------------------------------
           (Stephen F. Bollenbach)
 
            /s/ JOHN C. DANFORTH               Director                                March 26, 1999
---------------------------------------------
             (John C. Danforth)
 
         /s/ BEVERLY SILLS GREENOUGH           Director                                March 26, 1999
---------------------------------------------
          (Beverly Sills Greenough)
 
            /s/ GERALD GREENWALD               Director                                March 26, 1999
---------------------------------------------
             (Gerald Greenwald)
</TABLE>
 
                                      IV-2
<PAGE>   50
 
<TABLE>
<CAPTION>
                  SIGNATURE                                   TITLE                         DATE
                  ---------                                   -----                         ----
<C>                                            <S>                                     <C>
             /s/ CARLA A. HILLS                Director                                March 26, 1999
---------------------------------------------
              (Carla A. Hills)
 
               /s/ REUBEN MARK                 Director                                March 26, 1999
---------------------------------------------
                (Reuben Mark)
 
            /s/ MICHAEL A. MILES               Director                                March 26, 1999
---------------------------------------------
             (Michael A. Miles)
 
           /s/ RICHARD D. PARSONS              Director                                March 26, 1999
---------------------------------------------
            (Richard D. Parsons)
 
               /s/ R.E. TURNER                 Director                                March 26, 1999
---------------------------------------------
                (R.E. Turner)
 
         /s/ FRANCIS T. VINCENT, JR.           Director                                March 26, 1999
---------------------------------------------
          (Francis T. Vincent, Jr.)
</TABLE>
 
                                      IV-3
<PAGE>   51
 
          TIME WARNER INC. AND TIME WARNER ENTERTAINMENT COMPANY, L.P.
                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
                        AND OTHER FINANCIAL INFORMATION
 
<TABLE>
<CAPTION>
                                                                    PAGE
                                                              ----------------
                                                               TIME
                                                              WARNER     TWE
                                                              ------    ------
<S>                                                           <C>       <C>
Management's Discussion and Analysis of Results of
  Operations and Financial Condition........................    F-2       F-79
Consolidated Financial Statements:
  Balance Sheet.............................................   F-24       F-92
  Statement of Operations...................................   F-25       F-93
  Statement of Cash Flows...................................   F-26       F-94
  Statement of Shareholders' Equity and Partnership
     Capital................................................   F-27       F-95
  Notes to Consolidated Financial Statements................   F-28       F-96
Report of Management........................................   F-65
Report of Independent Auditors..............................   F-66      F-120
Selected Financial Information..............................   F-67      F-121
Quarterly Financial Information.............................   F-69      F-122
Supplementary Information...................................   F-70
Financial Statement Schedule II-Valuation and Qualifying
  Accounts..................................................   F-78      F-123
</TABLE>
 
                                       F-1
<PAGE>   52
 
                                TIME WARNER INC.
                      MANAGEMENT'S DISCUSSION AND ANALYSIS
                OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
 
DESCRIPTION OF BUSINESS
 
     Time Warner Inc. ("Time Warner" or the "Company"), together with its
consolidated and unconsolidated subsidiaries, is the world's largest media and
entertainment company. Time Warner's principal business objective is to create
and distribute branded information and entertainment copyrights throughout the
world. Time Warner classifies its business interests into four fundamental
areas: Cable Networks, consisting principally of interests in cable television
programming; Publishing, consisting principally of interests in magazine
publishing, book publishing and direct marketing; Entertainment, consisting
principally of interests in recorded music and music publishing, filmed
entertainment, television production and television broadcasting; and Cable,
consisting principally of interests in cable television systems.
 
     A majority of Time Warner's interests in filmed entertainment, television
production, television broadcasting and cable television systems, and a portion
of its interests in cable television programming are held through Time Warner
Entertainment Company, L.P. ("TWE"). Time Warner owns 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. Time Warner does not
consolidate TWE and certain related companies (the "Entertainment Group") for
financial reporting purposes because of certain limited partnership approval
rights related to TWE's interest in certain cable television systems.
 
OVERVIEW
 
     Time Warner and the Entertainment Group demonstrated strong financial
performances in 1998, as measured by the operating performance of their
businesses and the improved strength of their combined financial condition, as
more fully described herein. This performance was driven primarily by solid
business fundamentals and a disciplined financial focus on cost management and
controlling capital spending.
 
USE OF EBITA
 
     Time Warner 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 the $14 billion acquisition of Warner
Communications Inc. in 1989, the $6.2 billion acquisition of Turner Broadcasting
System, Inc. ("TBS") in 1996 and the $2.3 billion of cable acquisitions in 1996
and 1995. The exclusion of noncash amortization charges also is consistent with
management's belief that Time Warner's intangible assets, such as cable
television and sports franchises, music catalogues and copyrights, film and
television libraries and the goodwill associated with its brands, generally are
increasing in value and importance to Time Warner'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 Time Warner and the Entertainment Group 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.
 
                                       F-2
<PAGE>   53
                                TIME WARNER INC.
                      MANAGEMENT'S DISCUSSION AND ANALYSIS
        OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION -- (CONTINUED)
 
TRANSACTIONS AFFECTING COMPARABILITY OF RESULTS OF OPERATIONS
 
     As more fully described herein, the comparability of Time Warner's and the
Entertainment Group's operating results has been affected by certain significant
transactions and nonrecurring items in each period.
 
     For 1998, these significant transactions related to Time Warner's cable
business and included (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 in TWE-A/N, 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. ("Primestar"), a separate holding company (the "Primestar
Roll-up Transaction"), (iii) the reorganization of Time Warner Cable's business
telephony operations into a separate entity named Time Warner Telecom LLC (the
"Time Warner Telecom Reorganization") and (iv) the formation of a joint venture
to operate and expand Time Warner Cable's and MediaOne's existing high-speed
online businesses (the "Road Runner Joint Venture" and collectively, the "1998
Cable Transactions").
 
     In addition, there were a number of other significant, nonrecurring items
recognized in 1998 and 1997, consisting of (i) net pretax gains in the amount of
approximately $108 million in 1998 and $212 million in 1997 relating to the sale
or exchange of various cable television systems by Time Warner and TWE, (ii) a
pretax gain of approximately $250 million in 1997 relating to TWE's sale of its
interest in E! Entertainment Television, Inc. ("E! Entertainment"), (iii) a
pretax gain of $200 million in 1997 relating to Time Warner's disposal of its
interest in Hasbro, Inc. ("Hasbro"), (iv) a charge of approximately $210 million
in 1998 principally to reduce TWE's carrying value of its interest in Primestar,
(v) an increase of $234 million in Time Warner's 1998 preferred dividend
requirements relating to the premium paid in connection with its redemption of
Series M exchangeable preferred stock ("Series M Preferred Stock") and (vi) an
extraordinary loss of $55 million in 1997 on the retirement of debt.
 
     In order to meaningfully assess underlying operating trends, management
believes that the results of operations for 1998 and 1997 should be analyzed
after excluding the effects of these significant nonrecurring items. As such,
the following discussion and analysis focuses on amounts and trends adjusted to
exclude the impact of these unusual items. However, unusual items may occur in
any period. Accordingly, investors and other financial statement users
individually should consider the types of events and transactions for which
adjustments have been made.
 
     The comparability of Time Warner's 1997 and 1996 operating results also was
affected by certain significant transactions, consisting of (i) Time Warner's
October 1996 acquisition of TBS (the "TBS Transaction"), (ii) Time Warner's use
of approximately $1.55 billion of net proceeds from the issuance of Series M
Preferred Stock in April 1996 to reduce outstanding indebtedness and (iii)
certain other debt refinancings during the year (collectively, the "1996 Time
Warner Transactions"). Accordingly, the following discussion of operating
results for those periods is supplemented, where appropriate, by pro forma
financial information that gives effect to the 1996 Time Warner Transactions as
if they had occurred at the beginning of 1996. This pro forma information is
presented for informational purposes only and is not necessarily indicative of
the operating results that would have occurred had the transactions actually
occurred at the beginning of that period, nor is it necessarily indicative of
future operating results.
 
     Finally, per common share amounts for prior years have been restated to
give effect to a two-for-one common stock split that occurred on December 15,
1998.
 
                                       F-3
<PAGE>   54
                                TIME WARNER INC.
                      MANAGEMENT'S DISCUSSION AND ANALYSIS
        OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION -- (CONTINUED)
 
RESULTS OF OPERATIONS
 
1998 VS. 1997
 
     EBITA and operating income in 1998 and 1997 are as follows:
 
<TABLE>
<CAPTION>
                                                                YEARS ENDED DECEMBER 31,
                                                          ------------------------------------
                                                               EBITA          OPERATING INCOME
                                                          ----------------    ----------------
                                                           1998      1997      1998      1997
                                                          ------    ------    ------    ------
                                                                       (MILLIONS)
<S>                                                       <C>       <C>       <C>       <C>
Time Warner:
Publishing..............................................  $  607    $  529    $  569    $  481
Music...................................................     493       467       213       166
Cable Networks-TBS......................................     706       573       506       374
Filmed Entertainment-TBS................................     192       200       110       113
Cable(1)................................................     325       427       125       150
Intersegment elimination................................     (27)      (13)      (27)      (13)
                                                          ------    ------    ------    ------
Total...................................................  $2,296    $2,183    $1,496    $1,271
                                                          ======    ======    ======    ======
Entertainment Group:
Filmed Entertainment-Warner Bros........................  $  503    $  404    $  374    $  281
Broadcasting-The WB Network.............................     (93)      (88)      (96)      (88)
Cable Networks-HBO......................................     454       391       454       391
Cable(2)................................................   1,369     1,184       992       877
                                                          ------    ------    ------    ------
Total...................................................  $2,233    $1,891    $1,724    $1,461
                                                          ======    ======    ======    ======
</TABLE>
 
---------------
(1) Includes net pretax gains of approximately $18 million in 1998 and $12
    million in 1997 related to the sale or exchange of certain cable television
    systems.
 
(2) Includes net pretax gains of approximately $90 million in 1998 and $200
    million in 1997 related to the sale or exchange of certain cable television
    systems.
 
     Time Warner had revenues of $14.582 billion and net income of $168 million
($.31 loss per common share after preferred dividend requirements) in 1998,
compared to revenues of $13.294 billion, income of $301 million before an
extraordinary loss on the retirement of debt ($.01 loss per common share after
preferred dividend requirements) and net income of $246 million ($.06 loss per
common share after preferred dividend requirements) in 1997. Time Warner's
equity in the pretax income of the Entertainment Group was $356 million in 1998,
compared to $686 million in 1997.
 
     As previously described, the comparability of Time Warner's and the
Entertainment Group's operating results for 1998 and 1997 has been affected by
certain significant nonrecurring items recognized in each period, consisting of
gains and losses relating to the sale or exchange of cable television systems
and other investment-related activity. These nonrecurring items amounted to
approximately $100 million of net pretax losses in 1998, compared to
approximately $660 million of net pretax gains in 1997. In addition, preferred
dividend requirements for 1998 included a $234 million one-time increase
relating to the premium paid in connection with Time Warner's redemption of its
Series M Preferred Stock. Lastly, 1997 included a $55 million extraordinary loss
on the retirement of debt. The aggregate net effect of these significant,
nonrecurring items was a decrease in income per common share of $.25 per common
share in 1998, compared to an increase of $.27 per common share in 1997.
 
     Time Warner's net income decreased to $168 million in 1998, compared to net
income of $246 million in 1997. However, excluding the significant effect of the
nonrecurring items referred to above, net income
 
                                       F-4
<PAGE>   55
                                TIME WARNER INC.
                      MANAGEMENT'S DISCUSSION AND ANALYSIS
        OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION -- (CONTINUED)
 
increased by $300 million to $236 million in 1998, compared to a net loss of $64
million in 1997. As discussed more fully below, this improvement principally
resulted from an overall increase in Time Warner's business segment operating
income, an increase in income from its equity in the pretax income of the
Entertainment Group and lower interest expense associated with Time Warner's
debt reduction efforts and the TWE-A/N Transfers, offset in part by higher
losses from certain investments accounted for under the equity method of
accounting and lower gains on foreign exchange contracts. Similarly, excluding
the effect of these nonrecurring items, normalized net loss per common share was
$.06 in 1998, compared to a normalized net loss per common share of $.33 in
1997.
 
     The Entertainment Group had revenues of $12.256 billion and net income of
$331 million in 1998, compared to revenues of $11.328 billion, income of $642
million before an extraordinary loss on the retirement of debt and net income of
$619 million in 1997. Similarly, excluding the portion of the nonrecurring items
referred to above that was recognized by the Entertainment Group, net income
increased by $229 million to $465 million in 1998, compared to $236 million in
1997. As discussed more fully below, this improvement principally resulted from
an overall increase in the Entertainment Group's business segment operating
income (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 and
higher losses from certain investments accounted for under the equity method of
accounting.
 
     The relationship between income before income taxes and income tax expense
of Time Warner is principally affected by the amortization of goodwill and
certain other financial statement expenses that are not deductible for income
tax purposes. Income tax expense of Time Warner includes all income taxes
related to its allocable share of partnership income and its equity in the
income tax expense of corporate subsidiaries of the Entertainment Group.
 
TIME WARNER
 
     Publishing.  Revenues increased to $4.496 billion, compared to $4.290
billion in 1997. EBITA increased to $607 million from $529 million. Operating
income increased to $569 million from $481 million. Revenues benefited primarily
from significant increases in magazine advertising revenues, as well as
increases in magazine circulation revenues. The increase in advertising revenues
was principally due to a strong overall advertising market for most of the
division's magazines, primarily led by People, Time, Entertainment Weekly,
Fortune and In Style. The increase in circulation revenues was principally due
to higher subscription and newsstand revenues, primarily led by the same
magazines. EBITA and operating income increased principally as a result of the
revenue gains, cost savings and one-time gains on the sale of certain assets,
offset in part by lower results from direct marketing operations.
 
     Music.  Revenues increased to $4.025 billion, compared to $3.691 billion in
1997. EBITA increased to $493 million from $467 million. Operating income
increased to $213 million from $166 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 December 1998, the Music division had a domestic market share of
19.8%, as measured by SoundScan. EBITA and operating income increased
principally as a result of the revenue gains and cost savings, offset in part by
lower results from direct marketing operations, higher artist costs and the
absence of certain one-time gains recognized in 1997.
 
     Cable Networks-TBS.  Revenues increased to $3.325 billion, compared to
$2.900 billion in 1997. EBITA increased to $706 million from $573 million.
Operating income increased to $506 million from $374 million. Revenues benefited
from an increase in subscription and advertising revenues. The increase in
subscription revenues principally related to the conversion of TBS Superstation
from an advertiser-supported broadcast superstation to a copyright-paid, cable
television service, which allows TBS Superstation to charge cable
 
                                       F-5
<PAGE>   56
                                TIME WARNER INC.
                      MANAGEMENT'S DISCUSSION AND ANALYSIS
        OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION -- (CONTINUED)
 
operators for the right to carry its cable television programming. Subscription
revenues also increased as a result of an increase in subscriptions, primarily
at CNN, CNN International, TNT/Cartoon Europe and Turner Classic Movies, and
higher rates. The increase in advertising revenues was principally due to a
strong overall advertising market for most of the division's networks, including
TNT, Cartoon Network, TNT/ Cartoon Europe, CNN and CNN Headline News. EBITA and
operating income increased principally as a result of the revenue gains and
lower programming costs at TNT, offset in part by higher programming costs at
CNN and losses associated with the Goodwill Games.
 
     Filmed Entertainment-TBS.  Revenues increased to $1.917 billion, compared
to $1.531 billion in 1997. EBITA decreased to $192 million from $200 million.
Operating income decreased to $110 million from $113 million. Revenues benefited
from a significant increase in syndication sales resulting from the renewal by
existing television station customers of second-cycle broadcasting rights for
Seinfeld, as well as an increase in worldwide theatrical and home video revenues
at New Line Cinema. Despite the revenue increase, EBITA and operating income
decreased principally as a result of film write-offs relating to disappointing
results for theatrical releases of Castle Rock Entertainment in the first half
of 1998.
 
     Cable.  Revenues decreased to $964 million, compared to $997 million in
1997. EBITA decreased to $325 million from $427 million. Operating income
decreased to $125 million from $150 million. The Cable division's 1998 operating
results were negatively affected by the aggregate net impact of the
deconsolidation of certain of its operations in connection with the 1998 Cable
Transactions. Excluding the effect of the 1998 Cable Transactions, revenues
increased principally as a result of an increase in basic cable subscribers,
increases in regulated cable rates and an increase in advertising revenues.
Similarly excluding the effect of the 1998 Cable Transactions, EBITA and
operating income increased principally as a result of the revenue gains and
approximately $6 million of higher, net pretax 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, increased to $1.180
billion in 1998, compared to $1.044 billion in 1997. Interest expense decreased
to $891 million, compared to $1.049 billion, principally due to lower average
debt levels associated with the Company's debt reduction efforts and the TWE-A/N
Transfers. There was other expense, net, of $289 million in 1998 compared to
other income, net of $5 million in 1997, primarily due to lower
investment-related income, as well as lower gains on foreign exchange contracts
and higher losses associated with the Company's asset securitization program.
The significant decrease in investment-related income principally resulted from
the absence of a $200 million pretax gain recognized in 1997 in connection with
the disposal of Time Warner's interest in Hasbro and higher losses in 1998 from
certain investments accounted for under the equity method of accounting.
 
ENTERTAINMENT GROUP
 
     Filmed Entertainment-Warner Bros.  Revenues increased to $6.061 billion,
compared to $5.472 billion in 1997. EBITA increased to $503 million from $404
million. Operating income increased to $374 million from $281 million. Revenues
benefited from a significant increase in licensing fees from 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 and cost savings, offset in part by
lower international syndication sales of library product and lower results from
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 $260 million, compared
to $136 million in 1997. EBITA decreased to a loss of $93 million from a loss of
$88 million. Operating losses increased to $96 million
 
                                       F-6
<PAGE>   57
                                TIME WARNER INC.
                      MANAGEMENT'S DISCUSSION AND ANALYSIS
        OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION -- (CONTINUED)
 
from $88 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.
 
     Cable Networks-HBO.  Revenues increased to $2.052 billion, compared to
$1.923 billion in 1997. EBITA and operating income increased to $454 million
from $391 million. Revenues benefited primarily from an increase in
subscriptions to 34.6 million from 33.6 million at the end of 1997. EBITA and
operating income improved 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 $4.378 billion, compared to $4.243 billion in
1997. EBITA increased to $1.369 billion from $1.184 billion. Operating income
increased to $992 million from $877 million. The Cable division's 1998 operating
results were positively affected by the aggregate net impact of the 1998 Cable
Transactions. Excluding the effect of the 1998 Cable Transactions, revenues
increased principally as a result of an increase in basic cable subscribers,
increases in regulated cable rates and an increase in advertising revenues.
Similarly excluding the effect of the 1998 Cable Transactions, EBITA and
operating income increased principally as a result of the revenue gains, offset
in part by higher depreciation related to capital spending and approximately
$110 million of lower, net pretax gains relating to the sale or exchange of
certain cable television systems.
 
     As of December 31, 1998, including the cable operations of TWE-A/N and TWI
Cable Inc. ("TWI Cable"), there were 12.6 million subscribers under the
management of TWE's Cable division, as compared to 12.0 million subscribers at
the end of 1997. The number of subscribers at the end of 1997 excludes all
direct broadcast satellite subscribers that were transferred to Primestar in
1998 in connection with the Primestar Roll-up Transaction.
 
     Interest and Other, Net.  Interest and other, net, increased to $965
million in 1998, compared to $357 million in 1997. Interest expense increased to
$566 million, compared to $494 million in 1997, principally due to higher
average debt levels associated with the TWE-A/N Transfers. There was other
expense, net, of $399 million in 1998, compared to other income, net, of $137
million in 1997, primarily due to lower investment-related income, as well as
higher losses associated with TWE's asset securitization program. The
significant decrease in investment-related income principally resulted from the
absence of an approximate $250 million pretax gain recognized in 1997 in
connection with the sale of an interest in E! Entertainment, the inclusion of an
approximate $210 million charge recorded in 1998 principally to reduce the
carrying value of an interest in Primestar and higher losses in 1998 from
certain investments accounted for under the equity method of accounting.
 
                                       F-7
<PAGE>   58
                                TIME WARNER INC.
                      MANAGEMENT'S DISCUSSION AND ANALYSIS
        OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION -- (CONTINUED)
 
1997 VS. 1996
 
     EBITA and operating income in 1997 and 1996 are as follows:
 
<TABLE>
<CAPTION>
                                                             YEARS ENDED DECEMBER 31,
                                     -------------------------------------------------------------------------
                                                    EBITA                           OPERATING INCOME
                                     -----------------------------------   -----------------------------------
                                     HISTORICAL   PRO FORMA   HISTORICAL   HISTORICAL   PRO FORMA   HISTORICAL
                                        1997        1996         1996         1997        1996         1996
                                     ----------   ---------   ----------   ----------   ---------   ----------
                                                                    (MILLIONS)
<S>                                  <C>          <C>         <C>          <C>          <C>         <C>
Time Warner:
Publishing.........................    $  529      $  464       $  464       $  481      $  418       $  418
Music..............................       467         653          653          166         361          361
Cable Networks-TBS.................       573         472          142          374         297           99
Filmed Entertainment-TBS...........       200        (116)          30          113        (202)           8
Cable(1)...........................       427         353          353          150          75           75
Intersegment elimination...........       (13)        (10)           5          (13)        (10)           5
                                       ------      ------       ------       ------      ------       ------
Total..............................    $2,183      $1,816       $1,647       $1,271      $  939       $  966
                                       ======      ======       ======       ======      ======       ======
Entertainment Group:
Filmed Entertainment-Warner
  Bros. ...........................    $  404      $  379       $  379       $  281      $  254       $  254
Broadcasting-The WB Network........       (88)        (98)         (98)         (88)        (98)         (98)
Cable Networks-HBO.................       391         328          328          391         328          328
Cable(1)...........................     1,184         917          917          877         606          606
                                       ------      ------       ------       ------      ------       ------
Total..............................    $1,891      $1,526       $1,526       $1,461      $1,090       $1,090
                                       ======      ======       ======       ======      ======       ======
</TABLE>
 
---------------
(1) Includes net pretax gains in 1997 of approximately $12 million for Time
    Warner and $200 million for the Entertainment Group related to the sale or
    exchange of certain cable television systems.
 
     Time Warner had revenues of $13.294 billion, income of $301 million before
an extraordinary loss on the retirement of debt ($.01 loss per common share
after preferred dividend requirements) and net income of $246 million ($.06 loss
per common share after preferred dividend requirements) in 1997, compared to
revenues of $10.064 billion, a loss of $156 million before an extraordinary loss
on the retirement of debt ($.48 per common share after preferred dividend
requirements) and a net loss of $191 million ($.52 per common share after
preferred dividend requirements) in 1996. Time Warner's equity in the pretax
income of the Entertainment Group was $686 million in 1997, compared to $290
million in 1996.
 
     Time Warner's historical results of operations include the operating
results of TBS from October 10, 1996. On a pro forma basis, giving effect to the
1996 Time Warner Transactions as if each of such transactions had occurred at
the beginning of 1996, Time Warner would have reported for the year ended
December 31, 1996, revenues of $12.799 billion, depreciation expense of $368
million, EBITA of $1.816 billion, operating income of $939 million, equity in
the pretax income of the Entertainment Group of $290 million, a loss before
extraordinary item of $282 million ($.52 per common share) and a net loss of
$317 million ($.55 per common share). No pro forma financial information has
been presented for Time Warner for the year ended December 31, 1997 because the
1996 Time Warner Transactions are already reflected in the historical financial
statements of Time Warner.
 
     As previously described, the comparability of Time Warner's and the
Entertainment Group's historical operating results for 1997 and pro forma
results for 1996 has been affected further by certain significant nonrecurring
items recognized in 1997, consisting of net pretax gains relating to the sale or
exchange of cable
 
                                       F-8
<PAGE>   59
                                TIME WARNER INC.
                      MANAGEMENT'S DISCUSSION AND ANALYSIS
        OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION -- (CONTINUED)
 
television systems and other investment-related activity. These nonrecurring
items amounted to approximately $660 million of net pretax gains in 1997. In
addition, net income (loss) in each period included extraordinary losses on the
retirement of debt of $55 million in 1997 and $35 million in 1996. The aggregate
net effect of these significant, nonrecurring items was an increase in income
per common share of $.27 in 1997, compared to a decrease of $.03 per common
share in 1996.
 
     Time Warner's operating results improved from a pro forma net loss of $317
million in 1996 to net income of $246 million in 1997. Excluding the significant
effect of the nonrecurring items referred to above, Time Warner's net loss
improved by $218 million to a net loss of $64 million in 1997, compared to a net
loss of $282 million on a pro forma basis in 1996. As discussed more fully
below, this improvement principally resulted from an overall increase in Time
Warner's EBITA and operating income and an increase in income from its equity in
the pretax income of the Entertainment Group. Similarly, excluding the effect of
these nonrecurring items, normalized net loss per common share was $.33 in 1997,
compared to a normalized net loss per common share of $.52 on a pro forma basis
in 1996.
 
     On a historical basis, these underlying operating trends were mitigated by
an overall increase in interest expense principally relating to the assumption
of approximately $2.8 billion of debt in the TBS Transaction, and an increase in
noncash amortization of intangible assets, also relating to the TBS Transaction.
On a historical basis, after preferred dividend requirements that increased by
$62 million due to the April 1996 issuance of Series M Preferred Stock, Time
Warner's net loss applicable to common shares improved to $73 million for the
year ended December 31, 1997, compared to $448 million for the year ended
December 31, 1996. This improvement, as well as the dilutive effect from issuing
359.6 million equivalent shares of common stock in connection with the TBS
Transaction, resulted in a net loss per common share of $.06 for the year ended
December 31, 1997, compared to a $.52 net loss per common share for the year
ended December 31, 1996.
 
     On a historical basis, the Entertainment Group had revenues of $11.328
billion, income of $642 million before an extraordinary loss on the retirement
of debt and net income of $619 million in 1997, compared to revenues of $10.861
billion and net income of $220 million in 1996. Similarly, excluding the portion
of the nonrecurring items referred to above that was recognized by the
Entertainment Group, net income increased by $16 million to $236 million in
1997, compared to $220 million in 1996. As discussed more fully below, this
improvement principally resulted from an overall increase in EBITA and operating
income generated by the Entertainment Group's business segments, offset in part
by an increase in minority interest expense related to TWE-A/N.
 
     The relationship between income before income taxes and income tax expense
of Time Warner is principally affected by the amortization of goodwill and
certain other financial statement expenses that are not deductible for income
tax purposes. Income tax expense of Time Warner includes all income taxes
related to its allocable share of partnership income and its equity in the
income tax expense of corporate subsidiaries of the Entertainment Group.
 
TIME WARNER
 
     Publishing.  Revenues increased to $4.290 billion, compared to $4.117
billion in 1996. EBITA increased to $529 million from $464 million. Operating
income increased to $481 million from $418 million. Excluding the effect of
operations that were either recently sold or acquired, revenues benefited from a
significant increase in magazine advertising revenues, as well as increases in
circulation and direct marketing revenues. Contributing to the revenue gains
were increases achieved by People, Sports Illustrated, Time, Entertainment
Weekly, In Style and direct marketer Book-of-the-Month Club. EBITA and operating
income increased principally as a result of the revenue gains and, to a lesser
extent, continued cost savings.
 
                                       F-9
<PAGE>   60
                                TIME WARNER INC.
                      MANAGEMENT'S DISCUSSION AND ANALYSIS
        OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION -- (CONTINUED)
 
     Music.  Revenues decreased to $3.691 billion, compared to $3.949 billion in
1996. EBITA decreased to $467 million from $653 million. Operating income
decreased to $166 million from $361 million. Despite the Music division having a
domestic market share for the year of 20% as measured by SoundScan, the decline
in revenues principally related to softness in the overexpanded U.S. retail
marketplace, artist delays affecting the timing of releases of new product and a
decline in international recorded music sales. EBITA and operating income
decreased principally as a result of the decline in revenues and lower results
from direct marketing activities, offset in part by certain one-time gains.
 
     Cable Networks-TBS.  Cable Networks results reflect the acquisition of TBS
effective in October 1996. Such operating results are not comparable to the
prior year and, accordingly, are discussed on a pro forma basis.
 
     Revenues increased to $2.900 billion, compared to $2.477 billion on a pro
forma basis in 1996. EBITA increased to $573 million from $472 million.
Operating income increased to $374 million from $297 million. Revenues benefited
from increases in advertising and subscription revenues. Advertising revenues
increased due to a strong overall advertising market for the division's major
branded networks, including TNT, TBS Superstation, CNN and Cartoon Network.
Subscription revenues increased as a result of higher rates and an increase in
subscriptions, primarily at TNT, CNN, Cartoon Network and Turner Classic Movies.
EBITA and operating income increased principally as a result of the revenue
gains, offset in part by start-up costs for new networks, including the sports
news network CNN/SI and the Spanish-language news network CNN en Espanol.
 
     Filmed Entertainment-TBS.  Filmed Entertainment results reflect the
acquisition of TBS effective in October 1996. Such operating results are not
comparable to the prior year and, accordingly, are discussed on a pro forma
basis.
 
     Revenues increased to $1.531 billion, compared to $1.458 billion on a pro
forma basis in 1996. EBITA increased to $200 million from a loss of $116
million. Operating income increased to $113 million from a loss of $202 million.
Revenues benefited from increases in worldwide theatrical, home video and
television distribution revenues. EBITA and operating income increased
principally as a result of the revenue gains, merger-related cost savings and
the absence of approximately $200 million of write-offs recorded in 1996 that
related to disappointing results for theatrical releases.
 
     Cable.  Revenues increased to $997 million, compared to $909 million in
1996. EBITA increased to $427 million from $353 million. Operating income
increased to $150 million from $75 million. Revenues benefited from an increase
in basic cable subscribers, increases in regulated cable rates and an increase
in advertising and pay-per-view revenues. EBITA and operating income increased
principally as a result of the revenue gains, as well as gains of approximately
$12 million recognized in 1997 in connection with the sale of certain
investments.
 
     Interest and Other, Net.  Interest and other, net, decreased to $1.044
billion in 1997, compared to $1.174 billion in 1996. Interest expense increased
to $1.049 billion, compared to $968 million, principally due to the assumption
of approximately $2.8 billion of debt in the TBS Transaction. There was other
income, net, of $5 million in 1997 compared to other expense, net, of $206
million in 1996, principally because of the recognition of a $200 million pretax
gain in 1997 in connection with the redemption of certain mandatorily redeemable
preferred securities and the related disposal of Time Warner's interest in
Hasbro and lower losses from the reduction in carrying value of certain
investments, offset in part by costs associated with the Company's asset
securitization program.
 
                                      F-10
<PAGE>   61
                                TIME WARNER INC.
                      MANAGEMENT'S DISCUSSION AND ANALYSIS
        OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION -- (CONTINUED)
 
ENTERTAINMENT GROUP
 
     Filmed Entertainment-Warner Bros.  Revenues decreased to $5.472 billion,
compared to $5.648 billion in 1996. EBITA increased to $404 million from $379
million. Operating income increased to $281 million from $254 million. Revenues
decreased principally as a result of lower worldwide theatrical and home video
revenues, offset in part by increases in worldwide television distribution
revenues. EBITA and operating income increased principally as a result of
high-margin sales of library product that contributed to the strong performance
of worldwide television distribution operations, cost savings and certain
one-time gains, offset in part by higher depreciation principally relating to
the expansion of theme parks and consumer products operations.
 
     Broadcasting-The WB Network.  Revenues increased to $136 million, compared
to $87 million in 1996. EBITA and operating losses improved to a loss of $88
million from a loss of $98 million. The increase in revenues primarily resulted
from the expansion of programming in September 1996 to three nights of prime-
time scheduling and the expansion of Kids' WB!, the network's animated
programming lineup on Saturday mornings and weekdays. The 1997 operating loss
improved principally as a result of the revenue gains and the effect of an
increase in a limited partner's interest in the network that occurred in early
1997.
 
     Cable Networks-HBO.  Revenues increased to $1.923 billion, compared to
$1.763 billion in 1996. EBITA and operating income increased to $391 million
from $328 million. Revenues benefited primarily from an increase in
subscriptions to 33.6 million from 32.4 million at the end of 1996. EBITA and
operating income improved principally as a result of the revenue gains and, to a
lesser extent, cost savings.
 
     Cable.  Revenues increased to $4.243 billion, compared to $3.851 billion in
1996. EBITA increased to $1.184 billion from $917 million. Operating income
increased to $877 million from $606 million. Revenues benefited from an increase
in basic cable and Primestar-related, direct broadcast satellite subscribers,
increases in regulated cable rates and an increase in advertising and
pay-per-view revenues. EBITA and operating income increased principally as a
result of the revenue gains, as well as net gains of approximately $200 million
recognized in 1997 in connection with the sale or exchange of certain cable
systems. The increases in EBITA and operating income were partially offset by
higher depreciation related to capital spending.
 
     As of December 31, 1997, including Primestar-related, direct broadcast
satellite subscribers and the cable operations of TWE-A/N and TWI Cable, there
were 12.6 million subscribers under the management of TWE's Cable division, as
compared to 12.3 million subscribers at the end of 1996.
 
     Interest and Other, Net.  Interest and other, net, decreased to $357
million in 1997, compared to $524 million in 1996. Interest expense increased to
$494 million, compared to $478 million in 1996. There was other income, net, of
$137 million in 1997, compared to other expense, net, of $46 million in 1996,
principally due to higher gains on asset sales, including an approximate $250
million pretax gain on the sale of an interest in E! Entertainment recognized in
1997. This income was offset in part by higher losses from reductions in the
carrying value of certain investments and the dividend requirements on preferred
stock of a subsidiary issued in February 1997.
 
                                      F-11
<PAGE>   62
                                TIME WARNER INC.
                      MANAGEMENT'S DISCUSSION AND ANALYSIS
        OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION -- (CONTINUED)
 
FINANCIAL CONDITION AND LIQUIDITY
 
DECEMBER 31, 1998
 
TIME WARNER
 
1998 FINANCIAL CONDITION
 
     At December 31, 1998, Time Warner had $10.9 billion of debt, $442 million
of available cash and equivalents (net debt of $10.5 billion), $895 million of
borrowings against future stock option proceeds, $575 million of mandatorily
redeemable preferred securities of a subsidiary and $8.9 billion of
shareholders' equity, compared to $11.8 billion of debt, $645 million of
available cash and equivalents (net debt of $11.2 billion), $533 million of
borrowings against future stock option proceeds, $575 million of mandatorily
redeemable preferred securities of a subsidiary, $1.9 billion of Series M
Preferred Stock and $9.4 billion of shareholders' equity at December 31, 1997.
 
FINANCING ACTIVITIES
 
     During 1998, Time Warner continued its debt reduction efforts. Debt
reduction of approximately $3 billion was partially offset by a $2.1 billion
increase in debt in order to fund the 1998 redemption of Time Warner's Series M
Preferred Stock. This debt reduction was achieved principally by using cash
provided by operations, proceeds from certain asset sales, cash distributions
from TWE and the noncash transfer of approximately $1 billion of debt to TWE-A/N
as part of the TWE-A/N Transfers.
 
     In addition, during 1998, holders of Time Warner's $1.15 billion of
zero-coupon convertible notes due 2013 (the "Zero-Coupon Convertible Notes")
converted their notes into an aggregate 37.4 million shares of Time Warner
common stock. In order to partially offset the dilution resulting from this
conversion, Time Warner incurred a corresponding $1.15 billion of debt and used
the proceeds to repurchase common stock.
 
STOCK OPTION PROCEEDS CREDIT FACILITY
 
     In early 1998, Time Warner entered into a new five-year, $1.3 billion
revolving credit facility (the "Stock Option Proceeds Credit Facility"), which
replaced its previously existing facility. Borrowings under the Stock Option
Proceeds Credit Facility are principally used to fund stock repurchases and
approximately $12 million of future preferred dividend requirements on Time
Warner's convertible preferred stock. At December 31, 1998 and 1997, Time Warner
had outstanding borrowings against future stock option proceeds of $895 million
and $533 million, respectively.
 
     Because borrowings under the Stock Option Proceeds Credit Facility are
expected to be principally repaid by Time Warner from the cash proceeds related
to the exercise of employee stock options, Time Warner's principal credit rating
agencies have concluded that such borrowings and related financing costs are
credit neutral and are excludable from debt and interest expense, respectively,
for their purposes in evaluating Time Warner's leverage and coverage ratios. In
addition, because Time Warner has committed to use the Stock Option Proceeds
Credit Facility to fund preferred dividend requirements on certain series of its
convertible preferred stock, and has entered into certain escrow arrangements,
Time Warner's principal credit rating agencies similarly exclude such preferred
dividend requirements for purposes of evaluating Time Warner's coverage ratio.
See Note 8 to the accompanying consolidated financial statements for a summary
of the principal terms of the Stock Option Proceeds Credit Facility.
 
REDEMPTION OF SERIES M PREFERRED STOCK
 
     In December 1998, Time Warner redeemed all of its outstanding shares of
10 1/4% Series M Preferred Stock. The aggregate redemption cost of approximately
$2.1 billion was funded with proceeds from the
                                      F-12
<PAGE>   63
                                TIME WARNER INC.
                      MANAGEMENT'S DISCUSSION AND ANALYSIS
        OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION -- (CONTINUED)
 
issuance of lower-cost debt (the "1998 Series M Refinancing"). Because the
weighted-average interest rate of the debt is approximately 375 basis points
lower than the dividend rate of the Series M Preferred Stock and the interest on
the debt is tax deductible (whereas dividends are not), Time Warner expects to
realize approximately $100 to $125 million of annual cash savings as a result of
this redemption.
 
PREFERRED STOCK CONVERSIONS
 
     During 1998 and January 1999, Time Warner issued approximately 66 million
shares of common stock in connection with the conversion of 15.8 million shares
of convertible preferred stock. These conversions are expected to result in
approximately $60 million of cash dividend savings in the aggregate for Time
Warner through the end of 1999.
 
COMMON STOCK REPURCHASE PROGRAM
 
     During 1998, Time Warner acquired 59.9 million shares of its common stock
at an aggregate cost of $2.24 billion under its existing common stock repurchase
program, thereby increasing the cumulative shares purchased to approximately
95.1 million shares at an aggregate cost of $3.04 billion. Except for
repurchases of common stock using borrowings in 1998 that offset $1.15 billion
of debt reduction associated with the conversion of the Zero-Coupon Convertible
Notes into common stock, these repurchases were funded with stock option
exercise proceeds and borrowings under Time Warner's Stock Option Proceeds
Credit Facility.
 
     In January 1999, Time Warner's Board of Directors authorized a new common
stock repurchase program that allows the Company to repurchase, from time to
time, up to $5 billion of common stock. This program is expected to be completed
over a three-year period. However, actual repurchases in any period will be
subject to market conditions. Along with stock option exercise proceeds and
borrowings under the Stock Option Proceeds Credit Facility, additional funding
for this program is expected to be provided by anticipated future free cash flow
and financial capacity.
 
CREDIT STATISTICS
 
     The combination of EBITA growth, controlled capital spending and debt
reduction has resulted in improvements in Time Warner's financial condition and
overall financial flexibility, as reflected in its strengthening financial
ratios. These ratios, consisting of commonly used financial measures such as
leverage and coverage ratios, are used by credit rating agencies and other
credit analysts to measure the ability of a company to repay debt (leverage) and
to pay interest and preferred dividends (coverage). As a result of the
continuing improvements in Time Warner's financial performance, each of Standard
& Poor's and Moody's, Time Warner's principal credit rating agencies, upgraded
Time Warner in 1998 to an improved investment-grade credit rating.
 
     The leverage and coverage ratios are set forth below for each of Time
Warner and Time Warner and the Entertainment Group combined. Certain rating
agencies and other credit analysts place more emphasis on the combined ratios,
while others place more emphasis on the Time Warner stand-alone ratios. It
should be understood, however, that the assets of the Entertainment Group are
not freely available to fund the cash needs of Time Warner. The leverage ratio
represents the ratio of total debt, less available cash and equivalents, to
total business segment operating income before depreciation and amortization,
less corporate expenses ("Adjusted EBITDA"). The coverage ratio represents the
ratio of Adjusted EBITDA to total interest expense and/or preferred dividends.
 
                                      F-13
<PAGE>   64
                                TIME WARNER INC.
                      MANAGEMENT'S DISCUSSION AND ANALYSIS
        OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION -- (CONTINUED)
 
<TABLE>
<CAPTION>
                                                                  HISTORICAL        PRO FORMA
                                                              ------------------    ---------
                                                               1998       1997       1996(a)
                                                              -------    -------    ---------
<S>                                                           <C>        <C>        <C>
Time Warner and Entertainment Group combined:
  Leverage ratio............................................   3.0x       3.2x        4.1x
  Interest coverage ratio(b)................................   4.0x       3.5x        2.9x
  Interest and preferred dividends coverage ratio(b)(c).....   3.3x       2.8x        2.3x
Time Warner:
  Leverage ratio............................................   4.1x       4.5x        5.9x
  Interest coverage ratio(b)................................   3.1x       2.5x        2.0x
  Interest and preferred dividends coverage ratio(b)(c).....   2.3x       1.9x        1.5x
</TABLE>
 
---------------
 
(a) Pro forma ratios for 1996 give effect to the 1996 Time Warner Transactions
    as if they had occurred at the beginning of 1996. Historical ratios for 1996
    are not meaningful and have not been presented because they reflect the
    operating results of TBS for only a portion of the year in comparison to
    year-end net debt levels.
(b) Excludes interest paid to TWE in connection with borrowings under Time
    Warner's $400 million credit agreement with TWE and excludes interest on
    borrowings under the Stock Option Proceeds Credit Facility.
(c) Includes dividends related to certain preferred securities of subsidiaries.
    Excludes preferred dividends that Time Warner has funded with borrowings
    under the Stock Option Proceeds Credit Facility.
 
CASH FLOWS
 
     During 1998, Time Warner's cash provided by operations amounted to $1.845
billion and reflected $2.296 billion of EBITA from its Publishing, Music, Cable
Networks-TBS, Filmed Entertainment-TBS and Cable businesses, $378 million of
noncash depreciation expense, $17 million of proceeds from Time Warner's asset
securitization program and $698 million of distributions from TWE (excluding
$455 million representing the return of a portion of the Time Warner General
Partners' Senior Capital interest that has been classified as a source of cash
from investing activities), less $812 million of interest payments, $209 million
of income taxes, $86 million of corporate expenses and $437 million related to
an increase in other working capital requirements, balance sheet accounts and
noncash items. Cash provided by operations of $1.408 billion in 1997 reflected
$2.183 billion of business segment EBITA, $382 million of noncash depreciation
expense, $108 million of proceeds from Time Warner's asset securitization
program and $479 million of distributions from TWE (similarly excluding $455
million representing the return of a portion of the Time Warner General
Partners' Senior Capital interest that has been classified as a source of cash
from investing activities), less $929 million of interest payments, $253 million
of income taxes, $81 million of corporate expenses and $481 million related to
an increase in other working capital requirements, balance sheet accounts and
noncash items.
 
     Cash provided by investing activities was $353 million in 1998, compared to
cash used by investing activities of $45 million in 1997, principally as a
result of lower capital expenditures and an increase in investment proceeds
relating to Time Warner's debt reduction efforts, partially offset by an
increase in cash used for investments and acquisitions. Cash used for
investments and acquisitions in 1998 was offset in part by the effect of
consolidating approximately $200 million of cash of Paragon Communications
("Paragon") in connection with the TWE-A/N Transfers. Capital expenditures
decreased to $512 million in 1998, compared to $574 million in 1997.
 
     Cash used by financing activities was $2.401 billion in 1998, compared to
$1.232 billion in 1997. During 1998, Time Warner issued approximately $2.1
billion of debt and used the proceeds therefrom to redeem its Series M Preferred
Stock. Time Warner also had additional borrowings in 1998 that offset the
noncash reduction of $1.15 billion of debt relating to the conversion of the
Zero-Coupon Convertible Notes into common stock. Time Warner used the proceeds
from these borrowings, together with most of the combined
 
                                      F-14
<PAGE>   65
                                TIME WARNER INC.
                      MANAGEMENT'S DISCUSSION AND ANALYSIS
        OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION -- (CONTINUED)
 
$740 million of proceeds received from the exercise of employee stock options
and $362 million of net borrowings against future stock option proceeds, to
repurchase approximately 59.9 million shares of Time Warner common stock at an
aggregate cost of $2.24 billion. In addition, Time Warner paid $524 million of
dividends in 1998, reflecting its election in 1998 to pay dividends on its
Series M Preferred Stock in cash rather than in-kind. Cash used by financing
activities in 1997 principally resulted from approximately $1 billion of debt
reduction, the repurchase of approximately 12.4 million shares of Time Warner
common stock at an aggregate cost of $344 million and the payment of $338
million of dividends, offset in part by proceeds received from the exercise of
employee stock options.
 
     The assets and cash flows of TWE are restricted by certain borrowing and
partnership agreements and are unavailable to Time Warner except through the
payment of certain fees, reimbursements, cash distributions and loans, which are
subject to limitations. Under its bank credit agreement, TWE is permitted to
incur additional indebtedness to make loans, advances, distributions and other
cash payments to Time Warner, subject to its individual compliance with the cash
flow coverage and leverage ratio covenants contained therein.
 
     Management believes that Time Warner's operating cash flow, cash and
equivalents and additional borrowing capacity are sufficient to fund its capital
and liquidity needs for the foreseeable future without distributions and loans
from TWE above those permitted by existing agreements.
 
ENTERTAINMENT GROUP
 
1998 FINANCIAL CONDITION
 
     At December 31, 1998, the Entertainment Group had $6.6 billion of debt, $87
million of cash and equivalents (net debt of $6.5 billion), $217 million of
preferred stock of a subsidiary, $603 million of Time Warner General Partners'
Senior Capital and $5.2 billion of partners' capital, 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 $6.4 billion of partners' capital at December 31,
1997. Net debt of the Entertainment Group increased in 1998 principally as a
result of the TWE-A/N Transfers and increased borrowings to fund cash
distributions paid to Time Warner, partially offset by approximately $650
million of debt reduction associated with the formation of a cable television
joint venture in Texas (the "Texas Cable Joint Venture") with TCI
Communications, Inc. ("TCI"), a subsidiary of Tele-Communications, Inc.
 
CREDIT STATISTICS
 
     Entertainment Group leverage and coverage ratios for 1998, 1997 and 1996
were as follows:
 
<TABLE>
<CAPTION>
                                                              HISTORICAL
                                                         --------------------
                                                         1998    1997    1996
                                                         ----    ----    ----
<S>                                                      <C>     <C>     <C>
Leverage ratio.........................................   2.1x    2.0x    2.4x
Interest coverage ratio(a).............................   5.3x    5.4x    4.8x
</TABLE>
 
---------------
(a) Includes dividends related to the preferred stock of a subsidiary.
 
CASH FLOWS
 
     In 1998, the Entertainment Group's cash provided by operations amounted to
$2.288 billion and reflected $2.233 billion of EBITA from the Filmed
Entertainment-Warner Bros., Broadcasting-The WB Network, Cable Networks-HBO and
Cable businesses, $927 million of noncash depreciation expense and $166 million
from TWE's asset securitization program, less $537 million of interest payments,
$91 million of income taxes,
 
                                      F-15
<PAGE>   66
                                TIME WARNER INC.
                      MANAGEMENT'S DISCUSSION AND ANALYSIS
        OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION -- (CONTINUED)
 
$72 million of corporate expenses and $338 million related to an increase in
working capital requirements, other balance sheet accounts and noncash items.
Cash provided by operations of $1.799 billion in 1997 reflected $1.891 billion
of business segment EBITA, $956 million of noncash depreciation expense and $300
million from TWE's asset securitization program, less $493 million of interest
payments, $95 million of income taxes, $72 million of corporate expenses and
$688 million related to an increase in working capital requirements, other
balance sheet accounts and noncash items.
 
     Cash used by investing activities was $745 million in 1998, compared to
$1.217 billion in 1997, principally as a result of a $726 million increase in
investment proceeds, offset in part by a reduction of cash flows from
investments and acquisitions related to the deconsolidation of approximately
$200 million of Paragon's cash in connection with the TWE-A/N Transfers.
Investment proceeds increased principally due to TWE's debt reduction efforts,
including proceeds from the sale of TWE's remaining interest in Six Flags
Entertainment Corporation and the receipt of approximately $650 million of
proceeds upon the formation of the Texas Cable Joint Venture. Capital
expenditures were $1.603 billion in 1998, compared to $1.565 billion in 1997.
 
     Cash used by financing activities was $1.778 billion in 1998, compared to
$476 million in 1997. The use of cash in 1998 principally reflected $1.153
billion of distributions paid to Time Warner and the use of investment proceeds
to reduce debt in connection with TWE's debt reduction efforts. The use of cash
in 1997 principally reflected $934 million of distributions paid to Time Warner,
offset in part by $243 million of aggregate net proceeds from the issuance of
preferred stock of a subsidiary and an increase in borrowings used to fund cash
distributions to Time Warner.
 
     Management believes that the Entertainment Group'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 keep the business positioned for sustained,
long-term growth. Capital spending by Time Warner Cable, including the cable
operations of both Time Warner and TWE, amounted to $1.676 billion in 1998,
compared to $1.683 billion in 1997. Cable capital spending for 1999 is budgeted
to be approximately $1.5 billion and 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 and consistent with Time
Warner Cable's long-term strategic plan, Time Warner Cable agreed with the
Federal Communications Commission (the "FCC") in 1996 to invest a total of $4
billion in capital costs in connection with the upgrade of its cable
infrastructure. The agreement with the FCC covers all of the cable operations of
Time Warner Cable, including the owned or managed cable television systems of
Time Warner, TWE and TWE-A/N. As of December 31, 1998, Time Warner Cable had
approximately $1 billion remaining under this commitment. Management expects to
satisfy this commitment by December 31, 2000 when Time Warner Cable's
technological upgrade of its cable television systems is scheduled to be
substantially completed.
 
CABLE STRATEGY
 
     In addition to using cable operating cash flow to finance the level of
capital spending necessary to upgrade the technological capability of cable
television systems and develop new services, Time Warner, TWE and TWE-A/N have
completed or announced a series of transactions over the past year related to
the cable television business and related ancillary businesses. These
transactions consist of the TWE-A/N Transfers, the Primestar Roll-up
Transaction, the Time Warner Telecom Reorganization, the formation of the Road
Runner Joint Venture, the formation of the Texas Cable Joint Venture and other
TCI-related cable
 
                                      F-16
<PAGE>   67
                                TIME WARNER INC.
                      MANAGEMENT'S DISCUSSION AND ANALYSIS
        OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION -- (CONTINUED)
 
transactions and the anticipated formation with AT&T Corp. ("AT&T") of a cable
telephony joint venture (the "AT&T Cable Telephony Joint Venture").
 
     All of these transactions have reduced, or will reduce, either existing
debt and/or Time Warner's and TWE's share of future funding requirements for
these businesses. In addition, the formation of the Road Runner Joint Venture
and, ultimately, the AT&T Cable Telephony Joint Venture, when completed, will
enable Time Warner Cable to leverage its technologically advanced, high-capacity
cable architecture into new opportunities to create incremental value through
the development and exploitation of new services with strategic partners, such
as AT&T, Microsoft Corp. and Compaq Computer Corp.
 
     The proposed AT&T Cable Telephony Joint Venture is discussed more fully
below and the other transactions are described in Note 2 to the accompanying
consolidated financial statements.
 
AT&T Cable Telephony Joint Venture
 
     In February 1999, Time Warner, TWE and AT&T announced their intention to
form a strategic joint venture. This joint venture will offer AT&T-branded cable
telephony service to residential and small business customers over Time Warner
Cable's television systems for up to a twenty-year period. This transaction
effectively will allow Time Warner Cable to leverage its existing cable
infrastructure into a new growth opportunity in a non-core business, without the
need for any incremental capital investment.
 
     Under the preliminary terms announced by the parties, the joint venture
will be owned 22.5% by Time Warner Cable and 77.5% by AT&T. AT&T will be
responsible for funding all of the joint venture's negative cash flow and Time
Warner Cable's equity interest in the joint venture will not be diluted as a
result of AT&T's funding obligations. Because AT&T is expected to have
significant funding obligations through at least the first three years of the
joint venture's operations when capital will be deployed and services first
rolled-out, Time Warner Cable expects to benefit from the additional value
created from its "carried" interest.
 
     In addition to its equity interest, Time Warner Cable is expected to
receive the following payments from the joint venture:
 
      (i) Approximately $300 million of initial access fees, based on a rate of
          $15 per home passed that is payable in two annual installments once a
          particular service area has been upgraded and powered for cable
          telephony service. Time Warner Cable is expected to receive additional
          access fees in the future as its cable television systems continue to
          pass new homes.
 
      (ii) Recurring monthly subscriber fees in the initial amount of $1.50 per
           telephony subscriber, to be adjusted periodically to up to $6.00 per
           telephony subscriber in the sixth year of providing cable telephony
           service to any particular area. In addition, the joint venture is
           expected to guarantee certain minimum penetration levels to Time
           Warner Cable, ranging from 5% in the second year of providing cable
           telephony service to any particular area to up to 25% in the sixth
           year and thereafter.
 
     (iii) Additional monthly subscriber fees equal to 15% of the excess, if
           any, of monthly average cable telephony revenues in a particular
           service area over $100, after the fifth year of providing cable
           telephony service to any particular area.
 
     Further, management believes that the opportunity for consumers to select
one provider of AT&T-branded, "all-distance" wireline and wireless communication
services will contribute to increased cable television penetration in Time
Warner Cable's service areas and the continuing growth in Time Warner Cable's
revenues from the delivery of cable television services.
 
     This transaction is expected to close in the second half of 1999, subject
to the execution of definitive agreements by the parties and customary closing
conditions, including the approval of Advance/Newhouse
 
                                      F-17
<PAGE>   68
                                TIME WARNER INC.
                      MANAGEMENT'S DISCUSSION AND ANALYSIS
        OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION -- (CONTINUED)
 
and MediaOne and all necessary governmental and regulatory approvals. There can
be no assurance that such agreements will be completed or that such approvals
will be obtained.
 
OFF-BALANCE SHEET ASSETS
 
     As discussed below, Time Warner believes that the value of certain
off-balance sheet assets should be considered, along with other factors
discussed elsewhere herein, in evaluating the Company's financial condition and
prospects for future results of operations, including its ability to fund its
capital and liquidity needs.
 
Intangible Assets
 
     As a creator and distributor of branded information and entertainment
copyrights, Time Warner and the Entertainment Group have a significant amount of
internally generated intangible assets whose value is not fully reflected in
their respective consolidated balance sheets. Such intangible assets extend
across Time Warner's principal business interests, but are best exemplified by
Time Warner's collection of copyrighted music product, its libraries of
copyrighted film and television product and the creation or extension of brands.
Generally accepted accounting principles do not recognize the value of such
assets, except at the time they may be acquired in a business combination
accounted for by the purchase method of accounting.
 
     Because Time Warner normally owns the copyrights to such creative material,
it continually generates revenue through the sale of such products across
different media and in new and existing markets. The value of film and
television-related copyrighted product and trademarks is continually realized by
the licensing of films and television series to secondary markets and the
licensing of trademarks, such as the Looney Tunes characters and Batman, to the
retail industry and other markets. In addition, technological advances, such as
the introduction of the compact disc and home videocassette in the 1980's and,
potentially, the current exploitation of the digital video disc, have
historically generated significant revenue opportunities through the repackaging
and sale of such copyrighted products in the new technological format.
Accordingly, such intangible assets have significant off-balance sheet asset
value that is not fully reflected in the consolidated balance sheets of Time
Warner and the Entertainment Group.
 
Filmed Entertainment Backlog
 
     Backlog represents 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. Backlog of TWE's
Filmed Entertainment-Warner Bros. division amounted to $2.298 billion at
December 31, 1998 (including amounts relating to the licensing of film product
to Time Warner's and TWE's cable television networks of $769 million). In
addition, backlog of Time Warner's Filmed Entertainment-TBS division amounted to
$636 million at December 31, 1998 (including amounts relating to the licensing
of film product to Time Warner's and TWE's cable television networks of $226
million).
 
     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 received periodically
over the term of the related licensing agreements or on an accelerated basis
using TWE's $500 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.
 
                                      F-18
<PAGE>   69
                                TIME WARNER INC.
                      MANAGEMENT'S DISCUSSION AND ANALYSIS
        OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION -- (CONTINUED)
 
INTEREST RATE AND FOREIGN CURRENCY RISK MANAGEMENT
 
Interest Rate Swap Contracts
 
     Time Warner uses interest rate swap contracts to adjust the proportion of
total debt that is subject to variable and fixed interest rates. At December 31,
1998, Time Warner had interest rate swap contracts to pay floating-rates of
interest (average six-month LIBOR rate of 5.5%) and receive fixed-rates of
interest (average rate of 5.5%) on $1.6 billion notional amount of indebtedness,
which resulted in approximately 37% of Time Warner's underlying debt, and 39% of
the debt of Time Warner and the Entertainment Group combined, being subject to
variable interest rates. At December 31, 1997, Time Warner had interest rate
swap contracts on $2.3 billion notional amount of indebtedness.
 
     Based on Time Warner's variable-rate debt and related interest rate swap
contracts outstanding at December 31, 1998, each 25 basis point increase or
decrease in the level of interest rates would, respectively, increase or
decrease Time Warner's annual interest expense and related cash payments by
approximately $11 million, including $4 million related to interest rate swap
contracts. Such potential increases or decreases are based on certain
simplifying assumptions, including a constant level of variable-rate debt and
related interest rate swap contracts during the period and, for all maturities,
an immediate, across-the-board increase or decrease in the level of interest
rates with no other subsequent changes for the remainder of the period.
 
Foreign Exchange Contracts
 
     Time Warner uses foreign exchange contracts primarily to hedge the risk
that unremitted or future royalties and license fees owed to Time Warner or TWE
domestic companies for the sale or anticipated sale of U.S. copyrighted products
abroad may be adversely affected by changes in 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
and TWE's combined foreign currency exposures anticipated over the ensuing
twelve month period. At December 31, 1998, Time Warner had effectively hedged
approximately half of the combined estimated foreign currency exposures that
principally relate to anticipated cash flows to be remitted to the U.S. over the
ensuing twelve month period. To hedge this exposure, Time Warner used foreign
exchange contracts that generally have maturities of three months or less, which
generally will be rolled over to provide continuing coverage throughout the
year. Time Warner is reimbursed by or reimburses TWE for Time Warner contract
gains and losses related to TWE's foreign currency exposure. Time Warner often
closes foreign exchange sale contracts by purchasing an offsetting purchase
contract. At December 31, 1998, Time Warner had contracts for the sale of $755
million and the purchase of $259 million of foreign currencies at fixed rates,
compared to contracts for the sale of $507 million and the purchase of $139
million of foreign currencies at December 31, 1997.
 
     Based on the foreign exchange contracts outstanding at December 31, 1998,
each 5% devaluation of the U.S. dollar as compared to the level of foreign
exchange rates for currencies under contract at December 31, 1998 would result
in approximately $38 million of unrealized losses and $13 million of unrealized
gains on foreign exchange contracts involving foreign currency sales and
purchases, respectively. Conversely, a 5% appreciation of the U.S. dollar would
result in $38 million of unrealized gains and $13 million of unrealized losses,
respectively. With regard to the net $25 million of unrealized losses or gains
on foreign exchange contracts, Time Warner would be reimbursed by TWE, or would
reimburse TWE, respectively, for approximately $10 million, net, related to
TWE's foreign currency exposure. Consistent with the nature of the economic
hedge provided by such foreign exchange contracts, such unrealized gains or
losses would be offset by corresponding decreases or increases, respectively, in
the dollar value of future foreign currency royalty and license fee payments
that would be received in cash within the ensuing twelve month period from the
sale of U.S. copyrighted products abroad.
 
                                      F-19
<PAGE>   70
                                TIME WARNER INC.
                      MANAGEMENT'S DISCUSSION AND ANALYSIS
        OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION -- (CONTINUED)
 
GLOBAL FINANCIAL MARKETS
 
     During 1998, certain financial markets, mainly Brazil, Russia and a number
of Asian countries, experienced significant instability. Because less than 5% of
the combined revenues of Time Warner and the Entertainment Group are derived
from the sale of products and services in these countries, management does not
believe that the state of these financial markets poses a material risk to the
operations of Time Warner and the Entertainment Group.
 
EURO CONVERSION
 
     Effective January 1, 1999, the "euro" was established as a single currency
valid in more than two-thirds of the member countries of the European Union.
These member countries have a three-year transitional period to physically
convert their sovereign currencies to the euro. By July 1, 2002, all
participating member countries must eliminate their 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, Time Warner
continues to evaluate the short-term and long-term effects of the euro
conversion on its European operations, principally publishing, music, cable
networks and filmed entertainment.
 
     Time Warner believes that the most significant short-term impact of the
euro conversion is the need to modify its accounting and information systems to
handle an increasing volume of transactions during the transitional period in
both the euro and sovereign currencies of the participating member countries.
Time Warner has identified its accounting and information systems in need of
modification and an action plan has been formulated to address the nature and
timing of remediation efforts. Remediation efforts have begun and the plan is
expected to be substantially completed well before the end of the transitional
period. This timetable will be adjusted, if necessary, to meet the anticipated
needs of Time Warner's vendors and customers. Based on preliminary information,
costs to modify its accounting and information systems are not expected to be
material.
 
     Time Warner believes that the most significant long-term business risk of
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, Time Warner believes that these business risks may
be offset to some extent by lower material costs, other cost savings and
marketing opportunities. Notwithstanding such risks, management does not believe
that the euro conversion will have a material effect on Time Warner's financial
position, results of operations or cash flows in future periods.
 
YEAR 2000 TECHNOLOGY PREPAREDNESS
 
     Time Warner, together with its Entertainment Group 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.
 
     Time Warner's exposure to potential Year 2000 problems arises both in
technological operations under the control of the Company and in those dependent
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 Time Warner's potential Year 2000
exposures are dependent to some degree on one or more third parties. Failure to
achieve high levels of Year 2000 compliance could have a material adverse impact
on Time Warner and its financial statements.
 
                                      F-20
<PAGE>   71
                                TIME WARNER INC.
                      MANAGEMENT'S DISCUSSION AND ANALYSIS
        OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION -- (CONTINUED)
 
     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 that reports through the Company's Chief
Financial Officer to the Audit Committee of the Board of Directors.
 
     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
others or (3) meet its obligations under regulatory requirements and internal
accounting controls. The Company and its divisions, including the Entertainment
Group, have identified approximately 1,000 worldwide, "mission critical"
potential exposures. Of these, as of December 31, 1998, approximately 39% have
been identified by the divisions as Year 2000 compliant, approximately 46% as in
the remediation implementation or final testing stages, approximately 14% as in
the remediation planning stage and less than 1% as still in the assessment
stage. The Company currently expects that the assessment phase for the few
remaining potential exposures should be completed during the first quarter of
1999 and that remediation with respect to approximately 80% of all these
identified operations will be substantially completed in all material respects
by the end of the second quarter of 1999. The Company, however, could experience
unexpected delays. The Company is currently planning to impose a "quiet" period
at the beginning of the fourth quarter of 1999 during which any remaining
remediation involving installation or modification of systems that interface
with other systems will be minimized to permit the Company to conduct testing in
a stable environment.
 
     As stated above, however, the Company's business is heavily dependent on
third parties and these parties 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 was not Year 2000 compliant as of
December 31, 1998. The box manufacturers are working with cable industry groups
and have developed solutions that the Company is installing 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 ascertaining their state of
Year 2000 readiness through various means, including questionnaires, interviews,
on-site visits, system interface testing and industry group participation.
Moreover, Time Warner 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. Time Warner is taking steps to attempt to satisfy itself that the
third parties on which it is heavily reliant are Year 2000 compliant or that
alternate means of meeting its requirements are available, 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. In areas in which the Company is
uncertain
                                      F-21
<PAGE>   72
                                TIME WARNER INC.
                      MANAGEMENT'S DISCUSSION AND ANALYSIS
        OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION -- (CONTINUED)
 
about the anticipated Year 2000 readiness of a significant third party, the
Company is investigating available alternatives, if any.
 
     The Company, including the Entertainment Group, currently estimates that
the aggregate cost of its Year 2000 remediation program, which started in 1996,
will be approximately $125 to $175 million, of which an estimated 45% to 55% has
been incurred through December 31, 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. The Company anticipates that its remediation program, and related
expenditures, may continue into 2001 as temporary solutions to Year 2000
problems are replaced with upgraded equipment. 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 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 does 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, specific
contingency plans in the event it does not successfully complete all phases of
its Year 2000 program. The Company, however, has begun to examine its existing
standard business interruption strategies to evaluate whether they would
satisfactorily meet the demands of failures arising from Year 2000-related
problems. The Company intends to examine its status periodically to determine
the necessity of establishing and implementing such contingency plans or
additional strategies, which could involve, among other things, manual
workarounds, adjusting staffing strategies and sharing resources across
divisions.
 
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 document, 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. 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 the Company is under no obligation to (and
expressly disclaims any such obligation to) update or alter its forward-looking
statements whether as a result of such changes, new information or otherwise.
 
     Time Warner 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,
technological developments and (particularly in view of technological changes)
protection of their intellectual property rights. Time Warner's actual results
could differ materially from management's expectations because
 
                                      F-22
<PAGE>   73
                                TIME WARNER INC.
                      MANAGEMENT'S DISCUSSION AND ANALYSIS
        OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION -- (CONTINUED)
 
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 Time Warner's other filings and:
 
     - For Time Warner'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 "unbundling" requirements); increased difficulty
       in obtaining franchise renewals; the failure of new equipment (such as
       digital set-top boxes) or services (such as high-speed online services or
       telephony over cable or video on demand) to function properly, to appeal
       to enough consumers or to be available at reasonable prices and to be
       delivered in a timely fashion; and greater than expected increases in
       programming or other costs.
 
     - For Time Warner's cable programming and television businesses, greater
       than expected programming or production costs; public and cable operator
       resistance to price increases (and the negative impact on premium
       programmers of increases in basic cable rates); increased regulation of
       distribution agreements; the sensitivity of advertising to economic
       cyclicality; 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 Time Warner'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.
 
     - For Time Warner's music business, its ability to continue to attract and
       select desirable talent at manageable costs; the timely completion of
       albums by major artists; the popular demand for particular artists and
       albums; its ability to continue to enforce its intellectual property
       rights in digital environments; and the overall strength of global music
       sales.
 
     - For Time Warner's print media and publishing businesses, increases in
       paper and distribution costs; the introduction and increased popularity
       of alternative technologies for the provision of news and information,
       such as the Internet; and fluctuations in advertiser and consumer
       spending.
 
     - 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 address adequately their own Year 2000 issues.
 
     In addition, Time Warner's overall financial strategy, including growth in
operations, maintaining its financial ratios and strengthened balance sheet,
could be adversely affected by increased interest rates, failure to meet
earnings expectations, significant acquisitions or other transactions,
consequences of the euro conversion and changes in Time Warner's plans,
strategies and intentions.
 
                                      F-23
<PAGE>   74
 
                                TIME WARNER INC.
                           CONSOLIDATED BALANCE SHEET
                                  DECEMBER 31,
                      (MILLIONS, EXCEPT PER SHARE AMOUNTS)
 
<TABLE>
<CAPTION>
                                                               1998       1997
                                                              -------    -------
<S>                                                           <C>        <C>
ASSETS
CURRENT ASSETS
Cash and equivalents........................................  $   442    $   645
Receivables, less allowances of $1.007 billion and $991
  million...................................................    2,885      2,447
Inventories.................................................      946        830
Prepaid expenses............................................    1,176      1,089
                                                              -------    -------
Total current assets........................................    5,449      5,011
Noncurrent inventories......................................    1,900      1,766
Investments in and amounts due to and from Entertainment
  Group.....................................................    4,980      5,549
Other investments...........................................      794      1,495
Property, plant and equipment, net..........................    1,991      2,089
Music catalogues, contracts and copyrights..................      876        928
Cable television and sports franchises......................    2,868      3,982
Goodwill....................................................   11,919     12,572
Other assets................................................      863        771
                                                              -------    -------
Total assets................................................  $31,640    $34,163
                                                              =======    =======
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable............................................  $   996    $   912
Participations, royalties and programming costs payable.....    1,199      1,072
Debt due within one year....................................       19          8
Other current liabilities...................................    2,404      2,379
                                                              -------    -------
Total current liabilities...................................    4,618      4,371
Long-term debt..............................................   10,925     11,833
Borrowings against future stock option proceeds.............      895        533
Deferred income taxes.......................................    3,491      3,960
Unearned portion of paid subscriptions......................      741        672
Other liabilities...........................................    1,543      1,006
Company-obligated mandatorily redeemable preferred
  securities of a subsidiary holding solely subordinated
  debentures of a subsidiary of the Company.................      575        575
Series M exchangeable preferred stock, $.10 par value, 1.9
  million shares outstanding in 1997 with a $1.903 billion
  liquidation preference....................................       --      1,857
SHAREHOLDERS' EQUITY
Preferred stock, $.10 par value, 22.6 and 35.4 million
  shares outstanding, $2.260 and $3.539 billion liquidation
  preference................................................        2          4
Series LMCN-V Common Stock, $.01 par value, 57.1 million
  shares outstanding........................................        1          1
Common stock, $.01 par value, 1.118 and 1.038 billion shares
  outstanding...............................................       11         10
Paid-in capital.............................................   13,134     12,675
Accumulated deficit.........................................   (4,296)    (3,334)
                                                              -------    -------
Total shareholders' equity..................................    8,852      9,356
                                                              -------    -------
Total liabilities and shareholders' equity..................  $31,640    $34,163
                                                              =======    =======
</TABLE>
 
See accompanying notes.
                                      F-24
<PAGE>   75
 
                                TIME WARNER INC.
                      CONSOLIDATED STATEMENT OF OPERATIONS
                            YEARS ENDED DECEMBER 31,
                      (MILLIONS, EXCEPT PER SHARE AMOUNTS)
 
<TABLE>
<CAPTION>
                                                                1998        1997       1996
                                                              --------    --------    -------
<S>                                                           <C>         <C>         <C>
Revenues(a).................................................  $ 14,582    $ 13,294    $10,064
                                                              --------    --------    -------
Cost of revenues(a)(b)......................................     8,210       7,542      5,922
Selling, general and administrative(a)(b)...................     4,876       4,481      3,176
                                                              --------    --------    -------
Operating expenses..........................................    13,086      12,023      9,098
                                                              --------    --------    -------
Business segment operating income...........................     1,496       1,271        966
Equity in pretax income of Entertainment Group(a)...........       356         686        290
Interest and other, net(a)..................................    (1,180)     (1,044)    (1,174)
Corporate expenses(a).......................................       (86)        (81)       (78)
                                                              --------    --------    -------
Income before income taxes..................................       586         832          4
Income taxes................................................      (418)       (531)      (160)
                                                              --------    --------    -------
Income (loss) before extraordinary item.....................       168         301       (156)
Extraordinary loss on retirement of debt, net of $37 and $22
  million income tax benefit in 1997 and 1996,
  respectively..............................................        --         (55)       (35)
                                                              --------    --------    -------
Net income (loss)...........................................       168         246       (191)
Preferred dividend requirements(c)..........................      (540)       (319)      (257)
                                                              --------    --------    -------
Net loss applicable to common shares........................  $   (372)   $    (73)   $  (448)
                                                              ========    ========    =======
Basic and diluted loss per common share:
Loss before extraordinary item..............................  $   (.31)   $   (.01)   $  (.48)
                                                              ========    ========    =======
Net loss....................................................  $   (.31)   $   (.06)   $  (.52)
                                                              ========    ========    =======
Average common shares.......................................   1,194.7     1,135.4      862.4
                                                              ========    ========    =======
</TABLE>
 
---------------
(a) Includes the following income (expenses) resulting from transactions with
    the Entertainment Group and other related companies for the years ended
    December 31, 1998, 1997 and 1996, respectively: revenues-$487 million, $384
    million and $224 million; cost of revenues-$(322) million, $(245) million
    and $(177) million; selling, general and administrative-$(40) million, $(53)
    million and $34 million; equity in pretax income of Entertainment Group-$105
    million, $5 million and $(29) million; interest and other, net-$(9) million,
    $(36) million and $(33) million; and corporate expenses-$72 million, $72
    million and $69 million (Note 18).
 
<TABLE>
<S>                                                           <C>         <C>         <C>
(b) Includes depreciation and amortization expense of:......  $  1,178    $  1,294    $   988
                                                              ========    ========    =======
</TABLE>
 
(c) Preferred dividend requirements for 1998 include a one-time effect of $234
    million ($.19 loss per common share) relating to the premium paid in
    connection with the redemption of the Company's 10 1/4% Series M
    exchangeable preferred stock ("Series M Preferred Stock") at an aggregate
    cost of approximately $2.1 billion (Note 11).
 
See accompanying notes.
                                      F-25
<PAGE>   76
 
                                TIME WARNER INC.
                      CONSOLIDATED STATEMENT OF CASH FLOWS
                            YEARS ENDED DECEMBER 31,
                                   (MILLIONS)
 
<TABLE>
<CAPTION>
                                                               1998       1997       1996
                                                              -------    -------    -------
<S>                                                           <C>        <C>        <C>
OPERATIONS
Net income (loss)...........................................  $   168    $   246    $  (191)
Adjustments for noncash and nonoperating items:
Extraordinary loss on retirement of debt....................       --         55         35
Depreciation and amortization...............................    1,178      1,294        988
Noncash interest expense....................................       30         98         96
Excess (deficiency) of distributions over equity in pretax
  income of Entertainment Group.............................      342       (207)       (62)
Equity in losses (income) of other investee companies after
  distributions.............................................      147         36        (53)
Changes in operating assets and liabilities:
  Receivables...............................................     (597)      (167)       (39)
  Inventories...............................................     (312)       (84)      (180)
  Accounts payable and other liabilities....................      810        501       (408)
  Other balance sheet changes...............................       79       (364)        67
                                                              -------    -------    -------
Cash provided by operations.................................    1,845      1,408        253
                                                              -------    -------    -------
INVESTING ACTIVITIES
Investments and acquisitions................................     (159)      (113)      (261)
Capital expenditures........................................     (512)      (574)      (481)
Investment proceeds.........................................      569        187        318
Proceeds received from distribution of TWE Senior Capital...      455        455         --
                                                              -------    -------    -------
Cash provided (used) by investing activities................      353        (45)      (424)
                                                              -------    -------    -------
FINANCING ACTIVITIES
Borrowings..................................................    3,743      5,413      3,431
Debt repayments.............................................   (2,317)    (6,394)    (5,271)
Borrowings against future stock option proceeds.............    1,015        230        488
Repayments of borrowings against future stock option
  proceeds..................................................     (653)      (185)        --
Repurchases of Time Warner common stock.....................   (2,240)      (344)      (456)
Redemption of Series M Preferred Stock......................   (2,093)        --         --
Issuance of Series M Preferred Stock........................       --         --      1,550
Dividends paid..............................................     (524)      (338)      (287)
Proceeds received from stock option and dividend
  reinvestment plans........................................      740        454        105
Other, principally financing costs..........................      (72)       (68)       (60)
                                                              -------    -------    -------
Cash used by financing activities...........................   (2,401)    (1,232)      (500)
                                                              -------    -------    -------
INCREASE (DECREASE) IN CASH AND EQUIVALENTS.................     (203)       131       (671)
CASH AND EQUIVALENTS AT BEGINNING OF PERIOD(a)..............      645        514      1,185
                                                              -------    -------    -------
CASH AND EQUIVALENTS AT END OF PERIOD(a)....................  $   442    $   645    $   514
                                                              =======    =======    =======
</TABLE>
 
---------------
(a) Includes current and noncurrent cash and equivalents at December 31, 1996
    and 1995.
 
See accompanying notes.
                                      F-26
<PAGE>   77
 
                                TIME WARNER INC.
                 CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
                                   (MILLIONS)
 
<TABLE>
<CAPTION>
                                                              PREFERRED    COMMON    PAID-IN     ACCUMULATED
                                                                STOCK      STOCK     CAPITAL       DEFICIT       TOTAL
                                                              ---------    ------    --------    -----------    -------
<S>                                                           <C>          <C>       <C>         <C>            <C>
BALANCE AT DECEMBER 31, 1995................................    $ 30       $ 776     $ 5,034       $(2,173)     $ 3,667
Net loss....................................................                                          (191)        (191)
Increase in unrealized gains on securities, net of $11
  million tax expense.......................................                                            17           17
Foreign currency translation adjustments....................                                             9            9
                                                                                                   -------      -------
  Comprehensive income (loss)...............................                                          (165)        (165)
Common stock dividends......................................                                          (155)        (155)
Preferred stock dividends...................................                                          (257)        (257)
Issuance of common and preferred stock in the CVI
  acquisition...............................................       6           6         668                        680
Reduction in par value of common and preferred stock due to
  TBS Transaction...........................................     (32)       (774)        806                         --
Issuance of common stock in the TBS Transaction.............                   3       6,024                      6,027
Repurchases of Time Warner common stock.....................                            (456)                      (456)
Shares issued pursuant to stock option, dividend
  reinvestment and benefit plans............................                             163            (8)         155
Other.......................................................                               6                          6
                                                                ----       -----     -------       -------      -------
BALANCE AT DECEMBER 31, 1996................................       4          11      12,245        (2,758)       9,502
Net income..................................................                                           246          246
Decrease in unrealized gains on securities, net of $89
  million tax benefit(a)....................................                                          (128)        (128)
Foreign currency translation adjustments....................                                           (76)         (76)
                                                                                                   -------      -------
  Comprehensive income (loss)...............................                                            42           42
Common stock dividends......................................                                          (204)        (204)
Preferred stock dividends...................................                                          (319)        (319)
Issuance of common stock in connection with the TBS
  Transaction...............................................                              67                         67
Repurchases of Time Warner common stock.....................                            (344)                      (344)
Shares issued pursuant to stock option, dividend
  reinvestment and benefit plans............................                             711           (98)         613
Other.......................................................                              (4)            3           (1)
                                                                ----       -----     -------       -------      -------
BALANCE AT DECEMBER 31, 1997................................       4          11      12,675        (3,334)       9,356
Net income..................................................                                           168          168
Foreign currency translation adjustments....................                                             4            4
Increase in realized and unrealized losses on derivative
  financial instruments, net of $13 million tax benefit.....                                           (20)         (20)
Cumulative effect of change in accounting for derivative
  financial instruments, net of $3 million tax benefit......                                           (18)         (18)
                                                                                                   -------      -------
  Comprehensive income (loss)...............................                                           134          134
Common stock dividends......................................                                          (216)        (216)
Preferred stock dividends...................................                                          (540)        (540)
Issuance of common stock in connection with the conversion
  of zero-coupon convertible notes due 2013.................                           1,150                      1,150
Issuance of common stock in connection with the conversion
  of convertible preferred stock............................      (2)          1         151          (150)          --
Repurchases of Time Warner common stock.....................                  (1)     (2,239)                    (2,240)
Shares issued pursuant to stock option, dividend
  reinvestment and benefit plans............................                   1       1,397          (190)       1,208
                                                                ----       -----     -------       -------      -------
BALANCE AT DECEMBER 31, 1998................................    $  2       $  12     $13,134       $(4,296)     $ 8,852
                                                                ====       =====     =======       =======      =======
</TABLE>
 
---------------
(a) Includes a $13 million reduction (net of a $9 million tax effect) related to
    realized gains on the sale of securities in 1997. In prior periods, this
    amount was included in comprehensive income as a component of Time Warner's
    unrealized gains on securities.
 
See accompanying notes.
                                      F-27
<PAGE>   78
 
                                TIME WARNER INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
1.  ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
DESCRIPTION OF BUSINESS
 
     Time Warner Inc. ("Time Warner" or the "Company"), together with its
consolidated and unconsolidated subsidiaries, is the world's leading media and
entertainment company. Time Warner's principal business objective is to create
and distribute branded information and entertainment copyrights throughout the
world. Time Warner classifies its business interests into four fundamental
areas: Cable Networks, consisting principally of interests in cable television
programming; Publishing, consisting principally of interests in magazine
publishing, book publishing and direct marketing; Entertainment, consisting
principally of interests in recorded music and music publishing, filmed
entertainment, television production and television broadcasting; and Cable,
consisting principally of interests in cable television systems.
 
     A majority of Time Warner's interests in filmed entertainment, television
production, television broadcasting and cable television systems, and a portion
of its interests in cable television programming are held through Time Warner
Entertainment Company, L.P. ("TWE"). Time Warner owns 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. Time Warner does not
consolidate TWE and certain related companies (the "Entertainment Group") for
financial reporting purposes because of certain limited partnership approval
rights related to TWE's interest in certain cable television systems.
 
     Each of the business interests within Cable Networks, Publishing,
Entertainment and Cable is important to management's objective of increasing
shareholder value through the creation, extension and distribution of
recognizable brands and copyrights throughout the world. Such brands and
copyrights include (1) leading cable television networks, such as HBO, Cinemax,
CNN, TNT and the TBS Superstation, (2) magazine franchises such as Time, People
and Sports Illustrated and direct marketing brands such as Time Life Inc. and
Book-of-the-Month Club, (3) 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, (4) unique and extensive film,
television and animation libraries of Warner Bros. and Turner Broadcasting
System, Inc. ("TBS"), and trademarks such as the Looney Tunes characters, Batman
and The Flintstones, (5) The WB Network, a national broadcasting network
launched in 1995 as an extension of the Warner Bros. brand and as an additional
distribution outlet for the Company's collection of children's cartoons and
television programming and (6) Time Warner Cable, currently the largest operator
of cable television systems in the U.S.
 
     The operating results of Time Warner's various business interests are
presented herein as an indication of financial performance (Note 16). Except for
start-up losses incurred in connection with The WB Network, Time Warner'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 in various
acquisitions accounted for by the purchase method of accounting. Noncash
amortization of intangible assets recorded by Time Warner's business interests,
including the unconsolidated business interests of the Entertainment Group,
amounted to $1.309 billion in 1998, $1.342 billion in 1997 and $1.117 billion in
1996.
 
BASIS OF PRESENTATION
 
     The consolidated financial statements of Time Warner reflect the
acquisition on October 10, 1996 of the remaining 80% interest in TBS that it did
not already own and certain cable-related transactions, as more fully described
herein (Notes 2 and 3). As a result of the acquisition of TBS, a new parent
company with the name "Time Warner Inc." replaced the old parent company of the
same name (now known as Time Warner
 
                                      F-28
<PAGE>   79
                                TIME WARNER INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
Companies, Inc., "TW Companies"), and TW Companies and TBS became separate,
wholly owned subsidiaries of the new parent company. References herein to "Time
Warner" or the "Company" refer to TW Companies prior to October 10, 1996 and
Time Warner Inc. thereafter.
 
     Common stock, paid-in-capital, stock options, per common share and average
common share amounts for all prior periods have been restated to give effect to
a two-for-one common stock split that occurred on December 15, 1998. In
addition, certain reclassifications have been made to the prior years' financial
statements to conform to the 1998 presentation.
 
BASIS OF CONSOLIDATION AND ACCOUNTING FOR INVESTMENTS
 
     The consolidated financial statements include 100% of the assets,
liabilities, revenues, expenses, income, loss and cash flows of Time Warner and
all companies in which Time Warner has a controlling voting interest
("subsidiaries"), as if Time Warner and its subsidiaries were a single company.
Significant intercompany accounts and transactions between the consolidated
companies have been eliminated. Significant accounts and transactions between
Time Warner and the Entertainment Group are disclosed as related party
transactions (Note 18).
 
     The Entertainment Group and investments in certain other companies in which
Time Warner has significant influence, but less than a controlling voting
interest, are accounted for using the equity method. Under the equity method,
only Time Warner's investment in and amounts due to and from the equity investee
are included in the consolidated balance sheet, only Time Warner's share of the
investee's earnings is included in the consolidated operating results, and only
the dividends, cash distributions, loans or other cash received from the
investee, less any additional cash investments, loan repayments or other cash
paid to the investee are included in the consolidated cash flows.
 
     Investments in companies in which Time Warner does not have a controlling
interest or an ownership and voting interest so large as to exert significant
influence are accounted for at market value if the investments are publicly
traded and there are no resale restrictions, or at cost, if the sale of a
publicly-traded investment is restricted or if the investment is not publicly
traded. Unrealized gains and losses on investments accounted for at market value
are reported net-of-tax in accumulated deficit until the investment is sold, at
which time the realized gain or loss is included in income. Dividends and other
distributions of earnings from both market value and cost method investments are
included in income when declared.
 
     The effect of any changes in Time Warner's ownership interests resulting
from the issuance of equity capital by consolidated subsidiaries or equity
investees to unaffiliated parties is included in income.
 
FOREIGN CURRENCY TRANSLATION
 
     The financial position and operating results of substantially all foreign
operations are consolidated using the local currency as the functional currency.
Local currency assets and liabilities are translated at the rates of exchange on
the balance sheet date, and local currency revenues and expenses are translated
at average rates of exchange during the period. Resulting translation gains or
losses, which have not been material, are included in accumulated deficit.
 
USE OF ESTIMATES
 
     The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
footnotes thereto. Actual results could differ from those estimates.
 
     Significant estimates inherent in the preparation of the accompanying
consolidated financial statements include management's forecast of anticipated
revenues from the sale of future and existing music and publishing-related
products, as well as from the distribution of theatrical and television product,
in order to
 
                                      F-29
<PAGE>   80
                                TIME WARNER INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
evaluate the ultimate recoverability of accounts receivables, film inventory and
artist and author advances recorded as assets in the consolidated balance sheet.
Accounts receivables and sales in the music and publishing industries, as well
as sales of home video product in the filmed entertainment industry, are subject
to customers' rights to return unsold items. Management periodically reviews
such estimates and it is reasonably possible that management's assessment of
recoverability of accounts receivables, individual films and television product
and individual artist and author advances may change based on actual results and
other factors.
 
REVENUES AND COSTS
 
  Publishing and Music
 
     The unearned portion of paid magazine subscriptions is deferred until
magazines are delivered to subscribers. Upon each delivery, a proportionate
share of the gross subscription price is included in revenues. Magazine
advertising revenues are recognized when the advertisements are published.
 
     In accordance with industry practice, certain products (such as magazines,
books, home videocassettes, compact discs and cassettes) are sold to customers
with the right to return unsold items. Revenues from such sales are recognized
when the products are shipped based on gross sales less a provision for future
returns.
 
     Inventories of magazines, books, cassettes and compact discs are stated at
the lower of cost or estimated realizable value. Cost is determined using
first-in, first-out; last-in, first-out; and average cost methods. Returned
goods included in inventory are valued at estimated realizable value, but not in
excess of cost.
 
  Cable and Cable Networks
 
     A significant portion of cable system and cable network programming
revenues are derived from subscriber fees and advertising. Subscriber fees are
recorded as revenue in the period the service is provided and advertising
revenues are recognized in the period that the advertisements are exhibited. The
costs of rights to exhibit feature films and other programming on the cable
networks during one or more availability periods ("programming costs") generally
are recorded when the programming is initially available for exhibition, and are
allocated to the appropriate availability periods and amortized as the
programming is exhibited.
 
  Filmed Entertainment
 
     Feature films are produced or acquired for initial exhibition in theaters
followed by distribution in the home video, pay cable, basic cable, broadcast
network and syndicated television markets. Generally, distribution to the
theatrical, home video and pay cable markets (the primary markets) is
principally completed within eighteen months of initial release. Thereafter,
feature films are distributed to the basic cable, broadcast network and
syndicated television markets (the secondary markets). Theatrical revenues are
recognized as the films are exhibited. Home video revenues, less a provision for
returns, are recognized when the home videos are sold. Revenues from the
distribution of theatrical product to cable, broadcast network and syndicated
television markets are recognized when the films are available to telecast.
 
     Television films and series are initially produced for the networks or
first-run television syndication (the primary markets) and may be subsequently
licensed to foreign or domestic cable and syndicated television markets (the
secondary markets). Revenues from the distribution of television product are
recognized when the films or series are available to telecast, except for barter
agreements where the recognition of revenue is deferred until the related
advertisements are exhibited.
 
     License agreements for the telecast of theatrical and television product in
the cable, broadcast network and syndicated television markets are routinely
entered into well in advance of their available date for telecast, which is
generally determined by the telecast privileges granted under previous license
agreements. Accordingly, there are significant contractual rights to receive
cash and barter under these licensing agreements. For
 
                                      F-30
<PAGE>   81
                                TIME WARNER INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
cash contracts, the related revenues will not be recognized until such product
is available for telecast under the contractual terms of the related license
agreement. For barter contracts, the related revenues will not be recognized
until the product is available for telecast and the advertising spots received
under such contracts are either used or sold to third parties. All of these
contractual rights for which revenue is not yet recognizable is referred to as
"backlog."
 
     Inventories of theatrical and television product are stated at the lower of
amortized cost or net realizable value. Cost principally consists of direct
production costs and production overhead. A portion of the cost to acquire TBS
in 1996 was allocated to its theatrical and television product, including an
allocation to purchased program rights (such as the animation library of
Hanna-Barbera Inc. and the former film and television libraries of
Metro-Goldwyn-Mayer, Inc. and RKO Pictures, Inc.) and product that had been
exhibited at least once in all markets ("Library"). Library product is amortized
on a straight-line basis over twenty years. Individual films and series are
amortized, and the related participations and residuals are accrued, based on
the proportion that current revenues from the film or series bear to an estimate
of total revenues anticipated from all markets. These estimates are revised
periodically and losses, if any, are provided in full. Current film inventories
generally include the unamortized cost of completed feature films allocated to
the primary markets, television films and series in production pursuant to a
contract of sale, film rights acquired for the home video market and advances
pursuant to agreements to distribute third-party films in the primary markets.
Noncurrent film inventories generally include the unamortized cost of completed
theatrical and television films allocated to the secondary markets, theatrical
films in production and the Library.
 
  Proposed Changes to Film Accounting Standards
 
     In October 1998, the Accounting Standards Executive Committee of the
American Institute of Certified Public Accountants ("AcSEC") issued an exposure
draft of a proposed Statement of Position, "Accounting by Producers and
Distributors of Films" (the "SOP"). The proposed rules would establish new
accounting standards for producers and distributors of films. Among its many
provisions, the SOP would require revenue for the licensing of film and
television product to be recognized generally over the term of the related
agreement. This would represent a significant change to existing industry
practice, which generally requires such licensing revenue to be recognized when
the product is first available for telecast. This is because, after that date,
licensors have no further significant obligations under the terms of the related
licensing agreements.
 
     While the SOP's proposals in many other areas (i.e., advertising and film
cost amortization) generally are consistent with Time Warner's accounting
policies, this is not the case with the proposed changes in revenue recognition
for licensed product. Adopting the proposed accounting standards for licensed
product would result in a significant one-time, noncash charge to earnings upon
adoption that would be reflected as a cumulative effect of a change in
accounting principle. This one-time, noncash charge would be reversed in future
periods as an increase to operating income when Time Warner re-recognizes the
revenues associated with the licensing of its film and television product over
the periods of the related licensing agreements. The SOP proposes an effective
date of January 1, 2000 for calendar year-end companies, with earlier
application encouraged. The provisions of the SOP are still being deliberated by
AcSEC and could change significantly prior to the issuance of a final standard.
 
ADVERTISING
 
     In accordance with Financial Accounting Standards Board ("FASB") Statement
No. 53, "Financial Reporting by Producers and Distributors of Motion Picture
Films," advertising costs for theatrical and television product are capitalized
and amortized over the related revenue streams in each market that such costs
are intended to benefit, which generally does not exceed three months. Other
advertising costs are expensed upon the first exhibition of the advertisement,
except for certain direct-response advertising, for which the costs are
capitalized and amortized over the expected period of future benefits.
Direct-response advertising principally consists of product promotional
mailings, broadcast advertising, catalogs and other
 
                                      F-31
<PAGE>   82
                                TIME WARNER INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
promotional costs incurred in the Company's direct-marketing businesses.
Deferred advertising costs are generally amortized over periods of up to three
years subsequent to the promotional event using straight-line or accelerated
methods, with a significant portion of such costs amortized in twelve months or
less. Deferred advertising costs for Time Warner amounted to $282 million and
$244 million at December 31, 1998 and 1997, respectively. Advertising expense,
excluding theatrical and television product, amounted to $1.154 billion in 1998,
$1.080 billion in 1997 and $1.050 billion in 1996.
 
CASH AND EQUIVALENTS
 
     Cash equivalents consist of commercial paper and other investments that are
readily convertible into cash and have original maturities of three months or
less.
 
FINANCIAL INSTRUMENTS
 
     Effective July 1, 1998, Time Warner adopted FASB Statement No. 133,
"Accounting for Derivative Instruments and Hedging Activities" ("FAS 133"). FAS
133 requires that all derivative financial instruments, such as interest rate
swap contracts and foreign exchange contracts, be recognized in the financial
statements and measured at fair value regardless of the purpose or intent for
holding them. Changes in the fair value of derivative financial instruments are
either recognized periodically in income or shareholders' equity (as a component
of comprehensive income), depending on whether the derivative is being used to
hedge changes in fair value or cash flows. The adoption of FAS 133 did not have
a material effect on Time Warner's primary financial statements, but did reduce
comprehensive income by $18 million in the accompanying consolidated statement
of shareholders' equity.
 
     The carrying value of Time Warner's financial instruments approximates fair
value, except for differences with respect to long-term, fixed-rate debt (Note
7) and certain differences relating to cost method investments and other
financial instruments that are not significant. The fair value of financial
instruments is generally determined by reference to market values resulting from
trading on a national securities exchange or in an over-the-counter market. In
cases where quoted market prices are not available, such as for derivative
financial instruments, fair value is based on estimates using present value or
other valuation techniques.
 
PROPERTY, PLANT AND EQUIPMENT
 
     Property, plant and equipment are stated at cost. Additions to cable
property, plant and equipment generally include material, labor, overhead and
interest. Depreciation is provided generally on the straight-line method over
useful lives ranging up to thirty years for buildings and improvements and up to
sixteen years for furniture, fixtures, cable television and other equipment.
Property, plant and equipment consists of:
 
<TABLE>
<CAPTION>
                                                              DECEMBER 31,
                                                           ------------------
                                                            1998       1997
                                                           -------    -------
                                                               (MILLIONS)
<S>                                                        <C>        <C>
Land and buildings.......................................  $   963    $   962
  Cable television equipment.............................    1,035        941
  Furniture, fixtures and other equipment................    1,400      1,337
                                                           -------    -------
                                                             3,398      3,240
  Less accumulated depreciation..........................   (1,407)    (1,151)
                                                           -------    -------
Total....................................................  $ 1,991    $ 2,089
                                                           =======    =======
</TABLE>
 
                                      F-32
<PAGE>   83
                                TIME WARNER INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
INTANGIBLE ASSETS
 
     As a creator and distributor of branded information and entertainment
copyrights, Time Warner has a significant and growing number of intangible
assets, including goodwill, cable television and sports franchises, film and
television libraries, music catalogues, contracts and copyrights, and other
copyrighted products and trademarks. In accordance with generally accepted
accounting principles, Time Warner does not recognize the fair value of
internally generated intangible assets. Costs incurred to create and produce
copyrighted product, such as feature films, television series and compact discs,
are generally either expensed as incurred, or capitalized as tangible assets as
in the case of cash advances and inventoriable product costs. However,
accounting recognition is not given to any increasing asset value that may be
associated with the collection of the underlying copyrighted material.
Additionally, costs incurred to create or extend brands, such as magazine
titles, new television networks and Internet sites, generally result in losses
over an extended development period and are recognized as a reduction of income
as incurred, while any corresponding brand value created is not recognized as an
intangible asset in the consolidated balance sheet. On the other hand,
intangible assets acquired in business combinations accounted for by the
purchase method of accounting are capitalized and amortized over their expected
useful life as a noncash charge against future results of operations.
Accordingly, the intangible assets reported in the consolidated balance sheet do
not reflect the fair value of Time Warner's internally generated intangible
assets, but rather are limited to intangible assets resulting from certain
acquisitions in which the cost of the acquired companies exceeded the fair value
of their tangible assets at the time of acquisition.
 
     Time Warner amortizes goodwill and sports franchises over periods up to
forty years using the straight-line method. Cable television franchises, film
and television libraries, music catalogues, contracts and copyrights, and other
intangible assets are amortized over periods up to twenty years using the
straight-line method. Amortization of intangible assets amounted to $800 million
in 1998, $912 million in 1997 and $681 million in 1996. Accumulated amortization
of intangible assets at December 31, 1998 and 1997 amounted to $3.9 billion and
$3.181 billion, respectively.
 
     Time Warner periodically reviews the carrying value of acquired intangible
assets for each acquired entity to determine whether an impairment may exist.
Time Warner considers relevant cash flow and profitability information,
including estimated future operating results, trends and other available
information, in assessing whether the carrying value of intangible assets can be
recovered. If it is determined that the carrying value of intangible assets will
not be recovered from the undiscounted future cash flows of the acquired
business, the carrying value of such intangible assets would be considered
impaired and reduced by a charge to operations in the amount of the impairment.
An impairment charge is measured as any deficiency in the amount of estimated
undiscounted future cash flows of the acquired business available to recover the
carrying value related to the intangible assets.
 
INCOME TAXES
 
     Income taxes are provided using the liability method prescribed by FASB
Statement No. 109, "Accounting for Income Taxes." Under the liability method,
deferred income taxes reflect tax carryforwards and the net tax effects of
temporary differences between the carrying amount of assets and liabilities for
financial statement and income tax purposes, as determined under enacted tax
laws and rates. The financial effect of changes in tax laws or rates is
accounted for in the period of enactment. The subsequent realization of net
operating loss and investment tax credit carryforwards acquired in acquisitions
are accounted for as a reduction of goodwill.
 
     The principal operations of the Entertainment Group are conducted by
partnerships. Income tax expense includes all income taxes related to Time
Warner's allocable share of partnership income and its equity in the income tax
expense of corporate subsidiaries of the partnerships.
 
                                      F-33
<PAGE>   84
                                TIME WARNER INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
STOCK OPTIONS
 
     In accordance with Accounting Principles Board Opinion No. 25, "Accounting
for Stock Issued to Employees" ("APB 25"), compensation cost for stock options
is recognized in income based on the excess, if any, of the quoted market price
of the stock at the grant date of the award or other measurement date over the
amount an employee must pay to acquire the stock. Generally, the exercise price
for stock options granted to employees equals or exceeds the fair market value
of Time Warner common stock at the date of grant, thereby resulting in no
recognition of compensation expense by Time Warner.
 
LOSS PER COMMON SHARE
 
     Effective December 31, 1997, Time Warner adopted FASB Statement No. 128,
"Earnings per Share" ("FAS 128"), which established simplified standards for
computing and presenting earnings per share information. The adoption of FAS 128
did not have any effect on Time Warner's financial statements.
 
     Basic loss per common share is computed by dividing the net loss applicable
to common shares after preferred dividend requirements by the weighted average
of common shares outstanding during the period. Diluted loss per common share
adjusts basic loss per common share for the effects of convertible securities,
stock options and other potentially dilutive financial instruments, only in the
periods in which such effect is dilutive. Such effect was not dilutive in any of
the periods presented herein.
 
COMPREHENSIVE INCOME
 
     Effective January 1, 1997, Time Warner adopted FASB Statement No. 130,
"Reporting Comprehensive Income" ("FAS 130"). The new rules established
standards for the reporting of comprehensive income and its components in
financial statements. Comprehensive income consists of net income and other
gains and losses affecting shareholders' equity that, under generally accepted
accounting principles, are excluded from net income. For Time Warner, such items
consist primarily of unrealized gains and losses on marketable equity
investments, gains and losses on certain derivative financial instruments and
foreign currency translation gains and losses. The adoption of FAS 130 did not
have a material effect on Time Warner's primary financial statements, but did
affect the presentation of the accompanying consolidated statement of
shareholders' equity.
 
     The following summary sets forth the components of other comprehensive
income (loss) accumulated in shareholders' equity:
 
<TABLE>
<CAPTION>
                                                                                   ACCUMULATED
                                                     FOREIGN        DERIVATIVE        OTHER
                                    UNREALIZED       CURRENCY       FINANCIAL     COMPREHENSIVE
                                     GAINS ON      TRANSLATION      INSTRUMENT       INCOME
                                    SECURITIES    GAINS (LOSSES)      LOSSES         (LOSS)
                                    ----------    --------------    ----------    -------------
                                                            (MILLIONS)
<S>                                 <C>           <C>               <C>           <C>
Balance at December 31, 1997......      $5             $(87)           $ --           $ (82)
1998 activity.....................      --                4             (38)            (34)
                                        --             ----            ----           -----
Balance at December 31, 1998......      $5             $(83)           $(38)          $(116)
                                        ==             ====            ====           =====
</TABLE>
 
SEGMENT INFORMATION
 
     On December 31, 1997, Time Warner adopted FASB Statement No. 131,
"Disclosures about Segments of an Enterprise and Related Information" ("FAS
131"). The new rules established revised standards for public companies relating
to the reporting of financial and descriptive information about their operating
segments in financial statements. The adoption of FAS 131 did not have a
material effect on Time Warner's primary financial statements, but did affect
the disclosure of segment information contained elsewhere herein (Note 16).
 
                                      F-34
<PAGE>   85
                                TIME WARNER INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
2.  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
cable television systems and develop new services, Time Warner, TWE and the
TWE-Advance/Newhouse Partnership ("TWE-A/N") completed a series of transactions
in 1998. These transactions related to the cable television business and related
ancillary businesses that either reduced existing debt and/or Time Warner's and
TWE's share of future funding requirements for such businesses. These
transactions and a cable-related acquisition of Cablevision Industries
Corporation and related companies ("CVI") in 1996 are discussed more fully
below.
 
TCI CABLE TRANSACTIONS
 
     During 1998, Time Warner, TWE, TWE-A/N and TCI Communications, Inc.
("TCI"), a subsidiary of Tele-Communications, Inc., consummated or agreed to
complete a number of cable-related transactions. These transactions consisted of
(i) the formation in December 1998 of a cable television joint venture in Texas
(the "Texas Cable Joint Venture") that is managed by Time Warner Cable, a
division of TWE, and owns cable television systems serving an aggregate 1.1
million subscribers, subject to approximately $1.3 billion of debt, (ii) the
expansion in August 1998 of an existing joint venture in Kansas City, which is
managed by Time Warner Cable, through the contribution by TCI of a contiguous
cable television system serving approximately 95,000 subscribers, subject to
approximately $200 million of debt and (iii) the agreement to exchange in 1999
various cable television systems serving approximately 575,000 subscribers for
other cable television systems of comparable size in an effort to enhance each
company's geographic clusters of cable television properties (the "TCI Cable
Trades"). The Texas and Kansas City joint ventures are being accounted for under
the equity method of accounting.
 
     As a result of the Texas transaction, the combined debt of Time Warner and
TWE was reduced by approximately $650 million. Also, as a result of the Texas
and Kansas City transactions, Time Warner and TWE benefited from the geographic
clustering of cable television systems and the number of subscribers under the
management of Time Warner Cable was increased by approximately 660,000
subscribers, thereby making Time Warner Cable the largest cable television
operator in the U.S. The TCI Cable Trades are expected to close periodically
throughout 1999 and are subject to customary closing conditions, including all
necessary governmental and regulatory approvals. There can be no assurance that
such approvals will be obtained.
 
TIME WARNER TELECOM 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
"Time Warner Telecom Reorganization") whereby (i) those operations conducted by
Time Warner, TWE and TWE-A/N were each contributed to a new holding company
named Time Warner Telecom LLC ("Time Warner Telecom"), and then (ii) TWE's and
TWE-A/N's interests in Time Warner Telecom were distributed to their partners,
Time Warner, MediaOne and the Advance/ Newhouse Partnership
("Advance/Newhouse"), a limited partner in TWE-A/N. As a result of the Time
Warner Telecom Reorganization, Time Warner, MediaOne and Advance/Newhouse own
interests in Time Warner Telecom of 61.98%, 18.85% and 19.17%, respectively.
Time Warner's interest in Time Warner Telecom is being accounted for under the
equity method of accounting because of certain approval rights held by MediaOne
and Advance/Newhouse.
 
     Time Warner 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. Following the Time Warner
Telecom Reorganization, Time Warner Telecom raised approximately $400 million of
cash in July 1998 through the issuance of public notes that mature in 2008. Such
notes are non-recourse to Time
 
                                      F-35
<PAGE>   86
                                TIME WARNER INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
Warner and the proceeds are being used by Time Warner Telecom to expand and
further develop its telephony networks and services.
 
     In January 1999, Time Warner Telecom updated a previously filed,
preliminary registration statement with the Securities and Exchange Commission
to conduct an initial public offering of a minority interest of its common stock
(the "Time Warner Telecom IPO"). The Time Warner Telecom IPO was previously
postponed when the IPO market deteriorated and remains subject to market and
other conditions. There can be no assurance that it will be completed.
 
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 online
businesses (the "Road Runner Joint Venture"). In exchange for contributing these
operations, Time Warner received a common equity interest in the Road Runner
Joint Venture of 10.7%, TWE received a 25% interest, TWE-A/N received a 32.9%
interest and MediaOne received a 31.4% interest. In exchange for Microsoft and
Compaq contributing $425 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 8.6% by Time Warner, 20% by TWE,
26.3% by TWE-A/N, 25.1% by MediaOne, 10% by Microsoft and 10% by Compaq. Each of
Time Warner's, 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 being used by the Road Runner Joint Venture to continue to expand the roll
out of high-speed online services. Time Warner Cable has entered into an
affiliation agreement with the Road Runner Joint Venture, pursuant to which Time
Warner Cable provides Road Runner's high-speed online services to customers in
its cable franchise areas through its technologically advanced, high-capacity
cable architecture. In exchange, Time Warner Cable initially retains 70% of the
subscription revenues and 30% of the national advertising and transactional
revenues generated from the delivery of these online services to its cable
subscribers. Time Warner Cable's share of these subscription revenues will
change periodically to 75% by 2006.
 
PRIMESTAR
 
     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
Partners" and collectively, the "Primestar Assets") to Primestar, Inc.
("Primestar"), a separate holding company. As a result of that transfer and
similar transfers by the other previously existing partners of Primestar
Partners, Primestar Partners became an indirect wholly owned subsidiary of
Primestar. In exchange for contributing its interests in the Primestar Assets,
TWE received approximately 48 million shares of Primestar common stock
(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 Primestar. As a result of this transaction,
effective as of April 1, 1998, TWE deconsolidated the DBS Operations and the 24%
equity interest in Primestar received in the transaction is being accounted for
under the equity method of accounting. This transaction is referred to as the
"Primestar Roll-up Transaction."
 
     In connection with the Primestar Roll-up Transaction, Primestar and
Primestar Partners own and operate the medium-power direct broadcast satellite
business, portions of which were formerly owned by TCI Satellite Entertainment,
Inc. ("TSAT") and the other previously existing partners of Primestar Partners.
Certain high-power system assets, including two high-power satellites, continue
to be owned by Tempo Satellite, Inc.
 
                                      F-36
<PAGE>   87
                                TIME WARNER INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
("Tempo"), a wholly owned subsidiary of TSAT. However, Primestar Partners has an
option to lease or purchase the entire capacity of the high-power system from
Tempo. In addition, Primestar has an option to purchase the stock or assets of
Tempo from TSAT.
 
     In a related transaction, Primestar Partners 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
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.
 
     In the fourth quarter of 1998, TWE recorded a charge of approximately $210
million principally to reduce the carrying value of its interest in Primestar.
This charge reflected a significant decline in the fair value of Primestar
during the quarter and has been included in interest and other, net, in TWE's
1998 consolidated statement of operations.
 
     In addition, Primestar, Primestar Partners and the stockholders of
Primestar have entered into an agreement to sell the medium-power direct
broadcast satellite business and assets to DirecTV, a competitor of Primestar
owned by Hughes Electronics Corp. Also, Primestar, Primestar Partners, the
stockholders of Primestar and Tempo entered into a second agreement with
DirecTV, pursuant to which DirecTV will purchase the high-power satellites from
Tempo, and Primestar and Primestar Partners will relinquish their respective
rights to acquire or use such high-power satellites. The price to be paid by
DirecTV pursuant to these agreements confirmed the decline in value of TWE's
interest in Primestar. The ultimate disposition of the medium-power assets of
Primestar is subject to Primestar bondholder and regulatory approvals, and the
disposition of certain of the high-power satellite rights is also subject to
regulatory approvals. Accordingly, there can be no assurance that such approvals
will be obtained and that these transactions will be consummated.
 
TWE-A/N TRANSFERS
 
     As of December 31, 1998, TWE-A/N owned cable television systems (or
interests therein) serving approximately 6.3 million subscribers, of which 5.2
million subscribers were served by consolidated, wholly owned cable television
systems and 1.1 million subscribers were served by unconsolidated, partially
owned cable television systems. TWE-A/N had approximately $1.2 billion of debt
at December 31, 1998.
 
     TWE-A/N is owned approximately 64.8% by TWE, the managing partner, 33.3% by
Advance/ Newhouse and 1.9% indirectly by Time Warner. TWE consolidates the
partnership, and the partnership interests owned by Advance/Newhouse and Time
Warner are reflected in TWE's consolidated financial statements as minority
interest. In accordance with the partnership agreement, Advance/Newhouse can
require TWE to purchase its equity interest for fair market value at specified
intervals following the death of both of its principal shareholders. In
addition, TWE or Advance/Newhouse can initiate a restructuring of the
partnership, in which Advance/Newhouse would withdraw from the partnership and
receive one-third of the partnership's net assets.
 
     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 in TWE-A/N, 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,
 
                                      F-37
<PAGE>   88
                                TIME WARNER INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
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.
 
     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, Time Warner would have reported for the year
ended December 31, 1997 revenues of $13.233 billion, depreciation expense of
$375 million, operating income before noncash amortization of intangible assets
of $2.068 billion, operating income of $1.219 billion, equity in the pretax
income of the Entertainment Group of $679 million, income before extraordinary
item of $307 million ($.01 loss per common share) and net income of $252 million
($.06 loss per common share).
 
CVI ACQUISITION
 
     On January 4, 1996, Time Warner acquired CVI, which owned cable television
systems serving approximately 1.3 million subscribers, in exchange for the
issuance of approximately 5.8 million shares of common stock and approximately
6.3 million shares of new convertible preferred stock ("Series E Preferred
Stock" and "Series F Preferred Stock") and the assumption or incurrence of
approximately $2 billion of indebtedness. The acquisition was accounted for by
the purchase method of accounting for business combinations; accordingly, the
cost to acquire CVI of $904 million was allocated to the net assets acquired in
proportion to their respective fair values, as follows: cable television
franchises-$2.390 billion; goodwill-$688 million; other current and noncurrent
assets-$481 million; long-term debt-$1.766 billion; deferred income taxes-$731
million; and other current and noncurrent liabilities-$158 million.
 
     In October 1996, Time Warner reorganized the legal ownership of its wholly
owned cable subsidiaries, whereby the equity ownership of its other wholly owned
cable subsidiaries was contributed to CVI. In connection therewith, CVI was
renamed TWI Cable Inc.
 
3.  TBS TRANSACTION
 
     On October 10, 1996, Time Warner acquired the remaining 80% interest in TBS
that it did not already own (the "TBS Transaction"). As part of the transaction,
each of TW Companies and TBS became a separate, wholly owned subsidiary of Time
Warner which combines, for financial reporting purposes, the consolidated net
assets and operating results of TW Companies and TBS. Each issued and
outstanding share of each class of capital stock of TW Companies was converted
into one share of a substantially identical class of capital stock of Time
Warner.
 
     In connection with the TBS Transaction, Time Warner issued (i)
approximately 359.6 million shares of common stock (including 114.2 million
equivalent shares of common stock in the form of a special class of
non-redeemable common stock ("Series LMCN-V Common Stock") to affiliates of
Liberty Media Corporation ("LMC"), a subsidiary of Tele-Communications, Inc.),
in exchange for shares of TBS capital stock and pursuant to a separate option
agreement with LMC and its affiliates (the "SSSI Option Agreement") and
 
                                      F-38
<PAGE>   89
                                TIME WARNER INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
(ii) approximately 28 million stock options to replace all outstanding TBS stock
options. Time Warner also assumed approximately $2.8 billion of indebtedness.
 
     Of the aggregate consideration issued in the TBS Transaction, 12.8 million
equivalent shares of common stock in the form of Series LMCN-V Common Stock were
issued to LMC and its affiliates in June 1997 pursuant to the SSSI Option
Agreement. The SSSI Option Agreement enabled Time Warner to acquire
substantially all of the assets of Southern Satellite Systems, Inc. and its
affiliates ("SSSI"), a subsidiary of LMC that formerly provided uplink and
distribution services for WTBS (the "TBS Superstation"), for approximately $213
million effective as of December 31, 1997, the date on which the TBS
Superstation was converted to a copyright-paid, cable television programming
service.
 
     The TBS Transaction was accounted for by the purchase method of accounting
for business combinations; accordingly, the cost to acquire TBS of approximately
$6.2 billion was allocated to the net assets acquired in proportion to their
respective fair values, as follows: goodwill-$6.842 billion; other current and
noncurrent assets-$3.624 billion; long-term debt-$2.765 billion; deferred income
taxes-$117 million; and other current and noncurrent liabilities-$1.410 billion.
 
4.  ENTERTAINMENT GROUP
 
     Time Warner's investment in and amounts due to and from the Entertainment
Group at December 31, 1998 and 1997 consists of the following:
 
<TABLE>
<CAPTION>
                                                                DECEMBER 31,
                                                              ----------------
                                                               1998      1997
                                                              ------    ------
                                                                 (MILLIONS)
<S>                                                           <C>       <C>
Investment in TWE...........................................  $3,850    $5,577
Stock option related distributions due from TWE.............   1,130       417
Credit agreement debt due to TWE............................    (400)     (400)
Other net amounts due to TWE, principally related to home
  video distribution........................................    (395)     (141)
                                                              ------    ------
Investment in and amounts due to and from TWE...............   4,185     5,453
Investment in TWE-A/N and other Entertainment Group
  companies.................................................     795        96
                                                              ------    ------
Total.......................................................  $4,980    $5,549
                                                              ======    ======
</TABLE>
 
PARTNERSHIP STRUCTURE
 
     TWE is a Delaware limited partnership that 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 subsidiaries of Time
Warner. Certain Time Warner subsidiaries are the general partners of TWE ("Time
Warner General Partners").
 
     Time Warner, through its wholly owned subsidiaries, collectively owns
general and limited partnership interests in TWE consisting of 74.49% of the
Series A Capital and Residual Capital and 100% of the Senior Capital and Series
B Capital. The remaining 25.51% limited partnership interests in the Series A
Capital and Residual Capital of TWE are owned by MediaOne, which acquired such
interests in 1993 for $1.532 billion of cash and a $1.021 billion 4.4% note (the
"MediaOne Note Receivable") that was fully collected during 1996.
 
PARTNERSHIP CAPITAL AND ALLOCATION OF INCOME
 
     Each partner's interest in TWE generally consists of the undistributed
priority capital and residual equity amounts that were initially assigned to
that partner or its predecessor based on the estimated fair value of the net
assets each contributed to TWE ("Undistributed Contributed Capital"), plus, with
respect to the priority
 
                                      F-39
<PAGE>   90
                                TIME WARNER INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
capital interests only, any undistributed priority capital return. The priority
capital return consists of net partnership income allocated to date in
accordance with the provisions of the TWE partnership agreement and the right to
be allocated additional partnership income which, together, provides for the
various priority capital rates of return as specified in the table below. The
sum of Undistributed Contributed Capital and the undistributed priority capital
return is referred to herein as "Cumulative Priority Capital." Cumulative
Priority Capital is not necessarily indicative of the fair value of the
underlying priority capital interests principally due to above-market rates of
return on certain priority capital interests as compared to securities of
comparable credit risk and maturity, such as the 13.25% rate of return on the
Series B Capital interest owned by the Time Warner General Partners.
Furthermore, the ultimate realization of Cumulative Priority Capital could be
affected by the fair value of TWE, which is subject to fluctuation.
 
     A summary of the priority of Undistributed Contributed Capital, Time
Warner's ownership of Undistributed Contributed Capital and Cumulative Priority
Capital at December 31, 1998 and priority capital rates of return thereon is as
set forth below:
 
<TABLE>
<CAPTION>
                                                                              PRIORITY
                                               UNDISTRIBUTED    CUMULATIVE     CAPITAL
                                                CONTRIBUTED      PRIORITY     RATES OF         % OWNED BY
PRIORITY OF UNDISTRIBUTED CONTRIBUTED CAPITAL   CAPITAL(A)       CAPITAL      RETURN(B)       TIME WARNER
---------------------------------------------  -------------    ----------    ---------      --------------
                                                       (BILLIONS)
<S>                                            <C>              <C>           <C>            <C>
Senior Capital........................             $0.5           $ 0.6          8.00%           100.00%
Series A Capital......................              5.6            12.8         13.00%            74.49%
Series B Capital......................              2.9(d)          6.8         13.25%           100.00%
Residual Capital......................              3.3(d)          3.3(c)         --(c)          74.49%
</TABLE>
 
---------------
(a) Excludes partnership income or loss allocated thereto.
 
(b) To the extent income allocations are concurrently distributed, the priority
    capital rates of return on the Series A Capital and Series B Capital are 11%
    and 11.25%, respectively.
 
(c) Residual Capital is not entitled to stated priority rates of return and, as
    such, its Cumulative Priority Capital is equal to its Undistributed
    Contributed Capital. However, in the case of certain events such as the
    liquidation or dissolution of TWE, Residual Capital is entitled to any
    excess of the then fair value of the net assets of TWE over the aggregate
    amount of Cumulative Priority Capital and special tax allocations.
 
(d) The Undistributed Contributed Capital relating to the Series B Capital has
    priority over the priority returns on the Series A Capital. The
    Undistributed Contributed Capital relating to the Residual Capital has
    priority over the priority returns on the Series B Capital and the Series A
    Capital.
 
     Because Undistributed Contributed Capital is generally based on the fair
value of the net assets that each partner initially contributed to the
partnership, the aggregate of such amounts is significantly higher than TWE's
partners' capital as reflected in the consolidated financial statements, which
is based on the historical cost of the contributed net assets. For purposes of
allocating partnership income or loss to the partners, partnership income or
loss is based on the fair value of the net assets contributed to the partnership
and results in significantly less partnership income, or results in partnership
losses, in contrast to the net income reported by TWE for financial statement
purposes, which is also based on the historical cost of contributed net assets.
 
     Under the TWE partnership agreement, partnership income, to the extent
earned, is first allocated to the partners' capital accounts so that the
economic burden of the income tax consequences of partnership operations is
borne as though the partnership were taxed as a corporation ("special tax
allocations"). After any special tax allocations, partnership income is
allocated to the Senior Capital, Series A Capital and Series B Capital, in order
of priority, at rates of return ranging from 8% to 13.25% per annum, and finally
to the Residual Capital. Partnership losses generally are allocated first to
eliminate prior allocations of partnership income to, and then to reduce the
Undistributed Contributed Capital of, the Residual Capital, Series B Capital and
Series A Capital, in that order, then to reduce the Time Warner General
Partners' Senior Capital, including partnership income allocated thereto, and
finally to reduce any special tax allocations. To
 
                                      F-40
<PAGE>   91
                                TIME WARNER INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
the extent partnership income is insufficient to satisfy all special allocations
in a particular accounting period, the right to receive additional partnership
income necessary to provide for the various priority capital rates of return is
carried forward until satisfied out of future partnership income, including any
partnership income that may result from any liquidation, sale or dissolution of
TWE. TWE reported net income of $326 million, $614 million and $210 million in
1998, 1997 and 1996, respectively, no portion of which was allocated to the
limited partners.
 
     The Series B Capital owned by the Time Warner General Partners may be
increased if certain operating performance targets are achieved over a ten-year
period ending on December 31, 2001, although it does not appear likely at this
time that such targets will be achieved. In addition, MediaOne has an option to
obtain up to an additional 6.33% of Series A Capital and Residual Capital
interests, depending on cable operating performance. The option is exercisable
at any time through May 2005 at a maximum exercise price of $1.25 billion to
$1.8 billion, depending on the year of exercise. Either MediaOne or TWE may
elect that the exercise price be paid with partnership interests rather than
cash.
 
SUMMARIZED FINANCIAL INFORMATION OF THE ENTERTAINMENT GROUP
 
     Set forth below is summarized financial information of the Entertainment
Group, 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 Time Warner
Telecom Reorganization effective as of July 1, 1998.
 
<TABLE>
<CAPTION>
                                                          YEARS ENDED DECEMBER 31,
                                                        -----------------------------
                                                         1998       1997       1996
                                                        -------    -------    -------
                                                                 (MILLIONS)
<S>                                                     <C>        <C>        <C>
OPERATING STATEMENT INFORMATION
Revenues..............................................  $12,256    $11,328    $10,861
Depreciation and amortization.........................   (1,436)    (1,386)    (1,244)
Business segment operating income(1)..................    1,724      1,461      1,090
Interest and other, net(2)............................     (965)      (357)      (524)
Minority interest.....................................     (264)      (305)      (207)
Income before income taxes............................      423        727        290
Income before extraordinary item......................      331        642        220
Net income............................................      331        619        220
</TABLE>
 
---------------
(1) Includes net pretax gains of approximately $90 million in 1998 and $200
    million in 1997 related to the sale or exchange of certain cable television
    systems.
 
(2) Includes a charge of approximately $210 million in 1998 principally to
    reduce the carrying value of an interest in Primestar. 1997 includes a gain
    of approximately $250 million related to the sale of an interest in E!
    Entertainment Television, Inc. ("E! Entertainment").
 
                                      F-41
<PAGE>   92
                                TIME WARNER INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
<TABLE>
<CAPTION>
                                                          YEARS ENDED DECEMBER 31,
                                                        -----------------------------
                                                         1998       1997       1996
                                                        -------    -------    -------
                                                                 (MILLIONS)
<S>                                                     <C>        <C>        <C>
CASH FLOW INFORMATION
Cash provided by operations...........................  $ 2,288    $ 1,799    $ 1,912
Capital expenditures..................................   (1,603)    (1,565)    (1,719)
Investments and acquisitions..........................     (388)      (172)      (146)
Investment proceeds...................................    1,246        520        612
Borrowings............................................    1,514      3,400        215
Debt repayments.......................................   (1,898)    (3,085)      (716)
Issuance of preferred stock of subsidiary.............       --        243         --
Collections on note receivable from MediaOne..........       --         --        169
Capital distributions.................................   (1,153)      (934)      (228)
Other financing activities, net.......................     (241)      (100)       (92)
Increase (decrease) in cash and equivalents...........     (235)       106          7
</TABLE>
 
<TABLE>
<CAPTION>
                                                                 DECEMBER 31,
                                                              ------------------
                                                               1998       1997
                                                              -------    -------
                                                                  (MILLIONS)
<S>                                                           <C>        <C>
BALANCE SHEET INFORMATION
Cash and equivalents........................................  $    87    $   322
Total current assets........................................    4,187      3,623
Total assets................................................   22,241     20,739
Total current liabilities...................................    4,940      3,976
Long-term debt..............................................    6,578      5,990
Minority interests..........................................    1,522      1,210
Preferred stock of subsidiary...............................      217        233
Time Warner General Partners' Senior Capital................      603      1,118
Partners' capital...........................................    5,210      6,430
</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.
 
     The Time Warner General Partners received $579 million and $535 million in
1998 and 1997, respectively, of distributions from TWE relating to their Senior
Capital interests, thereby increasing the cumulative cash distributions received
from TWE on such interests to $1.5 billion. The Time Warner General Partners'
remaining $603 million Senior Capital interests and any undistributed
partnership income allocated thereto (based on an 8% annual rate of return) are
required to be distributed on July 1, 1999.
 
     At December 31, 1998 and 1997, the Time Warner General Partners had
recorded $1.130 billion and $417 million, respectively, of stock option related
distributions due from TWE, based on closing prices of Time Warner common stock
of $62.06 and $31.00, respectively. Time Warner is paid when the options are
exercised. The Time Warner General Partners also receive tax-related
distributions from TWE on a current basis. During 1998, the Time Warner General
Partners received distributions from TWE in the amount of $1.153 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), $314 million of tax-related distributions
and $260 million of stock option related distributions. During 1997, the Time
Warner General Partners received distributions from TWE in the amount of $934
million, consisting of $535 million of
 
                                      F-42
<PAGE>   93
                                TIME WARNER INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
Senior Capital distributions (representing the return of $455 million of
contributed capital and the distribution of $80 million of priority capital
return), $324 million of tax-related distributions and $75 million of stock
option related distributions. During 1996, the Time Warner General Partners
received distributions from TWE in the amount of $228 million, consisting of
$215 million of tax-related distributions and $13 million of stock option
related distributions. In addition to the tax, stock option and Time Warner
General Partners' Senior Capital distributions, TWE may make other capital
distributions to its partners that are also subject to certain limitations
contained in the TWE partnership and credit agreements.
 
     In addition, in connection with the Time Warner Telecom Reorganization, TWE
made a $191 million noncash distribution to its partners, of which certain
wholly owned subsidiaries of Time Warner received an interest in Time Warner
Telecom recorded at $143 million based on TWE's historical cost of the net
assets (Note 2).
 
DEBT GUARANTEES
 
     Each Time Warner General Partner has guaranteed a pro rata portion of
approximately $5.5 billion of TWE's debt and accrued interest at December 31,
1998, based on the relative fair value of the net assets each Time Warner
General Partner (or its predecessor) contributed to TWE. Such indebtedness is
recourse to each Time Warner General Partner only to the extent of its
guarantee. There are no restrictions on the ability of the Time Warner General
Partner guarantors to transfer assets, other than TWE assets, to parties that
are not guarantors. In addition, in connection with the TWE-A/N Transfers (Note
2), approximately $1.2 billion of TWE-A/N's debt and accrued interest at
December 31, 1998 has been guaranteed by TWI Cable 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. ("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 by TWE, principally as a result of
uncertainties surrounding realization that relate to ongoing litigation and
TWE's continuing guarantees of certain significant long-term obligations
associated with the Six Flags Over Texas and Six Flags Over Georgia theme parks.
 
5.  OTHER INVESTMENTS
 
     Time Warner's other investments consist of:
 
<TABLE>
<CAPTION>
                                                               DECEMBER 31,
                                                              --------------
                                                              1998     1997
                                                              ----    ------
                                                                (MILLIONS)
<S>                                                           <C>     <C>
Equity method investments...................................  $483    $1,350
Cost and fair-value method investments......................   311       145
                                                              ----    ------
Total.......................................................  $794    $1,495
                                                              ====    ======
</TABLE>
 
     In addition to TWE and its equity investees, companies accounted for using
the equity method include: Time Warner Telecom (62% owned), the Columbia House
Company partnerships (50% owned), other music joint ventures (generally 50%
owned) and Cinamerica Theatres, L.P. (sold in 1997, but previously 50%
 
                                      F-43
<PAGE>   94
                                TIME WARNER INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
owned). A summary of combined financial information as reported by the equity
investees of Time Warner is set forth below:
 
<TABLE>
<CAPTION>
                                                            YEARS ENDED DECEMBER 31,
                                                           --------------------------
                                                            1998      1997      1996
                                                           ------    ------    ------
                                                                   (MILLIONS)
<S>                                                        <C>       <C>       <C>
Revenues.................................................  $1,275    $1,336    $1,773
Depreciation and amortization............................     (43)      (13)      (29)
Operating income (loss)..................................      (1)       80       173
Net income (loss)........................................    (109)      (36)       61
Current assets...........................................   1,183       792     1,002
Total assets.............................................   2,065     1,132     1,616
Current liabilities......................................     587       418       517
Long-term debt...........................................   1,807     1,303     1,360
Total liabilities........................................   2,464     1,791     1,999
Total shareholders' deficit or partners' capital.........    (399)     (659)     (383)
</TABLE>
 
     In addition to the equity investees listed above, TWE's equity investees at
December 31, 1998 included: Comedy Partners, L.P. (50% owned), certain cable
television system joint ventures (generally 50% owned), the Road Runner Joint
Venture (57.9% owned, excluding Time Warner's direct 10.7% interest), Primestar
(24% owned), Six Flags (49% owned in 1997 and 1996), certain international cable
and programming joint ventures (25% to 50% owned) and Courtroom Television
Network (50% owned). A summary of combined financial information as reported by
the equity investees of TWE is set forth below:
 
<TABLE>
<CAPTION>
                                                            YEARS ENDED DECEMBER 31,
                                                           --------------------------
                                                            1998      1997      1996
                                                           ------    ------    ------
                                                                   (MILLIONS)
<S>                                                        <C>       <C>       <C>
Revenues.................................................  $2,329    $2,207    $1,823
Depreciation and amortization............................    (706)     (235)     (197)
Operating income (loss)..................................    (265)      118        62
Net loss.................................................    (352)      (82)     (138)
Current assets...........................................     665       412       624
Total assets.............................................   5,228     3,046     3,193
Current liabilities......................................     628       993       407
Long-term debt...........................................   2,917     1,625     2,197
Total liabilities........................................   3,699     2,734     2,829
Total shareholders' equity or partners' capital..........   1,529       312       364
</TABLE>
 
     Included in the foregoing summary is combined financial information of Time
Warner Cable's unconsolidated cable television systems that serve an aggregate
of 2.3 million subscribers as of December 31, 1998. Time Warner Cable has an
approximate 50% weighted-average interest in these cable television systems. For
1998, excluding the operating results of the Texas Cable Joint Venture which was
formed at the end of the year, these cable television systems reported combined
operating income of $93 million and combined depreciation and amortization of
$160 million. Similarly, at the end of 1998, including approximately $1.3
billion of debt of the Texas Cable Joint Venture, these cable television systems
had debt of approximately $2.4 billion.
 
                                      F-44
<PAGE>   95
                                TIME WARNER INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
6.  INVENTORIES
 
     Inventories consist of:
 
<TABLE>
<CAPTION>
                                                DECEMBER 31, 1998        DECEMBER 31, 1997
                                              ---------------------    ---------------------
                                              CURRENT    NONCURRENT    CURRENT    NONCURRENT
                                              -------    ----------    -------    ----------
                                                                (MILLIONS)
<S>                                           <C>        <C>           <C>        <C>
Film costs:
  Released, less amortization...............   $ 51        $  308       $ 68        $  228
  Completed and not released................     20            --         88            48
  In process and other......................      2           240         --           141
  Library, less amortization................     --         1,007         --         1,064
Programming costs, less amortization........    457           345        293           285
Magazines, books and recorded music.........    416            --        381            --
                                               ----        ------       ----        ------
Total.......................................   $946        $1,900       $830        $1,766
                                               ====        ======       ====        ======
</TABLE>
 
     Excluding the Library, the total cost incurred in the production of
theatrical and television product (including direct production costs, production
overhead and certain exploitation costs, such as film prints and home
videocassettes) amounted to $633 million in 1998 and $506 million in 1997; and
the total cost amortized amounted to $585 million and $613 million,
respectively. Excluding the Library, the unamortized cost of completed films at
December 31, 1998 amounted to $379 million, approximately 90% of which is
expected to be amortized within three years after release.
 
7.  LONG-TERM DEBT
 
     Long-term debt consists of:
 
<TABLE>
<CAPTION>
                                      WEIGHTED-AVERAGE                      DECEMBER 31,
                                      INTEREST RATE AT                   ------------------
                                      DECEMBER 31, 1998    MATURITIES     1998       1997
                                      -----------------    ----------    -------    -------
                                                                             (MILLIONS)
<S>                                   <C>                  <C>           <C>        <C>
Bank credit agreement borrowings....         6.0%               2002     $ 1,234    $ 2,600
Fixed-rate senior notes and
  debentures........................         7.8%          2000-2036       8,491      6,909
Variable-rate senior notes..........         4.8%          2009-2031       1,200      1,200
Zero-coupon convertible notes.......          --                  --          --      1,124
                                                                         -------    -------
Total...............................                                     $10,925    $11,833
                                                                         =======    =======
</TABLE>
 
     Substantially all of Time Warner's long-term debt represents the
obligations of its wholly owned subsidiaries TW Companies, TBS and TWI Cable.
Time Warner and each of TW Companies and TBS (the "Guarantor Subsidiaries") have
fully and unconditionally guaranteed any outstanding publicly traded
indebtedness of each other and, along with TWI Cable, have similarly guaranteed
each other's outstanding borrowings under their joint bank credit agreement. As
a result, the credit profile associated with the indebtedness of Time Warner or
any of the Guarantor Subsidiaries is substantially the same.
 
FINANCING ACTIVITIES
 
     During the past three years, in response to favorable market conditions and
in connection with certain acquisitions, Time Warner and its consolidated
subsidiaries have refinanced approximately $8.5 billion of debt. These debt
refinancings have had the positive effect of lowering the Company's cost of
borrowing, staggering debt maturities and, with respect to the redemption of
certain convertible securities, eliminating the potential dilution from the
conversion of such securities into 62.5 million shares of Time Warner common
stock. In connection with these refinancings, Time Warner recognized an
extraordinary loss on the retirement of debt of $55 million in 1997 and $35
million in 1996.
 
                                      F-45
<PAGE>   96
                                TIME WARNER INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     In addition to these refinancings, Time Warner continued its debt reduction
efforts in 1998. Debt reduction of approximately $3 billion was partially offset
by a $2.1 billion increase in debt in order to fund the 1998 redemption of Time
Warner's Series M Preferred Stock (Note 11). This debt reduction was achieved
principally by using cash provided by operations, proceeds from certain asset
sales, cash distributions from TWE and the noncash transfer of approximately $1
billion of debt to TWE-A/N as part of the TWE-A/N Transfers (Note 2).
 
ZERO-COUPON CONVERTIBLE NOTES
 
     During 1998, approximately $1.15 billion accreted amount of zero-coupon
convertible notes due 2013 (the "Zero-Coupon Convertible Notes") were converted
into an aggregate 37.4 million shares of Time Warner common stock. To partially
offset the dilution resulting from this conversion, Time Warner incurred a
corresponding $1.15 billion of debt and used the proceeds therefrom to
repurchase common stock (Note 12).
 
VARIABLE-RATE NOTES
 
     At December 31, 1998, variable-rate senior notes consisted of $600 million
principal amount of Floating Rate Reset Notes due July 29, 2009 that are
redeemable at the election of the holders, in whole but not in part, on July 29,
1999 (the "Two-Year Floating Rate Notes") and $600 million principal amount of
Floating Rate Reset Notes due December 30, 2031 that are similarly redeemable at
the election of the holders on December 30, 2001 (the "Five-Year Floating Rate
Notes"). The Two-Year Floating Rate Notes bear interest at a floating rate equal
to LIBOR less 115 basis points until July 29, 1999, at which time, if not
redeemed, the interest rate will be reset at a fixed rate equal to 6.16% plus a
margin based upon the credit risk of TW Companies at such time. The Five-Year
Floating Rate Notes bear interest at a floating rate equal to LIBOR less 25
basis points until December 30, 2001, at which time, if not redeemed, the
interest rate will be reset at a fixed rate equal to 6.59% plus a margin based
upon the credit risk of TW Companies at such time.
 
BANK CREDIT AGREEMENT
 
     As part of the debt refinancings referred to above, Time Warner, together
with certain of its consolidated and unconsolidated subsidiaries, entered into a
five-year revolving credit facility in November 1997 (the "1997 Credit
Agreement") and terminated its subsidiaries' financing arrangements under
certain previously existing bank credit facilities (the "Old Credit
Agreements"). This enabled Time Warner to reduce its aggregate borrowing
availability from $10.3 billion to $7.5 billion, lower interest rates and
refinance outstanding borrowings under the Old Credit Agreements in the amounts
of approximately $2.4 billion by subsidiaries of Time Warner and $2.1 billion by
TWE.
 
     The 1997 Credit Agreement permits borrowings in an aggregate amount of up
to $7.5 billion, with no scheduled reduction in credit availability prior to
maturity in November 2002. The borrowers under the 1997 Credit Agreement are
Time Warner, TW Companies, TBS, TWI Cable, TWE and TWE-A/N. Borrowings under the
1997 Credit Agreement are limited to (i) $6 billion in the aggregate for Time
Warner, TW Companies, TBS and TWI Cable, (ii) $7.5 billion in the case of TWE
and (iii) $2 billion in the case of TWE-A/N, subject in each case to an
aggregate borrowing limit of $7.5 billion and certain other limitations and
adjustments. Such borrowings bear interest at specific rates for each of the
borrowers (generally equal to LIBOR plus a margin initially ranging from 35 to
40 basis points) and each borrower is required to pay a commitment fee on the
unused portion of its commitment (initially ranging from .125% to .15% per
annum), which margin and fee vary based on the credit rating or financial
leverage of the applicable borrower. Borrowings may be used for general business
purposes and unused credit is available to support commercial paper borrowings.
The 1997 Credit Agreement contains certain covenants generally for each borrower
relating to, among other things, additional indebtedness; liens on assets; cash
flow coverage and leverage ratios; and dividends, distributions and other
restricted cash payments or transfers of assets from the borrowers to their
respective shareholders, partners or affiliates.
 
                                      F-46
<PAGE>   97
                                TIME WARNER INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
CREDIT AGREEMENT WITH TWE
 
     Time Warner has a credit agreement with TWE that allows it to borrow up to
$400 million from TWE through September 15, 2000. Outstanding borrowings from
TWE in the amount of $400 million bear interest at LIBOR plus 1% per annum. All
amounts due to TWE under this agreement have been reclassified to Time Warner's
investment in and amounts due to and from the Entertainment Group in the
accompanying consolidated balance sheet.
 
INTEREST EXPENSE AND MATURITIES
 
     At December 31, 1998, Time Warner had interest rate swap contracts to pay
floating-rates of interest and receive fixed-rates of interest on $1.6 billion
notional amount of indebtedness, which resulted in approximately 37% of Time
Warner's underlying debt being subject to variable interest rates (Note 15).
 
     Interest expense amounted to $891 million in 1998, $1.049 billion in 1997
and $968 million in 1996, including $6 million in 1998, $19 million in 1997 and
$26 million in 1996 which was paid to TWE in connection with borrowings under
Time Warner's $400 million credit agreement with TWE. The weighted-average
interest rate on Time Warner's total debt, including the effect of interest rate
swap contracts, was 7.2% at December 31, 1998 and 1997.
 
     Annual repayments of long-term debt for the five years subsequent to
December 31, 1998 consist of $500 million due in 2000, and $1.234 billion due in
2002. Such repayments exclude the aggregate redemption prices of $600 million in
1999 and $600 million in 2001 relating to the variable-rate senior notes, in the
years in which the holders thereof may first exercise their redemption options.
 
FAIR VALUE OF DEBT
 
     Based on the level of interest rates prevailing at December 31, 1998 and
1997, the fair value of Time Warner's fixed-rate debt exceeded its carrying
value by $1.098 billion and $753 million, respectively. Unrealized gains or
losses on debt do not result in the realization or expenditure of cash and
generally are not recognized for financial reporting purposes unless the debt is
retired prior to its maturity.
 
8.  BORROWINGS AGAINST FUTURE STOCK OPTION PROCEEDS
 
     In 1998, in connection with Time Warner's expanded common stock repurchase
program (Note 12), Time Warner entered into a new five-year, $1.3 billion
revolving credit facility (the "Stock Option Proceeds Credit Facility"), which
replaced its previously existing facility. Borrowings under the Stock Option
Proceeds Credit Facility are principally used to fund stock repurchases and
approximately $12 million of future preferred dividend requirements on Time
Warner's convertible preferred stock as of December 31, 1998. At December 31,
1998 and 1997, Time Warner had outstanding borrowings against future stock
option proceeds of $895 million and $533 million, respectively.
 
     The Stock Option Proceeds Credit Facility initially provides for borrowings
of up to $1.3 billion, of which up to $125 million is reserved solely for the
payment of interest and fees thereunder. Borrowings under the Stock Option
Proceeds Credit Facility generally bear interest at LIBOR plus a margin equal to
75 basis points and are principally expected to be repaid from the cash proceeds
received from the exercise of designated employee stock options. The receipt of
such stock option proceeds in excess of $900 million through March 2000, and
thereafter in full on a cumulative basis, permanently reduces the borrowing
availability under the facility. At December 31, 1998, based on a closing market
price of Time Warner common stock of $62.06, the aggregate value of potential
proceeds to Time Warner from the exercise of outstanding vested, "in the money"
stock options covered under the facility was approximately $1.9 billion,
representing a 1.5 to 1 coverage ratio over the related $1.3 billion borrowing
availability. To the extent that such stock option proceeds are not sufficient
to satisfy Time Warner's obligations under the Stock Option Proceeds Credit
 
                                      F-47
<PAGE>   98
                                TIME WARNER INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
Facility, Time Warner is generally required to repay such borrowings using
proceeds from the sale of shares of its common stock held in escrow under the
Stock Option Proceeds Credit Facility or, at Time Warner's election, using
available cash on hand. Time Warner had placed 76 million shares in escrow at
December 31, 1998, which shares are not considered to be issued and outstanding
capital stock of the Company. Time Warner may be required, from time to time, to
have up to 210 million shares held in escrow. In addition, as a result of Time
Warner's commitment to use the Stock Option Proceeds Credit Facility to fund
future preferred dividend requirements on certain classes of its convertible
preferred stock, Time Warner has also supplementally agreed to place in escrow
an amount of cash equal to any excess of the unpaid, future preferred dividend
requirements on such series of convertible preferred stock over the borrowing
availability under the facility at any time.
 
9.  INCOME TAXES
 
     Domestic and foreign pretax income (loss) are as follows:
 
<TABLE>
<CAPTION>
                                                             YEARS ENDED DECEMBER 31,
                                                            ---------------------------
                                                            1998       1997       1996
                                                            ----    ----------    -----
                                                                    (MILLIONS)
<S>                                                         <C>     <C>           <C>
Domestic..................................................  $486       $728       $(193)
Foreign...................................................   100        104         197
                                                            ----       ----       -----
Total.....................................................  $586       $832       $   4
                                                            ====       ====       =====
</TABLE>
 
     Current and deferred income taxes (tax benefits) provided are as follows:
 
<TABLE>
<CAPTION>
                                                             YEARS ENDED DECEMBER 31,
                                                           ----------------------------
                                                           1998        1997       1996
                                                           -----    ----------    -----
                                                                    (MILLIONS)
<S>                                                        <C>      <C>           <C>
Federal:
  Current(1).............................................  $ 436       $191       $  50
  Deferred...............................................   (259)        49        (143)
Foreign:
  Current(2).............................................    260        205         230
  Deferred...............................................    (49)        (3)        (16)
State and Local:
  Current(1).............................................    166         88          89
  Deferred...............................................   (136)         1         (50)
                                                           -----       ----       -----
Total....................................................  $ 418       $531       $ 160
                                                           =====       ====       =====
</TABLE>
 
---------------
 
(1) Includes utilization of tax carryforwards of $126 million in 1998, $109
    million in 1997 and $77 million in 1996. Excludes current federal and state
    and local tax benefits of $478 million in 1998, $165 million in 1997 and $20
    million in 1996 resulting from the exercise of stock options and vesting of
    restricted stock awards, which were credited directly to paid-in-capital.
    Excludes current federal tax benefits of $30 million in 1997 and $4 million
    in 1996 resulting from the retirement of debt, which reduced the
    extraordinary losses in such years.
 
(2) Includes foreign withholding taxes of $113 million in 1998, $114 million in
    1997 and $101 million in 1996.
 
     The differences between income taxes expected at the U.S. federal statutory
income tax rate of 35% and income taxes provided are as set forth below. The
relationship between income before income taxes and income tax expense is most
affected by the amortization of goodwill and certain other financial statement
expenses that are not deductible for income tax purposes.
 
                                      F-48
<PAGE>   99
                                TIME WARNER INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
<TABLE>
<CAPTION>
                                                               YEARS ENDED DECEMBER 31,
                                                              --------------------------
                                                               1998      1997      1996
                                                              ------    ------    ------
                                                                      (MILLIONS)
<S>                                                           <C>       <C>       <C>
Taxes on income at U.S. federal statutory rate..............   $205      $291      $  2
State and local taxes, net of federal tax benefits..........     20        58        26
Nondeductible goodwill amortization.........................    170       170       131
Other nondeductible expenses................................     13        11        10
Foreign income taxed at different rates, net of U.S. foreign
  tax credits...............................................     --         9         4
Other.......................................................     10        (8)      (13)
                                                               ----      ----      ----
Total.......................................................   $418      $531      $160
                                                               ====      ====      ====
</TABLE>
 
     Significant components of Time Warner's net deferred tax liabilities are as
follows:
 
<TABLE>
<CAPTION>
                                                                DECEMBER 31,
                                                              ----------------
                                                               1998      1997
                                                              ------    ------
                                                                 (MILLIONS)
<S>                                                           <C>       <C>
Assets acquired in business combinations....................  $3,158    $3,352
Depreciation and amortization...............................   1,112     1,152
Unrealized appreciation of certain marketable securities....       4         4
Other.......................................................     452       449
                                                              ------    ------
Deferred tax liabilities....................................   4,726     4,957
                                                              ------    ------
Tax carryforwards...........................................     304       327
Accrued liabilities.........................................     513       381
Receivable allowances and return reserves...................     217       203
Other.......................................................     201        86
                                                              ------    ------
Deferred tax assets.........................................   1,235       997
                                                              ------    ------
Net deferred tax liabilities................................  $3,491    $3,960
                                                              ======    ======
</TABLE>
 
     U.S. income and foreign withholding taxes have not been recorded on
permanently reinvested earnings of foreign subsidiaries aggregating
approximately $945 million at December 31, 1998. Determination of the amount of
unrecognized deferred U.S. income tax liability with respect to such earnings is
not practicable. If such earnings are repatriated, additional U.S. income and
foreign withholding taxes are substantially expected to be offset by the
accompanying foreign tax credits.
 
     U.S. federal tax carryforwards at December 31, 1998 consisted of $456
million of net operating losses, $109 million of investment tax credits and $34
million of alternative minimum tax credits. The utilization of certain
carryforwards is subject to limitations under U.S. federal income tax laws.
Except for the alternative
 
                                      F-49
<PAGE>   100
                                TIME WARNER INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
minimum tax credits which do not expire, the other U.S. federal tax
carryforwards expire in varying amounts as follows for income tax reporting
purposes:
 
<TABLE>
<CAPTION>
                                                                   CARRYFORWARDS
                                                              -----------------------
                                                                 NET       INVESTMENT
                                                              OPERATING       TAX
                                                               LOSSES       CREDITS
                                                              ---------    ----------
                                                                    (MILLIONS)
<S>                                                           <C>          <C>
1999........................................................    $  3          $  1
2000........................................................       1            12
2001........................................................       2            35
2002........................................................      --            32
Thereafter up to 2011.......................................     450            29
                                                                ----          ----
                                                                $456          $109
                                                                ====          ====
</TABLE>
 
10.  MANDATORILY REDEEMABLE PREFERRED SECURITIES
 
     In August 1995, Time Warner issued approximately 12.1 million
Company-obligated mandatorily redeemable preferred securities of a wholly owned
subsidiary ("PERCS") for aggregate gross proceeds of $374 million. The PERCS
were mandatorily redeemable in December 1997 for an amount per PERCS equal to
the lesser of $54.41, and the market value of 1.5 shares of common stock of
Hasbro, Inc. ("Hasbro") on December 17, 1997, payable in cash or, at Time
Warner's option, Hasbro common stock. Pursuant to these terms, Time Warner
redeemed the PERCS in December 1997 for all of its 18.1 million shares of Hasbro
common stock. In connection with this redemption and the related disposal of its
interest in Hasbro, Time Warner recognized a $200 million pretax gain in 1997,
which has been classified in interest and other, net, in the accompanying
consolidated statement of operations.
 
     In December 1995, Time Warner issued approximately 23 million
Company-obligated mandatorily redeemable preferred securities of a wholly owned
subsidiary ("Preferred Trust Securities") for aggregate gross proceeds of $575
million. The sole assets of the subsidiary that is the obligor on the Preferred
Trust Securities are $592 million principal amount of 8 7/8% subordinated
debentures of TW Companies due December 31, 2025. Cumulative cash distributions
are payable on the Preferred Trust Securities at an annual rate of 8 7/8%. The
Preferred Trust Securities are mandatorily redeemable for cash on December 31,
2025, and Time Warner has the right to redeem the Preferred Trust Securities, in
whole or in part, on or after December 31, 2000, or in other certain
circumstances, in each case at an amount per Preferred Trust Security equal to
$25 plus accrued and unpaid distributions thereon.
 
     Time Warner has certain obligations relating to the Preferred Trust
Securities which amount to a full and unconditional guaranty (on a subordinated
basis) of its subsidiary's obligations with respect thereto.
 
11.  REDEMPTION OF SERIES M PREFERRED STOCK
 
     In December 1998, Time Warner redeemed all of its outstanding shares of
10 1/4% Series M Preferred Stock, which were issued initially in April 1996. The
aggregate redemption cost of approximately $2.1 billion was funded with proceeds
from the issuance of lower-cost debt. As a result of this redemption, preferred
dividend requirements in Time Warner's 1998 consolidated statement of operations
include a one-time effect of $234 million ($.19 loss per common share) relating
to the redemption premium paid in connection therewith.
 
     Because the weighted-average interest rate of the debt is approximately 375
basis points lower than the dividend rate of the Series M Preferred Stock and
the interest on the debt is tax deductible (whereas
 
                                      F-50
<PAGE>   101
                                TIME WARNER INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
dividends are not), Time Warner expects to realize approximately $100 to $125
million of annual cash savings as a result of this redemption.
 
12.  SHAREHOLDERS' EQUITY
 
     At December 31, 1998, shareholders' equity of Time Warner included 22.6
million shares of convertible preferred stock that are convertible into 94.1
million shares of common stock, 57.1 million shares of Series LMCN-V Common
Stock that are convertible into 114.2 million shares of common stock and 1.118
billion shares of common stock (net of 18.7 million shares of common stock in
treasury). Time Warner currently is authorized to issue up to 250 million shares
of preferred stock, up to 2 billion shares of common stock and up to 200 million
shares of additional classes of common stock, including Series LMCN-V Common
Stock.
 
     In December 1998, a two-for-one common stock split was effectuated by the
payment of a 100% stock dividend in the amount of 558.2 million shares of common
stock (the "1998 Stock Split"). The 1998 Stock Split did not affect the number
of shares of Series LMCN-V Common Stock outstanding. Accordingly, each share of
Series LMCN-V Common Stock now is equivalent effectively to two shares of common
stock. Shares of Series LMCN-V Common Stock continue to have limited voting
rights.
 
     During 1998 and January 1999, Time Warner issued approximately 66 million
shares of common stock in connection with the conversion of 15.8 million shares
of convertible preferred stock. These conversions are expected to result in
approximately $60 million of cash dividend savings in the aggregate for Time
Warner through the end of 1999.
 
     During 1998, Time Warner acquired 59.9 million shares of its common stock
at an aggregate cost of $2.24 billion under its existing common stock repurchase
program, thereby increasing the cumulative shares purchased to approximately
95.1 million shares at an aggregate cost of $3.04 billion. Except for
repurchases of common stock using borrowings in 1998 that offset $1.15 billion
of debt reduction associated with the conversion of the Zero-Coupon Convertible
Notes into common stock, these repurchases were funded with stock option
exercise proceeds and borrowings under Time Warner's Stock Option Proceeds
Credit Facility.
 
     In January 1999, Time Warner's Board of Directors authorized a new common
stock repurchase program that allows the Company to repurchase, from time to
time, up to $5 billion of common stock. This program is expected to be completed
over a three-year period. However, actual repurchases in any period will be
subject to market conditions. Along with stock option exercise proceeds and
borrowings under the Stock Option Proceeds Credit Facility, additional funding
for this program is expected to be provided by anticipated future free cash flow
and financial capacity.
 
     As of December 31, 1998, Time Warner had approximately 22.6 million shares
of convertible preferred stock outstanding. However, in January 1999, all of the
outstanding shares of Series G and Series H preferred
 
                                      F-51
<PAGE>   102
                                TIME WARNER INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
stock were converted into 12.5 million shares of common stock. Set forth below
is a summary of the principal terms of Time Warner's classes of convertible
preferred stock:
 
<TABLE>
<CAPTION>
                                                   NUMBER OF SHARES    FINAL $3.75
                                                   OF COMMON STOCK      PER SHARE    EARLIEST    EARLIEST
                                      SHARES        ISSUABLE UPON       DIVIDEND     EXCHANGE   REDEMPTION
DESCRIPTION                         OUTSTANDING       CONVERSION          DATE         DATE        DATE
-----------                         -----------    ----------------    -----------   --------   ----------
                                    (MILLIONS)        (MILLIONS)
<S>                                 <C>            <C>                 <C>           <C>        <C>
Series D preferred stock..........     11.0              45.8             7/6/99      7/6/99      7/6/00
Series E preferred stock..........      3.1              13.0             1/4/01      1/4/01      1/4/01
Series F preferred stock..........      3.0              12.4             1/4/00      1/4/00      1/4/01
Series G preferred stock..........      1.2               5.0             9/5/99      9/5/99      9/5/99
Series H preferred stock..........      1.8               7.5             9/5/99      9/5/00      9/5/99
Series I preferred stock..........      0.7               2.9            10/2/99     10/2/99     10/2/99
Series J preferred stock..........      1.8               7.5             5/2/00      5/2/00      5/2/00
                                       ----             -----
Total shares outstanding at
  December 31, 1998...............     22.6              94.1
Conversion of Series G and H
  preferred stock in January
  1999............................     (3.0)            (12.5)
                                       ----             -----
Total shares outstanding at
  January 31, 1999................     19.6              81.6
                                       ====             =====
</TABLE>
 
     The principal terms of each outstanding series of convertible preferred
stock (collectively, the "Convertible Preferred Stock") are similar in nature,
unless otherwise noted below. Each share of Convertible Preferred Stock: (1) is
entitled to a liquidation preference of $100 per share, (2) is immediately
convertible into 4.16528 shares of Time Warner common stock at a conversion
price of $24 per share (based on its liquidation value), (3) entitles the holder
thereof (i) to receive for a four-year period from the date of issuance (or a
five-year period with respect to the Series E and Series J preferred stock) an
annual dividend per share equal to the greater of $3.75 and an amount equal to
the dividends paid on the Time Warner common stock into which each share may be
converted and (ii) to the extent that any of such shares of preferred stock
remain outstanding at the end of the period in which the minimum $3.75 per share
dividend is to be paid, the holders thereafter will receive dividends equal to
the dividends paid on shares of Time Warner common stock multiplied by the
number of shares into which their shares of preferred stock are convertible and
(4) entitles the holder thereof to vote with the common stockholders on all
matters on which the common stockholders are entitled to vote, and each share of
such Convertible Preferred Stock is entitled to four votes on any such matter.
 
     Time Warner has the right to exchange each series of Convertible Preferred
Stock for Time Warner common stock at the stated conversion price at any time on
or after the respective exchange date. In addition, Time Warner has the right to
redeem each series of Convertible Preferred Stock, in whole or in part, for cash
at the liquidation value plus accrued dividends, at any time on or after the
respective redemption date.
 
     Pursuant to Time Warner's shareholder rights plan, as amended, each share
of Time Warner common stock has attached to it one right, which becomes
exercisable in certain events involving the acquisition of 15% or more of the
then outstanding common stock of Time Warner on a fully diluted basis. Upon the
occurrence of such an event, each right entitles its holder to purchase for $75
the economic equivalent of common stock of Time Warner, or in certain
circumstances, of the acquiror, worth twice as much. In connection with the
plan, 8 million shares of preferred stock were reserved. The rights expire on
January 20, 2004.
 
     At December 31, 1998, Time Warner had convertible securities and
outstanding stock options that were convertible or exercisable into
approximately 230 million shares of common stock (as adjusted for the January
1999 conversion of Series G and Series H preferred stock).
 
                                      F-52
<PAGE>   103
                                TIME WARNER INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     At February 28, 1999, there were approximately 25,000 holders of record of
Time Warner common stock. This total does not include the large number of
investors who hold such shares through banks, brokers or other fiduciaries.
 
13.  STOCK OPTION PLANS
 
     Time Warner has various stock option plans under which Time Warner may
grant options to purchase Time Warner common stock to employees of Time Warner
and TWE. Such options have been granted to employees of Time Warner and TWE with
exercise prices equal to, or in excess of, fair market value at the date of
grant. Accordingly, in accordance with APB 25 and related interpretations,
compensation cost is not generally recognized for its stock option plans.
Generally, the options become exercisable over a three-year vesting period and
expire ten years from the date of grant. Had compensation cost for Time Warner's
stock option plans been determined based on the fair value at the grant dates
for all awards made subsequent to 1994 consistent with the method set forth
under FASB Statement No. 123, "Accounting for Stock-Based Compensation" ("FAS
123"), Time Warner's net income (loss) and net loss per common share would have
been changed to the pro forma amounts indicated below:
 
<TABLE>
<CAPTION>
                                                               YEARS ENDED DECEMBER 31,
                                                              --------------------------
                                                               1998      1997      1996
                                                              ------    ------    ------
                                                                  (MILLIONS, EXCEPT
                                                                  PER SHARE AMOUNTS)
<S>                                                           <C>       <C>       <C>
Net income (loss):
  As reported...............................................  $ 168     $ 246     $(191)
                                                              =====     =====     =====
  Pro forma.................................................  $ 106     $ 200     $(216)
                                                              =====     =====     =====
Net loss per common share:
  As reported...............................................  $(.31)    $(.06)    $(.52)
                                                              =====     =====     =====
  Pro forma.................................................  $(.36)    $(.10)    $(.55)
                                                              =====     =====     =====
</TABLE>
 
     FAS 123 is applicable only to stock options granted subsequent to December
31, 1994. Accordingly, since Time Warner's compensation expense associated with
such grants would generally be recognized over a three-year vesting period, the
initial impact of applying FAS 123 on pro forma net income for 1996 is not
comparable to the impact on pro forma net income for 1998 and 1997, when the pro
forma effect of the three-year vesting period has been fully reflected.
 
     For purposes of applying FAS 123, the fair value of each option grant is
estimated on the date of grant using the Black-Scholes option-pricing model with
the following weighted-average assumptions used for grants in 1998, 1997 and
1996: dividend yields of 0.5%, 1% and 1%, respectively; expected volatility of
21.6%, 21.9% and 21.7%, respectively; risk-free interest rates of 5.5%, 6.4% and
6.1%, respectively; and expected lives of 5 years in all periods. The weighted
average fair value of an option granted during the year was $11.13 ($6.57, net
of taxes), $6.58 ($3.88, net of taxes) and $5.78 ($3.41, net of taxes) for the
years ended December 31, 1998, 1997 and 1996, respectively. In each period, Time
Warner granted options to certain executives at exercise prices exceeding the
market price of Time Warner common stock on the date of grant. These
above-market options had a weighted average exercise price and fair value of
$49.54 and $9.45 ($5.58, net of taxes), respectively, in 1998; $32.45 and $6.29
($3.71, net of taxes), respectively, in 1997; and $26.44 and $4.44 ($2.62, net
of taxes), respectively, in 1996.
 
                                      F-53
<PAGE>   104
                                TIME WARNER INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     A summary of stock option activity under all plans is as follows:
 
<TABLE>
<CAPTION>
                                                                           WEIGHTED-
                                                              THOUSANDS     AVERAGE
                                                                 OF        EXERCISE
                                                               SHARES        PRICE
                                                              ---------    ---------
<S>                                                           <C>          <C>
Balance at January 1, 1996..................................   157,238      $15.68
Granted.....................................................    18,920       21.65
Exercised...................................................    (7,372)      13.45
Assumed in connection with the TBS Transaction..............    27,425       13.20
Cancelled...................................................      (477)      20.41
                                                               -------
Balance at December 31, 1996................................   195,734      $15.98
Granted.....................................................    16,544       22.41
Exercised...................................................   (32,632)      13.66
Cancelled...................................................      (942)      18.89
                                                               -------
Balance at December 31, 1997................................   178,704      $16.99
Granted.....................................................    18,100       37.71
Exercised...................................................   (48,323)      15.01
Cancelled...................................................      (417)      28.01
                                                               -------
Balance at December 31, 1998................................   148,064      $20.14
                                                               =======
</TABLE>
 
<TABLE>
<CAPTION>
                                                                DECEMBER 31,
                                                        -----------------------------
                                                         1998       1997       1996
                                                        -------    -------    -------
                                                                 (THOUSANDS)
<S>                                                     <C>        <C>        <C>
Exercisable...........................................  112,471    145,616    165,394
Available for future grants...........................   11,207     12,771     16,063
</TABLE>
 
     The following table summarizes information about stock options outstanding
at December 31, 1998:
 
<TABLE>
<CAPTION>
                                      OPTIONS OUTSTANDING                OPTIONS EXERCISABLE
                            ---------------------------------------    ------------------------
                                            WEIGHTED-
                                             AVERAGE      WEIGHTED-                   WEIGHTED-
                              NUMBER        REMAINING      AVERAGE       NUMBER        AVERAGE
RANGE OF                    OUTSTANDING    CONTRACTUAL    EXERCISE     EXERCISABLE    EXERCISE
EXERCISE PRICES             AT 12/31/98       LIFE          PRICE      AT 12/31/98      PRICE
---------------             -----------    -----------    ---------    -----------    ---------
                            (THOUSANDS)                                (THOUSANDS)
<S>                         <C>            <C>            <C>          <C>            <C>
Under $10.................      7,726       1.7 years      $ 8.98          7,726       $ 8.98
$10.00 to $15.00..........     25,239       3.1 years      $12.14         25,239       $12.14
$15.01 to $20.00..........     59,851       4.3 years      $18.20         55,545       $18.16
$20.01 to $30.00..........     35,538       6.4 years      $22.02         23,056       $21.73
$30.01 to $45.00..........     16,573       8.9 years      $35.09            905       $31.75
$45.01 to $54.05..........      3,137       9.1 years      $48.44             --           --
                              -------                                    -------
Total.....................    148,064       5.1 years      $20.14        112,471       $17.02
                              =======                                    =======
</TABLE>
 
     For options exercised by employees of TWE, Time Warner is reimbursed by TWE
for the amount by which the market value of Time Warner common stock on the
exercise date exceeds the exercise price, or the greater of the exercise price
or $13.88 for options granted prior to the TWE capitalization on June 30, 1992.
There were 47.7 million options held by employees of TWE at December 31, 1998,
33.4 million of which were exercisable.
 
                                      F-54
<PAGE>   105
                                TIME WARNER INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
14.  BENEFIT PLANS
 
     Time Warner and its subsidiaries have defined benefit pension plans
covering substantially all domestic employees. Pension benefits are based on
formulas that reflect the employees' years of service and compensation levels
during their employment period. Time Warner's common stock represents
approximately 12% and 7% of plan assets at December 31, 1998 and 1997,
respectively. A summary of activity for Time Warner's defined benefit pension
plans is as follows:
 
<TABLE>
<CAPTION>
                                                               YEARS ENDED DECEMBER 31,
                                                              --------------------------
                                                               1998      1997      1996
                                                              ------    ------    ------
                                                                      (MILLIONS)
<S>                                                           <C>       <C>       <C>
COMPONENTS OF PENSION EXPENSE
Service cost................................................   $ 53      $ 45      $ 49
Interest cost...............................................     74        68        64
Expected return on plan assets..............................    (73)      (62)      (57)
Net amortization and deferral...............................      2         1         4
                                                               ----      ----      ----
Total.......................................................   $ 56      $ 52      $ 60
                                                               ====      ====      ====
</TABLE>
 
<TABLE>
<CAPTION>
                                                                DECEMBER 31,
                                                              -----------------
                                                               1998       1997
                                                              ------      -----
                                                                 (MILLIONS)
<S>                                                           <C>         <C>
CHANGE IN PROJECTED BENEFIT OBLIGATION
Projected benefit obligation at beginning of year...........  $  990      $ 850
Service cost................................................      53         45
Interest cost...............................................      74         68
Actuarial loss..............................................      98         78
Benefits paid...............................................     (52)       (51)
                                                              ------      -----
Projected benefit obligation at end of year.................   1,163        990
                                                              ------      -----
CHANGE IN PLAN ASSETS
Fair value of plan assets at beginning of year..............     839        704
Actual return on plan assets................................     191        162
Employer contribution.......................................      16         15
Benefits paid...............................................     (46)       (42)
                                                              ------      -----
Fair value of plan assets at end of year....................   1,000        839
                                                              ------      -----
Unfunded projected benefit obligation.......................    (163)      (151)
Additional minimum liability(a).............................     (33)       (38)
Unrecognized actuarial loss (gain)..........................     (16)         3
Unrecognized prior service cost.............................      16         15
                                                              ------      -----
Accrued pension expense.....................................  $ (196)     $(171)
                                                              ======      =====
</TABLE>
 
---------------
(a) The additional minimum liability is offset fully by a corresponding
    intangible asset recognized in the consolidated balance sheet.
 
                                      F-55
<PAGE>   106
                                TIME WARNER INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
<TABLE>
<CAPTION>
                                                                  DECEMBER 31,
                                                              --------------------
                                                              1998    1997    1996
                                                              ----    ----    ----
<S>                                                           <C>     <C>     <C>
WEIGHTED-AVERAGE PENSION ASSUMPTIONS
Discount rate...............................................  6.75%   7.25%   7.75%
Expected return on plan assets..............................     9%      9%      9%
Rate of compensation increase...............................     6%      6%      6%
</TABLE>
 
     Included above are projected benefit obligations and accumulated benefit
obligations for unfunded defined benefit pension plans of $118 million and $97
million as of December 31, 1998, respectively; and $94 million and $72 million
as of December 31, 1997, respectively.
 
     Employees of Time Warner's operations in foreign countries participate to
varying degrees in local pension plans, which in the aggregate are not
significant.
 
     Time Warner also has certain defined contribution plans, including savings
and profit sharing plans, as to which the expense amounted to $84 million in
1998, $83 million in 1997 and $67 million in 1996. Contributions to the savings
plans are based upon a percentage of the employees' elected contributions.
Contributions to the profit sharing plans are generally determined by management
and approved by the boards of directors of the participating companies.
 
15.  DERIVATIVE FINANCIAL INSTRUMENTS
 
     Time Warner uses derivative financial instruments principally to manage the
risk that changes in interest rates will affect either the fair value of its
debt obligations or the amount of its future interest payments and, with regard
to foreign currency exchange rates, to manage the risk that changes in exchange
rates will affect the amount of unremitted or future royalties and license fees
to be received from the sale of U.S. copyrighted products abroad. The following
is a summary of Time Warner's risk management strategies and the effect of these
strategies on Time Warner's consolidated financial statements.
 
INTEREST RATE RISK MANAGEMENT
 
  Interest Rate Swap Contracts
 
     Interest rate swap contracts are used to adjust the proportion of total
debt that is subject to variable and fixed interest rates. Under an interest
rate swap contract, Time Warner either agrees to pay an amount equal to a
specified variable-rate of interest times a notional principal amount, and to
receive in return an amount equal to a specified fixed-rate of interest times
the same notional principal amount or, vice versa, to receive a variable-rate
amount and to pay a fixed-rate amount. The notional amounts of the contract are
not exchanged. No other cash payments are made unless the contract is terminated
prior to maturity, in which case the amount paid or received in settlement is
established by agreement at the time of termination, and usually represents the
net present value, at current rates of interest, of the remaining obligations to
exchange payments under the terms of the contract. Interest rate swap contracts
are entered into with a number of major financial institutions in order to
minimize counterparty credit risk.
 
     Time Warner accounts for its interest rate swap contracts differently based
on whether it has agreed to pay an amount based on a variable-rate or fixed-rate
of interest. For interest rate swap contracts under which Time Warner agrees to
pay variable-rates of interest, these contracts are considered to be a hedge
against changes in the fair value of Time Warner's fixed-rate debt obligations.
Accordingly, the interest rate swap contracts are reflected at fair value in
Time Warner's consolidated balance sheet and the related portion of fixed-rate
debt being hedged is reflected at an amount equal to the sum of its carrying
value plus an adjustment representing the change in fair value of the debt
obligations attributable to the interest rate risk being hedged. In addition,
changes during any accounting period in the fair value of these interest rate
swap contracts, as well as offsetting changes in the adjusted carrying value of
the related portion of fixed-rate debt
 
                                      F-56
<PAGE>   107
                                TIME WARNER INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
being hedged, are recognized as adjustments to interest expense in Time Warner's
consolidated statement of operations. The net effect of this accounting on Time
Warner's operating results is that interest expense on the portion of fixed-rate
debt being hedged is generally recorded based on variable interest rates.
 
     For interest rate swap contracts under which Time Warner agrees to pay
fixed-rates of interest, these contracts are considered to be a hedge against
changes in the amount of future cash flows associated with Time Warner's
interest payments of Time Warner's variable-rate debt obligations. Accordingly,
the interest rate swap contracts are reflected at fair value in Time Warner's
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 then amortized as an adjustment to interest
expense over the same period in which the related interest payments being hedged
are 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 interest payments being hedged, any changes in fair value relating to the
ineffective portion of these contracts are immediately recognized in income. The
net effect of this accounting on Time Warner's operating results is that
interest expense on the portion of variable-rate debt being hedged is generally
recorded based on fixed interest rates.
 
     At December 31, 1998, Time Warner had interest rate swap contracts to pay
variable-rates of interest (average six-month LIBOR rate of 5.5%) and receive
fixed-rates of interest (average rate of 5.5%) on $1.6 billion notional amount
of indebtedness, which resulted in approximately 37% of Time Warner's underlying
debt, and 39% of the debt of Time Warner and the Entertainment Group combined,
being subject to variable interest rates. The notional amount of outstanding
contracts by year of maturity at December 31, 1998 is as follows: 1999-$1.2
billion; and 2000-$400 million. At December 31, 1997, Time Warner had interest
rate swap contracts on $2.3 billion notional amount of indebtedness. The net
gain or loss on the ineffective portion of these interest rate swap contracts
was not material in any period.
 
  Interest Rate Lock Agreements
 
     In the past, Time Warner sometimes has used interest rate lock agreements
to hedge the risk that the cost of a future issuance of fixed-rate debt may be
adversely affected by changes in interest rates. Under an interest rate lock
agreement, Time Warner agrees to pay or receive an amount equal to the
difference between the net present value of the cash flows for a notional
principal amount of indebtedness based on the existing yield of a U.S. treasury
bond at the date when the agreement is established and at the date when the
agreement is settled, typically when Time Warner issues new debt. The notional
amounts of the agreement are not exchanged. Interest rate lock agreements are
entered into with a number of major financial institutions in order to minimize
counterparty credit risk.
 
     Interest rate lock agreements are reflected at fair value in Time Warner's
consolidated balance sheet and the related gains or losses on these agreements
are deferred in shareholders' equity (as a component of comprehensive income).
These deferred gains and losses are then amortized as an adjustment to interest
expense over the same period in which the related interest costs on the new debt
issuances are recognized in income.
 
     At December 31, 1998, Time Warner had outstanding interest rate lock
agreements for an aggregate $650 million notional principal amount of
indebtedness, which were settled in January 1999. Time Warner no longer intends
to use interest rate lock agreements to hedge the cost of future issuances of
fixed-rate debt. At December 31, 1998, Time Warner had deferred approximately
$32 million of net losses on interest rate lock agreements, of which
approximately $2 million is expected to be recognized in income over the next
twelve months.
 
                                      F-57
<PAGE>   108
                                TIME WARNER INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
FOREIGN CURRENCY RISK MANAGEMENT
 
     Foreign exchange contracts are used primarily by Time Warner to hedge the
risk that unremitted or future royalties and license fees owed to Time Warner or
TWE domestic companies for the sale or anticipated sale of U.S. copyrighted
products abroad may be adversely affected by changes in 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 and TWE's combined foreign currency exposures anticipated over
the ensuing twelve-month period. At December 31, 1998, Time Warner had
effectively hedged approximately half of the combined estimated foreign currency
exposures that principally relate to anticipated cash flows to be remitted to
the U.S. over the ensuing twelve-month period. To hedge this exposure, Time
Warner used foreign exchange contracts that generally have maturities of three
months or less, which generally will be 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.
 
     Time Warner 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 and 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 royalties
and 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 Time Warner's consolidated statement of
operations.
 
     At December 31, 1998, Time Warner had contracts for the sale of $755
million and the purchase of $259 million of foreign currencies at fixed rates,
primarily Japanese yen (40% of net contract value), English pounds (4%), German
marks (28%), Canadian dollars (10%) and French francs (16%), compared to
contracts for the sale of $507 million and the purchase of $139 million of
foreign currencies at December 31, 1997. Time Warner had deferred approximately
$6 million of net losses on foreign exchange contracts at December 31, 1998,
which is all expected to be recognized in income over the next twelve months.
For the years ended December 31, 1998, 1997 and 1996, Time Warner recognized $8
million in losses, $27 million in gains and $15 million in gains, respectively,
and TWE recognized $2 million in losses, $14 million in gains and $6 million in
gains, respectively, on foreign exchange contracts, which were or are expected
to be offset by corresponding decreases and increases, respectively, in the
dollar value of foreign currency royalties and license fee payments that have
been or are anticipated to be received in cash from the sale of U.S. copyrighted
products abroad.
 
16.  SEGMENT INFORMATION
 
     Time Warner classifies its businesses into four fundamental areas: Cable
Networks, consisting principally of interests in cable television programming;
Publishing, consisting principally of interests in magazine publishing, book
publishing and direct marketing; Entertainment, consisting principally of
interests in recorded music and music publishing, filmed entertainment,
television production and television broadcasting; and Cable, consisting
principally of interests in cable television systems. A majority of Time
Warner's interests in filmed entertainment, television production, television
broadcasting and cable television systems, and a portion of its interests in
cable television programming are held by the Entertainment Group. The
Entertainment Group is not consolidated for financial reporting purposes.
 
     Information as to the operations of Time Warner and the Entertainment Group
in different business segments is set forth below based on the nature of the
products and services offered. Time Warner evaluates performance based on
several factors, of which the primary financial measure is business segment
operating
 
                                      F-58
<PAGE>   109
                                TIME WARNER INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
income before noncash amortization of intangible assets ("EBITA"). The
accounting policies of the business segments are the same as those described in
the summary of significant accounting policies (Note 1). Intersegment sales are
accounted for at fair value as if the sales were to third parties.
 
     The operating results of Time Warner's and the Entertainment Group's cable
segments 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 Time Warner
Telecom Reorganization effective as of July 1, 1998. In addition, the operating
results of Time Warner reflect the cable networks and filmed
entertainment-related acquisition of TBS effective as of October 10, 1996.
 
<TABLE>
<CAPTION>
                                                          YEARS ENDED DECEMBER 31,
                                                        -----------------------------
                                                         1998       1997       1996
                                                        -------    -------    -------
                                                                 (MILLIONS)
<S>                                                     <C>        <C>        <C>
REVENUES
Time Warner:
Publishing............................................  $ 4,496    $ 4,290    $ 4,117
Music.................................................    4,025      3,691      3,949
Cable Networks-TBS....................................    3,325      2,900        680
Filmed Entertainment-TBS..............................    1,917      1,531        455
Cable.................................................      964        997        909
Intersegment elimination..............................     (145)      (115)       (46)
                                                        -------    -------    -------
Total.................................................  $14,582    $13,294    $10,064
                                                        =======    =======    =======
Entertainment Group:
Filmed Entertainment-Warner Bros......................  $ 6,061    $ 5,472    $ 5,648
Broadcasting-The WB Network...........................      260        136         87
Cable Networks-HBO....................................    2,052      1,923      1,763
Cable.................................................    4,378      4,243      3,851
Intersegment elimination..............................     (495)      (446)      (488)
                                                        -------    -------    -------
Total.................................................  $12,256    $11,328    $10,861
                                                        =======    =======    =======
</TABLE>
 
<TABLE>
<CAPTION>
                                                            YEARS ENDED DECEMBER 31,
                                                           --------------------------
                                                            1998      1997      1996
                                                           ------    ------    ------
                                                                   (MILLIONS)
<S>                                                        <C>       <C>       <C>
EBITA(1)
Time Warner:
Publishing...............................................  $  607    $  529    $  464
Music....................................................     493       467       653
Cable Networks-TBS.......................................     706       573       142
Filmed Entertainment-TBS.................................     192       200        30
Cable(2).................................................     325       427       353
Intersegment elimination.................................     (27)      (13)        5
                                                           ------    ------    ------
Total....................................................  $2,296    $2,183    $1,647
                                                           ======    ======    ======
Entertainment Group:
Filmed Entertainment-Warner Bros.........................  $  503    $  404    $  379
Broadcasting-The WB Network..............................     (93)      (88)      (98)
Cable Networks-HBO.......................................     454       391       328
Cable(3).................................................   1,369     1,184       917
                                                           ------    ------    ------
Total....................................................  $2,233    $1,891    $1,526
                                                           ======    ======    ======
</TABLE>
 
---------------
 
(1) EBITA represents business segment operating income before noncash
    amortization of intangible assets. After deducting amortization of
    intangible assets, Time Warner's business segment operating income was
    $1.496 billion in 1998, $1.271 billion in 1997 and $966 million in 1996.
    Similarly, business segment operating income of the Entertainment Group was
    $1.724 billion in 1998, $1.461 billion in 1997 and $1.090 billion in 1996.
 
(2) Includes net pretax gains of approximately $18 million in 1998 and $12
    million in 1997 related to the sale or exchange of certain cable television
    systems.
 
(3) Includes net pretax gains of approximately $90 million in 1998 and $200
    million in 1997 related to the sale or exchange of certain cable television
    systems.
                                      F-59
<PAGE>   110
                                TIME WARNER INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
<TABLE>
<CAPTION>
                                                               YEARS ENDED DECEMBER 31,
                                                              --------------------------
                                                               1998      1997      1996
                                                              ------    ------    ------
                                                                      (MILLIONS)
<S>                                                           <C>       <C>       <C>
DEPRECIATION OF PROPERTY, PLANT AND EQUIPMENT
Time Warner:
Publishing..................................................   $ 80      $ 79      $ 71
Music.......................................................     72        83        91
Cable Networks-TBS..........................................     93        87        20
Filmed Entertainment-TBS....................................      6         7         2
Cable.......................................................    127       126       123
                                                               ----      ----      ----
Total.......................................................   $378      $382      $307
                                                               ====      ====      ====
Entertainment Group:
Filmed Entertainment-Warner Bros. ..........................   $166      $197      $167
Broadcasting-The WB Network.................................      1         1        --
Cable Networks-HBO..........................................     23        22        22
Cable.......................................................    737       736       619
                                                               ----      ----      ----
Total.......................................................   $927      $956      $808
                                                               ====      ====      ====
</TABLE>
 
<TABLE>
<CAPTION>
                                                               YEARS ENDED DECEMBER 31,
                                                              --------------------------
                                                               1998      1997      1996
                                                              ------    ------    ------
                                                                      (MILLIONS)
<S>                                                           <C>       <C>       <C>
AMORTIZATION OF INTANGIBLE ASSETS(1)
Time Warner:
Publishing..................................................   $ 38      $ 48      $ 46
Music.......................................................    280       301       292
Cable Networks-TBS..........................................    200       199        43
Filmed Entertainment-TBS....................................     82        87        22
Cable.......................................................    200       277       278
                                                               ----      ----      ----
Total.......................................................   $800      $912      $681
                                                               ====      ====      ====
Entertainment Group:
Filmed Entertainment-Warner Bros. ..........................   $129      $123      $125
Broadcasting-The WB Network.................................      3        --        --
Cable Networks-HBO..........................................     --        --        --
Cable.......................................................    377       307       311
                                                               ----      ----      ----
Total.......................................................   $509      $430      $436
                                                               ====      ====      ====
</TABLE>
 
---------------
(1) Amortization includes amortization relating to all business combinations
    accounted for by the purchase method, including the $14 billion acquisition
    of Warner Communications Inc. in 1989, the $6.2 billion acquisition of TBS
    in 1996 and the $2.3 billion of cable acquisitions in 1996 and 1995.
 
                                      F-60
<PAGE>   111
                                TIME WARNER INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     Information as to the assets and capital expenditures of Time Warner and
the Entertainment Group is as follows:
 
<TABLE>
<CAPTION>
                                                                DECEMBER 31,
                                                        -----------------------------
                                                         1998       1997       1996
                                                        -------    -------    -------
                                                                 (MILLIONS)
<S>                                                     <C>        <C>        <C>
ASSETS
Time Warner:
Publishing............................................  $ 2,726    $ 2,490    $ 2,418
Music.................................................    7,354      6,507      7,478
Cable Networks-TBS....................................    8,485      8,372      7,860
Filmed Entertainment-TBS..............................    2,774      2,950      3,232
Cable.................................................    4,434      7,043      7,257
Entertainment Group(1)................................    4,980      5,549      5,814
Corporate(2)..........................................      887      1,252      1,005
                                                        -------    -------    -------
Total.................................................  $31,640    $34,163    $35,064
                                                        =======    =======    =======
Entertainment Group:
Filmed Entertainment-Warner Bros. ....................  $ 8,811    $ 8,106    $ 8,111
Broadcasting-The WB Network...........................      244        113         67
Cable Networks-HBO....................................    1,159      1,080        997
Cable.................................................   11,314     10,771     10,202
Corporate(2)..........................................      713        669        650
                                                        -------    -------    -------
Total.................................................  $22,241    $20,739    $20,027
                                                        =======    =======    =======
</TABLE>
 
---------------
(1) Entertainment Group assets represent Time Warner's investment in and amounts
    due to and from the Entertainment Group.
(2) Consists principally of cash, cash equivalents and other investments.
 
<TABLE>
<CAPTION>
                                                            YEARS ENDED DECEMBER 31,
                                                           --------------------------
                                                            1998      1997      1996
                                                           ------    ------    ------
                                                                   (MILLIONS)
<S>                                                        <C>       <C>       <C>
CAPITAL EXPENDITURES
Time Warner:
Publishing...............................................  $   58    $   77    $   76
Music....................................................      92        87       142
Cable Networks-TBS.......................................     120       113        34
Filmed Entertainment-TBS.................................       3         3         2
Cable....................................................     225       282       215
Corporate................................................      14        12        12
                                                           ------    ------    ------
Total....................................................  $  512    $  574    $  481
                                                           ======    ======    ======
Entertainment Group:
Filmed Entertainment-Warner Bros. .......................  $  122    $  144    $  340
Broadcasting-The WB Network..............................       1         1         2
Cable Networks-HBO.......................................      23        19        29
Cable(1).................................................   1,451     1,401     1,348
Corporate................................................       6        --        --
                                                           ------    ------    ------
Total....................................................  $1,603    $1,565    $1,719
                                                           ======    ======    ======
</TABLE>
 
---------------
(1) Cable capital expenditures were funded in part through collections on the
    MediaOne Note Receivable in the amount of $169 million in 1996 (Note 4). The
    MediaOne Note Receivable was fully collected during 1996.
 
                                      F-61
<PAGE>   112
                                TIME WARNER INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     Information as to Time Warner's operations in different geographical areas
is as follows:
 
<TABLE>
<CAPTION>
                                                          YEARS ENDED DECEMBER 31,
                                                        -----------------------------
                                                         1998       1997       1996
                                                        -------    -------    -------
                                                                 (MILLIONS)
<S>                                                     <C>        <C>        <C>
REVENUES(1)
Time Warner:
United States.........................................  $11,220    $10,159    $ 7,262
United Kingdom........................................      542        449        372
Germany...............................................      432        420        452
Japan.................................................      405        417        399
Canada................................................      284        262        209
France................................................      227        195        229
Other international...................................    1,472      1,392      1,141
                                                        -------    -------    -------
Total.................................................  $14,582    $13,294    $10,064
                                                        =======    =======    =======
Entertainment Group:
United States.........................................  $10,177    $ 9,096    $ 8,727
United Kingdom........................................      459        488        383
Germany...............................................      263        284        374
Japan.................................................      162        172        196
Canada................................................      145        137        157
France................................................      163        152        143
Other international...................................      887        999        881
                                                        -------    -------    -------
Total.................................................  $12,256    $11,328    $10,861
                                                        =======    =======    =======
</TABLE>
 
---------------
(1) Revenues are attributed to countries based on location of customer.
 
     Because a substantial portion of Time Warner's international revenues is
derived from the sale of U.S. copyrighted products abroad, assets located
outside the United States are not material.
 
17.  COMMITMENTS AND CONTINGENCIES
 
     Time Warner's total rent expense amounted to $286 million in 1998, $237
million in 1997 and $192 million in 1996. The minimum rental commitments under
noncancellable long-term operating leases are: 1999-$259 million; 2000-$244
million; 2001-$222 million; 2002-$205 million; 2003-$193 million; and after
2003-$940 million.
 
     Time Warner's minimum commitments and guarantees under certain programming,
licensing, artists, athletes, franchise and other agreements aggregated
approximately $6.6 billion at December 31, 1998, which are payable principally
over a five-year period. Such amounts do not include the Time Warner General
Partner and TWI Cable guarantees of approximately $6.7 billion of TWE's and
TWE-A/N's debt and accrued interest.
 
     Time Warner is subject to numerous legal proceedings, including certain
litigation relating to Six Flags. In management's opinion and considering
established reserves, the resolution of these matters will not have a material
effect, individually and in the aggregate, on Time Warner's financial
statements.
 
                                      F-62
<PAGE>   113
                                TIME WARNER INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
18.  RELATED PARTY TRANSACTIONS
 
     In the normal course of conducting their businesses, Time Warner and its
subsidiaries and affiliates have had various transactions with TWE and other
Entertainment Group companies, generally on terms resulting from a negotiation
between the affected units that in management's view results in reasonable
allocations. Employees of TWE participate in various Time Warner medical, stock
option and other benefit plans for which Time Warner charges TWE its allocable
share of plan expenses, including administrative costs. In addition, Time Warner
provides TWE with certain corporate support services for which it received a fee
in the amount of $72 million, $72 million and $69 million in 1998, 1997 and
1996, respectively.
 
     Time Warner's Cable division has management services agreements with TWE,
pursuant to which TWE manages, or provides services to, the cable television
systems owned by Time Warner. Such cable television systems also pay TWE for the
right to carry cable television programming provided by TWE's cable networks.
Similarly, Time Warner receives fees from TWE's cable television systems for the
right to carry cable television programming provided by Time Warner's cable
networks.
 
     Time Warner's and TWE's Cable division have sold or exchanged, or agreed to
sell or exchange, various cable television systems to MediaOne in an effort to
strengthen their geographic clustering of cable television properties.
 
     Time Warner's Filmed Entertainment-TBS division has various service
agreements with TWE's Filmed Entertainment-Warner Bros. division, pursuant to
which TWE's Filmed Entertainment-Warner Bros. division provides certain
management and distribution services for Time Warner's theatrical, television
and animated product, as well as certain services for administrative and
technical support.
 
     Time Warner's Cable Networks-TBS division has license agreements with TWE,
pursuant to which the cable networks have acquired broadcast rights to certain
film and television product. In addition, Time Warner's Music division provides
home videocassette distribution services to certain TWE operations, and certain
TWE units place advertising in magazines published by Time Warner's Publishing
division.
 
     Time Warner has a credit agreement with TWE that allows it to borrow up to
$400 million from TWE through September 15, 2000. Outstanding borrowings from
TWE in the amount of $400 million bear interest at LIBOR plus 1% per annum.
 
     In addition to transactions with TWE and other Entertainment Group
companies, Time Warner has had transactions with the Columbia House Company
partnerships, Comedy Partners, L.P., Time Warner Telecom, the Road Runner Joint
Venture and other equity investees of Time Warner and the Entertainment Group,
generally with respect to sales of products and services in the ordinary course
of business.
 
19.  ADDITIONAL FINANCIAL INFORMATION
 
CASH FLOWS
 
     As of December 31, 1998, Time Warner had certain asset securitization
facilities, which provide for the accelerated receipt of up to approximately $1
billion of cash on available receivables. In connection with each of these
securitization facilities, Time Warner sells, on a revolving and nonrecourse
basis, certain of its accounts receivables ("Pooled Receivables") to a wholly
owned, special purpose entity which, in turn, sells a percentage ownership
interest in the Pooled Receivables to a third-party, commercial paper conduit
sponsored by a financial institution. These securitization transactions have
been accounted for as a sale in accordance with FASB Statement No. 125,
"Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities." Accordingly, accounts receivables sold under this
securitization program have been reflected as a reduction in receivables in the
accompanying consolidated balance sheet. Net proceeds received under this
securitization program were $17 million in 1998, $108 million in 1997 and $147
million in 1996.
 
                                      F-63
<PAGE>   114
                                TIME WARNER INC.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     Additional financial information with respect to cash flows is as follows:
 
<TABLE>
<CAPTION>
                                                              YEARS ENDED DECEMBER 31,
                                                             --------------------------
                                                             1998       1997       1996
                                                             ----    ----------    ----
                                                                     (MILLIONS)
<S>                                                          <C>     <C>           <C>
Cash payments made for interest............................  $812       $929       $839
Cash payments made for income taxes........................   261        305        382
Tax-related distributions received from TWE................   314        324        215
Income tax refunds received................................    52         52         44
</TABLE>
 
     Noncash investing activities in 1998 included the Time Warner Telecom
Reorganization, the formation of the Road Runner Joint Venture and the TWE-A/N
Transfers (Note 2). Noncash financing activities included the conversion of
$1.15 billion of Zero-Coupon Convertible Notes into 37.4 million shares of
common stock in 1998 (Note 7) and the conversion of 12.8 million shares of
convertible preferred stock into approximately 53.5 million shares of common
stock (Note 12). Noncash financing activities in 1997 included the redemption of
the PERCS in exchange for Time Warner's interest in Hasbro (Note 10) and the
payment of $185 million of noncash dividends on the Series M Preferred Stock.
Noncash investing activities in 1996 included the $6.2 billion acquisition of
TBS and the $904 million acquisition of CVI in exchange for capital stock (Notes
2 and 3). Noncash financing activities in 1996 included the payment of $122
million of noncash dividends on the Series M Preferred Stock.
 
OTHER CURRENT LIABILITIES
 
     Other current liabilities consist of:
 
<TABLE>
<CAPTION>
                                                                DECEMBER 31,
                                                              ----------------
                                                               1998      1997
                                                              ------    ------
                                                                 (MILLIONS)
<S>                                                           <C>       <C>
Accrued expenses............................................  $1,542    $1,716
Accrued compensation........................................     538       430
Accrued income taxes........................................      93        28
Deferred revenues...........................................     231       205
                                                              ------    ------
Total.......................................................  $2,404    $2,379
                                                              ======    ======
</TABLE>
 
                                      F-64
<PAGE>   115
 
                              REPORT OF MANAGEMENT
 
     The accompanying consolidated financial statements have been prepared by
management in conformity with generally accepted accounting principles, and
necessarily include some amounts that are based on management's best estimates
and judgments.
 
     Time Warner maintains a system of internal accounting controls designed to
provide management with reasonable assurance that assets are safeguarded against
loss from unauthorized use or disposition, and that transactions are executed in
accordance with management's authorization and recorded properly. The concept of
reasonable assurance is based on the recognition that the cost of a system of
internal control should not exceed the benefits derived and that the evaluation
of those factors requires estimates and judgments by management. Further,
because of inherent limitations in any system of internal accounting control,
errors or irregularities may occur and not be detected. Nevertheless, management
believes that a high level of internal control is maintained by Time Warner
through the selection and training of qualified personnel, the establishment and
communication of accounting and business policies, and its internal audit
program.
 
     The Audit Committee of the Board of Directors, composed solely of directors
who are not employees of Time Warner, meets periodically with management and
with Time Warner's internal auditors and independent auditors to review matters
relating to the quality of financial reporting and internal accounting control,
and the nature, extent and results of their audits. Time Warner's internal
auditors and independent auditors have free access to the Audit Committee.
 
<TABLE>
<S>                           <C>
Richard J. Bressler           John A. LaBarca
Executive Vice President and  Senior Vice President and
Chief Financial Officer       Controller
</TABLE>
 
                                      F-65
<PAGE>   116
 
                         REPORT OF INDEPENDENT AUDITORS
 
The Board of Directors and Shareholders
Time Warner Inc.
 
     We have audited the accompanying consolidated balance sheet of Time Warner
Inc. ("Time Warner") as of December 31, 1998 and 1997, and the related
consolidated statements of operations, cash flows and shareholders' equity for
each of the three years in the period ended December 31, 1998. Our audits also
included the financial statement schedule and supplementary information listed
in the Index at Item 14(a). These financial statements, schedule and
supplementary information are the responsibility of Time Warner's management.
Our responsibility is to express an opinion on these financial statements,
schedule and supplementary information based on our audits.
 
     We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
 
     In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Time Warner at
December 31, 1998 and 1997, and the consolidated results of its operations and
its cash flows for each of the three years in the period ended December 31,
1998, in conformity with generally accepted accounting principles. Also, in our
opinion, the related financial statement schedule and supplementary information,
when considered in relation to the basic financial statements taken as a whole,
present fairly in all material respects the information set forth therein.
 
                                          ERNST & YOUNG LLP
 
New York, New York
February 3, 1999
 
                                      F-66
<PAGE>   117
 
                                TIME WARNER INC.
                         SELECTED FINANCIAL INFORMATION
 
     The selected financial information for each of the five years in the period
ended December 31, 1998 set forth below has been derived from and should be read
in conjunction with the financial statements and other financial information
presented elsewhere herein. Capitalized terms are as defined and described in
such consolidated financial statements, or elsewhere herein.
 
     The selected historical financial information for 1998 reflects (a) the
TWE-A/N Transfers and (b) the redemption of Series M Preferred Stock at an
aggregate cost of approximately $2.1 billion using proceeds from the issuance of
lower-cost debt. The selected historical financial information for 1996 reflects
(a) the TBS Transaction, including the assumption of approximately $2.8 billion
of indebtedness, (b) the use of approximately $1.55 billion of net proceeds from
the issuance of Series M Preferred Stock to reduce outstanding indebtedness and
(c) the acquisition of CVI, including the assumption or incurrence of
approximately $2 billion of indebtedness. The selected historical financial
information for 1995 reflects (a) the acquisitions of KBLCOM Incorporated and
Summit Communications Group, Inc., including the assumption or incurrence of
approximately $1.3 billion of indebtedness and (b) the exchange by Toshiba
Corporation and ITOCHU Corporation of their direct and indirect interests in
TWE.
 
     Per common share amounts and average common shares have been restated to
give effect to the two-for-one common stock split that occurred on December 15,
1998.
 
<TABLE>
<CAPTION>
                                                         YEARS ENDED DECEMBER 31,
                                             -------------------------------------------------
                                              1998       1997       1996       1995      1994
                                             -------    -------    -------    ------    ------
                                                   (MILLIONS, EXCEPT PER SHARE AMOUNTS)
<S>                                          <C>        <C>        <C>        <C>       <C>
SELECTED OPERATING STATEMENT INFORMATION
Revenues...................................  $14,582    $13,294    $10,064    $8,067    $7,396
Depreciation and amortization..............   (1,178)    (1,294)      (988)     (559)     (437)
Business segment operating income(a).......    1,496      1,271        966       697       713
Equity in pretax income of Entertainment
  Group(b).................................      356        686        290       256       176
Interest and other, net(c).................   (1,180)    (1,044)    (1,174)     (877)     (724)
Income (loss) before extraordinary item....      168        301       (156)     (124)      (91)
Net income (loss)(d).......................      168        246       (191)     (166)      (91)
Net loss applicable to common shares (after
  preferred dividends)(d)(e)...............     (372)       (73)      (448)     (218)     (104)
Per share of common stock:
  Basic and diluted net loss(d)(e).........  $ (0.31)   $ (0.06)   $ (0.52)   $(0.28)   $(0.14)
  Dividends................................  $  0.18    $  0.18    $  0.18    $ 0.18    $0.175
Average common shares......................  1,194.7    1,135.4      862.4     767.6     757.8
</TABLE>
 
---------------
(a) Business segment operating income for the year ended December 31, 1995
    includes $85 million in losses relating to certain businesses and joint
    ventures owned by the Music division which were restructured or closed.
 
(b) Time Warner's equity in the pretax income of the Entertainment Group for the
    years ended December 31, 1998 and 1997 includes approximately $120 million
    of net losses and $450 million of gains, respectively, relating to the sale
    or exchange of various cable television systems and other investment-related
    activity.
 
(c) Interest and other, net, for the year ended December 31, 1997 includes a
    $200 million pretax gain relating to the disposal of Time Warner's interest
    in Hasbro and the related redemption of certain mandatorily redeemable
    preferred securities of a subsidiary.
 
(d) Net income (loss) for each of the years ended December 31, 1997, 1996 and
    1995 includes an extraordinary loss on the retirement of debt of $55 million
    ($.05 per common share), $35 million ($.04 per common share) and $42 million
    ($.05 per common share), respectively.
 
(e) Preferred dividend requirements for the year ended December 31, 1998 include
    a one-time effect of $234 million ($.19 loss per common share) relating to
    the premium paid in connection with the redemption of Time Warner's Series M
    Preferred Stock.
 
                                      F-67
<PAGE>   118
 
<TABLE>
<CAPTION>
                                                              DECEMBER 31,
                                           ---------------------------------------------------
                                            1998       1997       1996       1995       1994
                                           -------    -------    -------    -------    -------
                                                               (MILLIONS)
<S>                                        <C>        <C>        <C>        <C>        <C>
SELECTED BALANCE SHEET INFORMATION
Cash and equivalents.....................  $   442    $   645    $   514    $ 1,185    $   282
Total assets.............................   31,640     34,163     35,064     22,132     16,716
Debt due within one year.................       19          8         11         34        355
Long-term debt...........................   10,925     11,833     12,713      9,907      8,839
Borrowings against future stock option
  proceeds...............................      895        533        488         --         --
Company-obligated mandatorily redeemable
  preferred securities of subsidiaries...      575        575        949        949         --
Series M exchangeable preferred stock....       --      1,857      1,672         --         --
Shareholders' equity:
  Preferred stock liquidation
     preference..........................    2,260      3,539      3,559      2,994        140
  Equity applicable to common stock......    6,592      5,817      5,943        673      1,008
  Total shareholders' equity.............    8,852      9,356      9,502      3,667      1,148
Total capitalization.....................   21,266     24,162     25,335     14,557     10,342
</TABLE>
 
                                      F-68
<PAGE>   119
 
                                TIME WARNER INC.
                  QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
<TABLE>
<CAPTION>
                                                                          NET
                                                 EQUITY                  INCOME       BASIC
                                                IN PRETAX                (LOSS)       INCOME
                                  OPERATING      INCOME                APPLICABLE   (LOSS) PER
                                  INCOME OF     (LOSS) OF      NET         TO         COMMON
                                  BUSINESS    ENTERTAINMENT   INCOME     COMMON       SHARE
       QUARTER         REVENUES   SEGMENTS        GROUP       (LOSS)   SHARES(E)    (E)(F)(G)
       -------         --------   ---------   -------------   ------   ----------   ----------
                                        (MILLIONS, EXCEPT PER SHARE AMOUNTS)
<S>                    <C>        <C>         <C>             <C>      <C>          <C>
1998
1st..................  $ 3,137     $  170         $107         $(62)     $(144)       $(0.12)
2nd(a)(b)............    3,672        384          166          101         23          0.02
3rd..................    3,578        315          164           39        (37)        (0.03)
4th(a)(b)............    4,195        627          (81)          90       (214)        (0.17)
Year(a)(b)...........   14,582      1,496          356          168       (372)        (0.31)
 
1997
1st(c)(d)............  $ 3,034     $  194         $318         $ 35      $ (43)       $(0.04)
2nd..................    3,193        345          108           30        (49)        (0.04)
3rd(c)...............    3,231        263           96          (35)      (116)        (0.10)
4th(c)(d)............    3,836        469          164          216        135          0.12
Year(c)(d)...........   13,294      1,271          686          246        (73)        (0.06)
 
<CAPTION>
 
                        DILUTED
                         INCOME
                       (LOSS) PER   DIVIDENDS                 COMMON
                         COMMON        PER       AVERAGE     STOCK(G)
                         SHARE       COMMON      COMMON     -----------
       QUARTER         (E)(F)(G)    SHARE(G)    SHARES(G)   HIGH    LOW
       -------         ----------   ---------   ---------   ----    ---
                             (MILLIONS, EXCEPT PER SHARE AMOUNTS)
<S>                    <C>          <C>         <C>         <C>     <C>
1998
1st..................    $(0.12)     $0.045      1,156.6    $37 3/4 $29 1/16
2nd(a)(b)............      0.02       0.045      1,192.6     44 7/16  36 1/16
3rd..................     (0.03)      0.045      1,202.6     50      39
4th(a)(b)............     (0.17)      0.045      1,227.2     63 1/8  37 9/16
Year(a)(b)...........     (0.31)       0.18      1,194.7     63 1/8  29 1/16
1997
1st(c)(d)............    $(0.04)     $0.045      1,117.8    $22 1/2 $18 3/16
2nd..................     (0.04)      0.045      1,122.0     25 3/8  20 3/16
3rd(c)...............     (0.10)      0.045      1,146.6     28 3/16  19 1/4
4th(c)(d)............      0.11       0.045      1,155.0     31      26 1/2
Year(c)(d)...........     (0.06)       0.18      1,135.4     31      18 3/16
</TABLE>
 
---------------
(a) As indicated below, Time Warner's income (loss) per common share in 1998 has
    been affected by certain significant nonrecurring items. These items
    consisted of gains and losses relating to the sale or exchange of various
    cable television systems and other investment-related activity and the
    effect of redeeming Time Warner's Series M Preferred Stock. The aggregate
    net effect of these items in 1998 was to increase (decrease) income per
    common share by $.03 in the second quarter of 1998, and $(.28) in the fourth
    quarter of 1998, thereby aggregating $(.25) per common share for the year.
 
(b) Time Warner's equity in the pretax income (loss) of the Entertainment Group
    for 1998 includes net gains of approximately $90 million for the year
    relating to the sale or exchange of certain cable television systems, of
    which approximately $70 million was recorded in the second quarter of 1998.
    In addition, Time Warner's equity in the pretax income (loss) of the
    Entertainment Group for the fourth quarter of 1998 includes a charge of
    approximately $210 million principally to reduce the carrying value of an
    interest in Primestar.
 
(c) Time Warner's income (loss) per common share in 1997 has been affected by
    certain significant nonrecurring items. These items consisted of net pretax
    gains relating to the sale or exchange of various cable television systems
    and other investment-related activity and extraordinary losses on the
    retirement of debt. The aggregate net effect of these items in 1997 was to
    increase (decrease) income per common share by $.13 in the first quarter of
    1997, $(.01) in the third quarter of 1997 and $.15 in the fourth quarter of
    1997, thereby aggregating $.27 per common share for the year. Included in
    these amounts are extraordinary losses on the retirement of debt of $17
    million ($.02 per common share) in the first quarter of 1997, $7 million
    ($.01 per common share) in the third quarter of 1997 and $31 million ($.02
    per common share) in the fourth quarter of 1997. Also included in these
    amounts for the fourth quarter of 1997 is a $200 million pretax gain ($.10
    per common share) relating to the disposal of Time Warner's interest in
    Hasbro and its related redemption of certain mandatorily redeemable
    preferred securities of a subsidiary.
 
(d) Time Warner's equity in the pretax income of the Entertainment Group for the
    first quarter of 1997 includes an approximate $250 million pretax gain
    relating to the sale of TWE's interest in E! Entertainment. Time Warner's
    equity in the pretax income of the Entertainment Group for 1997 also
    includes net gains of approximately $200 million for the year relating to
    the sale or exchange of certain cable television systems, of which
    approximately $160 million was recorded in the fourth quarter of 1997.
 
(e) After preferred dividend requirements. Preferred dividend requirements for
    the fourth quarter of 1998 include a one-time increase of $234 million ($.19
    loss per common share) relating to the premium paid in connection with the
    redemption of Time Warner's Series M Preferred Stock.
 
(f) Per common share amounts for the quarters and full years have each been
    calculated separately. Accordingly, quarterly amounts may not add to the
    annual amounts because of differences in the average common shares
    outstanding during each period and, with regard to diluted per common share
    amounts only, because of the inclusion of the effect of potentially dilutive
    securities only in the periods in which such effect would have been
    dilutive.
 
(g) Previously reported amounts have been restated for the two-for-one common
    stock split that occurred on December 15, 1998.
 
                                      F-69
<PAGE>   120
 
                                TIME WARNER INC.
                           SUPPLEMENTARY INFORMATION
                  CONDENSED CONSOLIDATING FINANCIAL STATEMENTS
 
     Time Warner Companies, Inc. ("TW Companies") and Turner Broadcasting
System, Inc. ("TBS" and, together with TW Companies, the "Guarantor
Subsidiaries") are wholly owned subsidiaries of Time Warner Inc. ("Time
Warner"). Time Warner, TW Companies and TBS have fully and unconditionally
guaranteed all of the outstanding publicly traded indebtedness of each other.
Set forth below are condensed consolidating financial statements of Time Warner,
including each of the Guarantor Subsidiaries, presented for the information of
each company's public debtholders. Separate financial statements and other
disclosures relating to the Guarantor Subsidiaries have not been presented
because management has determined that this information would not be material to
such debtholders. The following condensed consolidating financial statements
present the results of operations, financial position and cash flows of (i) Time
Warner, TW Companies and TBS (in each case, reflecting investments in its
consolidated subsidiaries under the equity method of accounting), (ii) the
direct and indirect non-guarantor subsidiaries of Time Warner and (iii) the
eliminations necessary to arrive at the information for Time Warner on a
consolidated basis. These condensed consolidating financial statements should be
read in conjunction with the accompanying consolidated financial statements of
Time Warner.
 
                     CONSOLIDATING STATEMENT OF OPERATIONS
                      FOR THE YEAR ENDED DECEMBER 31, 1998
 
<TABLE>
<CAPTION>
                                                                            NON-                          TIME
                                            TIME       TW                GUARANTOR                       WARNER
                                           WARNER   COMPANIES    TBS    SUBSIDIARIES   ELIMINATIONS   CONSOLIDATED
                                           ------   ---------   -----   ------------   ------------   ------------
                                                                         (MILLIONS)
<S>                                        <C>      <C>         <C>     <C>            <C>            <C>
Revenues.................................  $  --     $   --     $ 720     $13,886        $   (24)       $14,582
                                           -----     ------     -----     -------        -------        -------
Cost of revenues(1)......................     --         --       303       7,931            (24)         8,210
Selling, general and administrative(1)...     --         --       211       4,665             --          4,876
                                           -----     ------     -----     -------        -------        -------
Operating expenses.......................     --         --       514      12,596            (24)        13,086
                                           -----     ------     -----     -------        -------        -------
Business segment operating income........     --         --       206       1,290             --          1,496
Equity in pretax income of consolidated
  subsidiaries...........................    770      1,283       327          --         (2,380)            --
Equity in pretax income of Entertainment
  Group..................................     --         --        --         423            (67)           356
Interest and other, net..................    (98)      (756)     (159)       (103)           (64)        (1,180)
Corporate expenses.......................    (86)       (55)      (16)        (64)           135            (86)
                                           -----     ------     -----     -------        -------        -------
Income before income taxes...............    586        472       358       1,546         (2,376)           586
Income taxes.............................   (418)      (322)     (212)       (816)         1,350           (418)
                                           -----     ------     -----     -------        -------        -------
Net income...............................  $ 168     $  150     $ 146     $   730        $(1,026)       $   168
                                           =====     ======     =====     =======        =======        =======
---------------
(1) Includes depreciation and
    amortization expense of:.............  $  --     $   --     $   9     $ 1,169        $    --        $ 1,178
                                           =====     ======     =====     =======        =======        =======
</TABLE>
 
                                      F-70
<PAGE>   121
                                TIME WARNER INC.
                           SUPPLEMENTARY INFORMATION
          CONDENSED CONSOLIDATING FINANCIAL STATEMENTS -- (CONTINUED)
 
                     CONSOLIDATING STATEMENT OF OPERATIONS
                      FOR THE YEAR ENDED DECEMBER 31, 1997
 
<TABLE>
<CAPTION>
                                                                            NON-                          TIME
                                            TIME       TW                GUARANTOR                       WARNER
                                           WARNER   COMPANIES    TBS    SUBSIDIARIES   ELIMINATIONS   CONSOLIDATED
                                           ------   ---------   -----   ------------   ------------   ------------
                                                                         (MILLIONS)
<S>                                        <C>      <C>         <C>     <C>            <C>            <C>
Revenues.................................  $  --     $   --     $ 523     $12,771        $    --        $13,294
                                           -----     ------     -----     -------        -------        -------
Cost of revenues(1)......................     --         --       250       7,292             --          7,542
Selling, general and administrative(1)...     --         --       171       4,310             --          4,481
                                           -----     ------     -----     -------        -------        -------
Operating expenses.......................     --         --       421      11,602             --         12,023
                                           -----     ------     -----     -------        -------        -------
Business segment operating income........     --         --       102       1,169             --          1,271
Equity in pretax income of consolidated
  subsidiaries...........................    922      1,729       378          --         (3,029)            --
Equity in pretax income of Entertainment
  Group..................................     --         --        --         727            (41)           686
Interest and other, net..................     (9)      (994)     (203)        211            (49)        (1,044)
Corporate expenses.......................    (81)       (54)      (12)        (60)           126            (81)
                                           -----     ------     -----     -------        -------        -------
Income before income taxes...............    832        681       265       2,047         (2,993)           832
Income taxes.............................   (531)      (390)     (175)     (1,032)         1,597           (531)
                                           -----     ------     -----     -------        -------        -------
Income before extraordinary item.........    301        291        90       1,015         (1,396)           301
Extraordinary loss on retirement of debt,
  net of tax.............................    (55)       (51)       (4)        (51)           106            (55)
                                           -----     ------     -----     -------        -------        -------
Net income...............................  $ 246     $  240     $  86     $   964        $(1,290)       $   246
                                           =====     ======     =====     =======        =======        =======
---------------
(1) Includes depreciation and
    amortization expense of:.............  $  --     $   --     $  21     $ 1,273        $    --        $ 1,294
                                           =====     ======     =====     =======        =======        =======
</TABLE>
 
                                      F-71
<PAGE>   122
                                TIME WARNER INC.
                           SUPPLEMENTARY INFORMATION
          CONDENSED CONSOLIDATING FINANCIAL STATEMENTS -- (CONTINUED)
 
                       CONSOLIDATING STATEMENT OF OPERATIONS
                        FOR THE YEAR ENDED DECEMBER 31, 1996
 
<TABLE>
<CAPTION>
                                                                            NON-                          TIME
                                             TIME       TW               GUARANTOR                       WARNER
                                            WARNER   COMPANIES   TBS    SUBSIDIARIES   ELIMINATIONS   CONSOLIDATED
                                            ------   ---------   ----   ------------   ------------   ------------
                                                                          (MILLIONS)
<S>                                         <C>      <C>         <C>    <C>            <C>            <C>
Revenues..................................   $ --      $  --     $128      $9,936         $  --         $10,064
                                             ----      -----     ----      ------         -----         -------
Cost of revenues(1).......................     --         --       52       5,870            --           5,922
Selling, general and administrative(1)....     --         --       58       3,118            --           3,176
                                             ----      -----     ----      ------         -----         -------
Operating expenses........................     --         --      110       8,988            --           9,098
                                             ----      -----     ----      ------         -----         -------
Business segment operating income.........     --         --       18         948            --             966
Equity in pretax income of consolidated
  subsidiaries............................    156        776       63          --          (995)             --
Equity in pretax income of Entertainment
  Group...................................     --         --       --         290            --             290
Interest and other, net...................    (16)      (729)     (29)       (400)           --          (1,174)
Corporate expenses........................    (17)       (62)     (10)        (64)           75             (78)
                                             ----      -----     ----      ------         -----         -------
Income (loss) before income taxes.........    123        (15)      42         774          (920)              4
Income taxes..............................    (64)      (130)     (39)       (494)          567            (160)
                                             ----      -----     ----      ------         -----         -------
Income (loss) before extraordinary item...     59       (145)       3         280          (353)           (156)
Extraordinary loss on retirement of debt,
  net of tax..............................     --        (35)      --          --            --             (35)
                                             ----      -----     ----      ------         -----         -------
Net income (loss).........................   $ 59      $(180)    $  3      $  280         $(353)        $  (191)
                                             ====      =====     ====      ======         =====         =======
---------------
(1) Includes depreciation and amortization
    expense of:...........................   $ --      $  --     $  6      $  982         $  --         $   988
                                             ====      =====     ====      ======         =====         =======
</TABLE>
 
                                      F-72
<PAGE>   123
                                TIME WARNER INC.
                           SUPPLEMENTARY INFORMATION
          CONDENSED CONSOLIDATING FINANCIAL STATEMENTS -- (CONTINUED)
 
                          CONSOLIDATING BALANCE SHEET
                               DECEMBER 31, 1998
 
<TABLE>
<CAPTION>
                                                                                        NON-                          TIME
                                                     TIME        TW                  GUARANTOR                       WARNER
                                                    WARNER    COMPANIES     TBS     SUBSIDIARIES   ELIMINATIONS   CONSOLIDATED
                                                    -------   ---------   -------   ------------   ------------   ------------
                                                                                    (MILLIONS)
<S>                                                 <C>       <C>         <C>       <C>            <C>            <C>
ASSETS
CURRENT ASSETS
Cash and equivalents..............................  $    --    $    66    $    25     $   351        $     --       $   442
Receivables, net..................................       10         56         78       2,750              (9)        2,885
Inventories.......................................       --         --        131         815              --           946
Prepaid expenses..................................       17          5         --       1,166             (12)        1,176
                                                    -------    -------    -------     -------        --------       -------
Total current assets..............................       27        127        234       5,082             (21)        5,449
Noncurrent inventories............................       --         --        156       1,744              --         1,900
Investments in and amounts due to and from
  consolidated subsidiaries.......................   15,222     13,745      9,465          --         (38,432)           --
Investments in and amounts due to and from
  Entertainment Group.............................       --        919         --       4,169            (108)        4,980
Other investments.................................      211         15         24       1,194            (650)          794
Property, plant and equipment, net................       55         --         44       1,892              --         1,991
Music catalogues, contracts and copyrights........       --         --         --         876              --           876
Cable television and sports franchises............       --         --         --       2,868              --         2,868
Goodwill..........................................       --         --         --      11,919              --        11,919
Other assets......................................       65        116         59         631              (8)          863
                                                    -------    -------    -------     -------        --------       -------
Total assets......................................  $15,580    $14,922    $ 9,982     $30,375        $(39,219)      $31,640
                                                    =======    =======    =======     =======        ========       =======
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable..................................  $    20    $    --    $    11     $   965        $     --       $   996
Participations, royalties and programming
  costs payable...................................       --         --         31       1,168              --         1,199
Debt due within one year..........................       --         --         --          19              --            19
Other current liabilities.........................      308        229        176       1,705             (14)        2,404
                                                    -------    -------    -------     -------        --------       -------
Total current liabilities.........................      328        229        218       3,857             (14)        4,618
Long-term debt....................................    1,584      7,346        747       1,248              --        10,925
Debt due to affiliates............................       --         --      1,647         158          (1,805)           --
Borrowings against future stock option proceeds...      895         --         --          --              --           895
Deferred income taxes.............................    3,491      3,324        246       3,570          (7,140)        3,491
Unearned portion of paid subscriptions............       --         --         --         741              --           741
Other liabilities.................................      430         --        116         997              --         1,543
TW Companies-obligated mandatorily redeemable
  preferred securities of a subsidiary holding
  solely subordinated debentures of TW
  Companies.......................................       --         --         --         575              --           575
SHAREHOLDERS' EQUITY
Due to (from) Time Warner and subsidiaries........       --     (2,313)      (479)     (2,317)          5,109            --
Other shareholders' equity........................    8,852      6,336      7,487      21,546         (35,369)        8,852
                                                    -------    -------    -------     -------        --------       -------
Total shareholders' equity........................    8,852      4,023      7,008      19,229         (30,260)        8,852
                                                    -------    -------    -------     -------        --------       -------
Total liabilities and shareholders' equity........  $15,580    $14,922    $ 9,982     $30,375        $(39,219)      $31,640
                                                    =======    =======    =======     =======        ========       =======
</TABLE>
 
                                      F-73
<PAGE>   124
                                TIME WARNER INC.
                           SUPPLEMENTARY INFORMATION
          CONDENSED CONSOLIDATING FINANCIAL STATEMENTS -- (CONTINUED)
 
                          CONSOLIDATING BALANCE SHEET
                               DECEMBER 31, 1997
 
<TABLE>
<CAPTION>
                                                                                        NON-                          TIME
                                                     TIME        TW                  GUARANTOR                       WARNER
                                                    WARNER    COMPANIES     TBS     SUBSIDIARIES   ELIMINATIONS   CONSOLIDATED
                                                    -------   ---------   -------   ------------   ------------   ------------
                                                                                    (MILLIONS)
<S>                                                 <C>       <C>         <C>       <C>            <C>            <C>
ASSETS
CURRENT ASSETS
Cash and equivalents..............................  $    --    $   372    $     9     $   264        $     --       $   645
Receivables, net..................................       34         82          9       2,350             (28)        2,447
Inventories.......................................       --         --        112         718              --           830
Prepaid expenses..................................       21         14          5       1,063             (14)        1,089
                                                    -------    -------    -------     -------        --------       -------
Total current assets..............................       55        468        135       4,395             (42)        5,011
Noncurrent inventories............................       --         --        123       1,643              --         1,766
Investments in and amounts due to and from
  consolidated subsidiaries.......................   16,189     14,995      9,950          --         (41,134)           --
Investments in and amounts due to and from
  Entertainment Group.............................       --        970         --       4,620             (41)        5,549
Other investments.................................      106          1         24       1,957            (593)        1,495
Property, plant and equipment, net................       68         --         48       1,973              --         2,089
Music catalogues, contracts and copyrights........       --         --         --         928              --           928
Cable television and sports franchises............       --         --         --       3,982              --         3,982
Goodwill..........................................       --         --         --      12,572              --        12,572
Other assets......................................       54        124        118         483              (8)          771
                                                    -------    -------    -------     -------        --------       -------
Total assets......................................  $16,472    $16,558    $10,398     $32,553        $(41,818)      $34,163
                                                    =======    =======    =======     =======        ========       =======
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable..................................  $    24    $    --    $    11     $   877        $     --       $   912
Participations, royalties and programming costs
  payable.........................................       --         --         10       1,062              --         1,072
Debt due within one year..........................       --         --         --           8              --             8
Other current liabilities.........................      442        284        234       1,371              48         2,379
                                                    -------    -------    -------     -------        --------       -------
Total current liabilities.........................      466        284        255       3,318              48         4,371
Long-term debt....................................       --      8,462        747       2,624              --        11,833
Debt due to affiliates............................       --         --      1,722         158          (1,880)           --
Borrowings against future stock option proceeds...      533         --         --          --              --           533
Deferred income taxes.............................    3,960      3,797        243       4,040          (8,080)        3,960
Unearned portion of paid subscriptions............       --         --         --         672              --           672
Other liabilities.................................      300         20         90         596              --         1,006
TW Companies-obligated mandatorily redeemable
  preferred securities of a subsidiary holding
  solely subordinated debentures of TW
  Companies.......................................       --         --         --         575              --           575
Series M exchangeable preferred stock.............    1,857         --         --          --              --         1,857
SHAREHOLDERS' EQUITY
Due to (from) Time Warner and subsidiaries........       --     (2,195)        --        (256)          2,451            --
Other shareholders' equity........................    9,356      6,190      7,341      20,826         (34,357)        9,356
                                                    -------    -------    -------     -------        --------       -------
Total shareholders' equity........................    9,356      3,995      7,341      20,570         (31,906)        9,356
                                                    -------    -------    -------     -------        --------       -------
Total liabilities and shareholders' equity........  $16,472    $16,558    $10,398     $32,553        $(41,818)      $34,163
                                                    =======    =======    =======     =======        ========       =======
</TABLE>
 
                                      F-74
<PAGE>   125
                                TIME WARNER INC.
                           SUPPLEMENTARY INFORMATION
          CONDENSED CONSOLIDATING FINANCIAL STATEMENTS -- (CONTINUED)
 
                     CONSOLIDATING STATEMENT OF CASH FLOWS
                      FOR THE YEAR ENDED DECEMBER 31, 1998
 
<TABLE>
<CAPTION>
                                                                                         NON-                          TIME
                                                        TIME        TW                GUARANTOR                       WARNER
                                                       WARNER    COMPANIES    TBS    SUBSIDIARIES   ELIMINATIONS   CONSOLIDATED
                                                       -------   ---------   -----   ------------   ------------   ------------
                                                                                      (MILLIONS)
<S>                                                    <C>       <C>         <C>     <C>            <C>            <C>
OPERATIONS
Net income...........................................  $   168    $   150    $ 146     $   730        $(1,026)       $   168
Adjustments for noncash and nonoperating items:
Depreciation and amortization........................       --         --        9       1,169             --          1,178
Noncash interest expense.............................       --         30       --          --             --             30
Excess (deficiency) of distributions over equity in
  pretax income of consolidated subsidiaries.........    1,767       (666)     374          --         (1,475)            --
Excess of distributions over equity in pretax income
  of Entertainment Group.............................       --         --       --         275             67            342
Equity in losses of other investee companies after
  distributions......................................       --         --       --          90             57            147
Changes in operating assets and liabilities..........      212      2,869     (426)       (538)        (2,137)           (20)
                                                       -------    -------    -----     -------        -------        -------
Cash provided by operations..........................    2,147      2,383      103       1,726         (4,514)         1,845
                                                       -------    -------    -----     -------        -------        -------
INVESTING ACTIVITIES
Investments and acquisitions.........................     (213)        --       --          54             --           (159)
Advances to parents and consolidated subsidiaries....       --     (2,716)      --        (263)         2,979             --
Repayments of advances from consolidated
  subsidiaries.......................................       75         --       --          --            (75)            --
Capital expenditures.................................       --         --      (12)       (500)            --           (512)
Investment proceeds..................................       --         --       --         569             --            569
Proceeds received from distribution of TWE Senior
  Capital............................................       --         --       --         455             --            455
                                                       -------    -------    -----     -------        -------        -------
Cash provided (used) by investing activities.........     (138)    (2,716)     (12)        315          2,904            353
                                                       -------    -------    -----     -------        -------        -------
FINANCING ACTIVITIES
Borrowings...........................................    1,584        498       --       1,661             --          3,743
Debt repayments......................................       --       (500)     (75)     (1,817)            75         (2,317)
Change in due to/from parent.........................      220         43       --      (1,798)         1,535             --
Borrowings against future stock option proceeds......    1,015         --       --          --             --          1,015
Repayments of borrowings against future stock option
  proceeds...........................................     (653)        --       --          --             --           (653)
Repurchases of Time Warner common stock..............   (2,240)        --       --          --             --         (2,240)
Redemption of Series M Preferred Stock...............   (2,093)        --       --          --             --         (2,093)
Dividends paid.......................................     (524)        --       --          --             --           (524)
Proceeds received from stock option and dividend
  reinvestment plans.................................      740         --       --          --             --            740
Other, principally financing costs...................      (58)       (14)      --          --             --            (72)
                                                       -------    -------    -----     -------        -------        -------
Cash provided (used) by financing activities.........   (2,009)        27      (75)     (1,954)         1,610         (2,401)
                                                       -------    -------    -----     -------        -------        -------
INCREASE (DECREASE) IN CASH AND EQUIVALENTS..........       --       (306)      16          87             --           (203)
                                                       -------    -------    -----     -------        -------        -------
CASH AND EQUIVALENTS AT BEGINNING OF PERIOD..........       --        372        9         264             --            645
                                                       -------    -------    -----     -------        -------        -------
CASH AND EQUIVALENTS AT END OF PERIOD................  $    --    $    66    $  25     $   351        $    --        $   442
                                                       =======    =======    =====     =======        =======        =======
</TABLE>
 
                                      F-75
<PAGE>   126
                                TIME WARNER INC.
                           SUPPLEMENTARY INFORMATION
          CONDENSED CONSOLIDATING FINANCIAL STATEMENTS -- (CONTINUED)
 
                     CONSOLIDATING STATEMENT OF CASH FLOWS
                      FOR THE YEAR ENDED DECEMBER 31, 1997
 
<TABLE>
<CAPTION>
                                                                                        NON-                          TIME
                                                        TIME       TW                GUARANTOR                       WARNER
                                                       WARNER   COMPANIES    TBS    SUBSIDIARIES   ELIMINATIONS   CONSOLIDATED
                                                       ------   ---------   -----   ------------   ------------   ------------
                                                                                     (MILLIONS)
<S>                                                    <C>      <C>         <C>     <C>            <C>            <C>
OPERATIONS
Net income...........................................  $ 246     $   240    $  86     $   964        $(1,290)       $   246
Adjustments for noncash and nonoperating items:
Extraordinary loss on retirement of debt.............     55          51        4          51           (106)            55
Depreciation and amortization........................     --          --       21       1,273             --          1,294
Noncash interest expense.............................     --          95        3          --             --             98
Excess of distributions over equity in pretax income
  of consolidated subsidiaries.......................    558          89      119          --           (766)            --
Deficiency of distributions over equity in pretax
  income of Entertainment Group......................     --          --       --        (248)            41           (207)
Equity in losses (income) of other investee companies
  after distributions................................     --          --       --          (9)            45             36
Changes in operating assets and liabilities..........    (95)        633       13        (668)             3           (114)
                                                       -----     -------    -----     -------        -------        -------
Cash provided by operations..........................    764       1,108      246       1,363         (2,073)         1,408
                                                       -----     -------    -----     -------        -------        -------
INVESTING ACTIVITIES
Investments and acquisitions.........................    (19)         --       --         (94)            --           (113)
Advances to parents and consolidated subsidiaries....   (778)       (134)      --        (113)         1,025             --
Repayments of advances from consolidated
  subsidiaries.......................................     41          --       --         385           (426)            --
Capital expenditures.................................     --          --      (11)       (563)            --           (574)
Investment proceeds..................................     --          --       --         187             --            187
Proceeds received from distribution of TWE Senior
  Capital............................................     --          --       --         455             --            455
                                                       -----     -------    -----     -------        -------        -------
Cash provided (used) by investing activities.........   (756)       (134)     (11)        257            599            (45)
                                                       -----     -------    -----     -------        -------        -------
FINANCING ACTIVITIES
Borrowings...........................................     --       2,443      737       3,104           (871)         5,413
Debt repayments......................................     --      (1,887)    (963)     (3,544)            --         (6,394)
Change in due to/from parent.........................    113      (1,281)      --      (1,177)         2,345             --
Borrowings against future stock option proceeds......    230          --       --          --             --            230
Repayments of borrowings against future stock option
  proceeds...........................................   (185)         --       --          --             --           (185)
Repurchases of Time Warner common stock..............   (344)         --       --          --             --           (344)
Dividends paid.......................................   (338)         --       --          --             --           (338)
Proceeds received from stock option and dividend
  reinvestment plans.................................    454          --       --          --             --            454
Other, principally financing costs...................     --         (14)      --         (54)            --            (68)
                                                       -----     -------    -----     -------        -------        -------
Cash used by financing activities....................    (70)       (739)    (226)     (1,671)         1,474         (1,232)
                                                       -----     -------    -----     -------        -------        -------
INCREASE (DECREASE) IN CASH AND EQUIVALENTS..........    (62)        235        9         (51)            --            131
CASH AND EQUIVALENTS AT BEGINNING OF PERIOD..........     62         137       --         315             --            514
                                                       -----     -------    -----     -------        -------        -------
CASH AND EQUIVALENTS AT END OF PERIOD................  $  --     $   372    $   9     $   264        $    --        $   645
                                                       =====     =======    =====     =======        =======        =======
</TABLE>
 
                                      F-76
<PAGE>   127
                                TIME WARNER INC.
                           SUPPLEMENTARY INFORMATION
          CONDENSED CONSOLIDATING FINANCIAL STATEMENTS -- (CONTINUED)
 
                     CONSOLIDATING STATEMENT OF CASH FLOWS
                      FOR THE YEAR ENDED DECEMBER 31, 1996
 
<TABLE>
<CAPTION>
                                                                                        NON-                          TIME
                                                     TIME        TW                  GUARANTOR                       WARNER
                                                    WARNER    COMPANIES     TBS     SUBSIDIARIES   ELIMINATIONS   CONSOLIDATED
                                                    -------   ---------   -------   ------------   ------------   ------------
                                                                                    (MILLIONS)
<S>                                                 <C>       <C>         <C>       <C>            <C>            <C>
OPERATIONS
Net income (loss).................................  $    59    $  (180)   $     3     $   280        $  (353)       $  (191)
Adjustments for noncash and nonoperating items:
Extraordinary loss on retirement of debt..........       --         35         --          --             --             35
Depreciation and amortization.....................       --         --          6         982             --            988
Noncash interest expense..........................       --         91          5          --             --             96
Excess (deficiency) of distributions over equity
  in pretax income of consolidated subsidiaries...      213       (330)        91          --             26             --
Deficiency of distributions over equity in pretax
  income of Entertainment Group...................       --         --         --         (62)            --            (62)
Equity in income of other investee companies after
  distributions...................................       --         --         --         (53)            --            (53)
Changes in operating assets and liabilities.......       35        530        (27)       (685)          (413)          (560)
                                                    -------    -------    -------     -------        -------        -------
Cash provided by operations.......................      307        146         78         462           (740)           253
                                                    -------    -------    -------     -------        -------        -------
INVESTING ACTIVITIES
Investments and acquisitions......................       58         --         --        (293)           (26)          (261)
Advances to parents and consolidated
  subsidiaries....................................   (1,300)      (155)        --          --          1,455             --
Repayments of advances from consolidated
  subsidiaries....................................    1,000         --         --          --         (1,000)            --
Capital expenditures..............................       --         --         (5)       (476)            --           (481)
Investment proceeds...............................       --         --         --         318             --            318
                                                    -------    -------    -------     -------        -------        -------
Cash used by investing activities.................     (242)      (155)        (5)       (451)           429           (424)
                                                    -------    -------    -------     -------        -------        -------
FINANCING ACTIVITIES
Borrowings........................................       --        864        985       2,591         (1,009)         3,431
Debt repayments...................................       --     (1,634)    (1,058)     (2,579)            --         (5,271)
Change in due to/from parent......................       --     (1,349)        --          29          1,320             --
Borrowings against future stock option proceeds...       63        425         --          --             --            488
Repurchases of Time Warner common stock...........       (4)      (452)        --          --             --           (456)
Issuance of Series M Preferred Stock..............       --      1,550         --          --             --          1,550
Dividends paid....................................      (84)      (203)        --          --             --           (287)
Proceeds received from stock option and dividend
  reinvestment plans..............................       22         83         --          --             --            105
Other, principally financing costs................       --        (60)        --          --             --            (60)
                                                    -------    -------    -------     -------        -------        -------
Cash provided (used) by financing activities......       (3)      (776)       (73)         41            311           (500)
                                                    -------    -------    -------     -------        -------        -------
INCREASE (DECREASE) IN CASH AND EQUIVALENTS.......       62       (785)        --          52             --           (671)
CASH AND EQUIVALENTS AT BEGINNING OF PERIOD.......       --        922         --         263             --          1,185
                                                    -------    -------    -------     -------        -------        -------
CASH AND EQUIVALENTS AT END OF PERIOD.............  $    62    $   137    $    --     $   315        $    --        $   514
                                                    =======    =======    =======     =======        =======        =======
</TABLE>
 
                                      F-77
<PAGE>   128
 
                                TIME WARNER INC.
                SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
                  YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
 
<TABLE>
<CAPTION>
                                                              ADDITIONS
                                                BALANCE AT    CHARGED TO                      BALANCE
                                                BEGINNING     COSTS AND                       AT END
DESCRIPTION                                     OF PERIOD      EXPENSES     DEDUCTIONS       OF PERIOD
-----------                                     ----------    ----------    ----------       ---------
                                                                      (MILLIONS)
<S>                                             <C>           <C>           <C>              <C>
1998:
Reserves deducted from accounts receivable:
  Allowance for doubtful accounts.............    $ 311        $   323       $  (318)(c)      $  316
  Reserves for sales returns and allowances...      680          2,490        (2,479)(d)(e)      691
                                                  -----        -------       -------          ------
Total.........................................    $ 991        $ 2,813       $(2,797)         $1,007
                                                  =====        =======       =======          ======
Reserves deducted from amounts due to
  publishers (accounts payable)
  Allowance for magazine and book returns.....    $(171)       $(1,206)      $ 1,157(e)       $ (220)
                                                  =====        =======       =======          ======
1997:
Reserves deducted from accounts receivable:
  Allowance for doubtful accounts.............    $ 236        $   379       $  (304)(c)      $  311
  Reserves for sales returns and allowances...      740          2,599        (2,659)(d)(e)      680
                                                  -----        -------       -------          ------
Total.........................................    $ 976        $ 2,978       $(2,963)         $  991
                                                  =====        =======       =======          ======
Reserves deducted from amounts due to
  publishers (accounts payable)
  Allowance for magazine and book returns.....    $(179)       $(1,070)      $ 1,078(e)       $ (171)
                                                  =====        =======       =======          ======
1996:
Reserves deducted from accounts receivable:
  Allowance for doubtful accounts.............    $ 188        $   312(a)    $  (264)(c)      $  236
  Reserves for sales returns and allowances...      598          2,628(b)     (2,486)(d)(e)      740
                                                  -----        -------       -------          ------
Total.........................................    $ 786        $ 2,940       $(2,750)         $  976
                                                  =====        =======       =======          ======
Reserves deducted from amounts due to
  publishers (accounts payable)
  Allowance for magazine and book returns.....    $(163)       $(1,023)      $ 1,007(e)       $ (179)
                                                  =====        =======       =======          ======
</TABLE>
 
---------------
(a) Includes $40 million charged to other accounts in connection with the
    allocation of Time Warner's cost to acquire the remaining 80% interest in
    TBS that it did not already own.
 
(b) Includes $21 million charged to other accounts in connection with the
    allocation of Time Warner's cost to acquire the remaining 80% interest in
    TBS that it did not already own.
 
(c) Represents uncollectible receivables charged against reserve.
 
(d) Represents returns or allowances applied against reserve.
 
(e) The distribution of magazines and books not owned by Time Warner results in
    a receivable recorded at the sales price and a corresponding liability to
    the publisher recorded at the sales price less the distribution commission
    recognized by Time Warner as revenue. Therefore, it would be misleading to
    compare magazine and book revenues to the provision charged to the reserve
    for magazine and book returns that is deducted from accounts receivable
    without also considering the related offsetting activity in the reserve for
    magazine and book returns that is deducted from the liability due to the
    publishers.
 
                                      F-78
<PAGE>   129
 
                    TIME WARNER ENTERTAINMENT COMPANY, L.P.
                      MANAGEMENT'S DISCUSSION AND ANALYSIS
                OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
 
DESCRIPTION OF BUSINESS
 
     Time Warner Entertainment Company, L.P. ("TWE" or the "Company") classifies
its business interests into three fundamental areas: Cable Networks, consisting
principally of interests in cable television programming; Entertainment,
consisting principally of interests in filmed entertainment, television
production and television broadcasting; 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.
 
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 also is 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, generally are 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.
 
TRANSACTIONS AFFECTING COMPARABILITY OF RESULTS OF OPERATIONS
 
     As more fully described herein, the comparability of TWE's operating
results has been affected by certain significant transactions and nonrecurring
items in each period.
 
     For 1998, these significant transactions related to TWE's cable business
and included (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 in TWE-A/N, 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. ("Primestar"), a separate holding company (the "Primestar
Roll-up Transaction"), (iii) the reorganization of Time Warner Cable's Time
Warner Telecom operations into a separate entity named Time Warner Telecom LLC
(the "Time Warner Telecom Reorganization") and (iv) the formation of a joint
venture to operate and expand Time Warner Cable's and MediaOne Group Inc.'s
("MediaOne") existing high-speed online businesses (the "Road Runner Joint
Venture" and collectively, the "1998 Cable Transactions").
 
     In addition, there were a number of other significant, nonrecurring items
recognized in 1998 and 1997, consisting of (i) net pretax gains in the amount of
approximately $90 million in 1998 and $200 million in 1997 relating to the sale
or exchange of various cable television systems, (ii) a pretax gain of
approximately $250 million in 1997 relating to the sale of its interest in E!
Entertainment Television, Inc. ("E! Entertainment"), (iii) a charge of
approximately $210 million in 1998 principally to reduce the carrying value of
its interest in Primestar and (iv) an extraordinary loss of $23 million in 1997
on the retirement of debt.
 
                                      F-79
<PAGE>   130
                    TIME WARNER ENTERTAINMENT COMPANY, L.P.
                      MANAGEMENT'S DISCUSSION AND ANALYSIS
        OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION -- (CONTINUED)
 
     In order to meaningfully assess underlying operating trends, management
believes that the results of operations for 1998 and 1997 should be analyzed
after excluding the effects of these significant nonrecurring items. As such,
the following discussion and analysis focuses on amounts and trends adjusted to
exclude the impact of these unusual items. However, unusual items may occur in
any period. Accordingly, investors and other financial statement users
individually should consider the types of events and transactions for which
adjustments have been made.
 
RESULTS OF OPERATIONS
 
1998 VS. 1997
 
     EBITA and operating income in 1998 and 1997 are as follows:
 
<TABLE>
<CAPTION>
                                                        YEARS ENDED DECEMBER 31,
                                                  ------------------------------------
                                                       EBITA          OPERATING INCOME
                                                  ----------------    ----------------
                                                   1998      1997      1998      1997
                                                  ------    ------    ------    ------
                                                               (MILLIONS)
<S>                                               <C>       <C>       <C>       <C>
Filmed Entertainment-Warner Bros................  $  498    $  387    $  369    $  264
Broadcasting-The WB Network.....................     (93)      (88)      (96)      (88)
Cable Networks-HBO..............................     454       391       454       391
Cable(1)........................................   1,369     1,184       992       877
                                                  ------    ------    ------    ------
Total...........................................  $2,228    $1,874    $1,719    $1,444
                                                  ======    ======    ======    ======
</TABLE>
 
---------------
(1) Includes net gains of approximately $90 million and $200 million recognized
    in 1998 and 1997, respectively, related to the sale or exchange of certain
    cable television systems.
 
     TWE had revenues of $12.246 billion and net income of $326 million for the
year ended December 31, 1998, compared to revenues of $11.318 billion, income of
$637 million before an extraordinary loss on the retirement of debt and net
income of $614 million for the year ended December 31, 1997.
 
     As previously described, the comparability of TWE's operating results for
1998 and 1997 has been affected by certain significant nonrecurring items
recognized in each period, consisting of gains and losses relating to the sale
or exchange of cable television systems and other investment-related activity.
These nonrecurring items amounted to approximately $120 million of net pretax
losses in 1998, compared to approximately $450 million of net pretax gains in
1997. In addition, net income in 1997 included an extraordinary loss on the
retirement of debt of $23 million.
 
     TWE's net income decreased to $326 million in 1998, compared to $614
million in 1997. However, excluding the significant effect of the nonrecurring
items referred to above, net income increased by $229 million to $460 million in
1998, compared to $231 million in 1997. As discussed more fully below, this
improvement principally resulted from an overall increase in TWE's business
segment operating income (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 and higher losses from certain investments accounted for
under the equity method of accounting.
 
     As a U.S. partnership, TWE is not subject to U.S. federal and state income
taxation. Income and withholding taxes of $92 million in the year ended December
31, 1998, and $85 million in the year ended December 31, 1997, have been
provided for the operations of TWE's domestic and foreign subsidiary
corporations.
 
     Filmed Entertainment-Warner Bros.  Revenues increased to $6.051 billion,
compared to $5.462 billion in 1997. EBITA increased to $498 million from $387
million. Operating income increased to $369 million
 
                                      F-80
<PAGE>   131
                    TIME WARNER ENTERTAINMENT COMPANY, L.P.
                      MANAGEMENT'S DISCUSSION AND ANALYSIS
        OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION -- (CONTINUED)
 
from $264 million. Revenues benefited from a significant increase in licensing
fees from 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 and cost savings,
offset in part by lower international syndication sales of library product and
lower results from 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 $260 million, compared
to $136 million in 1997. EBITA decreased to a loss of $93 million from a loss of
$88 million. Operating losses increased to $96 million from $88 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.
 
     Cable Networks-HBO.  Revenues increased to $2.052 billion, compared to
$1.923 billion in 1997. EBITA and operating income increased to $454 million
from $391 million. Revenues benefited primarily from an increase in
subscriptions to 34.6 million from 33.6 million at the end of 1997. EBITA and
operating income improved 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 $4.378 billion, compared to $4.243 billion in
1997. EBITA increased to $1.369 billion from $1.184 billion. Operating income
increased to $992 million from $877 million. The Cable division's 1998 operating
results were positively affected by the aggregate net impact of the 1998 Cable
Transactions. Excluding the effect of the 1998 Cable Transactions, revenues
increased principally as a result of an increase in basic cable subscribers,
increases in regulated cable rates and an increase in advertising revenues.
Similarly excluding the effect of the 1998 Cable Transactions, EBITA and
operating income increased principally as a result of the revenue gains, offset
in part by higher depreciation related to capital spending and approximately
$110 million of lower, net pretax gains relating to the sale or exchange of
certain cable television systems.
 
     As of December 31, 1998, including the cable operations of TWE-A/N and Time
Warner, there were 12.6 million subscribers under the management of TWE's Cable
division, as compared to 12.0 million subscribers at the end of 1997. The number
of subscribers at the end of 1997 excludes all direct broadcast satellite
subscribers that were transferred to Primestar in 1998 in connection with the
Primestar Roll-up Transaction.
 
     Interest and Other, Net.  Interest and other, net, increased to $965
million, compared to $345 million in 1997. Interest expense increased to $566
million, compared to $490 million in 1997 principally due to higher average debt
levels associated with the TWE-A/N Transfers. There was other expense, net, of
$399 million in 1998, compared to other income, net, of $145 million in 1997,
primarily due to lower investment-related income, as well as higher losses
associated with TWE's asset securitization program. The significant decrease in
investment-related income principally resulted from the absence of an
approximate $250 million pretax gain recognized in 1997 in connection with the
sale of an interest in E! Entertainment, the inclusion of an approximate $210
million charge recorded in 1998 principally to reduce the carrying value of an
interest in Primestar and higher losses in 1998 from certain investments
accounted for under the equity method of accounting.
 
                                      F-81
<PAGE>   132
                    TIME WARNER ENTERTAINMENT COMPANY, L.P.
                      MANAGEMENT'S DISCUSSION AND ANALYSIS
        OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION -- (CONTINUED)
 
1997 VS. 1996
 
     EBITA and operating income in 1997 and 1996 are as follows:
 
<TABLE>
<CAPTION>
                                                        YEARS ENDED DECEMBER 31,
                                                  ------------------------------------
                                                       EBITA          OPERATING INCOME
                                                  ----------------    ----------------
                                                   1997      1996      1997      1996
                                                  ------    ------    ------    ------
                                                               (MILLIONS)
<S>                                               <C>       <C>       <C>       <C>
Filmed Entertainment-Warner Bros. ..............  $  387    $  367    $  264    $  242
Broadcasting-The WB Network.....................     (88)      (98)      (88)      (98)
Cable Networks-HBO..............................     391       328       391       328
Cable(1)........................................   1,184       917       877       606
                                                  ------    ------    ------    ------
Total...........................................  $1,874    $1,514    $1,444    $1,078
                                                  ======    ======    ======    ======
</TABLE>
 
---------------
(1) Includes net gains of approximately $200 million recognized in 1997 related
    to the sale or exchange of certain cable television systems.
 
     TWE had revenues of $11.318 billion, income of $637 million before an
extraordinary loss on the retirement of debt and net income of $614 million for
the year ended December 31, 1997, compared to revenues of $10.852 billion and
net income of $210 million for the year ended December 31, 1996.
 
     As previously described, the comparability of TWE's operating results for
1997 and 1996 has been affected by certain significant nonrecurring items
recognized in 1997, consisting of net pretax gains relating to the sale or
exchange of cable television systems and other investment-related activity.
These nonrecurring items amounted to approximately $450 million of net pretax
gains in 1997. In addition, net income in 1997 included an extraordinary loss on
the retirement of debt of $23 million.
 
     TWE's net income increased to $614 million in 1997, compared to $210
million in 1996. Excluding the significant effect of the nonrecurring items
referred to above, net income increased by $21 million to $231 million in 1997,
compared to $210 million in 1996. As discussed more fully below, this
improvement principally resulted from an overall increase in EBITA and operating
income generated by TWE's business segments, offset in part by an increase in
minority interest expense related to TWE-A/N.
 
     As a U.S. partnership, TWE is not subject to U.S. federal and state income
taxation. Income and withholding taxes of $85 million in the year ended December
31, 1997, and $70 million in the year ended December 31, 1996, have been
provided for the operations of TWE's domestic and foreign subsidiary
corporations.
 
     Filmed Entertainment-Warner Bros.  Revenues decreased to $5.462 billion,
compared to $5.639 billion in 1996. EBITA increased to $387 million from $367
million. Operating income increased to $264 million from $242 million. Revenues
decreased principally as a result of lower worldwide theatrical and home video
revenues, offset in part by increases in worldwide television distribution
revenues. EBITA and operating income increased principally as a result of
high-margin sales of library product that contributed to the strong performance
of worldwide television distribution operations, cost savings and certain
one-time gains, offset in part by higher depreciation principally relating to
the expansion of theme parks and consumer products operations.
 
     Broadcasting-The WB Network.  Revenues increased to $136 million, compared
to $87 million in 1996. EBITA and operating losses improved to a loss of $88
million from a loss of $98 million. The increase in revenues primarily resulted
from the expansion of programming in September 1996 to three nights of prime-
time scheduling and the expansion of Kids' WB!, the network's animated
programming lineup on Saturday
 
                                      F-82
<PAGE>   133
                    TIME WARNER ENTERTAINMENT COMPANY, L.P.
                      MANAGEMENT'S DISCUSSION AND ANALYSIS
        OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION -- (CONTINUED)
 
mornings and weekdays. The 1997 operating loss improved principally as a result
of the revenue gains and the effect of an increase in a limited partner's
interest in the network that occurred in early 1997.
 
     Cable Networks-HBO.  Revenues increased to $1.923 billion, compared to
$1.763 billion in 1996. EBITA and operating income increased to $391 million
from $328 million. Revenues benefited primarily from an increase in
subscriptions to 33.6 million from 32.4 million at the end of 1996. EBITA and
operating income improved principally as a result of the revenue gains and, to a
lesser extent, cost savings.
 
     Cable.  Revenues increased to $4.243 billion, compared to $3.851 billion in
1996. EBITA increased to $1.184 billion from $917 million. Operating income
increased to $877 million from $606 million. Revenues benefited from an increase
in basic cable and Primestar-related, direct broadcast satellite subscribers,
increases in regulated cable rates and an increase in advertising and
pay-per-view revenues. EBITA and operating income increased principally as a
result of the revenue gains, as well as net gains of approximately $200 million
recognized in 1997 in connection with the sale or exchange of certain cable
systems. The increases in EBITA and operating income were partially offset by
higher depreciation relating to capital spending.
 
     As of December 31, 1997, including Primestar-related, direct broadcast
satellite subscribers and the cable operations of TWE-A/N and Time Warner, there
were 12.6 million subscribers under the management of TWE's Cable division, as
compared to 12.3 million subscribers at the end of 1996.
 
     Interest and Other, Net.  Interest and other, net, decreased to $345
million, compared to $522 million in 1996. Interest expense increased to $490
million, compared to $475 million in 1996. There was other income, net, of $145
million in 1997, compared to other expense, net, of $47 million in 1996,
principally due to higher gains on asset sales, including an approximate $250
million pretax gain on the sale of an interest in E! Entertainment recognized in
1997. This income was offset in part by higher losses from reductions in the
carrying value of certain investments and the dividend requirements on preferred
stock of a subsidiary issued in February 1997.
 
FINANCIAL CONDITION AND LIQUIDITY
 
DECEMBER 31, 1998
 
1998 FINANCIAL CONDITION
 
     At December 31, 1998, TWE had $6.6 billion of debt, $87 million of cash and
equivalents (net debt of $6.5 billion), $217 million of preferred stock of a
subsidiary, $603 million of Time Warner General Partners' Senior Capital and
$5.1 billion of partners' capital, 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 in 1998 principally as a result of the TWE-A/N Transfers and
increased borrowings to fund cash distributions paid to Time Warner, partially
offset by approximately $650 million of debt reduction associated with the
formation of a cable television joint venture in Texas (the "Texas Cable Joint
Venture") with TCI Communications, Inc. ("TCI"), a subsidiary of
Tele-Communications, Inc.
 
CREDIT STATISTICS
 
     TWE's financial ratios, consisting of commonly used financial measures such
as leverage and coverage ratios, are used by credit rating agencies and other
credit analysts to measure the ability of a company to repay debt (leverage) and
to pay interest (coverage). The leverage ratio represents the ratio of total
debt, less cash to total business segment operating income before depreciation
and amortization, less corporate expenses
 
                                      F-83
<PAGE>   134
                    TIME WARNER ENTERTAINMENT COMPANY, L.P.
                      MANAGEMENT'S DISCUSSION AND ANALYSIS
        OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION -- (CONTINUED)
 
("Adjusted EBITDA"). The coverage ratio represents the ratio of Adjusted EBITDA
to total interest expense. Those ratios are set forth below:
 
<TABLE>
<CAPTION>
                                                              1998    1997    1996
                                                              ----    ----    ----
<S>                                                           <C>     <C>     <C>
Leverage ratio..............................................   2.1x    2.1x    2.4x
Interest coverage ratio(a)..................................   5.3x    5.4x    4.7x
</TABLE>
 
---------------
(a) Includes dividends related to the preferred stock of a subsidiary.
 
CASH FLOWS
 
     In 1998, TWE's cash provided by operations amounted to $2.288 billion and
reflected $2.228 billion of EBITA from the Filmed Entertainment-Warner Bros.,
Broadcasting-The WB Network, Cable Networks-HBO and Cable businesses, $927
million of noncash depreciation expense and $166 million from the securitization
of backlog, less $537 million of interest payments, $91 million of income taxes,
$72 million of corporate expenses and $333 million related to an increase in
working capital requirements, other balance sheet accounts and noncash items.
Cash provided by operations of $1.834 billion in 1997 reflected $1.874 billion
of business segment EBITA, $940 million of noncash depreciation expense and $300
million from the securitization of backlog, less $493 million of interest
payments, $95 million of income taxes, $72 million of corporate expenses and
$620 million related to an increase in working capital requirements, other
balance sheet accounts and noncash items.
 
     Cash used by investing activities was $745 million in 1998, compared to
$1.252 billion in 1997, principally as a result of a $761 million increase in
investment proceeds, offset in part by a reduction of cash flows from
investments and acquisitions related to the deconsolidation of approximately
$200 million of cash of Paragon Communications in connection with the TWE-A/N
Transfers. Investment proceeds increased principally due to TWE's debt reduction
efforts, including proceeds from the sale of TWE's remaining interest in Six
Flags Entertainment Corporation and the receipt of approximately $650 million of
proceeds upon the formation of the Texas Cable Joint Venture with TCI. Capital
expenditures were $1.603 billion in 1998, and $1.565 billion in 1997.
 
     Cash used by financing activities was $1.778 million in 1998, compared to
$476 million in 1997. The use of cash in 1998 principally reflected $1.153
billion of distributions paid to Time Warner and the use of investment proceeds
to reduce debt in connection with TWE's debt reduction efforts. The use of cash
in 1997 principally reflected $934 million of distributions paid to Time Warner,
offset in part by $243 million of aggregate net proceeds from the issuance of
preferred stock of a subsidiary and an increase in borrowings 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 keep the business positioned for sustained,
long-term growth. Capital spending by TWE's Cable division amounted to $1.451
billion in 1998, compared to $1.401 billion in 1997. Capital spending by TWE's
Cable division for 1999 is budgeted to be approximately $1.2 billion and 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 and consistent with Time Warner Cable's long-term strategic plan, Time
Warner Cable agreed with the Federal Communications Commission (the "FCC") in
1996 to invest a total of $4 billion in capital costs in connection with the
upgrade
 
                                      F-84
<PAGE>   135
                    TIME WARNER ENTERTAINMENT COMPANY, L.P.
                      MANAGEMENT'S DISCUSSION AND ANALYSIS
        OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION -- (CONTINUED)
 
of its cable infrastructure. 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. As of December 31, 1998, Time Warner
Cable had approximately $1 billion remaining under this commitment, of which
approximately $700 million is expected to be incurred for the upgrade of TWE's
and TWE-A/N's owned and managed cable television systems. Management expects to
satisfy this commitment by December 31, 2000 when Time Warner Cable's
technological upgrade of its cable television systems is scheduled to be
substantially completed.
 
CABLE STRATEGY
 
     In addition to using cable operating cash flow to finance the level of
capital spending necessary to upgrade the technological capability of cable
television systems and develop new services, Time Warner, TWE and TWE-A/N have
completed or announced a series of transactions over the past year related to
the cable television business and related ancillary businesses. These
transactions consist of the TWE-A/N Transfers, the Primestar Roll-up
Transaction, the Time Warner Telecom Reorganization, the formation of the Road
Runner Joint Venture, the formation of the Texas Cable Joint Venture and other
TCI-related cable transactions and the anticipated formation with AT&T Corp.
("AT&T") of a cable telephony joint venture (the "AT&T Cable Telephony Joint
Venture").
 
     Except for the TWE-A/N Transfers, these transactions have reduced, or will
reduce, either existing debt and/or TWE's share of future funding requirements
for these businesses. In addition, the formation of the Road Runner Joint
Venture and, ultimately, the AT&T Cable Telephony Joint Venture, when completed,
will enable Time Warner Cable to leverage its technologically advanced,
high-capacity cable architecture into new opportunities to create incremental
value through the development and exploitation of new services with strategic
partners, such as AT&T, Microsoft Corp. and Compaq Computer Corp.
 
     The proposed AT&T Cable Telephony Joint Venture is discussed more fully
below and the other transactions are described in Note 2 to the accompanying
consolidated financial statements.
 
  AT&T Cable Telephony Joint Venture
 
     In February 1999, Time Warner, TWE and AT&T announced their intention to
form a strategic joint venture. This joint venture will offer AT&T-branded cable
telephony service to residential and small business customers over Time Warner
Cable's television systems for up to a twenty-year period. This transaction
effectively will allow Time Warner Cable to leverage its existing cable
infrastructure into a new growth opportunity in a non-core business, without the
need for any incremental capital investment.
 
     Under the preliminary terms announced by the parties, the joint venture
will be owned 22.5% by Time Warner Cable and 77.5% by AT&T. AT&T will be
responsible for funding all of the joint venture's negative cash flow and Time
Warner Cable's equity interest in the joint venture will not be diluted as a
result of AT&T's funding obligations. Because AT&T is expected to have
significant funding obligations through at least the first three years of the
joint venture's operations when capital will be deployed and services first
rolled-out, Time Warner Cable expects to benefit from the additional value
created from its "carried" interest.
 
     In addition to its equity interest, Time Warner Cable is expected to
receive the following payments from the joint venture:
 
     (i)  Approximately $300 million of initial access fees, based on a rate of
          $15 per home passed that is payable in two annual installments once a
          particular service area has been upgraded and powered for cable
          telephony service. Time Warner Cable is expected to receive additional
          access fees in the future as its cable television systems continue to
          pass new homes.
 
                                      F-85
<PAGE>   136
                    TIME WARNER ENTERTAINMENT COMPANY, L.P.
                      MANAGEMENT'S DISCUSSION AND ANALYSIS
        OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION -- (CONTINUED)
 
     (ii)  Recurring monthly subscriber fees in the initial amount of $1.50 per
           telephony subscriber, to be adjusted periodically to up to $6.00 per
           telephony subscriber in the sixth year of providing cable telephony
           service to any particular area. In addition, the joint venture is
           expected to guarantee certain minimum penetration levels to Time
           Warner Cable, ranging from 5% in the second year of providing cable
           telephony service to any particular area to up to 25% in the sixth
           year and thereafter.
 
     (iii) Additional monthly subscriber fees equal to 15% of the excess, if
           any, of monthly average cable telephony revenues in a particular
           service area over $100, after the fifth year of providing cable
           telephony service to any particular area.
 
     Further, management believes that the opportunity for consumers to select
one provider of AT&T-branded, "all-distance" wireline and wireless communication
services will contribute to increased cable television penetration in Time
Warner Cable's service areas and the continuing growth in Time Warner Cable's
revenues from the delivery of cable television services.
 
     This transaction is expected to close in the second half of 1999, subject
to the execution of definitive agreements by the parties and customary closing
conditions, including the approval of Advance/Newhouse and MediaOne and all
necessary governmental and regulatory approvals. There can be no assurance that
such agreements will be completed or that such approvals will be obtained.
 
OFF-BALANCE SHEET ASSETS
 
     As discussed below, TWE believes that the value of certain off-balance
sheet assets should be considered, along with other factors discussed elsewhere
herein, in evaluating TWE's financial condition and prospects for future results
of operations, including its ability to meet its capital and liquidity needs.
 
  Intangible Assets
 
     As a creator and distributor of branded information and entertainment
copyrights, TWE has a significant amount of internally generated intangible
assets whose value is not fully reflected in the consolidated balance sheet.
Such intangible assets extend across TWE's principal business interests, but are
best exemplified by its interest in Warner Bros.' and HBO's copyrighted film and
television product libraries, and the creation or extension of brands. Generally
accepted accounting principles do not recognize the value of such assets, except
at the time they may be acquired in a business combination accounted for by the
purchase method of accounting.
 
     Because TWE normally owns the copyrights to such creative material, it
continually generates revenue through the sale of such products across different
media and in new and existing markets. The value of film and television-related
copyrighted product and trademarks is continually realized by the licensing of
films and television series to secondary markets and the licensing of
trademarks, such as the Looney Tunes characters and Batman, to the retail
industry and other markets. In addition, technological advances, such as the
introduction of the home videocassette in the 1980's and, potentially, the
current exploitation of the digital video disc, have historically generated
significant revenue opportunities through the repackaging and sale of such
copyrighted products in the new technological format. Accordingly, such
intangible assets have significant off-balance sheet asset value that is not
fully reflected in TWE's consolidated balance sheet.
 
  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 $2.298 billion at December 31, 1998 (including amounts
relating to TWE's cable television networks of $199 million and $570 million to
Time Warner's cable television networks).
 
                                      F-86
<PAGE>   137
                    TIME WARNER ENTERTAINMENT COMPANY, L.P.
                      MANAGEMENT'S DISCUSSION AND ANALYSIS
        OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION -- (CONTINUED)
 
     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 received periodically
over the term of the related licensing agreements or on an accelerated basis
using a $500 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.
 
FOREIGN CURRENCY RISK MANAGEMENT
 
     Time Warner uses foreign exchange contracts primarily to hedge the risk
that unremitted or future license fees owed to TWE domestic companies for the
sale or anticipated sale of U.S. copyrighted products abroad may be adversely
affected by changes in 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 December 31, 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. To hedge this exposure, Time Warner used foreign
exchange contracts that generally have maturities of three months or less, which
generally will be rolled over to provide continuing coverage throughout the
year. TWE is reimbursed by or reimburses Time Warner for Time Warner contract
gains and losses related to TWE's foreign currency exposure. Time Warner often
closes foreign exchange contracts by purchasing an offsetting purchase contract.
At December 31, 1998, Time Warner had contracts for the sale of $755 million and
the purchase of $259 million of foreign currencies at fixed rates. Of Time
Warner's $496 million net sale contract position, $298 million of the foreign
exchange sale contracts and $101 million of the foreign exchange purchase
contracts related to TWE's foreign currency exposure, compared to contracts for
the sale of $105 million of foreign currencies at December 31, 1997.
 
     Based on Time Warner's outstanding foreign exchange contracts related to
TWE's exposure at December 31, 1998, each 5% devaluation of the U.S. dollar as
compared to the level of foreign exchange rates for currencies under contract at
December 31, 1998 would result in approximately $10 million of unrealized losses
on foreign exchange contracts. Conversely, a 5% appreciation of the U.S. dollar
as compared to the level of foreign exchange rates for currencies under contract
at December 31, 1998 would result in $10 million of unrealized gains on
contracts. Consistent with the nature of the economic hedge provided by such
foreign exchange contracts, such unrealized gains or losses would be offset by
corresponding decreases or increases, respectively, in the dollar value of
future foreign currency license fee payments that would be received in cash
within the ensuing twelve month period from the sale of U.S. copyrighted
products abroad.
 
GLOBAL FINANCIAL MARKETS
 
     During 1998, certain financial markets, mainly Brazil, Russia and a number
of Asian countries, experienced significant instability. Because less than 5% of
the revenues of TWE are derived from the sale of products and services in these
countries, management does not believe that the state of these financial markets
poses a material risk to the operations of TWE.
 
EURO CONVERSION
 
     Effective January 1, 1999, the "euro" was established as a single currency
valid in more than two-thirds of the member countries of the European Union.
These member countries have a three-year transitional period to physically
convert their sovereign currencies to the euro. By July 1, 2002, all
participating member countries must eliminate their currencies and replace their
legal tender with euro-denominated bills and coins.
 
                                      F-87
<PAGE>   138
                    TIME WARNER ENTERTAINMENT COMPANY, L.P.
                      MANAGEMENT'S DISCUSSION AND ANALYSIS
        OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION -- (CONTINUED)
 
Notwithstanding this transitional period, many commercial transactions are
expected to become euro-denominated well before the July 2002 deadline.
Accordingly, TWE continues to evaluate the short-term and long-term effects of
the euro conversion on its European Operations, principally filmed
entertainment.
 
     TWE believes that the most significant short-term impact of the euro
conversion is the need to modify its accounting and information systems to
handle an increasing volume of transactions during the transitional period in
both the euro and sovereign currencies of the participating member countries.
TWE has identified its accounting and information systems in need of
modification and an action plan has been formulated to address the nature and
timing of remediation efforts. Remediation efforts have begun and the plan is
expected to be substantially completed well before the end of the transitional
period. This timetable will be adjusted, if necessary, to meet the anticipated
needs of TWE's vendors and customers. Based on preliminary information, costs to
modify its accounting and information systems are not expected to be material.
 
     TWE believes that the most significant long-term business risk of 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 material costs, other cost savings and marketing
opportunities. Notwithstanding such risks, management does not believe that the
euro conversion will have a material effect on TWE's financial position, results
of operations or cash flows in future periods.
 
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 arises both in technological
operations under the control of the Company and in those dependent 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 dependent to some degree on one or more third parties. Failure to achieve
high levels of Year 2000 compliance 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
others 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 December
31, 1998, approximately 41% have been identified by the divisions as Year 2000
compliant, approximately 41% as in the remediation implementation or final
testing stages, approximately 18% as in the remediation planning stage and less
than 1% as in the assessment stage. The Company currently expects that the
assessment phase for these few remaining potential
 
                                      F-88
<PAGE>   139
                    TIME WARNER ENTERTAINMENT COMPANY, L.P.
                      MANAGEMENT'S DISCUSSION AND ANALYSIS
        OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION -- (CONTINUED)
 
exposures should be completed during the first quarter of 1999 and that
remediation with respect to approximately 80% of all these identified operations
will be substantially completed in all material respects by the end of the
second quarter of 1999. The Company, however, could experience unexpected
delays. The Company is currently planning to impose a "quiet" period at the
beginning of the fourth quarter of 1999 during which any remaining remediation
involving installation or modification of systems that interface with other
systems will be minimized to permit the Company to conduct testing in a stable
environment.
 
     As stated above, however, the Company's business is heavily dependent on
third parties and these parties 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 was not Year 2000 compliant as of
December 31, 1998. The box manufacturers are working with cable industry groups
and have developed solutions that the Company is installing 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 ascertaining their state of
Year 2000 readiness through various means, including questionnaires, interviews,
on-site visits, system interface testing and industry group participation.
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 satisfy itself that the third
parties on which it is heavily reliant are Year 2000 compliant or that alternate
means of meeting its requirements are available, 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. In areas in which the Company is uncertain
about the anticipated Year 2000 readiness of a significant third party, the
Company is investigating available alternatives, if any.
 
     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 45% to 55% has been incurred through December 31,
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. The Company anticipates that its
remediation program, and related expenditures, may continue into 2001 as
temporary solutions to Year 2000 problems are replaced with upgraded equipment.
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 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 does 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.
 
                                      F-89
<PAGE>   140
                    TIME WARNER ENTERTAINMENT COMPANY, L.P.
                      MANAGEMENT'S DISCUSSION AND ANALYSIS
        OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION -- (CONTINUED)
 
     The Company has been focusing its efforts on identification and remediation
of its Year 2000 exposures and has not yet developed significant, specific
contingency plans in the event it does not successfully complete all phases of
its Year 2000 program. The Company, however, has begun to examine its existing
standard business interruption strategies to evaluate whether they would
satisfactorily meet the demands of failures arising from Year 2000-related
problems. The Company intends to examine its status periodically to determine
the necessity of establishing and implementing such contingency plans or
additional strategies, which could involve, among other things, manual
workarounds, adjusting staffing strategies and sharing resources across
divisions.
 
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 document, 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. 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
whether as a result of such changes, new information or otherwise.
 
     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, technological
developments 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
       "unbundling" requirements); increased difficulty in obtaining franchise
       renewals; the failure of new equipment (such as digital set-top boxes) or
       services (such as high-speed online services or telephony over cable or
       video on demand) to function properly, to appeal to enough consumers or
       to be available at reasonable prices and 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 (and the negative impact on premium
       programmers of increases in basic cable rates); increased regulation of
       distribution agreements; the sensitivity of advertising to economic
       cyclicality; 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,
 
                                      F-90
<PAGE>   141
                    TIME WARNER ENTERTAINMENT COMPANY, L.P.
                      MANAGEMENT'S DISCUSSION AND ANALYSIS
        OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION -- (CONTINUED)
 
       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 address adequately their own Year 2000 issues.
 
     In addition, TWE's overall financial strategy, including growth in
operations, maintaining its financial ratios and strengthened balance sheet,
could be adversely affected by increased interest rates, failure to meet
earnings expectations, significant acquisitions or other transactions,
consequences of the euro conversion and changes in TWE's plans, strategies and
intentions.
 
                                      F-91
<PAGE>   142
 
                    TIME WARNER ENTERTAINMENT COMPANY, L.P.
                           CONSOLIDATED BALANCE SHEET
                                  DECEMBER 31,
                                   (MILLIONS)
 
<TABLE>
<CAPTION>
                                                               1998       1997
                                                              -------    -------
<S>                                                           <C>        <C>
ASSETS
CURRENT ASSETS
Cash and equivalents........................................  $    87    $   322
Receivables, including $765 and $385 million due from Time
  Warner, less allowances of $506 and $424 million..........    2,618      1,914
Inventories.................................................    1,312      1,204
Prepaid expenses............................................      166        182
                                                              -------    -------
Total current assets........................................    4,183      3,622
 
Noncurrent inventories......................................    2,327      2,254
Loan receivable from Time Warner............................      400        400
Investments.................................................      886        315
Property, plant and equipment, net..........................    6,041      6,557
Cable television franchises.................................    3,773      3,063
Goodwill....................................................    3,854      3,859
Other assets................................................      766        661
                                                              -------    -------
Total assets................................................  $22,230    $20,731
                                                              =======    =======
LIABILITIES AND PARTNERS' CAPITAL
CURRENT LIABILITIES
Accounts payable............................................  $ 1,473    $ 1,123
Participations and programming costs payable................    1,515      1,176
Debt due within one year....................................        6          8
Other current liabilities, including $370 and $184 million
  due to Time Warner........................................    1,942      1,667
                                                              -------    -------
Total current liabilities...................................    4,936      3,974
 
Long-term debt..............................................    6,578      5,990
Other long-term liabilities, including $1.130 billion and
  $477 million due to Time Warner...........................    3,267      1,873
Minority interests..........................................    1,522      1,210
Preferred stock of subsidiary holding solely a mortgage note
  of its parent.............................................      217        233
Time Warner General Partners' Senior Capital................      603      1,118
 
PARTNERS' CAPITAL
Contributed capital.........................................    7,341      7,537
Undistributed partnership earnings (deficit)................   (2,234)    (1,204)
                                                              -------    -------
Total partners' capital.....................................    5,107      6,333
                                                              -------    -------
Total liabilities and partners' capital.....................  $22,230    $20,731
                                                              =======    =======
</TABLE>
 
See accompanying notes.
 
                                      F-92
<PAGE>   143
 
                    TIME WARNER ENTERTAINMENT COMPANY, L.P.
                      CONSOLIDATED STATEMENT OF OPERATIONS
                            YEARS ENDED DECEMBER 31,
                                   (MILLIONS)
 
<TABLE>
<CAPTION>
                                                               1998       1997       1996
                                                              -------    -------    -------
<S>                                                           <C>        <C>        <C>
Revenues (a)................................................  $12,246    $11,318    $10,852
                                                              -------    -------    -------
Cost of revenues (a)(b).....................................    8,196      7,406      7,441
Selling, general and administrative (a)(b)..................    2,331      2,468      2,333
                                                              -------    -------    -------
 
Operating expenses..........................................   10,527      9,874      9,774
                                                              -------    -------    -------
 
Business segment operating income...........................    1,719      1,444      1,078
Interest and other, net (a).................................     (965)      (345)      (522)
Minority interest...........................................     (264)      (305)      (207)
Corporate services (a)......................................      (72)       (72)       (69)
                                                              -------    -------    -------
 
Income before income taxes..................................      418        722        280
Income taxes................................................      (92)       (85)       (70)
                                                              -------    -------    -------
 
Income before extraordinary item............................      326        637        210
Extraordinary loss on retirement of debt....................       --        (23)        --
                                                              -------    -------    -------
 
Net income..................................................  $   326    $   614    $   210
                                                              =======    =======    =======
</TABLE>
 
---------------
(a) Includes the following income (expenses) resulting from transactions with
    the partners of TWE and other related companies for the years ended December
    31, 1998, 1997 and 1996, respectively: revenues-$695 million, $431 million
    and $198 million; cost of revenues-$(220) million, $(167) million and $(95)
    million; selling, general and administrative-$(26) million, $18 million and
    $(38) million; interest and other, net-$6 million, $30 million and $30
    million; and corporate services-$(72) million, $(72) million and $(69)
    million (Note 14).
 
<TABLE>
<S>                                                           <C>        <C>        <C>
(b) Includes depreciation and amortization expense of.......  $ 1,436    $ 1,370    $ 1,235
                                                              =======    =======    =======
</TABLE>
 
See accompanying notes.
 
                                      F-93
<PAGE>   144
 
                    TIME WARNER ENTERTAINMENT COMPANY, L.P.
                      CONSOLIDATED STATEMENT OF CASH FLOWS
                            YEARS ENDED DECEMBER 31,
                                   (MILLIONS)
 
<TABLE>
<CAPTION>
                                                               1998       1997       1996
                                                              -------    -------    -------
<S>                                                           <C>        <C>        <C>
OPERATIONS
Net income..................................................  $   326    $   614    $   210
Adjustments for noncash and nonoperating items:
Extraordinary loss on retirement of debt....................       --         23         --
Depreciation and amortization...............................    1,436      1,370      1,235
Equity in losses of investee companies after
  distributions.............................................      149         57         38
Changes in operating assets and liabilities:
  Receivables...............................................     (825)      (273)       (50)
  Inventories...............................................     (238)      (114)      (637)
  Accounts payable and other liabilities....................    1,178        393        970
  Other balance sheet changes...............................      262       (236)       146
                                                              -------    -------    -------
 
Cash provided by operations.................................    2,288      1,834      1,912
                                                              -------    -------    -------
 
INVESTING ACTIVITIES
Investments and acquisitions................................     (388)      (172)      (146)
Capital expenditures........................................   (1,603)    (1,565)    (1,719)
Investment proceeds.........................................    1,246        485        612
                                                              -------    -------    -------
 
Cash used by investing activities...........................     (745)    (1,252)    (1,253)
                                                              -------    -------    -------
 
FINANCING ACTIVITIES
Borrowings..................................................    1,514      3,400        215
Debt repayments.............................................   (1,898)    (3,085)      (716)
Issuance of preferred stock of subsidiary...................       --        243         --
Collections on note receivable from MediaOne................       --         --        169
Capital distributions.......................................   (1,153)      (934)      (228)
Other.......................................................     (241)      (100)       (92)
                                                              -------    -------    -------
 
Cash used by financing activities...........................   (1,778)      (476)      (652)
                                                              -------    -------    -------
 
INCREASE (DECREASE) IN CASH AND EQUIVALENTS.................     (235)       106          7
 
CASH AND EQUIVALENTS AT BEGINNING OF PERIOD.................      322        216        209
                                                              -------    -------    -------
 
CASH AND EQUIVALENTS AT END OF PERIOD.......................  $    87    $   322    $   216
                                                              =======    =======    =======
</TABLE>
 
See accompanying notes.
 
                                      F-94
<PAGE>   145
 
                    TIME WARNER ENTERTAINMENT COMPANY, L.P.
                 CONSOLIDATED STATEMENT OF PARTNERSHIP CAPITAL
                                   (MILLIONS)
 
<TABLE>
<CAPTION>
                                                                                         PARTNERS' CAPITAL
                                                          TIME WARNER   ----------------------------------------------------
                                                            GENERAL                   UNDISTRIBUTED
                                                           PARTNERS'                   PARTNERSHIP     MEDIAONE      TOTAL
                                                            SENIOR      CONTRIBUTED     EARNINGS         NOTE      PARTNERS'
                                                            CAPITAL       CAPITAL       (DEFICIT)     RECEIVABLE    CAPITAL
                                                          -----------   -----------   -------------   ----------   ---------
<S>                                                       <C>           <C>           <C>             <C>          <C>
BALANCE AT DECEMBER 31, 1995............................    $1,426        $7,522         $  (875)       $(169)      $ 6,478
 
Net income..............................................                                     210                        210
Increase in unrealized gains on securities..............                                       4                          4
Foreign currency translation adjustments................                                      14                         14
                                                                                         -------                    -------
    Comprehensive income................................                                     228                        228
 
Stock option and tax-related distributions..............                                    (199)                      (199)
Capital contributions...................................                      15                                         15
Allocation of income....................................       117                          (117)                      (117)
Collections.............................................                                                  169           169
                                                            ------        ------         -------        -----       -------
BALANCE AT DECEMBER 31, 1996............................     1,543         7,537            (963)          --         6,574
 
Net income..............................................                                     614                        614
Increase in unrealized gains on securities..............                                       7                          7
Foreign currency translation adjustments................                                     (29)                       (29)
                                                                                         -------                    -------
    Comprehensive income................................                                     592                        592
 
Stock option, tax-related and Senior Capital
  distributions.........................................      (535)                         (723)                      (723)
Allocation of income....................................       110                          (110)                      (110)
                                                            ------        ------         -------        -----       -------
BALANCE AT DECEMBER 31, 1997............................     1,118         7,537          (1,204)          --         6,333
 
Net income..............................................                                     326                        326
Increase in unrealized gains on securities..............                                       2                          2
Foreign currency translation adjustments................                                      (1)                        (1)
Increase in realized and unrealized losses on derivative
  financial instruments.................................                                      (6)                        (6)
                                                                                         -------                    -------
 
    Comprehensive income................................                                     321                        321
 
Stock option, tax-related and Senior Capital
  distributions.........................................      (579)                       (1,287)                    (1,287)
Distribution of Time Warner Telecom interests...........                    (191)                                      (191)
Allocation of income....................................        64                           (64)                       (64)
Other...................................................                      (5)                                        (5)
                                                            ------        ------         -------        -----       -------
BALANCE AT DECEMBER 31, 1998............................    $  603        $7,341         $(2,234)       $  --       $ 5,107
                                                            ======        ======         =======        =====       =======
</TABLE>
 
See accompanying notes.
 
                                      F-95
<PAGE>   146
 
                    TIME WARNER ENTERTAINMENT COMPANY, L.P.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
1.  ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
DESCRIPTION OF BUSINESS
 
     Time Warner Entertainment Company, L.P., a Delaware limited partnership
("TWE"), classifies its business interests into three fundamental areas: Cable
Networks, consisting principally of interests in cable television programming;
Entertainment, consisting principally of interests in filmed entertainment,
television production and television broadcasting; and Cable, consisting
principally of interests in cable television systems.
 
     Each of the business interests within Cable Networks, Entertainment and
Cable is important to TWE's objective of increasing partner value through the
creation, extension and distribution of recognizable brands and copyrights
throughout the world. Such brands and copyrights include (1) HBO and Cinemax,
the leading pay television services (2) the unique and extensive film,
television and animation libraries of Warner Bros. and trademarks such as the
Looney Tunes characters and Batman, (3) The WB Network, a national broadcasting
network launched in 1995 as an extension of the Warner Bros. brand and as an
additional distribution outlet for Warner Bros.' collection of children's
cartoons and television programming and (4) Time Warner Cable, currently the
largest operator of cable television systems in the U.S.
 
     The operating results of TWE's various business interests are presented
herein as an indication of financial performance (Note 12). 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 $509 million in 1998, $430 million in 1997 and $436
million in 1996.
 
     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., which acquired such interests in 1993 for $1.532 billion of cash and a
$1.021 billion 4.4% note (the "MediaOne Note Receivable") that was fully
collected during 1996. Certain of Time Warner's subsidiaries are the general
partners of TWE ("Time Warner General Partners").
 
BASIS OF PRESENTATION
 
     The consolidated financial statements of TWE reflect certain cable-related
transactions as more fully described herein (Note 2). Certain reclassifications
have been made to the prior years' financial statements to conform to the 1998
presentation.
 
BASIS OF CONSOLIDATION AND ACCOUNTING FOR INVESTMENTS
 
     The consolidated financial statements include 100% of the assets,
liabilities, revenues, expenses, income, loss and cash flows of TWE and all
companies in which TWE has a controlling voting interest ("subsidiaries"), as if
TWE and its subsidiaries were a single company. Significant intercompany
accounts and transactions between the consolidated companies have been
eliminated. Significant accounts and transactions between TWE and its partners
and affiliates are disclosed as related party transactions (Note 14).
 
                                      F-96
<PAGE>   147
                    TIME WARNER ENTERTAINMENT COMPANY, L.P.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     Investments in companies in which TWE has significant influence, but less
than a controlling voting interest, are accounted for using the equity method.
Under the equity method, only TWE's investment in and amounts due to and from
the equity investee are included in the consolidated balance sheet, only TWE's
share of the investee's earnings is included in the consolidated operating
results, and only the dividends, cash distributions, loans or other cash
received from the investee, less any additional cash investments, loan
repayments or other cash paid to the investee are included in the consolidated
cash flows.
 
     Investments in companies in which TWE does not have a controlling interest
or an ownership and voting interest so large as to exert significant influence
are accounted for at market value if the investments are publicly traded and
there are no resale restrictions, or at cost, if the sale of a publicly traded
investment is restricted or if the investment is not publicly traded. Unrealized
gains and losses on investments accounted for at market value are reported in
partners' capital until the investment is sold, at which time the realized gain
or loss is included in income. Dividends and other distributions of earnings
from both market value and cost method investments are included in income when
declared.
 
FOREIGN CURRENCY TRANSLATION
 
     The financial position and operating results of substantially all foreign
operations are consolidated using the local currency as the functional currency.
Local currency assets and liabilities are translated at the rates of exchange on
the balance sheet date, and local currency revenues and expenses are translated
at average rates of exchange during the period. Resulting translation gains or
losses, which have not been material, are included in partners' capital.
 
USE OF ESTIMATES
 
     The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
footnotes thereto. Actual results could differ from those estimates.
 
     Significant estimates inherent in the preparation of the accompanying
consolidated financial statements include management's forecast of anticipated
revenues from the distribution of theatrical and television product in order to
evaluate the ultimate recoverability of accounts receivables and film inventory
recorded as assets in the consolidated balance sheet. Accounts receivables and
sales related to the distribution of home video product in the filmed
entertainment industry are subject to customers' rights to return unsold items.
Management periodically reviews such estimates and it is reasonably possible
that management's assessment of recoverability of accounts receivables and
individual films and television product may change based on actual results and
other factors.
 
REVENUES AND COSTS
 
  Cable and Cable Networks
 
     A significant portion of cable system and cable programming revenues are
derived from subscriber fees. Subscriber fees are recorded as revenue in the
period the service is provided. The costs of rights to exhibit feature films and
other programming on pay cable services during one or more availability periods
("programming costs") generally are recorded when the programming is initially
available for exhibition, and are allocated to the appropriate availability
periods and amortized as the programming is exhibited.
 
  Filmed Entertainment
 
     Feature films are produced or acquired for initial exhibition in theaters
followed by distribution in the home video, pay cable, basic cable, broadcast
network and syndicated television markets. Generally, distribution to the
theatrical, home video and pay cable markets (the primary markets) is
principally
 
                                      F-97
<PAGE>   148
                    TIME WARNER ENTERTAINMENT COMPANY, L.P.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
completed within eighteen months of initial release. Thereafter, feature films
are distributed to the basic cable, broadcast network and syndicated television
markets (the secondary markets). Theatrical revenues are recognized as the films
are exhibited. Home video revenues, less a provision for returns, are recognized
when the home videos are sold. Revenues from the distribution of theatrical
product to cable, broadcast network and syndicated television markets are
recognized when the films are available to telecast.
 
     Television films and series are initially produced for the networks or
first-run television syndication (the primary markets) and may be subsequently
licensed to foreign or domestic cable and syndicated television markets (the
secondary markets). Revenues from the distribution of television product are
recognized when the films or series are available to telecast, except for barter
agreements where the recognition of revenue is deferred until the related
advertisements are exhibited.
 
     License agreements for the telecast of theatrical and television product in
the cable, broadcast network and syndicated television markets are routinely
entered into well in advance of their available date for telecast, which is
generally determined by the telecast privileges granted under previous license
agreements. Accordingly, there are significant contractual rights to receive
cash and barter under these licensing agreements. For cash contracts, the
related revenues will not be recognized until such product is available for
telecast under the contractual terms of the related license agreement. For
barter contracts, the related revenues will not be recognized until the product
is available for telecast and the advertising spots received under such
contracts are either used or sold to third parties. All of these contractual
rights for which revenue is not yet recognizable is referred to as "backlog."
Excluding advertising barter contracts, Warner Bros.' backlog amounted to $2.298
billion at December 31, 1998 (including amounts relating to the licensing of
film product to TWE's cable television networks of $199 million and $570 million
to Time Warner's cable television networks).
 
     Inventories of theatrical and television product are stated at the lower of
amortized cost or net realizable value. Cost principally consists of direct
production costs and production overhead. A portion of the cost to acquire WCI
in 1989 was allocated to its theatrical and television product, including an
allocation to product that had been exhibited at least once in all markets
("Library"). Library product is amortized on a straight-line basis over twenty
years. Individual films and series are amortized, and the related participations
and residuals are accrued, based on the proportion that current revenues from
the film or series bear to an estimate of total revenues anticipated from all
markets. These estimates are revised periodically and losses, if any, are
provided in full. Current film inventories generally include the unamortized
cost of completed feature films allocated to the primary markets, television
films and series in production pursuant to a contract of sale, film rights
acquired for the home video market and advances pursuant to agreements to
distribute third-party films in the primary markets. Noncurrent film inventories
generally include the unamortized cost of completed theatrical and television
films allocated to the secondary markets, theatrical films in production and the
Library.
 
  Proposed Changes to Film Accounting Standards
 
     In October 1998, the Accounting Standards Executive Committee of the
American Institute of Certified Public Accountants ("AcSEC") issued an exposure
draft of a proposed Statement of Position, "Accounting by Producers and
Distributors of Films" (the "SOP"). The proposed rules would establish new
accounting standards for producers and distributors of films. Among its many
provisions, the SOP would require revenue for the licensing of film and
television product to be recognized generally over the term of the related
agreement. This would represent a significant change to existing industry
practice, which generally requires such licensing revenue to be recognized when
the product is first available for telecast. This is because, after that date,
licensors have no further significant obligations under the terms of the related
licensing agreements.
 
     While the SOP's proposals in many other areas (i.e., advertising and film
cost amortization) generally are consistent with TWE's accounting policies, this
is not the case with the proposed changes in revenue recognition for licensed
product. Adopting the proposed accounting standards for licensed product would
 
                                      F-98
<PAGE>   149
                    TIME WARNER ENTERTAINMENT COMPANY, L.P.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
result in a significant one-time, noncash charge to earnings upon adoption that
would be reflected as a cumulative effect of a change in accounting principle.
This one-time, noncash charge would be reversed in future periods as an increase
to operating income when TWE re-recognizes the revenues associated with the
licensing of its film and television product over the periods of the related
licensing agreements. The SOP proposes an effective date of January 1, 2000 for
calendar year-end companies, with earlier application encouraged. The provisions
of the SOP are still being deliberated by AcSEC and could change significantly
prior to the issuance of a final standard.
 
ADVERTISING
 
     In accordance with the Financial Accounting Standards Board ("FASB")
Statement No. 53, "Financial Reporting by Producers and Distributors of Motion
Picture Films," advertising costs for theatrical and television product are
capitalized and amortized over the related revenue streams in each market that
such costs are intended to benefit, which generally does not exceed three
months. Other advertising costs are expensed upon the first exhibition of the
advertisement. Advertising expense, excluding theatrical and television product,
amounted to $284 million in 1998, $288 million in 1997 and $332 million in 1996.
 
CASH AND EQUIVALENTS
 
     Cash equivalents consist of commercial paper and other investments that are
readily convertible into cash and have original maturities of three months or
less.
 
FINANCIAL INSTRUMENTS
 
     Effective July 1, 1998, TWE adopted FASB 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. Changes in the fair value of
derivative financial instruments are either recognized periodically in income or
shareholders' equity (as a component of comprehensive income), depending on
whether the derivative is being used to hedge changes in fair value or cash
flows. The adoption of FAS 133 did not have a material effect on TWE's financial
statements.
 
     The carrying value of TWE's financial instruments approximates fair value,
except for differences with respect to long-term, fixed-rate debt (Note 5) and
certain differences relating to cost method investments and other financial
instruments that are not significant. The fair value of financial instruments is
generally determined by reference to market values resulting from trading on a
national securities exchange or in an over-the-counter market. In cases where
quoted market prices are not available, fair value is based using present value
or other valuation techniques.
 
PROPERTY, PLANT AND EQUIPMENT
 
     Property, plant and equipment are stated at cost. Additions to cable
property, plant and equipment generally include material, labor, overhead and
interest. Depreciation is provided generally on the straight-line
 
                                      F-99
<PAGE>   150
                    TIME WARNER ENTERTAINMENT COMPANY, L.P.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
method over useful lives ranging up to thirty years for buildings and
improvements and up to sixteen years for furniture, fixtures, cable television
and other equipment. Property, plant and equipment consists of:
 
<TABLE>
<CAPTION>
                                                                 DECEMBER 31,
                                                              ------------------
                                                               1998       1997
                                                              -------    -------
                                                                  (MILLIONS)
<S>                                                           <C>        <C>
Land and buildings..........................................  $   797    $   804
Cable television equipment..................................    6,612      7,423
Furniture, fixtures and other equipment.....................    2,313      2,310
                                                              -------    -------
                                                                9,722     10,537
Less accumulated depreciation...............................   (3,681)    (3,980)
                                                              -------    -------
Total.......................................................  $ 6,041    $ 6,557
                                                              =======    =======
</TABLE>
 
INTANGIBLE ASSETS
 
     As a creator and distributor of branded information and entertainment
copyrights, TWE has a significant and growing number of intangible assets,
including goodwill, cable television franchises, film and television libraries
and other copyrighted products and trademarks. In accordance with generally
accepted accounting principles, TWE does not recognize the fair value of
internally generated intangible assets. Costs incurred to create and produce
copyrighted product, such as feature films and television series, are generally
either expensed as incurred, or capitalized as tangible assets, as in the case
of cash advances and inventoriable product costs. However, accounting
recognition is not given to any increasing asset value that may be associated
with the collection of the underlying copyrighted material. Additionally, costs
incurred to create or extend brands, such as the start-up of The WB Network and
Internet sites, generally result in losses over an extended development period
and are recognized as a reduction of income as incurred, while any corresponding
brand value created is not recognized as an intangible asset in the consolidated
balance sheet. On the other hand, intangible assets acquired in business
combinations accounted for by the purchase method of accounting are capitalized
and amortized over their expected useful life as a noncash charge against future
results of operations. Accordingly, the intangible assets reported in the
consolidated balance sheet do not reflect the fair value of TWE's internally
generated intangible assets, but rather are limited to intangible assets
resulting from certain acquisitions in which the cost of the acquired companies
exceeded the fair value of their tangible assets at the time of acquisition.
 
     TWE amortizes goodwill over periods up to forty years using the
straight-line method. Cable television franchises, film and television libraries
and other intangible assets are amortized over periods up to twenty years using
the straight-line method. Amortization of intangible assets amounted to $509
million in 1998, $430 million in 1997 and $436 million in 1996. Accumulated
amortization of intangible assets at December 31, 1998 and 1997 amounted to
$3.505 billion and $3.020 billion, respectively.
 
     TWE periodically reviews the carrying value of acquired intangible assets
for each acquired entity to determine whether an impairment may exist. TWE
considers relevant cash flow and profitability information, including estimated
future operating results, trends and other available information, in assessing
whether the carrying value of intangible assets can be recovered. If it is
determined that the carrying value of intangible assets will not be recovered
from the undiscounted future cash flows of the acquired business, the carrying
value of such intangible assets would be considered impaired and reduced by a
charge to operations in the amount of the impairment. An impairment charge is
measured as any deficiency in the amount of estimated undiscounted future cash
flows of the acquired business available to recover the carrying value related
to the intangible assets.
 
                                      F-100
<PAGE>   151
                    TIME WARNER ENTERTAINMENT COMPANY, L.P.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
INCOME TAXES
 
     As a Delaware limited partnership, TWE is not subject to U.S. federal and
state income taxation. However, certain of TWE's operations are conducted by
subsidiary corporations that are subject to domestic or foreign taxation. Income
taxes are provided on the income of such corporations using the liability method
prescribed by FASB Statement No. 109, "Accounting for Income Taxes."
 
COMPREHENSIVE INCOME
 
     Effective January 1, 1997, TWE adopted FASB Statement No. 130, "Reporting
Comprehensive Income" ("FAS 130"). The new rules established standards for the
reporting of comprehensive income and its components in financial statements.
Comprehensive income consists of net income and other gains and losses affecting
partners' capital that, under generally accepted accounting principles, are
excluded from net income. For TWE, such items consist primarily of unrealized
gains and losses on marketable equity investments and foreign currency
translation gains and losses. The adoption of FAS 130 did not have a material
effect on TWE's primary financial statements, but did affect the presentation of
the accompanying consolidated statement of partnership capital.
 
     The following summary sets forth the components of other comprehensive
income (loss) accumulated in partners' capital:
 
<TABLE>
<CAPTION>
                                                                                   ACCUMULATED
                                                       FOREIGN      DERIVATIVE        OTHER
                                       UNREALIZED     CURRENCY      FINANCIAL     COMPREHENSIVE
                                        GAINS ON     TRANSLATION    INSTRUMENT       INCOME
                                       SECURITIES      LOSSES         LOSSES         (LOSS)
                                       ----------    -----------    ----------    -------------
                                                              (MILLIONS)
<S>                                    <C>           <C>            <C>           <C>
Balance at December 31, 1997.........      $7           $(42)          $--            $(35)
1998 activity........................       2             (1)           (6)             (5)
                                           --           ----           ---            ----
Balance at December 31, 1998.........      $9           $(43)          $(6)           $(40)
                                           ==           ====           ===            ====
</TABLE>
 
SEGMENT INFORMATION
 
     On December 31, 1997, TWE adopted FASB Statement No. 131, "Disclosures
about Segments of an Enterprise and Related Information" ("FAS 131"). The new
rules established revised standards for public companies relating to the
reporting of financial and descriptive information about their operating
segments in financial statements. The adoption of FAS 131 did not have a
material effect on TWE's primary financial statements, but did affect the
disclosure of segment information contained elsewhere herein (Note 12).
 
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
cable television systems and develop new services, Time Warner, TWE and the
TWE-Advance/Newhouse Partnership ("TWE-A/N") completed a series of transactions
in 1998. These transactions 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.
 
TCI CABLE TRANSACTIONS
 
     During 1998, Time Warner, TWE, TWE-A/N and TCI Communications, Inc.
("TCI"), a subsidiary of Tele-Communications, Inc., consummated or agreed to
complete a number of cable-related transactions.
 
                                      F-101
<PAGE>   152
                    TIME WARNER ENTERTAINMENT COMPANY, L.P.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
These transactions consisted of (i) the formation in December 1998 of a cable
television joint venture in Texas (the "Texas Cable Joint Venture") that is
managed by Time Warner Cable, a division of TWE, and owns cable television
systems serving an aggregate 1.1 million subscribers, subject to approximately
$1.3 billion of debt, (ii) the expansion in August 1998 of an existing joint
venture in Kansas City, which is managed by Time Warner Cable, through the
contribution by TCI of a contiguous cable television system serving
approximately 95,000 subscribers, subject to approximately $200 million of debt
and (iii) the agreement to exchange in 1999 various cable television systems
serving approximately 575,000 subscribers for other cable television systems of
comparable size in an effort to enhance each company's geographic clusters of
cable television properties (the "TCI Cable Trades"). The Texas and Kansas City
joint ventures are being accounted for under the equity method of accounting.
 
     As a result of the Texas transaction, the combined debt of TWE and TWE-A/N
was reduced by approximately $650 million. Also, as a result of the Texas and
Kansas City transactions, TWE benefited from the geographic clustering of cable
television systems and the number of subscribers under its management was
increased by approximately 660,000 subscribers, thereby making Time Warner Cable
the largest cable television operator in the U.S. The TCI Cable Trades are
expected to close periodically throughout 1999 and are subject to customary
closing conditions, including all necessary governmental and regulatory
approvals. There can be no assurance that such approvals will be obtained.
 
TIME WARNER TELECOM REORGANIZATION
 
     In July 1998, in an effort to combine their Time Warner Telecom operations
into a single entity that is intended to be self-financing, Time Warner, TWE and
TWE-A/N completed a reorganization of their Time Warner Telecom operations (the
"Time Warner Telecom Reorganization"), whereby (i) those operations conducted by
Time Warner, TWE and TWE-A/N were each contributed to a new holding company
named Time Warner Telecom LLC ("Time Warner Telecom"), and then (ii) TWE's and
TWE-A/N's interests in Time Warner Telecom were distributed to their partners,
Time Warner, MediaOne and the Advance/ Newhouse Partnership
("Advance/Newhouse"), a limited partner in TWE-A/N. Time Warner 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 Time Warner Telecom Reorganization, Time Warner,
MediaOne and Advance/Newhouse own interests in Time Warner Telecom of 61.98%,
18.85% and 19.17%, respectively. TWE and TWE-A/N do not have continuing equity
interests in these Time Warner Telecom operations. TWE and TWE-A/N recorded the
distribution of their Time Warner Telecom operations to their respective
partners based on the $242 million historical cost of the net assets, of which
$191 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 online
businesses (the "Road Runner Joint Venture"). In exchange for contributing these
operations, Time Warner received a common equity interest in the Road Runner
Joint Venture of 10.7%, TWE received a 25% interest, TWE-A/N received a 32.9%
interest and MediaOne received a 31.4% interest. In exchange for Microsoft and
Compaq contributing $425 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 8.6% by Time Warner, 20% by TWE,
26.3% by TWE-A/N, 25.1% by MediaOne, 10% by Microsoft and 10% by Compaq. Each of
Time Warner's, TWE's and TWE-A/N's interest in the Road Runner Joint Venture is
being accounted for under the equity method of accounting.
 
                                      F-102
<PAGE>   153
                    TIME WARNER ENTERTAINMENT COMPANY, L.P.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     The aggregate $425 million of capital contributed by Microsoft and Compaq
is being used by the Road Runner Joint Venture to continue to expand the roll
out of high-speed online services. Time Warner Cable has entered into an
affiliation agreement with the Road Runner Joint Venture, pursuant to which Time
Warner Cable provides Road Runner's high-speed online services to customers in
its cable franchise areas through its technologically advanced, high-capacity
cable architecture. In exchange, Time Warner Cable initially retains 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 subscription revenues will
change periodically to 75% by 2006.
 
PRIMESTAR
 
     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
Partners" and collectively, the "Primestar Assets") to Primestar, Inc.
("Primestar"), a separate holding company. As a result of that transfer and
similar transfers by the other previously existing partners of Primestar
Partners, Primestar Partners became an indirect wholly owned subsidiary of
Primestar. In exchange for contributing its interests in the Primestar Assets,
TWE received approximately 48 million shares of Primestar common stock
(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 Primestar. As a result of this transaction,
effective as of April 1, 1998, TWE deconsolidated the DBS Operations and the 24%
equity interest in Primestar received in the transaction is being accounted for
under the equity method of accounting. This transaction is referred to as the
"Primestar Roll-up Transaction."
 
     In connection with the Primestar Roll-up Transaction, Primestar and
Primestar Partners own and operate the medium-power direct broadcast satellite
business, portions of which were formerly owned by TCI Satellite Entertainment,
Inc. ("TSAT") and the other previously existing partners of Primestar Partners.
Certain high-power system assets, including two high-power satellites, continue
to be owned by Tempo Satellite, Inc. ("Tempo"), a wholly owned subsidiary of
TSAT. However, Primestar Partners has an option to lease or purchase the entire
capacity of the high-power system from Tempo. In addition, Primestar has an
option to purchase the stock or assets of Tempo from TSAT.
 
     In a related transaction, Primestar Partners 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
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.
 
     In the fourth quarter of 1998, TWE recorded a charge of approximately $210
million principally to reduce the carrying value of its interest in Primestar.
This charge reflected a significant decline in the fair value of Primestar
during the quarter and has been included in interest and other, net, in TWE's
1998 consolidated statement of operations.
 
     In addition, Primestar, Primestar Partners and the stockholders of
Primestar have entered into an agreement to sell the medium-power direct
broadcast satellite business and assets to DirecTV, a competitor of Primestar
owned by Hughes Electronics Corp. Also, Primestar, Primestar Partners, the
stockholders of Primestar and Tempo entered into a second agreement with
DirecTV, pursuant to which DirecTV will purchase the high-power satellites from
Tempo, and Primestar and Primestar Partners will relinquish their
 
                                      F-103
<PAGE>   154
                    TIME WARNER ENTERTAINMENT COMPANY, L.P.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
respective rights to acquire or use such high-power satellites. The price to be
paid by DirecTV pursuant to these agreements confirmed the decline in value of
TWE's interest in Primestar. The ultimate disposition of the medium-power assets
of Primestar is subject to Primestar bondholder and regulatory approvals, and
the disposition of certain of the high-power satellite rights is also subject to
regulatory approvals. Accordingly, there can be no assurance that such approvals
will be obtained and that these transactions will be consummated.
 
TWE-A/N TRANSFERS
 
     As of December 31, 1998, TWE-A/N owns cable television systems (or
interests therein) serving approximately 6.3 million subscribers, of which 5.2
million subscribers were served by consolidated, wholly owned cable television
systems and 1.1 million subscribers were served by unconsolidated, partially
owned cable television systems. TWE-A/N had approximately $1.2 billion of debt
at December 31, 1998.
 
     TWE-A/N is owned approximately 64.8% by TWE, the managing partner, 33.3% by
Advance/ Newhouse and 1.9% indirectly by Time Warner. TWE consolidates the
partnership, and the partnership interests owned by Advance/Newhouse and Time
Warner are reflected in TWE's consolidated financial statements as minority
interest. In accordance with the partnership agreement, Advance/Newhouse can
require TWE to purchase its equity interest for fair market value at specified
intervals following the death of both of its principal shareholders. In
addition, TWE or Advance/Newhouse can initiate a restructuring of the
partnership, in which Advance/Newhouse would withdraw from the partnership and
receive one-third of the partnership's net assets.
 
     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 in TWE-A/N, 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.
 
     The TWE-A/N Transfers were accounted for effective as of January 1, 1998
and TWE has continued to consolidate TWE-A/N.
 
     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 year ended
December 31, 1997, respectively, revenues of $11.379 billion, depreciation
expense of $947 million, operating income before noncash amortization of
intangible assets of $1.989 billion, operating income of $1.496 billion, and net
income of $607 million.
 
SALE OR EXCHANGE OF CABLE TELEVISION SYSTEMS
 
     In 1998 and 1997, in an effort to enhance its geographic clustering of
cable television properties, TWE sold or exchanged various cable television
systems. As a result of these transactions, TWE recognized net,
 
                                      F-104
<PAGE>   155
                    TIME WARNER ENTERTAINMENT COMPANY, L.P.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
pretax gains of approximately $90 million and $200 million in 1998 and 1997,
respectively, which 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 by TWE, principally as a result of
uncertainties surrounding realization that relate to ongoing litigation and
TWE's continuing guarantees of certain significant long-term obligations
associated with the Six Flags Over Texas and Six Flags Over Georgia theme parks.
 
3.  INVENTORIES
 
     TWE's inventories consist of:
 
<TABLE>
<CAPTION>
                                                              DECEMBER 31,
                                             ----------------------------------------------
                                                     1998                     1997
                                             ---------------------    ---------------------
                                             CURRENT    NONCURRENT    CURRENT    NONCURRENT
                                             -------    ----------    -------    ----------
                                                               (MILLIONS)
<S>                                          <C>        <C>           <C>        <C>
Film costs:
  Released, less amortization..............  $  614       $  744      $  545       $  658
  Completed and not released...............     179           76         170           50
  In process and other.....................      23          572          27          595
  Library, less amortization...............      --          560          --          612
Programming costs, less amortization.......     426          375         382          339
Merchandise................................      70           --          80           --
                                             ------       ------      ------       ------
Total......................................  $1,312       $2,327      $1,204       $2,254
                                             ======       ======      ======       ======
</TABLE>
 
     Excluding the Library, the total cost incurred in the production of
theatrical and television product (including direct production costs, production
overhead and certain exploitation costs, such as film prints and home
videocassettes) amounted to $2.665 billion in 1998, $2.360 billion in 1997 and
$2.543 billion in 1996; and the total cost amortized amounted to $2.502 billion,
$2.329 billion and $1.998 billion, respectively. Excluding the Library, the
unamortized cost of completed films at December 31, 1998 amounted to $1.613
billion, approximately 90% of which is expected to be amortized within three
years after release.
 
4.  INVESTMENTS
 
     TWE's investments consist of:
 
<TABLE>
<CAPTION>
                                                              DECEMBER 31,
                                                              ------------
                                                              1998    1997
                                                              ----    ----
                                                               (MILLIONS)
<S>                                                           <C>     <C>
Equity method investments...................................  $574    $238
Cost and fair-value method investments......................   312      77
                                                              ----    ----
Total.......................................................  $886    $315
                                                              ====    ====
</TABLE>
 
                                      F-105
<PAGE>   156
                    TIME WARNER ENTERTAINMENT COMPANY, L.P.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     In the first quarter of 1997, TWE sold its 58% interest in E! Entertainment
Television, Inc. ("E! Entertainment"). A pretax gain of approximately $250
million relating to this sale has been included in the accompanying consolidated
statement of operations.
 
     At December 31, 1998, companies accounted for using the equity method
included: Comedy Partners, L.P. (50% owned), certain cable system joint ventures
(generally 50% owned), the Road Runner Joint Venture (57.9% owned, excluding
Time Warner's direct 10.7% interest), Primestar (24% owned), Six Flags (49%
owned in 1997 and 1996), certain international cable and programming joint
ventures (25% to 50% owned) and Courtroom Television Network (50% owned). A
summary of combined financial information as reported by the equity investees of
TWE is set forth below:
 
<TABLE>
<CAPTION>
                                                            YEARS ENDED DECEMBER 31,
                                                           --------------------------
                                                            1998      1997      1996
                                                           ------    ------    ------
                                                                   (MILLIONS)
<S>                                                        <C>       <C>       <C>
Revenues.................................................  $2,329    $2,207    $1,823
Depreciation and amortization............................    (706)     (235)     (197)
Operating income (loss)..................................    (265)      118        62
Net loss.................................................    (352)      (82)     (138)
Current assets...........................................     665       412       624
Total assets.............................................   5,228     3,046     3,193
Current liabilities......................................     628       993       407
Long-term debt...........................................   2,917     1,625     2,197
Total liabilities........................................   3,699     2,734     2,829
Total shareholders' equity or partners' capital..........   1,529       312       364
</TABLE>
 
5.  LONG-TERM DEBT
 
<TABLE>
<CAPTION>
                                       WEIGHTED-AVERAGE                     DECEMBER 31,
                                       INTEREST RATE AT                   ----------------
                                       DECEMBER 31, 1998    MATURITIES     1998      1997
                                       -----------------    ----------    ------    ------
                                                                             (MILLIONS)
<S>                                    <C>                  <C>           <C>       <C>
Bank credit agreement borrowings.....         6.0%            2002        $2,711    $1,970
Commercial paper.....................         5.4%            1999            62       210
Fixed-rate senior notes and
  debentures.........................         8.6%          2002-2033      3,805     3,810
                                                                          ------    ------
          Total......................                                     $6,578    $5,990
                                                                          ======    ======
</TABLE>
 
BANK CREDIT AGREEMENT
 
     In November 1997, TWE and TWE-A/N, together with Time Warner Inc. and
certain of its consolidated subsidiaries, entered into a five-year revolving
credit facility (the "1997 Credit Agreement") and terminated their previously
existing bank credit facility (the "Old Credit Agreement"). This enabled TWE to
reduce its aggregate borrowing availability from $8.3 billion to $7.5 billion,
lower interest rates and refinance approximately $2.1 billion of its outstanding
borrowings under the Old Credit Agreement. In connection therewith, TWE
recognized an extraordinary loss of $23 million in 1997.
 
     The 1997 Credit Agreement permits borrowings in an aggregate amount of up
to $7.5 billion, with no scheduled reduction in credit availability prior to
maturity in November 2002. The borrowers under the 1997 Credit Agreement are
TWE, TWE-A/N, Time Warner Inc., TW Companies, TBS and TWI Cable. Borrowings
under the 1997 Credit Agreement are limited to (i) $7.5 billion in the case of
TWE, (ii) $2 billion in the case of TWE-A/N and (iii) $6 billion in the
aggregate for Time Warner Inc., TW Companies, TBS and TWI Cable, subject in each
case to an aggregate borrowing limit of $7.5 billion and certain other
 
                                      F-106
<PAGE>   157
                    TIME WARNER ENTERTAINMENT COMPANY, L.P.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
limitations and adjustments. Such borrowings bear interest at specific rates for
each of the borrowers (generally equal to LIBOR plus a margin initially equal to
40 basis points for TWE and 35 basis points for TWE-A/N) and each borrower is
required to pay a commitment fee on the unused portion of its commitment
(initially equal to .15% per annum for TWE and .125% per annum for TWE-A/N),
which margin and fee vary based on the credit rating or financial leverage of
the applicable borrower. Borrowings may be used for general business purposes
and unused credit is available to support commercial paper borrowings. The 1997
Credit Agreement contains certain covenants generally for each borrower relating
to, among other things, additional indebtedness; liens on assets; cash flow
coverage and leverage ratios; and dividends, distributions and other restricted
cash payments or transfers of assets from the borrowers to their respective
shareholders, partners or affiliates.
 
DEBT GUARANTEES
 
     Each Time Warner General Partner has guaranteed a pro rata portion of
approximately $5.5 billion of TWE's debt and accrued interest at December 31,
1998, based on the relative fair value of the net assets each Time Warner
General Partner (or its predecessor) contributed to TWE (the "Time Warner
General Partner Guarantees"). Such indebtedness is recourse to each Time Warner
General Partner only to the extent of its guarantee. The indenture pursuant to
which TWE's notes and debentures have been issued (the "Indenture") requires the
majority consent of the holders of the notes and debentures to terminate the
Time Warner General Partner Guarantees. There are generally no restrictions on
the ability of the Time Warner General Partner guarantors to transfer material
assets, other than TWE assets, to parties that are not guarantors. In addition,
in connection with the TWE-A/N Transfers (Note 2), approximately $1.2 billion of
TWE-A/N's debt and accrued interest at December 31, 1998 has been guaranteed by
TWI Cable and certain of its subsidiaries.
 
INTEREST EXPENSE AND MATURITIES
 
     Interest expense was $566 million in 1998, $490 million in 1997 and $475
million in 1996. The weighted average interest rate on TWE's total debt was 7.5%
and 7.8% at December 31, 1998 and 1997, respectively.
 
     Annual repayments of long-term debt for the five years subsequent to
December 31, 1998 consist only of $3.373 billion due in 2002. This includes all
borrowings under the 1997 Credit Agreement, as well as any commercial paper
borrowings supported thereby. TWE has the intent and ability under the 1997
Credit Agreement to continue to refinance its commercial paper borrowings on a
long-term basis.
 
FAIR VALUE OF DEBT
 
     Based on the level of interest rates prevailing at December 31, 1998 and
1997, the fair value of TWE's fixed-rate debt exceeded its carrying value by
$764 million and $532 million, respectively. Unrealized gains or losses on debt
do not result in the realization or expenditure of cash and generally are not
recognized for financial reporting purposes unless the debt is retired prior to
its maturity.
 
6.  INCOME TAXES
 
     Domestic and foreign pretax income (loss) are as follows:
 
<TABLE>
<CAPTION>
                                                               YEARS ENDED DECEMBER 31,
                                                              --------------------------
                                                               1998      1997      1996
                                                              ------    ------    ------
                                                                      (MILLIONS)
<S>                                                           <C>       <C>       <C>
Domestic....................................................   $438      $654      $263
Foreign.....................................................    (20)       68        17
                                                               ----      ----      ----
Total.......................................................   $418      $722      $280
                                                               ====      ====      ====
</TABLE>
 
                                      F-107
<PAGE>   158
                    TIME WARNER ENTERTAINMENT COMPANY, L.P.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     As a partnership, TWE is not subject to U.S. federal, state or local income
taxation. However, certain of TWE's operations are conducted by subsidiary
corporations that are subject to domestic or foreign taxation. Income taxes
(benefits) of TWE and subsidiary corporations are as set forth below:
 
<TABLE>
<CAPTION>
                                                               YEARS ENDED DECEMBER 31,
                                                              --------------------------
                                                               1998      1997      1996
                                                              ------    ------    ------
                                                                      (MILLIONS)
<S>                                                           <C>       <C>       <C>
Federal:
  Current...................................................   $  6      $  2      $  4
  Deferred..................................................     (7)      (10)       (3)
Foreign:
  Current(1)................................................    106        69        86
  Deferred..................................................    (15)       22       (21)
State and local:
  Current...................................................      4         4         5
  Deferred..................................................     (2)       (2)       (1)
                                                               ----      ----      ----
Total income taxes..........................................   $ 92      $ 85      $ 70
                                                               ====      ====      ====
</TABLE>
 
---------------
(1) Includes foreign withholding taxes of $62 million in 1998, $58 million in
    1997 and $54 million in 1996.
 
     The financial statement basis of TWE's assets exceeds the corresponding tax
basis by $7.5 billion at December 31, 1998, principally as a result of
differences in accounting for depreciable and amortizable assets for financial
statement and income tax purposes.
 
7.  PREFERRED STOCK OF SUBSIDIARY
 
     In February 1997, a newly formed, substantially owned subsidiary of TWE
(the "REIT") issued 250,000 shares of preferred stock ("REIT Preferred Stock").
The REIT is intended to qualify as a real estate investment trust under the
Internal Revenue Code of 1986, as amended. TWE used the aggregate net proceeds
from the transaction of $243 million to reduce its bank debt. The sole asset of
the REIT is a $432 million mortgage note payable by TWE, which has been secured
by certain real estate owned by TWE or its affiliates.
 
     Each share of REIT Preferred Stock is entitled to a liquidation preference
of $1,000 and entitles the holder thereof to receive cumulative cash dividends,
payable quarterly, at the rate of 14.253% per annum through December 30, 2006
and 1% per annum thereafter, which results in an effective dividend yield of
8.48%. Shares of REIT Preferred Stock are redeemable currently because the REIT
has received a legal opinion stating that certain proposed changes to the tax
regulations have substantially increased the likelihood that the dividends paid
by the REIT or interest paid under the mortgage note will not be fully
deductible for federal income tax purposes. TWE has the right to liquidate or
dissolve the REIT at any time after December 30, 2006 or, at any time prior
thereto, upon the approval of the holders of at least two-thirds of the
outstanding shares of REIT Preferred Stock.
 
8.  TWE PARTNERS' CAPITAL
 
PARTNERSHIP CAPITAL AND ALLOCATION OF INCOME
 
     Each partner's interest in TWE generally consists of the undistributed
priority capital and residual equity amounts that were initially assigned to
that partner or its predecessor based on the estimated fair value of the net
assets each contributed to the partnership ("Undistributed Contributed
Capital"), plus, with respect to the priority capital interests only, any
undistributed priority capital return. The priority capital return consists of
net partnership income allocated to date in accordance with the provisions of
the TWE partnership agreement
 
                                      F-108
<PAGE>   159
                    TIME WARNER ENTERTAINMENT COMPANY, L.P.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
and the right to be allocated additional partnership income which, together,
provides for the various priority capital rates of return as specified in the
table below. The sum of Undistributed Contributed Capital and the undistributed
priority capital return is referred to herein as "Cumulative Priority Capital."
Cumulative Priority Capital is not necessarily indicative of the fair value of
the underlying priority capital interests principally due to above-market rates
of return on certain priority capital interests as compared to securities of
comparable credit risk and maturity, such as the 13.25% rate of return on the
Series B Capital interest owned by the Time Warner General Partners.
Furthermore, the ultimate realization of Cumulative Priority Capital could be
affected by the fair value of TWE, which is subject to fluctuation.
 
     A summary of the priority of Undistributed Contributed Capital, ownership
of Undistributed Contributed Capital and Cumulative Priority Capital at December
31, 1998 and priority capital rates of return thereon is set forth below:
 
<TABLE>
<CAPTION>
                                                            PRIORITY       TIME       LIMITED PARTNERS
                             UNDISTRIBUTED    CUMULATIVE     CAPITAL      WARNER     ------------------
PRIORITY OF UNDISTRIBUTED     CONTRIBUTED      PRIORITY     RATES OF     GENERAL      TIME
CONTRIBUTED CAPITAL           CAPITAL(A)       CAPITAL      RETURN(B)    PARTNERS    WARNER    MEDIAONE
-------------------------    -------------    ----------    ---------    --------    ------    --------
                                     (BILLIONS)                                        (OWNERSHIP %)
<S>                          <C>              <C>           <C>          <C>         <C>       <C>
Senior Capital.............      $0.5           $ 0.6          8.00%      100.00%       --         --
Series A Capital...........       5.6            12.8         13.00%       63.27%    11.22%     25.51%
Series B Capital...........       2.9(d)          6.8         13.25%      100.00%       --         --
Residual Capital...........       3.3(d)          3.3(c)         --(c)     63.27%    11.22%     25.51%
</TABLE>
 
---------------
(a) Excludes partnership income or loss allocated thereto.
(b) To the extent income allocations are concurrently distributed, the priority
    capital rates of return on the Series A Capital and Series B Capital are 11%
    and 11.25%, respectively.
(c) Residual Capital is not entitled to stated priority rates of return and, as
    such, its Cumulative Priority Capital is equal to its Undistributed
    Contributed Capital. However, in the case of certain events such as the
    liquidation or dissolution of TWE, Residual Capital is entitled to any
    excess of the then fair value of the net assets of TWE over the aggregate
    amount of Cumulative Priority Capital and special tax allocations.
(d) The Undistributed Contributed Capital relating to the Series B Capital has
    priority over the priority returns on the Series A Capital. The
    Undistributed Contributed Capital relating to the Residual Capital has
    priority over the priority returns on the Series B Capital and the Series A
    Capital.
 
     Because Undistributed Contributed Capital is generally based on the fair
value of the net assets that each partner initially contributed to the
partnership, the aggregate of such amounts is significantly higher than TWE's
partners' capital as reflected in the consolidated financial statements, which
is based on the historical cost of the contributed net assets. For purposes of
allocating partnership income or loss to the partners, partnership income or
loss is based on the fair value of the net assets contributed to the partnership
and results in significantly less partnership income, or results in partnership
losses, in contrast to the net income reported by TWE for financial statement
purposes, which is also based on the historical cost of contributed net assets.
 
     Under the TWE partnership agreement, partnership income, to the extent
earned, is first allocated to the partners' capital accounts so that the
economic burden of the income tax consequences of partnership operations is
borne as though the partnership were taxed as a corporation ("special tax
allocations"). After any special tax allocations, partnership income is
allocated to the Senior Capital, Series A Capital and Series B Capital, in order
of priority, at rates of return ranging from 8% to 13.25% per annum, and finally
to the Residual Capital. Partnership losses generally are allocated first to
eliminate prior allocations of partnership income to, and then to reduce the
Undistributed Contributed Capital of, the Residual Capital, Series B Capital and
Series A Capital, in that order, then to reduce the Time Warner General
Partners' Senior Capital, including partnership income allocated thereto, and
finally to reduce any special tax allocations. To the extent partnership income
is insufficient to satisfy all special allocations in a particular accounting
period, the right to receive additional partnership income necessary to provide
for the various priority capital rates of
 
                                      F-109
<PAGE>   160
                    TIME WARNER ENTERTAINMENT COMPANY, L.P.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
return is carried forward until satisfied out of future partnership income,
including any partnership income that may result from any liquidation, sale or
dissolution of TWE.
 
     The Series B Capital owned by subsidiaries of Time Warner may be increased
if certain operating performance targets are achieved over a ten-year period
ending on December 31, 2001, although it does not appear likely at this time
that such targets will be achieved. In addition, MediaOne has an option to
obtain up to an additional 6.33% of Series A Capital and Residual Capital
interests, depending on cable operating performance. The option is exercisable
at any time through May 2005 at a maximum exercise price of $1.25 billion to
$1.8 billion, depending on the year of exercise. Either MediaOne or TWE may
elect that the exercise price be paid with partnership interests rather than
cash.
 
CAPITAL DISTRIBUTIONS
 
     Distributions and loans to the partners are subject to partnership and
credit agreement limitations. Generally, TWE must be in compliance with the cash
flow coverage and leverage ratios, restricted payment limitations and other
credit agreement covenants in order to make such distributions or loans.
 
     In 1998 and 1997, the Time Warner General Partners received $579 million
and $535 million, respectively, of distributions from TWE relating to their
Senior Capital interests (representing the return of $455 million of contributed
capital in each period and the distribution of $124 million and $80 million,
respectively, of priority capital return), which, when taken together with a
$366 million distribution in 1995 (representing a portion of the priority
capital return) increased the cumulative cash distributions received from TWE on
such interests to $1.5 billion. The Time Warner General Partners' remaining $603
million Senior Capital interests and any undistributed partnership income
allocated thereto (based on an 8% annual rate of return) are required to be
distributed on July 1, 1999.
 
     TWE reimburses Time Warner for the amount by which the market price on the
exercise date of Time Warner common stock options exercised by employees of TWE
exceeds the exercise price or, with respect to options granted prior to the TWE
capitalization, the greater of the exercise price and $13.88, the market price
of the common stock at the time of the TWE capitalization on June 30, 1992
("Stock Option Distributions"). TWE accrues Stock Option Distributions and a
corresponding liability with respect to unexercised options when the market
price of Time Warner common stock increases during the accounting period, and
reverses previously accrued Stock Option Distributions and the corresponding
liability when the market price of Time Warner common stock declines. Stock
Option Distributions are paid when the options are exercised. At December 31,
1998 and 1997, TWE had recorded a liability for Stock Option Distributions of
$1.130 billion and $417 million, respectively, based on the unexercised options
and the market prices at such dates of $62.06 and $31.00, respectively, per Time
Warner common share. This liability reflects the accrual of $973 million and
$399 million of Stock Option Distributions in 1998 and 1997, respectively, when
the market price of Time Warner common stock increased during such periods, and
the reversal of $16 million of previously accrued Stock Option Distributions in
1996 when the market price of Time Warner common stock declined. TWE paid Stock
Option Distributions to Time Warner in the amount of $260 million in 1998, $75
million in 1997 and $13 million in 1996.
 
     Cash distributions are required to be made to the partners to permit them
to pay income taxes at statutory rates based on their allocable taxable income
from TWE ("Tax Distributions"), including any taxable income generated by the
Beneficial Assets, subject to limitations referred to herein. The aggregate
amount of such Tax Distributions is computed generally by reference to the taxes
that TWE would have been required to pay if it were a corporation. Tax
Distributions are paid to the partners on a current basis. TWE paid Tax
Distributions to the Time Warner General Partners in the amount of $314 million
in 1998, $324 million in 1997 and $215 million in 1996.
 
     In addition to Stock Option Distributions, Tax Distributions and Senior
Capital Distributions, quarterly cash distributions may be made to the partners
to the extent of excess cash, as defined in the TWE partnership
 
                                      F-110
<PAGE>   161
                    TIME WARNER ENTERTAINMENT COMPANY, L.P.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
agreement. Such cash distributions will generally be made on a priority and pro
rata basis with respect to each partner's interest in the Series A Capital,
Series B Capital and Residual Capital. However, cash distributions to the Time
Warner General Partners with respect to their Series A Capital and Residual
Capital interests will be deferred until the limited partners receive aggregate
distributions (excluding Tax Distributions) of approximately $800 million.
Similarly, cash distributions with respect to the Time Warner General Partners'
Series B Capital interest will be deferred until the limited partners receive
aggregate distributions of $1.6 billion. If any such deferral occurs, a portion
of the corresponding partnership income allocations with respect to such
deferred amounts will be made at a rate higher than otherwise would have been
the case. As of December 31, 1998, no cash distributions have been made to the
limited partners. In addition, if a division of TWE or a substantial portion
thereof is sold, the net proceeds of such sale, less expenses and proceeds used
to repay outstanding debt, will be required to be distributed with respect to
the partners' partnership interests. Similar distributions are required to be
made in the event of a financing or refinancing of debt. Subject to any
limitations on the incurrence of additional debt contained in the TWE
partnership and credit agreements, and the Indenture, TWE may borrow funds to
make distributions.
 
     In addition, in connection with the Time Warner Telecom Reorganization, TWE
recorded a $191 million noncash distribution to its partners based on the
historical cost of the net assets (Note 2).
 
9.  STOCK OPTION PLANS
 
     Time Warner has various stock option plans under which Time Warner may
grant options to purchase Time Warner common stock to employees of Time Warner
and TWE. Such options have been granted to employees of TWE with exercise prices
equal to, or in excess of, fair market value at the date of grant. Accordingly,
in accordance with Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees" and related interpretations, no compensation cost has
been recognized by Time Warner, nor charged to TWE, related to such stock option
plans. Generally, the options become exercisable over a three-year vesting
period and expire ten years from the date of grant. Had compensation cost for
Time Warner's stock option plans been determined based on the fair value at the
grant dates for all awards made subsequent to 1994 consistent with the method
set forth under FASB Statement No. 123, "Accounting for Stock-Based
Compensation" ("FAS 123"), TWE's allocable share of compensation cost would have
decreased its net income to the pro forma amounts indicated below:
 
<TABLE>
<CAPTION>
                                                               YEARS ENDED DECEMBER 31,
                                                              --------------------------
                                                               1998      1997      1996
                                                              ------    ------    ------
                                                                      (MILLIONS)
<S>                                                           <C>       <C>       <C>
Net income:
  As reported...............................................   $326      $614      $210
                                                               ====      ====      ====
  Pro forma.................................................   $285      $584      $193
                                                               ====      ====      ====
</TABLE>
 
     FAS 123 is applicable only to stock options granted subsequent to December
31, 1994. Accordingly, since TWE's compensation expense associated with such
grants would generally be recognized over a three-year vesting period, the
initial impact of applying FAS 123 on pro forma net income for 1996 is not
comparable to the impact on pro forma net income for 1998 and 1997, when the pro
forma effect of the three-year vesting period has been fully reflected.
 
     For purposes of applying FAS 123, the fair value of each option grant is
estimated on the date of grant using the Black-Scholes option-pricing model with
the following weighted-average assumptions used for grants to TWE employees in
1998, 1997 and 1996: dividend yields of 0.5%, 1% and 1%, respectively; expected
volatility of 21.7%, 22.2% and 21.7%, respectively; risk-free interest rates of
5.5%, 6.3% and 5.7%, respectively; and expected lives of 5 years in all periods.
 
                                      F-111
<PAGE>   162
                    TIME WARNER ENTERTAINMENT COMPANY, L.P.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     In December 1998, Time Warner completed a two-for-one common stock split.
Accordingly, the following stock option information for all prior periods has
been restated to give effect to this stock split.
 
     The weighted average fair value of an option granted to TWE employees
during the year was $11.03, $6.09 and $5.22 for the years ended December 31,
1998, 1997 and 1996, respectively. In 1996, Time Warner granted options to
certain TWE executives at exercise prices exceeding the market price of Time
Warner common stock on the date of grant. These above-market options had a
weighted average exercise price and fair value of $24.26 and $3.41.
 
     A summary of stock option activity with respect to employees of TWE is as
follows:
 
<TABLE>
<CAPTION>
                                                                           WEIGHTED-
                                                              THOUSANDS     AVERAGE
                                                                 OF        EXERCISE
                                                               SHARES        PRICE
                                                              ---------    ---------
<S>                                                           <C>          <C>
Balance at January 1, 1996..................................    57,069      $16.63
Granted.....................................................     9,021       21.24
Exercised...................................................    (2,485)      14.34
Cancelled(a)................................................    (2,983)      15.68
                                                               -------
Balance at December 31, 1996................................    60,622      $17.46
Granted.....................................................     7,839       20.68
Exercised...................................................    (7,045)      14.37
Cancelled(a)................................................    (2,412)      16.76
                                                               -------
Balance at December 31, 1997................................    59,004      $18.28
Granted.....................................................     5,767       37.82
Exercised...................................................   (15,957)      16.42
Cancelled(a)................................................    (1,073)      14.36
                                                               -------
Balance at December 31, 1998................................    47,741      $21.35
                                                               =======
</TABLE>
 
---------------
(a) Includes all options cancelled and forfeited during the year, as well as
    options related to employees who have been transferred out of and into TWE
    to and from other Time Warner divisions.
 
<TABLE>
<CAPTION>
                                                                  DECEMBER 31,
                                                           --------------------------
                                                            1998      1997      1996
                                                           ------    ------    ------
                                                                  (THOUSANDS)
<S>                                                        <C>       <C>       <C>
Exercisable..............................................  33,370    43,022    45,544
</TABLE>
 
                                      F-112
<PAGE>   163
                    TIME WARNER ENTERTAINMENT COMPANY, L.P.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     The following table summarizes information about stock options outstanding
with respect to employees of TWE at December 31, 1998:
 
<TABLE>
<CAPTION>
                                       OPTIONS OUTSTANDING                OPTIONS EXERCISABLE
                             ---------------------------------------    ------------------------
                                             WEIGHTED-
                                              AVERAGE      WEIGHTED-                   WEIGHTED-
                               NUMBER        REMAINING      AVERAGE       NUMBER        AVERAGE
                             OUTSTANDING    CONTRACTUAL    EXERCISE     EXERCISABLE    EXERCISE
RANGE OF EXERCISE PRICES     AT 12/31/98       LIFE          PRICE      AT 12/31/98      PRICE
------------------------     -----------    -----------    ---------    -----------    ---------
                             (THOUSANDS)                                (THOUSANDS)
<S>                          <C>            <C>            <C>          <C>            <C>
Under $10..................       374        1.1 years      $ 8.37           374        $ 8.37
$10.00 to $15.00...........     5,183        2.8 years      $12.54         5,183        $12.54
$15.01 to $20.00...........    17,035        5.2 years      $18.34        13,433        $18.21
$20.01 to $30.00...........    19,254        5.7 years      $21.66        14,329        $21.46
$30.01 to $45.00...........     4,582        9.0 years      $34.70            51        $30.28
$45.01 to $52.39...........     1,313        9.1 years      $47.82            --            --
                               ------                                     ------
Total......................    47,741        5.6 years      $21.35        33,370        $18.63
                               ======                                     ======
</TABLE>
 
     TWE reimburses Time Warner for the use of Time Warner stock options on the
basis described in Note 8.
 
10.  BENEFIT PLANS
 
     TWE and its divisions have defined benefit pension plans covering
substantially all domestic employees. Pension benefits are based on formulas
that reflect the employees' years of service and compensation levels during
their employment period. Time Warner's common stock represents approximately 12%
and 7% of plan assets at December 31, 1998 and 1997, respectively. A summary of
activity for TWE's defined benefit pension plans is as follows:
 
<TABLE>
<CAPTION>
                                                               YEARS ENDED DECEMBER 31,
                                                              --------------------------
                                                               1998      1997      1996
                                                              ------    ------    ------
                                                                      (MILLIONS)
<S>                                                           <C>       <C>       <C>
COMPONENTS OF PENSION EXPENSE
Service cost................................................   $ 42      $ 33      $ 33
Interest cost...............................................     36        31        28
Expected return on plan assets..............................    (35)      (26)      (23)
Net amortization and deferral...............................     --        --         3
                                                               ----      ----      ----
Total.......................................................   $ 43      $ 38      $ 41
                                                               ====      ====      ====
</TABLE>
 
                                      F-113
<PAGE>   164
                    TIME WARNER ENTERTAINMENT COMPANY, L.P.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
<TABLE>
<CAPTION>
                                                              DECEMBER 31,
                                                              -------------
                                                              1998     1997
                                                              -----    ----
                                                               (MILLIONS)
<S>                                                           <C>      <C>
CHANGE IN PROJECTED BENEFIT OBLIGATION
Projected benefit obligation at beginning of year...........  $ 461    $359
Service cost................................................     42      33
Interest cost...............................................     36      31
Actuarial loss..............................................     61      48
Benefits paid...............................................    (14)    (10)
                                                              -----    ----
Projected benefit obligation at end of year.................    586     461
                                                              -----    ----
CHANGE IN PLAN ASSETS
Fair value of plan assets at beginning of year..............    364     284
Actual return on plan assets................................    112      71
Employer contribution.......................................     18      19
Benefits paid...............................................    (14)    (10)
                                                              -----    ----
Fair value of plan assets at end of year....................    480     364
                                                              -----    ----
Unfunded projected benefit obligation.......................   (106)    (97)
Additional minimum liability(a).............................     (4)    (10)
Unrecognized actuarial loss (gain)..........................    (10)      3
Unrecognized prior service cost.............................      5       8
                                                              -----    ----
Accrued pension expense.....................................  $(115)   $(96)
                                                              =====    ====
</TABLE>
 
---------------
(a) The additional minimum liability is offset fully by a corresponding
    intangible asset recognized in the consolidated balance sheet.
 
<TABLE>
<CAPTION>
                                                                  DECEMBER 31,
                                                              --------------------
                                                              1998    1997    1996
                                                              ----    ----    ----
<S>                                                           <C>     <C>     <C>
WEIGHTED-AVERAGE PENSION ASSUMPTIONS
Discount rate...............................................  6.75%   7.25%   7.75%
Expected return on plan assets..............................     9%      9%      9%
Rate of compensation increase...............................     6%      6%      6%
</TABLE>
 
     Included above are projected benefit obligations and accumulated benefit
obligations for unfunded defined benefit pension plans of $39 million and $27
million as of December 31, 1998, respectively; and $29 million and $19 million
as of December 31, 1997, respectively.
 
     Certain domestic employees of TWE participate in multi-employer pension
plans as to which the expense amounted to $35 million in 1998, $29 million in
1997 and $30 million in 1996. Employees of TWE's operations in foreign countries
participate to varying degrees in local pension plans, which in the aggregate
are not significant.
 
     Certain TWE employees also participate in Time Warner's savings and profit
sharing plans, as to which the expense amounted to $35 million in 1998, $30
million in 1997 and $28 million in 1996. Contributions to the savings plans are
based upon a percentage of the employees' elected contributions. Contributions
to the profit sharing plans are generally determined by management.
 
11.  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
 
                                      F-114
<PAGE>   165
                    TIME WARNER ENTERTAINMENT COMPANY, L.P.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
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 December 31, 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. To hedge this exposure, Time Warner used foreign
exchange contracts that generally have maturities of three months or less, which
generally will be 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 December 31, 1998, Time Warner had contracts for the sale of $755
million and the purchase of $259 million of foreign currencies at fixed rates.
Of Time Warner's $496 million net sale contract position, $298 million of the
foreign exchange sale contracts and $101 million of the foreign exchange
purchase contracts related to TWE's foreign currency exposure, primarily
Japanese yen (29% of net contract position related to TWE), French francs (29%),
German marks (32%) and Canadian dollars (5%), compared to a net sale contract
position of $105 million of foreign currencies at December 31, 1997. TWE had
deferred approximately $6 million of net losses on foreign exchange contracts at
December 31, 1998, which is all expected to be recognized in income over the
next twelve months. For the years ended December 31, 1998, 1997 and 1996, TWE
recognized $2 million in losses, $14 million in gains and $6 million in gains,
respectively, on foreign exchange contracts, which were or are expected to be
offset by corresponding decreases and increases, respectively, in the dollar
value of foreign currency license fee payments that have been or are anticipated
to be received in cash from the sale of U.S. copyrighted products abroad. Time
Warner places foreign currency contracts with a number of major financial
institutions in order to minimize counterparty credit risk.
 
12.  SEGMENT INFORMATION
 
     TWE classifies its business interests into three fundamental areas: Cable
Networks, consisting principally of interests in cable television programming;
Entertainment, consisting principally of interests in filmed entertainment,
television production and television broadcasting; 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 accounting policies of the business segments
are the same as those described in the
 
                                      F-115
<PAGE>   166
                    TIME WARNER ENTERTAINMENT COMPANY, L.P.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
summary of significant accounting policies (Note 1). Intersegment sales are
accounted for at fair value as if the sales were to third parties.
 
     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 Time Warner Telecom Reorganization effective as of July 1,
1998.
 
<TABLE>
<CAPTION>
                                                            YEARS ENDED DECEMBER 31,
                                                        --------------------------------
                                                         1998         1997        1996
                                                        -------    ----------    -------
                                                                   (MILLIONS)
<S>                                                     <C>        <C>           <C>
REVENUES
Filmed Entertainment-Warner Bros......................  $ 6,051     $ 5,462      $ 5,639
Broadcasting-The WB Network...........................      260         136           87
Cable Networks-HBO....................................    2,052       1,923        1,763
Cable.................................................    4,378       4,243        3,851
Intersegment elimination..............................     (495)       (446)        (488)
                                                        -------     -------      -------
Total.................................................  $12,246     $11,318      $10,852
                                                        =======     =======      =======
</TABLE>
 
<TABLE>
<CAPTION>
                                                            YEARS ENDED DECEMBER 31,
                                                        --------------------------------
                                                         1998         1997        1996
                                                        -------    ----------    -------
                                                                   (MILLIONS)
<S>                                                     <C>        <C>           <C>
EBITA(1)
Filmed Entertainment-Warner Bros......................     $498        $387         $367
Broadcasting-The WB Network...........................      (93)        (88)         (98)
Cable Networks-HBO....................................      454         391          328
Cable(2)..............................................    1,369       1,184          917
                                                        -------     -------      -------
Total.................................................   $2,228      $1,874       $1,514
                                                        =======     =======      =======
</TABLE>
 
---------------
(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 was $1.719
    billion in 1998, $1.444 billion in 1997 and $1.078 billion in 1996.
(2) Includes net gains of approximately $90 million and $200 million recognized
    in 1998 and 1997, respectively, related to the sale or exchange of certain
    cable television systems.
 
<TABLE>
<CAPTION>
                                                            YEARS ENDED DECEMBER 31,
                                                        --------------------------------
                                                         1998         1997        1996
                                                        -------    ----------    -------
                                                                   (MILLIONS)
<S>                                                     <C>        <C>           <C>
DEPRECIATION OF PROPERTY, PLANT AND EQUIPMENT
Filmed Entertainment-Warner Bros......................     $166        $181         $158
Broadcasting-The WB Network...........................        1           1           --
Cable Networks-HBO....................................       23          22           22
Cable.................................................      737         736          619
                                                        -------     -------      -------
Total.................................................     $927        $940         $799
                                                        =======     =======      =======
</TABLE>
 
<TABLE>
<CAPTION>
                                                            YEARS ENDED DECEMBER 31,
                                                        --------------------------------
                                                         1998         1997        1996
                                                        -------    ----------    -------
                                                                   (MILLIONS)
<S>                                                     <C>        <C>           <C>
AMORTIZATION OF INTANGIBLE ASSETS(1)
Filmed Entertainment-Warner Bros......................     $129        $123         $125
Broadcasting-The WB Network...........................        3          --           --
Cable Networks-HBO....................................       --          --           --
Cable.................................................      377         307          311
                                                        -------     -------      -------
Total.................................................     $509        $430         $436
                                                        =======     =======      =======
</TABLE>
 
---------------
(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.
 
                                      F-116
<PAGE>   167
                    TIME WARNER ENTERTAINMENT COMPANY, L.P.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     Information as to the assets and capital expenditures of TWE is as follows:
 
<TABLE>
<CAPTION>
                                                                DECEMBER 31,
                                                        -----------------------------
                                                         1998       1997       1996
                                                        -------    -------    -------
                                                                 (MILLIONS)
<S>                                                     <C>        <C>        <C>
ASSETS
Filmed Entertainment-Warner Bros......................  $ 8,800    $ 8,098    $ 8,057
Broadcasting-The WB Network...........................      244        113         67
Cable Networks-HBO....................................    1,159      1,080        997
Cable.................................................   11,314     10,771     10,202
Corporate(1)..........................................      713        669        650
                                                        -------    -------    -------
Total.................................................  $22,230    $20,731    $19,973
                                                        =======    =======    =======
</TABLE>
 
---------------
(1) Consists principally of cash, cash equivalents and other investments.
 
<TABLE>
<CAPTION>
                                                            YEARS ENDED DECEMBER 31,
                                                           --------------------------
                                                            1998      1997      1996
                                                           ------    ------    ------
                                                                   (MILLIONS)
<S>                                                        <C>       <C>       <C>
CAPITAL EXPENDITURES
Filmed Entertainment-Warner Bros.........................  $  122    $  144    $  340
Broadcasting-The WB Network..............................       1         1         2
Cable Networks-HBO.......................................      23        19        29
Cable(1).................................................   1,451     1,401     1,348
Corporate................................................       6        --        --
                                                           ------    ------    ------
Total....................................................  $1,603    $1,565    $1,719
                                                           ======    ======    ======
</TABLE>
 
---------------
(1) Cable capital expenditures were funded in part through collections on the
    MediaOne Note Receivable in the amount of $169 million in 1996 (Note 1). The
    MediaOne Note Receivable was fully collected during 1996.
 
     Information as to TWE's operations in different geographical areas is as
follows:
 
<TABLE>
<CAPTION>
                                                          YEARS ENDED DECEMBER 31,
                                                        -----------------------------
                                                         1998       1997       1996
                                                        -------    -------    -------
                                                                 (MILLIONS)
<S>                                                     <C>        <C>        <C>
REVENUES(1)
United States.........................................  $10,167    $ 9,086    $ 8,718
United Kingdom........................................      459        488        383
Germany...............................................      263        284        374
Japan.................................................      162        172        196
France................................................      163        152        143
Canada................................................      145        137        157
Other international...................................      887        999        881
                                                        -------    -------    -------
Total.................................................  $12,246    $11,318    $10,852
                                                        =======    =======    =======
</TABLE>
 
---------------
(1) Revenues are attributed to countries based on location of customer.
 
     Because a substantial portion of TWE's international revenues is derived
from the sale of U.S. copyrighted products abroad, assets located outside the
United States are not material.
 
13.  COMMITMENTS AND CONTINGENCIES
 
     TWE's total rent expense amounted to $218 million in 1998, $218 million in
1997 and $205 million in 1996. The minimum rental commitments under
noncancellable long-term operating leases are: 1999-$186 million; 2000-$175
million; 2001-$164 million; 2002-$155 million; 2003-$136 million; and after
2003-$736 million.
 
                                      F-117
<PAGE>   168
                    TIME WARNER ENTERTAINMENT COMPANY, L.P.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     TWE's minimum commitments and guarantees under certain programming,
licensing, franchise and other agreements aggregated approximately $6.3 billion
at December 31, 1998, which are payable principally over a five-year period.
 
     TWE is subject to numerous legal proceedings (including certain litigation
relating to Six Flags). In management's opinion and considering established
reserves, the resolution of these matters will not have a material effect,
individually and in the aggregate, on TWE's financial statements.
 
14.  RELATED PARTY TRANSACTIONS
 
     In the normal course of conducting their businesses, TWE units have had
various transactions with Time Warner units, generally on terms resulting from a
negotiation between the affected units that in management's view results in
reasonable allocations. Employees of TWE participate in various Time Warner
medical, stock option and other benefit plans for which TWE is charged its
allocable share of plan expenses, including administrative costs. In addition,
Time Warner provides TWE with certain corporate services for which TWE paid a
fee in the amount of $72 million, $72 million and $69 million in 1998, 1997 and
1996, respectively.
 
     TWE was required to pay a $130 million advisory fee to MediaOne over a
five-year period that ended September 15, 1998 for MediaOne's expertise in
telecommunications, telephony and information technology, and its participation
in the management and technological upgrade of TWE's cable systems.
 
     TWE has management services agreements with Time Warner's Cable division,
pursuant to which TWE manages, or provides services to, the cable television
systems owned by Time Warner. Such cable television systems also pay fees to TWE
for the right to carry cable television programming provided by TWE's cable
networks. Similarly, TWE's cable television systems pay fees to Time Warner for
the right to carry cable television programming provided by Time Warner's cable
networks.
 
     TWE's Cable division has agreed to sell or exchange various cable
television systems to MediaOne in an effort to strengthen its geographic
clustering of cable television properties.
 
     TWE's Filmed Entertainment-Warner Bros. division has various service
agreements with Time Warner's Filmed Entertainment-TBS division, pursuant to
which TWE's Filmed Entertainment-Warner Bros. division provides certain
management and distribution services for Time Warner's theatrical, television
and animated product, as well as certain services for administrative and
technical support.
 
     Time Warner's Cable Networks-TBS division has license agreements with TWE,
pursuant to which the cable networks have acquired broadcast rights to certain
film and television product. In addition, Time Warner's Music division provides
home videocassette distribution services to certain TWE operations, and certain
TWE units place advertising in magazines published by Time Warner's Publishing
division.
 
     Time Warner has a credit agreement with TWE that allows it to borrow up to
$400 million from TWE through September 15, 2000. Outstanding borrowings from
TWE in the amount of $400 million bear interest at LIBOR plus 1% per annum.
 
     In addition to transactions with its partners, TWE has had transactions
with the Columbia House Company partnerships, Comedy Partners, L.P., Time Warner
Telecom, the Road Runner Joint Venture and other equity investees of Time Warner
and the Entertainment Group, generally with respect to sales of products and
services in the ordinary course of business. TWE also has distribution and
merchandising agreements with Time Warner Entertainment Japan Inc., a company
owned by certain former and existing partners of TWE to conduct TWE's businesses
in Japan.
 
                                      F-118
<PAGE>   169
                    TIME WARNER ENTERTAINMENT COMPANY, L.P.
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
15.  ADDITIONAL FINANCIAL INFORMATION
 
CASH FLOWS
 
     TWE established an asset securitization facility on December 31, 1997,
which effectively provides for the accelerated receipt of up to $500 million of
cash through the year 2000 on available licensing contracts. Assets securitized
under this facility consist of cash contracts for the licensing of theatrical
and television product for broadcast network and syndicated television
exhibition, under which revenues have not been recognized because such product
is not available for telecast until a later date ("Backlog Contracts"). In
connection with this securitization facility, TWE sells, on a revolving and
nonrecourse basis, certain of its Backlog Contracts ("Pooled Backlog Contracts")
to a wholly owned, special purpose entity which, in turn, sells a percentage
ownership interest in the Pooled Backlog Contracts to a third-party, commercial
paper conduit sponsored by a financial institution.
 
     Because the Backlog Contracts securitized under this facility consist of
cash contracts for the licensing of theatrical and television product that have
already been produced, the recognition of revenue for such completed product is
only dependent upon the commencement of the availability period for telecast
under the terms of the licensing agreements. Accordingly, the proceeds received
under the program are classified as deferred revenues in long-term liabilities
in the accompanying consolidated balance sheet. Net proceeds of approximately
$166 million were received under this securitization program in 1998.
 
     Additional financial information with respect to cash flows is as follows:
 
<TABLE>
<CAPTION>
                                                               YEARS ENDED DECEMBER 31,
                                                              --------------------------
                                                               1998      1997      1996
                                                              ------    ------    ------
                                                                      (MILLIONS)
<S>                                                           <C>       <C>       <C>
Cash payments made for interest.............................   $537      $493      $513
Cash payments made for income taxes, net....................     91        95        74
Noncash capital contributions (distributions), net..........    973       399        (1)
</TABLE>
 
     Noncash investing and financing activities in 1998 included the Time Warner
Telecom Reorganization, the TWE-A/N Transfers, the Primestar Roll-up Transaction
and the exchange of certain cable television systems (Note 2).
 
OTHER CURRENT LIABILITIES
 
     Other current liabilities consist of:
 
<TABLE>
<CAPTION>
                                                                DECEMBER 31,
                                                              ----------------
                                                               1998      1997
                                                              ------    ------
                                                                 (MILLIONS)
<S>                                                           <C>       <C>
Accrued expenses............................................  $1,395    $1,159
Accrued compensation........................................     298       253
Deferred revenues...........................................     249       255
                                                              ------    ------
Total.......................................................  $1,942    $1,667
                                                              ======    ======
</TABLE>
 
                                      F-119
<PAGE>   170
 
                         REPORT OF INDEPENDENT AUDITORS
 
The Partners of
Time Warner Entertainment Company, L.P.
 
     We have audited the accompanying consolidated balance sheet of Time Warner
Entertainment Company, L.P. ("TWE") as of December 31, 1998 and 1997, and the
related consolidated statements of operations, cash flows and partnership
capital for each of the three years in the period ended December 31, 1998. Our
audits also included the financial statement schedule listed in the Index at
Item 14(a). These financial statements and schedule are the responsibility of
TWE's management. Our responsibility is to express an opinion on these financial
statements and schedule based on our audits.
 
     We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
 
     In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of TWE at December
31, 1998 and 1997, and the consolidated results of its operations and its cash
flows for each of the three years in the period ended December 31, 1998, in
conformity with generally accepted accounting principles. Also, in our opinion,
the related financial statement schedule, when considered in relation to the
basic financial statements taken as a whole, presents fairly in all material
respects the information set forth therein.
 
                                          ERNST & YOUNG LLP
 
New York, New York
February 3, 1999
 
                                      F-120
<PAGE>   171
 
                    TIME WARNER ENTERTAINMENT COMPANY, L.P.
                         SELECTED FINANCIAL INFORMATION
 
     The selected financial information for each of the five years in the period
ended December 31, 1998 set forth below has been derived from and should be read
in conjunction with the consolidated financial statements and other financial
information presented elsewhere herein. Capitalized terms are as defined and
described in such consolidated financial statements, or elsewhere herein.
 
     The selected historical financial information for 1998 reflects (a) the
TWE-A/N Transfers effective as of January 1, 1998, (b) the Primestar Roll-up
Transaction effective as of April 1, 1998, (c) the formation of the Road Runner
Joint Venture effective as of June 30, 1998 and (d) the Time Warner Telecom
Reorganization effective as of July 1, 1998. The selected historical financial
information for 1995 reflects the consolidation by TWE of TWE-A/N resulting from
the formation of such partnership, effective as of April 1, 1995, and the
consolidation of Paragon effective as of July 6, 1995. The selected historical
financial information gives effect to the deconsolidation of Six Flags resulting
from the disposition by TWE of a 51% interest in Six Flags effective as of June
23, 1995.
 
<TABLE>
<CAPTION>
                                                         YEARS ENDED DECEMBER 31,
                                            --------------------------------------------------
                                             1998       1997       1996       1995       1994
                                            -------    -------    -------    -------    ------
                                                                (MILLIONS)
<S>                                         <C>        <C>        <C>        <C>        <C>
SELECTED OPERATING STATEMENT INFORMATION
Revenues..................................  $12,246    $11,318    $10,852    $ 9,517    $8,460
Depreciation and amortization.............   (1,436)    (1,370)    (1,235)    (1,039)     (943)
Business segment operating income(1)......    1,719      1,444      1,078        960       848
Interest and other, net(2)................     (965)      (345)      (522)      (580)     (587)
Income before extraordinary item..........      326        637        210         97       161
Net income(3).............................      326        614        210         73       161
</TABLE>
 
<TABLE>
<CAPTION>
                                                              DECEMBER 31,
                                           ---------------------------------------------------
                                            1998       1997       1996       1995       1994
                                           -------    -------    -------    -------    -------
                                                               (MILLIONS)
<S>                                        <C>        <C>        <C>        <C>        <C>
SELECTED BALANCE SHEET INFORMATION
Cash and equivalents.....................  $    87    $   322    $   216    $   209    $ 1,071
Total assets.............................   22,230     20,731     19,973     18,905     18,662
Debt due within one year.................        6          8          7         47         32
Long-term debt...........................    6,578      5,990      5,676      6,137      7,160
Preferred stock of subsidiary............      217        233         --         --         --
Time Warner General Partners' Senior
  Capital................................      603      1,118      1,543      1,426      1,663
Partners' capital........................    5,107      6,333      6,574      6,478      6,233
</TABLE>
 
---------------
(1) Includes net gains of approximately $90 million and $200 million recognized
    in 1998 and 1997, respectively, related to the sale or exchange of certain
    cable television systems.
(2) Includes a charge of approximately $210 million in 1998 to reduce the
    carrying value of an interest in Primestar and a gain of approximately $250
    million in 1997 related to the sale of an interest in E! Entertainment.
(3) Net income for each of the years ended December 31, 1997 and 1995 includes
    an extraordinary loss on the retirement of debt of $23 million and $24
    million, respectively.
 
                                      F-121
<PAGE>   172
 
                    TIME WARNER ENTERTAINMENT COMPANY, L.P.
                  QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
 
<TABLE>
<CAPTION>
                                                                          OPERATING
                                                                          INCOME OF      NET
                                                                           BUSINESS     INCOME
QUARTER                                                       REVENUES     SEGMENTS     (LOSS)
-------                                                       --------    ----------    ------
                                                                          (MILLIONS)
<S>                                                           <C>         <C>           <C>
1998
1st.........................................................  $ 2,910       $  369      $ 108
2nd(a)......................................................    2,850          455        155
3rd.........................................................    3,220          468        172
4th(b)......................................................    3,266          427       (109)
Year(a)(b)..................................................   12,246        1,719        326
 
1997
1st(c)......................................................  $ 2,600       $  329      $ 320
2nd.........................................................    2,728          320         82
3rd.........................................................    2,855          335         81
4th(d)(e)...................................................    3,135          460        131
Year........................................................   11,318        1,444        614
</TABLE>
 
---------------
(a) Operating income includes net gains of approximately $90 million for the
    year relating to the sale or exchange of certain cable television systems,
    of which approximately $70 million was recorded in the second quarter of
    1998.
(b) Net income (loss) for the fourth quarter of 1998 includes a charge of
    approximately $210 million principally to reduce the carrying value of an
    interest in Primestar.
(c) Net income in the first quarter of 1997 includes a gain of approximately
    $250 million related to the sale of an interest in E! Entertainment.
(d) Operating income for 1997 includes net gains of approximately $200 million
    for the year relating to the sale or exchange of certain cable television
    systems, of which approximately $160 million was recorded in the fourth
    quarter of 1997.
(e) Net income for the fourth quarter of 1997 includes an extraordinary loss on
    the retirement of debt of $23 million.
 
                                      F-122
<PAGE>   173
 
                    TIME WARNER ENTERTAINMENT COMPANY, L.P.
                SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
                  YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
 
<TABLE>
<CAPTION>
                                                                 ADDITIONS
                                                   BALANCE AT    CHARGED TO                   BALANCE
                                                   BEGINNING     COSTS AND                    AT END
DESCRIPTION                                        OF PERIOD      EXPENSES     DEDUCTIONS    OF PERIOD
-----------                                        ----------    ----------    ----------    ---------
                                                                       (MILLIONS)
<S>                                                <C>           <C>           <C>           <C>
1998:
Reserves deducted from accounts receivable:
  Allowance for doubtful accounts................     $218          $144         $ (91)(a)     $271
  Reserves for sales returns and allowances......      206           338          (309)(b)      235
                                                      ----          ----         -----         ----
Total............................................     $424          $482         $(400)        $506
                                                      ====          ====         =====         ====
1997:
Reserves deducted from accounts receivable:
  Allowance for doubtful accounts................     $195          $113         $ (90)(a)     $218
  Reserves for sales returns and allowances......      178           289          (261)(b)      206
                                                      ----          ----         -----         ----
Total............................................     $373          $402         $(351)        $424
                                                      ====          ====         =====         ====
1996:
Reserves deducted from accounts receivable:
  Allowance for doubtful accounts................     $196          $ 97         $ (98)(a)     $195
  Reserves for sales returns and allowances......      169           278          (269)(b)      178
                                                      ----          ----         -----         ----
Total............................................     $365          $375         $(367)        $373
                                                      ====          ====         =====         ====
</TABLE>
 
---------------
(a) Represents uncollectible receivables charged against the reserve.
(b) Represents returns or allowances applied against the reserve.
 
                                      F-123
<PAGE>   174
 
                                 EXHIBIT INDEX
 
<TABLE>
<CAPTION>
                                                                          SEQUENTIAL
 EXHIBIT                                                                     PAGE
  NUMBER                            DESCRIPTION                             NUMBER
 -------                            -----------                           ----------
<S>         <C>                                                           <C>
 3.(i)(a)   Restated Certificate of Incorporation of the Registrant as        *
            filed with the Secretary of State of the State of Delaware
            on October 10, 1996 (which is incorporated herein by
            reference to Exhibit 4.3 to the Registrant's Post-Effective
            Amendment No. 1 on Form S-8 to the Registrant's Registration
            Statement on Form S-4 filed with the Commission on October
            11, 1996 (Registration No. 333-11471) (the "S-8 Registration
            Statement")).
 3.(i)(b)   Certificate of Increase of the Number of Shares of Series         *
            Common Stock of the Registrant Designated as Series LMCN-V
            Common Stock as filed with the Secretary of State of the
            State of Delaware on August 13, 1997 (which is incorporated
            herein by reference to Exhibit 3.(i)(b) to the Registrant's
            Quarterly Report on Form 10-Q for the quarter ended
            September 30, 1997).
 3.(i)(c)   Certificate of Amendment of Restated Certificate of               *
            Incorporation of the Registrant as filed with the Secretary
            of State of the State of Delaware on May 19, 1997 (which is
            incorporated herein by reference to Exhibit 3.(i)(c) to the
            Registrant's Quarterly Report on Form 10-Q for the quarter
            ended June 30, 1997 (the "June 1997 Form 10-Q")).
 3.(i)(d)   Certificate of Amendment of Restated Certificate of               *
            Incorporation of the Registrant as filed with the Secretary
            of State of the State of Delaware on October 10, 1996 (which
            is incorporated herein by reference to Exhibit 4.4 to the
            Registrant's S-8 Registration Statement).
 3.(i)(e)   Certificate of the Voting Powers, Designations, Preferences       *
            and Relative, Participating, Optional or Other Special
            Rights, and Qualifications, Limitations or Restrictions
            Thereof, of Series LMC Common Stock of the Registrant as
            filed with the Secretary of State of the State of Delaware
            on October 10, 1996 (which is incorporated herein by
            reference to Exhibit 4.5 to the Registrant's S-8
            Registration Statement).
 3.(i)(f)   Certificate of the Voting Powers, Designations, Preferences       *
            and Relative, Participating, Optional or Other Special
            Rights, and Qualifications, Limitations or Restrictions
            Thereof, of Series LMCN-V Common Stock of the Registrant as
            filed with the Secretary of State of the State of Delaware
            on October 10, 1996 (which is incorporated herein by
            reference to Exhibit 4.6 to the Registrant's S-8
            Registration Statement).
 3.(i)(g)   Certificate of the Voting Powers, Designations, Preferences       *
            and Relative, Participating, Optional or Other Special
            Rights, and Qualifications, Limitations or Restrictions
            Thereof, of Series A Participating Cumulative Preferred
            Stock of the Registrant as filed with the Secretary of State
            of the State of Delaware on October 10, 1996 (which is
            incorporated herein by reference to Exhibit 4.7 to the
            Registrant's S-8 Registration Statement).
 3.(i)(h)   Certificate of the Voting Powers, Designations, Preferences       *
            and Relative, Participating, Optional or Other Special
            Rights, and Qualifications, Limitations or Restrictions
            Thereof, of Series D Convertible Preferred Stock of the
            Registrant as filed with the Secretary of State of the State
            of Delaware on October 10, 1996 (which is incorporated
            herein by reference to Exhibit 4.8 to the Registrant's S-8
            Registration Statement).
</TABLE>
 
                                        i
<PAGE>   175
 
<TABLE>
<CAPTION>
                                                                          SEQUENTIAL
 EXHIBIT                                                                     PAGE
  NUMBER                            DESCRIPTION                             NUMBER
 -------                            -----------                           ----------
<S>         <C>                                                           <C>
 3.(i)(i)   Certificate of the Voting Powers, Designations, Preferences       *
            and Relative, Participating, Optional or Other Special
            Rights, and Qualifications, Limitations or Restrictions
            Thereof, of Series E Convertible Preferred Stock of the
            Registrant as filed with the Secretary of State of the State
            of Delaware on October 10, 1996 (which is incorporated
            herein by reference to Exhibit 4.9 to the Registrant's S-8
            Registration Statement).
 3.(i)(j)   Certificate of Correction of the Certificate of the Voting        *
            Powers, Designations, Preferences and Relative,
            Participating, Optional or Other Special Rights, and
            Qualifications, Limitations or Restrictions Thereof, of
            Series E Convertible Preferred Stock of the Registrant as
            filed with the Secretary of State of the State of Delaware
            on November 13, 1996 (which is incorporated herein by
            reference to Exhibit 3.i(h) to the Registrant's Annual
            Report on Form 10-K for the year ended December 31, 1996
            (the "1996 Form 10-K")).
 3.(i)(k)   Certificate of the Voting Powers, Designations, Preferences       *
            and Relative, Participating, Optional or Other Special
            Rights, and Qualifications, Limitations or Restrictions
            Thereof, of Series F Convertible Preferred Stock of the
            Registrant as filed with the Secretary of State of the State
            of Delaware on October 10, 1996 (which is incorporated
            herein by reference to Exhibit 4.10 to the Registrant's S-8
            Registration Statement).
 3.(i)(l)   Certificate of Correction of the Certificate of the Voting        *
            Powers, Designations, Preferences and Relative,
            Participating, Optional or Other Special Rights, and
            Qualifications, Limitations or Restrictions Thereof, of
            Series F Convertible Preferred Stock of the Registrant as
            filed with the Secretary of State of the State of Delaware
            on November 13, 1996 (which is incorporated herein by
            reference to Exhibit 3.(i)(j) of the Registrant's 1996 Form
            10-K).
 3.(i)(m)   Certificate of Elimination of the Certificate of the Voting
            Powers, Designations, Preferences and Relative,
            Participating, Optional or Other Special Rights and
            Qualifications, Limitations or Restrictions Thereof, of
            Series G Convertible Preferred Stock of the Registrant as
            filed with the Secretary of State of the State of Delaware
            on March 18, 1999.
 3.(i)(n)   Certificate of the Voting Powers, Designations, Preferences       *
            and Relative, Participating, Optional or Other Special
            Rights, and Qualifications, Limitations or Restrictions
            Thereof, of Series G Convertible Preferred Stock of the
            Registrant as filed with the Secretary of State of the State
            of Delaware on October 10, 1996 (which is incorporated
            herein by reference to Exhibit 4.11 to the Registrant's S-8
            Registration Statement).
 3.(i)(o)   Certificate of Elimination of the Certificate of the Voting
            Powers, Designations, Preferences and Relative,
            Participating, Optional or Other Special Rights and
            Qualifications, Limitations or Restrictions Thereof, of
            Series H Convertible Preferred Stock of the Registrant as
            filed with the Secretary of State of the State of Delaware
            on March 18, 1999.
 3.(i)(p)   Certificate of the Voting Powers, Designations, Preferences       *
            and Relative, Participating, Optional or Other Special
            Rights, and Qualifications, Limitations or Restrictions
            Thereof, of Series H Convertible Preferred Stock of the
            Registrant as filed with the Secretary of State of the State
            of Delaware on October 10, 1996 (which is incorporated
            herein by reference to Exhibit 4.12 to the Registrant's S-8
            Registration Statement).
</TABLE>
 
                                       ii
<PAGE>   176
 
<TABLE>
<CAPTION>
                                                                          SEQUENTIAL
 EXHIBIT                                                                     PAGE
  NUMBER                            DESCRIPTION                             NUMBER
 -------                            -----------                           ----------
<S>         <C>                                                           <C>
 3.(i)(q)   Certificate of the Voting Powers, Designations, Preferences       *
            and Relative, Participating, Optional or Other Special
            Rights, and Qualifications, Limitations or Restrictions
            Thereof, of Series I Convertible Preferred Stock of the
            Registrant as filed with the Secretary of State of the State
            of Delaware on October 10, 1996 (which is incorporated
            herein by reference to Exhibit 4.13 to the Registrant's S-8
            Registration Statement).
 3.(i)(r)   Certificate of the Voting Powers, Designations, Preferences       *
            and Relative, Participating, Optional or Other Special
            Rights, and Qualifications, Limitations or Restrictions
            Thereof, of Series J Convertible Preferred Stock of the
            Registrant as filed with the Secretary of State of the State
            of Delaware on October 10, 1996 (which is incorporated
            herein by reference to Exhibit 4.14 to the Registrant's S-8
            Registration Statement).
 3.(i)(s)   Certificate of Elimination of the Voting Powers,
            Designations, Preferences and Relative, Participating,
            Optional or Other Special Rights, and Qualifications,
            Limitations or Restrictions Thereof, of 10 1/4% Series M
            Exchangeable Preferred Stock of the Registrant as filed with
            the Secretary of State of the State of Delaware on March 18,
            1999.
 3.(i)(t)   Certificate of the Voting Powers, Designations, Preferences       *
            and Relative, Participating, Optional or Other Special
            Rights, and Qualifications, Limitations or Restrictions
            Thereof, of 10 1/4% Series M Exchangeable Preferred Stock of
            the Registrant as filed with the Secretary of State of the
            State of Delaware on October 10, 1996 (which is incorporated
            herein by reference to Exhibit 4.15 to the Registrant's S-8
            Registration Statement).
 3.(ii)     By-laws of the Registrant as of November 19, 1998.
 4.1        Rights Agreement (the "Rights Agreement") dated as of             *
            October 10, 1996 between the Registrant and ChaseMellon
            Shareholder Services L.L.C. ("ChaseMellon") (which is
            incorporated herein by reference to Exhibit 4.17 to the
            Registrant's S-8 Registration Statement).
 4.2        Amendment No. 1 to the Rights Agreement dated as of December
            15, 1998 between the Registrant and ChaseMellon.
 4.3        Amendment No. 2 to the Rights Agreement dated as of January
            21, 1999 between the Registrant and ChaseMellon.
 4.4        Indenture dated as of June 1, 1998 among the Registrant,          *
            Time Warner Companies, Inc. ("TWCI"), Turner Broadcasting
            System, Inc. ("TBS") and The Chase Manhattan Bank, as
            Trustee ("Chase Manhattan") (which is incorporated herein by
            reference to Exhibit 4 to the Registrant's Quarterly Report
            on Form 10-Q for the period ended June 30, 1998).
 4.5        Indenture dated as of April 30, 1992, as amended by the           *
            First Supplemental Indenture, dated as of June 30, 1992,
            among Time Warner Entertainment Company, L.P. ("TWE"), TWCI,
            certain of TWCI's subsidiaries that are parties thereto and
            The Bank of New York ("BONY"), as Trustee (which is
            incorporated herein by reference to Exhibits 10(g) and 10(h)
            to TWCI's Current Report on Form 8-K dated July 14, 1992
            (File No. 1-8637) ("TWCI's July 1992 Form 8-K")).
</TABLE>
 
                                       iii
<PAGE>   177
 
<TABLE>
<CAPTION>
                                                                          SEQUENTIAL
 EXHIBIT                                                                     PAGE
  NUMBER                            DESCRIPTION                             NUMBER
 -------                            -----------                           ----------
<S>         <C>                                                           <C>
 4.6        Second Supplemental Indenture, dated as of December 9, 1992,      *
            among TWE, TWCI, certain of TWCI's subsidiaries that are
            parties thereto and BONY, as Trustee (which is incorporated
            herein by reference to Exhibit 4.2 to Amendment No. 1 to
            TWE's Registration Statement on Form S-4 (Registration No.
            33-67688) filed with the Commission on October 25, 1993
            ("TWE's 1993 Form S-4")).
 4.7        Third Supplemental Indenture, dated as of October 12, 1993,       *
            among TWE, TWCI, certain of TWCI's subsidiaries that are
            parties thereto and BONY, as Trustee (which is incorporated
            herein by reference to Exhibit 4.3 to TWE's 1993 Form S-4).
 4.8        Fourth Supplemental Indenture, dated as of March 29, 1994,        *
            among TWE, TWCI, certain of TWCI's subsidiaries that are
            parties thereto and BONY, as Trustee (which is incorporated
            herein by reference to Exhibit 4.4 to TWE's Annual Report on
            Form 10-K for the year ended December 31, 1993 (File No.
            1-12259) ("TWE's 1993 Form 10-K")).
 4.9        Fifth Supplemental Indenture, dated as of December 28, 1994,      *
            among TWE, TWCI, certain of TWCI's subsidiaries that are
            parties thereto and BONY, as Trustee (which is incorporated
            herein by reference to Exhibit 4.5 to TWE's Annual Report on
            Form 10-K for the year ended December 31, 1994 (File No.
            1-12259)).
 4.10       Sixth Supplemental Indenture, dated as of September 29,           *
            1997, among TWE, TWCI, certain of TWCI's subsidiaries that
            are parties thereto and BONY, as Trustee (which is
            incorporated herein by reference to Exhibit 4.7 to the
            Registrant's Annual Report on Form 10-K for the year ended
            December 31, 1997 (the "1997 Form 10-K)).
 4.11       Seventh Supplemental Indenture, dated as of December 29,          *
            1997, among TWE, TWCI, certain of TWCI's subsidiaries that
            are parties thereto and BONY, as Trustee (which is
            incorporated herein by reference to Exhibit 4.7 to the
            Registrant's 1997 Form 10-K).
 4.12       Indenture dated as of January 15, 1993 between TWCI and           *
            Chase Manhattan, as Trustee (which is incorporated herein by
            reference to Exhibit 4.11 to TWCI's Annual Report on Form
            10-K for the year ended December 31, 1992 (File No.
            1-8637)).
 4.13       First Supplemental Indenture dated as of June 15, 1993            *
            between TWCI and Chase Manhattan, as Trustee (which is
            incorporated herein by reference to Exhibit 4 to TWCI's
            Quarterly Report on Form 10-Q for the quarter ended June 30,
            1993 (File No. 1-8637)).
 4.14       Second Supplemental Indenture dated as of October 10, 1996        *
            among the Registrant, TWCI and Chase Manhattan, as Trustee
            (which is incorporated herein by reference to Exhibit 4.1 to
            TWCI's Quarterly Report on Form 10-Q for the quarter ended
            September 30, 1996).
 4.15       Third Supplemental Indenture dated as of December 31, 1996        *
            among the Registrant, TWCI and Chase Manhattan, as Trustee
            (which is incorporated herein by reference to Exhibit 4.10
            to the Registrant's 1996 Form 10-K).
</TABLE>
 
                                       iv
<PAGE>   178
 
<TABLE>
<CAPTION>
                                                                          SEQUENTIAL
 EXHIBIT                                                                     PAGE
  NUMBER                            DESCRIPTION                             NUMBER
 -------                            -----------                           ----------
<S>         <C>                                                           <C>
 4.16       Fourth Supplemental Indenture dated as of December 17, 1997       *
            among the Registrant, TWCI, Turner Broadcasting System, Inc.
            ("TBS") and Chase Manhattan, as Trustee (which is
            incorporated herein by reference to Exhibit 4.4 to the
            Registrant's, TWCI's and TBS's Registration Statement on
            Form S-4 (Registration Nos. 333-45703, 333-45703-02 and
            333-45703-01) filed with the Commission on February 5, 1998
            (the "1998 Form S-4").
 4.17       Fifth Supplemental Indenture dated as of January 12, 1998         *
            among the Registrant, TWCI, TBS and Chase Manhattan, as
            Trustee (which is incorporated herein by reference to
            Exhibit 4.5 to the Registrant's, TWCI's and TBS's 1998 Form
            S-4).
 4.18       Sixth Supplemental Indenture dated as of March 17, 1998           *
            among the Registrant, TWCI, TBS and Chase Manhattan, as
            Trustee (which is incorporated herein by reference to
            Exhibit 4.15 to the Registrant's 1997 Form 10-K).
 4.19       Trust Agreement dated as of April 1, 1998 among the               *
            Registrant, as Grantor and U.S. Trust Company of California,
            N.A., as Trustee (which is incorporated herein by reference
            to Exhibit 4.16 to the Registrant's 1997 Form 10-K).
10.1        Time Warner 1986 Stock Option Plan, as amended through March      *
            20, 1997 (which is incorporated herein by reference to
            Exhibit 10.1 to the Registrant's 1997 Form 10-K).
10.2        1988 Stock Incentive Plan of Time Warner Inc., as amended         *
            through March 20, 1997 (which is incorporated herein by
            reference to Exhibit 10.2 to the Registrant's 1997 Form
            10-K).
10.3        Time Warner 1989 Stock Incentive Plan, as amended through         *
            March 20, 1997 (which is incorporated herein by reference to
            Exhibit 10.3 to the Registrant's 1997 Form 10-K).
10.4        Time Warner 1994 Stock Option Plan, as amended through
            November 19, 1998.
10.5        Time Warner Corporate Group Stock Incentive Plan, as amended      *
            through March 20, 1997 (which is incorporated herein by
            reference to Exhibit 10.5 to the Registrant's 1997 Form
            10-K).
10.6        Time Warner 1997 Stock Option Plan (which is incorporated         *
            herein by reference to Annex A to the Registrant's
            definitive Proxy Statement dated March 28, 1997 used in
            connection with the Registrant's 1997 annual meeting of
            stockholders).
10.7        Time Warner 1988 Restricted Stock Plan for Non-Employee           *
            Directors, as amended through November 18, 1993 (which is
            incorporated herein by reference to Exhibit 10.8 of TWCI's
            Annual Report on Form 10-K for the year ended December 31,
            1993 (File No. 1-8637) ("TWCI's 1993 Form 10-K")).
10.8        Time Warner 1996 Stock Option Plan for Non-Employee               *
            Directors (which is incorporated herein by reference to
            Annex A to TWCI's definitive Proxy Statement dated March 29,
            1996 used in connection with TWCI's 1996 Annual Meeting of
            Stockholders).
10.9        Deferred Compensation Plan for Directors of Time Warner, as       *
            amended through November 18, 1993 (which is incorporated
            herein by reference to Exhibit 10.9 to TWCI's 1993 Form 10-K
            (File No. 1-8637)).
10.10       Time Warner Retirement Plan for Outside Directors, as             *
            amended through May 16, 1996 (which is incorporated herein
            by reference to Exhibit 10.9 to the Registrant's 1996 Form
            10-K).
</TABLE>
 
                                        v
<PAGE>   179
 
<TABLE>
<CAPTION>
                                                                          SEQUENTIAL
 EXHIBIT                                                                     PAGE
  NUMBER                            DESCRIPTION                             NUMBER
 -------                            -----------                           ----------
<S>         <C>                                                           <C>
10.11       Amended and Restated Time Warner Inc. Annual Bonus Plan for       *
            Executive Officers (which is incorporated herein by
            reference to Annex A to TWCI's definitive Proxy Statement
            dated March 30, 1995 used in connection with TWCI's 1995
            Annual Meeting of Stockholders).
10.12       Time Warner Inc. Deferred Compensation Plan (which is             *
            incorporated herein by reference to Exhibit 4 to the
            Registrant's Registration Statement on Form S-8 filed with
            the Commission on December 18, 1998 (Registration No.
            333-69161)).
10.13       Amended and Restated Employment Agreement effective as of
            January 1, 1998, as amended December 2, 1998, between the
            Registrant and Gerald M. Levin.
10.14       Amended and Restated Employment Agreement effective as of
            January 1, 1998, as amended December 15, 1998, between the
            Registrant and R.E. Turner ("Turner").
10.15       Amended and Restated Employment Agreement effective as of
            January 1, 1999, between the Registrant and Richard D.
            Parsons.
10.16       Amended and Restated Employment Agreement effective as of
            January 1, 1998, as amended December 2, 1998, between the
            Registrant and Peter R. Haje.
10.17       Amended and Restated Employment Agreement effective as of
            January 1, 1999, between the Registrant and Richard J.
            Bressler.
10.18       Amended and Restated Employment Agreement effective as of
            April 1, 1998, as amended December 2, 1998, between the
            Registrant and Timothy A. Boggs.
10.19       Amended and Restated Employment Agreement effective as of
            April 1, 1998, as amended December 2, 1998, between the
            Registrant and John A. LaBarca.
10.20       Employment Agreement effective as of January 11, 1999,
            between the Registrant and Andrew J. Kaslow.
10.21       Second Amended and Restated LMC Agreement dated as of             *
            September 22, 1995 among TWCI, Liberty Media Corporation
            ("LMC"), TCI Turner Preferred, Inc. ("TCITP"), Communication
            Capital Corp. ("CCC") and United Cable Turner Investment,
            Inc. (which is incorporated herein by reference to Exhibit
            10(a) to TWCI's Current Report on Form 8-K dated September
            6, 1996 ("TWCI's September 1996 Form 8-K")).
10.22       Agreement Containing Consent Order dated August 14, 1996          *
            among TWCI, TBS, Tele-Communications, Inc., LMC and the
            Federal Trade Commission (which is incorporated herein by
            reference to Exhibit 2(b) to TWCI's September 1996 Form
            8-K).
10.23       Stockholders' Agreement dated as of October 10, 1996 among        *
            the Registrant, Turner, TCITP, Liberty Broadcasting Inc.
            CCC, Turner Outdoor Inc. ("Turner Outdoor") and Turner
            Partners, L.P. ("Turner's Partners") (which is incorporated
            herein by reference to Exhibit 10.22 to the Registrant's
            1996 Form 10-K).
10.24       Investors Agreement (No. 1) dated as of October 10, 1996          *
            among the Registrant, Turner, Turner Outdoor and Turner
            Partners (which is incorporated herein by reference to
            Exhibit 10.23 to the Registrant's 1996 Form 10-K).
10.25       Investors Agreement (No. 2) dated as of October 10, 1996          *
            among the Registrant, Turner Foundation, Inc. ("Turner
            Foundation") and Robert E. Turner Charitable Remainder
            Unitrust No. 2 ("Turner Trust") (which is incorporated
            herein by reference to Exhibit 10.24 to the Registrant's
            1996 Form 10-K).
</TABLE>
 
                                       vi
<PAGE>   180
 
<TABLE>
<CAPTION>
                                                                          SEQUENTIAL
 EXHIBIT                                                                     PAGE
  NUMBER                            DESCRIPTION                             NUMBER
 -------                            -----------                           ----------
<S>         <C>                                                           <C>
10.26       Registration Rights Agreement dated as of October 10, 1996        *
            among the Registrant, Turner, Turner Outdoor, Turner
            Foundation, Turner Trust and Turner Partners (which is
            incorporated herein by reference to Exhibit 10.25 to the
            Registrant's 1996 Form 10-K).
10.27       Credit Agreement dated as of November 10, 1997 among the          *
            Registrant, TWCI, TWE, TBS, Time Warner
            Entertainment-Advance/Newhouse Partnership ("TWE-A/N
            Partnership") and TWI Cable Inc., as Credit Parties, Chase
            Manhattan, as Administrative Agent, Bank of America National
            Trust and Savings Association, BONY and Morgan Guaranty
            Trust Company of New York, as Documentation and Syndication
            Agents and Chase Securities Inc., as Arranger (which is
            incorporated herein by reference to Exhibit 10.26 to the
            Registrant's 1997 Form 10-K).
10.28       Agreement of Limited Partnership, dated as of October 29,         *
            1991, as amended by the Letter Agreement, dated February 11,
            1992, and the Letter Agreement dated June 23, 1992, among
            TWCI and certain of its subsidiaries, ITOCHU Corporation
            ("ITOCHU") and Toshiba Corporation ("Toshiba") ("TWE
            Partnership Agreement, as amended") (which is incorporated
            herein by reference to Exhibit (A) to TWCI's Current Report
            on Form 8-K dated October 29, 1991 (File No. 1-8637) and
            Exhibit 10(b) and 10(c) to TWCI's July 1992 Form 8-K).
10.29       Admission Agreement, dated as of May 16, 1993, between TWE        *
            and US WEST, Inc. ("US West") (which is incorporated herein
            by reference to Exhibit 10(a) to TWE's Current Report on
            Form 8-K dated May 16, 1993 (File No. 1-2878)).
10.30       Amendment Agreement, dated as of September 14, 1993, among        *
            ITOCHU, Toshiba, TWCI, US West and certain of their
            respective subsidiaries, amending the TWE Partnership
            Agreement, as amended (which is incorporated herein by
            reference to Exhibit 3.2 to TWE's 1993 Form 10-K (File No.
            1-2878)).
10.31       Restructuring Agreement dated as of August 31, 1995 among         *
            TWCI, ITOCHU and ITOCHU Entertainment Inc. (which is
            incorporated herein by reference to Exhibit 2(a) to TWCI's
            Current Report on Form 8-K dated August 31, 1995 ("TWCI's
            August 1995 Form 8-K")).
10.32       Restructuring Agreement dated as of August 31, 1995 between       *
            TWCI and Toshiba (including Form of Registration Rights
            Agreement, between TWCI and Toshiba) (which is incorporated
            herein by reference to Exhibit 2(b) to TWCI's August 1995
            Form 8-K).
10.33       Option Agreement, dated as of September 15, 1993, between         *
            TWE and US West (which is incorporated herein by reference
            to Exhibit 10.9 to TWE's 1993 Form 10-K (File No. 1-2878)).
10.34       Contribution Agreement dated as of September 9, 1994 among        *
            TWE, Advance Publications, Inc. ("Advance Publications"),
            Newhouse Broadcasting Corporation ("Newhouse"),
            Advance/Newhouse Partnership ("Advance/Newhouse"), and
            TWE-AN Partnership (which is incorporated herein by
            reference to Exhibit 10(a) to TWE's Current Report on Form
            8-K dated September 9, 1994 ("TWE's September 1994 Form
            8-K")).
10.35       Partnership Agreement, dated as of September 9, 1994,             *
            between TWE and Advance/Newhouse (which is incorporated
            herein by reference to Exhibit 10(b) to TWE's September 1994
            Form 8-K).
</TABLE>
 
                                       vii
<PAGE>   181
 
<TABLE>
<CAPTION>
                                                                          SEQUENTIAL
 EXHIBIT                                                                     PAGE
  NUMBER                            DESCRIPTION                             NUMBER
 -------                            -----------                           ----------
<S>         <C>                                                           <C>
10.36       Letter Agreement dated April 1, 1995 among TWE,                   *
            Advance/Newhouse, Advance Publications and Newhouse (which
            is incorporated herein by reference to Exhibit 10(c) to
            TWE's Current Report on Form 8-K dated April 1, 1995).
10.37       Amended and Restated Transaction Agreement, dated as of           *
            October 27, 1997 among Advance Publications,
            Advance/Newhouse, TWE, TW Holding Co. and TWE-AN Partnership
            (which is incorporated herein by reference to Exhibit 99(c)
            to the Registrant's Current Report on Form 8-K dated October
            27, 1997).
10.38       Transaction Agreement No. 2 dated as of June 23, 1998 among
            Advance Publications, Newhouse, Advance/Newhouse, TWE,
            Paragon Communications ("Paragon") and TWE-AN Partnership.
10.39       Transaction Agreement No. 3 dated as of September 15, 1998
            among Advance Publications, Newhouse, Advance/Newhouse, TWE,
            Paragon and TWE-AN Partnership.
10.40       First Amendment to the Partnership Agreement of TWE-AN
            Partnership dated as of February 12, 1998 among TWE,
            Advance/Newhouse and TW Holding Co.
10.41       Second Amendment to the Partnership Agreement of TWE-AN
            Partnership dated as of December 31, 1998 among TWE,
            Advance/Newhouse and Paragon.
10.42       Third Amendment to the Partnership Agreement of TWE-AN
            Partnership dated as of March 1, 1999 among TWE,
            Advance/Newhouse and Paragon.
21          Subsidiaries of the Registrant.
23          Consent of Ernst & Young LLP, Independent Auditors.
27          Financial Data Schedule.
99.1        Annual Report on Form 11-K of the Time Warner Savings Plan
            for the year ended December 31, 1998 (to be filed by
            amendment).
99.2        Annual Report on Form 11-K of the Time Warner Thrift Plan
            for the year ended December 31, 1998 (to be filed by
            amendment).
99.3        Annual Report on Form 11-K of the TWC Savings Plan for the
            year ended December 31, 1998 (to be filed by amendment).
</TABLE>
 
---------------
* Incorporated by reference.
 
     The Registrant hereby agrees to furnish to the Securities and Exchange
Commission at its request copies of long-term debt instruments defining the
rights of holders of outstanding long-term debt that are not required to be
filed herewith.
 
                                      viii