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Warner Music Group Corp. - Annual Report: 2018 (Form 10-K)

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

(Mark One)

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended September 30, 2018

OR

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission File Number 001-32502

 

Warner Music Group Corp.

(Exact name of Registrant as specified in its charter)

 

 

Delaware

 

13-4271875

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

1633 Broadway

New York, NY

 

10019

(Address of principal executive offices)

 

(Zip Code)

Registrant’s telephone number, including area code: (212) 275-2000

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act: None

 

Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes      No  

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes      No  

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes      No  

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulations S-T (§232.405 of this chapter) during the preceding 12 months (or for shorter period that the registrant was required to submit such files).    Yes      No  

Indicate by check mark if the disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendments to this Form 10-K.  

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer

 

  

 

 

Accelerated filer

 

 

 

 

 

 

Non-accelerated filer

 

  

 

 

Smaller reporting company

 

Emerging growth company

 

 

 

 

 

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.)    Yes      No  

There is no public market for the Registrant’s common stock. As of December 20, 2018 the number of shares of the Registrant’s common stock, par value $0.001 per share, outstanding was 1,052. All of the Registrant’s common stock is owned by affiliates of Access Industries, Inc. The Registrant has filed all Exchange Act reports for the preceding 12 months.

 

 

 

 


 

WARNER MUSIC GROUP CORP.

INDEX

 

 

  

 

  

 

Page
Number

 Part I.

  

Item 1.

  

 Business

 

1

 

  

 Item 1A.

  

 Risk Factors

 

16

 

  

 Item 1B.

  

 Unresolved Staff Comments

 

27

 

  

 Item 2.

  

 Properties

 

28

 

  

 Item 3.

  

 Legal Proceedings

 

28

 

  

 Item 4.

  

 Mine Safety Disclosures

 

29

 Part II.

  

 Item 5.

  

 Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

30

 

  

 Item 6.

  

 Selected Financial Data

 

31

 

  

 Item 7.

  

 Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

32

 

  

 Item 7A.

  

 Quantitative and Qualitative Disclosures About Market Risk

 

72

 

  

 Item 8.

  

 Financial Statements and Supplementary Data

 

73

 

  

 Item 9.

  

 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

 

123

 

  

 Item 9A.

  

 Controls and Procedures

 

123

 

  

 Item 9B.

  

 Other Information

 

124

 Part III.

  

 Item 10.

  

 Directors, Executive Officers and Corporate Governance

 

125

 

  

 Item 11.

  

 Executive Compensation

 

131

 

  

 Item 12.

  

 Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

 

146

 

  

 Item 13.

  

 Certain Relationships and Related Transactions, and Director Independence

 

147

 

  

 Item 14.

  

 Principal Accountant Fees and Services

 

149

Part IV.

  

Item 15.

  

 Exhibits and Financial Statement Schedules

 

150

 

 

Item 16.

  

 Form 10-K Summary

 

155

Signatures

 

156

 

 

 

 


 

ITEM 1.

BUSINESS

FORWARD-LOOKING STATEMENTS

This annual report on Form 10-K (this “Annual Report”) includes “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These statements are based on current expectations, estimates, forecasts and projections about the industry in which we operate, management’s beliefs and assumptions. Words such as “may,” “will,” “expect,” “intend,” “estimate,” “anticipate,” “believe,” or “continue” or the negative thereof or variations of such words and similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and involve risks, uncertainties and assumptions, which are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in such forward-looking statements. We disclaim any duty to update or revise any forward-looking statements whether as a result of new information, future events or otherwise.

Introduction

Warner Music Group Corp. (the “Company”) was formed on November 21, 2003. We are the direct parent of WMG Holdings Corp. (“Holdings”), which is the direct parent of WMG Acquisition Corp. (“Acquisition Corp.”). Acquisition Corp. is one of the world’s major music-based content companies.

Acquisition of Warner Music Group by Access Industries

Pursuant to the Agreement and Plan of Merger, dated as of May 6, 2011 (the “Merger Agreement”), by and among the Company, AI Entertainment Holdings LLC (formerly Airplanes Music LLC), a Delaware limited liability company (“Parent”) and an affiliate of Access Industries, Inc. (“Access”), and Airplanes Merger Sub, Inc., a Delaware corporation and a wholly owned subsidiary of Parent (“Merger Sub”), on July 20, 2011 (the “Merger Closing Date”), Merger Sub merged with and into the Company with the Company surviving as a wholly owned subsidiary of Parent (the “Merger”). In connection with the Merger, the Company delisted its common stock from the New York Stock Exchange (the “NYSE”). The Company continues to voluntarily file with the U.S. Securities and Exchange Commission (the “SEC”) current and periodic reports that would be required to be filed with the SEC pursuant to Section 15(d) of the Exchange Act as provided for in certain covenants contained in the instruments covering its outstanding indebtedness. All of the Company’s common stock is owned by affiliates of Access.

Our Company

We are one of the world’s major music-based content companies. Our company is composed of two businesses: Recorded Music and Music Publishing. We believe we are the world’s third-largest recorded music company and also the world’s third-largest music publishing company. We are a global company, generating over half of our revenues in more than 50 countries outside of the United States. We generated revenues of $4.005 billion during the fiscal year ended September 30, 2018.

Our Recorded Music business produces revenue primarily through the marketing, sale and licensing of recorded music in various physical (such as CDs, Vinyl and DVDs) and digital (such as streaming and downloads) formats. We have one of the world’s largest and most diverse recorded music catalogs. Our Recorded Music business also benefits from additional revenue streams associated with artists, including merchandising, fan clubs, sponsorships, concert promotions and artist management, among other areas. Some of these revenues streams are generated through rights we receive in our recording agreements. We often refer to these rights as “artist services and expanded-rights” and to the recording agreements which provide us with participations in such rights as “expanded-rights deals” or “360° deals.” We have also made a number of recent acquisitions aimed at expanding our Recorded Music business, including Sodatone, a premier artist and repertoire (“A&R”) insight tool, UPROXX, one of the most influential media brands for youth culture; Spinnin’ Records, one of the world’s leading independent electronic music companies; Songkick, the live music and ticketing destination, and in October 2018 the acquisition of EMP Merchandising, one of Europe’s leading specialty music and entertainment merchandise e-tailers. Prior to intersegment eliminations, our Recorded Music business generated revenues of $3.360 billion during the fiscal year ended September 30, 2018.

Our Music Publishing business owns and acquires rights to musical compositions, exploits and markets these compositions, and receives royalties or fees for their use. We publish music across a broad range of musical styles and hold rights in over one million copyrights from over 70,000 songwriters and composers. Prior to intersegment eliminations, our Music Publishing business generated revenues of $653 million during the fiscal year ended September 30, 2018.

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We maintain an Internet site at www.wmg.com. Our website and the information posted on it or connected to it shall not be deemed to be incorporated by reference into this Annual Report.

Company History

Our history dates back to 1929, when Jack Warner, president of Warner Bros. Pictures, founded Music Publishers Holding Company (“MPHC”) to acquire music copyrights as a means of providing inexpensive music for films. Encouraged by the success of MPHC, Warner Bros. extended its presence in the music industry with the founding of Warner Bros. Records in 1958 as a means of distributing movie soundtracks and further utilizing actors’ contracts. For over 50 years, Warner Bros. Records has led the industry both creatively and financially with the discovery of many of the world’s biggest recording artists. Warner Bros. Records acquired Frank Sinatra’s Reprise Records in 1963. Our Atlantic Records label was launched in 1947 by Ahmet Ertegun and Herb Abramson as a small New York-based label focused on jazz and R&B and Elektra Records was founded in 1950 by Jac Holzman as a folk music label. Atlantic Records and Elektra Records were consolidated in 2004 to form the Atlantic Records Group. Since 1970, our international Recorded Music business has been responsible for the sale and marketing of our U.S. recording artists abroad as well as the discovery and development of international recording artists.

Chappell & Intersong Music Group, including Chappell & Co., a company whose history dates back to 1811, was acquired in 1987, expanding our Music Publishing business. We continue to diversify our presence through acquisitions and joint ventures with various labels, such as our acquisition of Ryko in 2006, our acquisition of a majority interest in Roadrunner Music Group B.V. (“Roadrunner”) in 2007 (we also acquired the remaining interest in Roadrunner in 2010), the acquisition of Spinnin’ in 2017, and the acquisition of music publishing catalogs and businesses, such as the Non-Stop Music production music catalog in 2007 and Southside Independent Music Publishing in 2011.

On July 20, 2011, we completed the Merger with an affiliate of Access pursuant to which Access became the beneficial owner of 100% of our equity and our controlling shareholder.

On July 1, 2013, we completed the acquisition (the “PLG Acquisition”) of Parlophone Label Group (“PLG”). PLG included a broad range of some of the world’s best-known recordings and classic and contemporary artists spanning a wide array of musical genres. PLG was comprised of the historic Parlophone label and Chrysalis and Ensign labels in the U.K., as well as EMI Classics and Virgin Classics, and EMI’s recorded music operations in Belgium, Czech Republic, Denmark, France, Norway, Poland, Portugal, Slovakia, Spain and Sweden. PLG’s artists included Air, Alain Souchon, Camille, Coldplay, Daft Punk, Danger Mouse, David Bowie, David Guetta, Deep Purple, Duran Duran, Eliza Doolittle, Gorillaz, Iron Maiden, Jean-Louis Aubert, Jethro Tull, Julien Clerc, Kylie Minogue, M. Pokora, Magic System, Pablo Alborán, Pink Floyd, Roxette, Tina Turner and Tinie Tempah, as well as many developing and up-and-coming artists. PLG’s EMI Classics and Virgin Classics brand names were not included with the PLG Acquisition. WMG has rebranded these businesses, respectively, as Warner Classics and Erato.

Warner Music Group is today home to a collection of record labels, including Asylum, Atlantic, Big Beat, Canvasback, East West, Elektra, Erato, FFRR, Fueled by Ramen, Nonesuch, Parlophone, Reprise, Rhino, Roadrunner, Sire, Spinnin’, Warner Bros., Warner Classics and Warner Music Nashville, as well as Warner/Chappell Music, one of the world’s leading music publishers.

Our Business Strengths

We believe the following competitive strengths will enable us to grow our revenue and increase our margins and cash flow and to continue to generate recurring revenue through our diverse base of Recorded Music and Music Publishing assets:

Evergreen Catalog of Recorded Music and Music Publishing Content and Vibrant Roster of Recording Artists and Songwriters. We believe the depth and quality of our Recorded Music and Music Publishing catalogs stand out, with a collection of owned and controlled evergreen recordings and songs that generate steady cash flows. We believe these assets demonstrate our historical success in developing talent and will help to attract future talent in order to enable our continued success. We have been able to consistently attract, develop and retain successful recording artists and songwriters. Our talented A&R teams are focused on finding and nurturing future successful recording artists and songwriters, as evidenced by our roster of recording artists and songwriters and our recent successes in our Recorded Music and Music Publishing businesses. We believe our relative size, the strength and experience of our management team, our ability to respond to industry and consumer trends and challenges, our diverse array of genres, our large catalog of hit recordings and songs and our A&R skills will help us continue to generate steady cash flows.

Highly Diversified Revenue Base. Our revenue base is derived largely from recurring sources such as our Recorded Music and Music Publishing catalogs and new recordings and songs from our roster of recording artists and songwriters. In any given year, only a small percentage of our total revenue depends on recording artists and songwriters without an established track record and our revenue base does not depend on any single recording artist, songwriter, recording or song. We have built a large and diverse catalog of recordings and songs that covers a wide breadth of musical styles, including pop, rock, jazz, classical, country, R&B, hip-hop, rap,

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reggae, Latin, alternative, folk, blues, gospel and other Christian music. We are a significant player in each of our major geographic regions. Continuing to enter into additional expanded-rights deals and to build and acquire artist services capabilities will further diversify the revenue base of our Recorded Music business, and we continue to make selective investments in established and emerging markets.

Flexible Cost Structure with Low Capital Expenditure Requirements. We have a highly variable cost structure, with substantial discretionary spending and minimal capital requirements beyond improving our IT infrastructure. We have contractual flexibility with regard to the timing and amounts of advances paid to recording artists and songwriters as well as discretion regarding future investment in new recording artists and songwriters, which allows us to respond to changing industry conditions. Our significant discretion with regard to the timing and expenditure of variable costs provides us with considerable flexibility in managing our expenses. In addition, our capital expenditure maintenance requirements are predictable. In fiscal years 2017 and 2018 we incurred additional capital expenditures in connection with the consolidation of our West Coast operations, and the relocation of our United States shared services center to Nashville. We also continue to focus on cost control by seeking sensible opportunities to convert fixed costs to variable costs, to enhance our effectiveness, flexibility, structure and performance by reducing and realigning long-term costs and continuing to implement changes to better align our workforce with the changing nature of the music industry by continuing to shift resources from our physical sales channels to efforts focused on digital distribution and emerging technologies and other new revenue streams.

Continued Transition to Higher-Margin Digital Platforms. We derive revenue from different digital business models and products, including digital streaming of both audio and video content and digital downloads of single tracks and albums. We have established ourselves as a leader in the music industry’s transition to the digital era by expanding our distribution channels through strong partnerships and developing innovative products and services to further leverage our content and rights. For the fiscal year ended September 30, 2018, digital revenue represented approximately 56% of our total revenue versus 52% for the fiscal year ended September 30, 2017 and in fiscal years 2017 and 2018 digital streaming was our largest source of Recorded Music revenue. We have integrated the development of innovative digital products and strategies throughout our business and have established a culture of product innovation. Through our digital initiatives we have established strong relationships with our customers and have become a leader in the expanding worldwide digital music business. Due to the absence of certain costs associated with physical products, such as manufacturing, distribution, inventory and returns, we continue to experience higher margins on our digital product offerings than our physical product offerings.

Strong Management Team and Strategic Investor. Our management team has continued to successfully implement our business strategy, including delivering strong results in our digital business, delivering a steadily increasing flow of new music and continuing to diversify our revenue mix. At the same time, management has remained vigilant in managing costs and maintaining financial flexibility. During fiscal year 2013, our management team successfully completed the PLG Acquisition and related financing. During fiscal years 2012 to 2018, management completed several refinancings of our debt, lowering interest expenses and in October 2018 financed the acquisition of EMP Merchandising. In addition, since our acquisition by Access in July 2011, we have benefited from our partnership with Access, which has provided us with strategic direction and planning support to help us manage the ongoing transition in the music industry.

Our Strategy

We expect to increase revenues and cash flow through the following business strategies:

Attract, Develop and Retain Established and Emerging Recording Artists and Songwriters. A critical element of our strategy is to produce a steadily increasing flow of new music by finding, developing and retaining recording artists and songwriters who achieve long-term success. We expect to enhance the value of our assets by continuing to attract and develop new recording artists and songwriters with staying power and market potential. Our A&R teams seek to sign talented recording artists who will generate a meaningful level of revenues and increase the enduring value of our catalog on an ongoing basis. We also work to identify promising songwriters who write musical compositions that will augment the lasting value and stability of our music publishing catalog. We regularly evaluate our recording artist and songwriter rosters to ensure that we remain focused on developing the most promising and profitable talent and are committed to maintaining financial discipline in evaluating agreements with artists. We will also continue to evaluate opportunities to add to our catalog or acquire or make investments in companies engaged in businesses that are similar or complementary to ours on a selective basis.

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Maximize the Value of Our Music Assets. Our relationships with recording artists and songwriters, along with our recorded music and music publishing catalogs are our most valuable assets. We intend to continue to exploit the value of these assets through a variety of distribution channels, formats and products to generate significant cash flow from our music-based content. We believe that the ability to monetize our music-based content will improve over time as we drive users and engagement across current and emerging distribution channels. We will seek to exploit the potential of previously under-monetized content in new channels, formats and product offerings. We will also continue to work with our partners to explore creative approaches and develop new deal structures and product offerings to take advantage of new distribution channels. We also intend to continue to expand our global footprint through strategic acquisitions, partnerships and organic growth in markets where we see opportunities to grow revenues, supplementing our global organization with local investment.

Capitalize on Digital Distribution and Emerging Technologies. We are embracing commercial innovation and believe the growth of digital formats will continue to produce new means for the distribution, exploitation and monetization of the assets of our Recorded Music and Music Publishing businesses. We believe that the continued development of legitimate online and mobile channels for the consumption of music-based content and increasing access to digital music services present significant promise and opportunity for the music industry. Legitimate digital music services offer ease of use, discovery, quality, portability and seamlessness relative to illegal alternatives. We intend to continue to extend our global reach by executing deals with new partners and developing optimal business models that will enable us to monetize our content across various platforms, services and devices. For the year ended September 30, 2018, our Recorded Music digital revenue significantly exceeded physical revenue. We also intend to continue to support and invest in emerging technologies, including artificial intelligence, artificial reality, virtual reality, high-resolution audio, mobile messaging, social and other technologies to continue to build new revenue streams and position us for long-term growth.

Focus on Continued Management of Our Cost Structure. We plan to continue to maintain a disciplined approach to cost management in our business and to pursue additional cost savings with a focus on aligning our cost structure with our strategy and optimizing the implementation of our strategy. As part of this focus, we will continue to monitor industry conditions to ensure that our business remains aligned with industry trends. We also plan to continue to aggressively shift resources from our physical sales channels to efforts focused on digital sales channels and other new revenue streams. As digital revenue makes up a greater portion of total revenue, we plan to manage our cost structure accordingly. In addition, we will continue to look for opportunities to convert fixed costs to variable costs through realigning or outsourcing certain functions or leveraging more effective IT systems where these initiatives provide additional cost savings. We are constantly monitoring our costs and seeking additional cost savings.

Contain Digital Piracy. Containing piracy continues to be a major focus of the music industry and we, along with the rest of the industry, continue to take multiple measures through the development of new business models, technological innovation, litigation, education and the promotion of legislation and voluntary agreements to combat piracy, including filing civil lawsuits, participating in education programs, lobbying for tougher anti-piracy legislation and other initiatives to preserve the value of music copyrights. We expect that the effectiveness of technological measures to deter piracy will continue to improve including the ability to automate large-scale takedowns of infringing links, the identification of major brands advertising on rogue sites, sending notices via ISPs to repeat infringers and website/domain blocking and takedowns of infringing mobile applications. We believe these actions and technologies, in addition to the expansive growth of legitimate online and mobile music offerings, will help to limit the revenue lost to digital piracy. Research conducted by AudienceNet, a recognized third-party market research firm, on behalf of the International Federation of the Phonographic Industry (“IFPI”), shows that the net incidence of music being consumed based on some form of copyright infringement across 18 key countries in 2018 reached 38%, with ‘streamripping’ being the dominant form. However, pirated content only accounted for 7% of total music listening time in a typical week, eclipsed by legitimate sources of music such as radio and licensed audio and video streaming services.

Recorded Music (84% of consolidated revenues, before intersegment eliminations, for each of the fiscal years ended September 30, 2018, 2017 and 2016)

Our Recorded Music business primarily consists of the discovery and development of artists and the related marketing, distribution and licensing of recorded music produced by such artists. We play an integral role in virtually all aspects of the recorded music value chain from discovering and developing talent to producing music and marketing and promoting artists and their products.

In the United States, our Recorded Music operations are conducted principally through our major record labels— Atlantic Records and Warner Bros. Records. In October 2018, we launched Elektra Music Group in the Unites States as a standalone label group, which comprises the Elektra, Fueled by Ramen and Roadrunner labels. Our Recorded Music operations also include Rhino, a division that specializes in marketing our music catalog through compilations, reissuances of previously released music and video titles and releasing previously unreleased material from our vault. We also conduct our Recorded Music operations through a collection of additional record labels including Asylum, Big Beat, Canvasback, East West, Erato, FFRR, Nonesuch, Parlophone, Reprise, Sire, Spinnin’, Warner Classics and Warner Music Nashville.

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Outside the United States, our Recorded Music activities are conducted in more than 50 countries through various subsidiaries, affiliates and non-affiliated licensees. Internationally, we engage in the same activities as in the United States: discovering and signing artists and distributing, marketing and selling their recorded music. In most cases, we also market and distribute the music of those artists for whom our domestic record labels have international rights. In certain smaller markets, we license the right to distribute our records to non-affiliated third-party record labels.

Our Recorded Music distribution operations include Warner-Elektra-Atlantic Corporation (“WEA Corp.”), which markets and sells music and video products to retailers and wholesale distributors; Alternative Distribution Alliance (“ADA”), which distributes the products of independent labels to retail and wholesale distributors; and various distribution centers and ventures operated internationally.

In addition to our Recorded Music products being sold in physical retail outlets, our Recorded Music products are also sold in physical form to online physical retailers such as Amazon.com, barnesandnoble.com and bestbuy.com and in digital form to an expanded universe of digital partners, including digital streaming services such as Amazon, Apple, Deezer, Napster, SoundCloud, Spotify, Tencent and YouTube, digital radio services such as iHeart Radio, Pandora and Sirius XM and digital download services such as Apple’s iTunes and Google Play.

We have integrated the exploitation of digital content into all aspects of our business, including A&R, marketing, promotion and distribution. Our business development executives work closely with A&R departments to ensure that while music is being produced, digital assets are also created with all distribution channels in mind, including streaming services, social networking sites, online portals and music-centered destinations. We also work side-by-side with our online and mobile partners to test new concepts. We believe existing and new digital businesses will be a significant source of growth and will provide new opportunities to successfully monetize our assets and create new revenue streams. The proportion of digital revenues attributed to each distribution channel varies by region and proportions may change as the roll out of new technologies continues. As an owner of music content, we believe we are well positioned to take advantage of growth in digital distribution and emerging technologies to maximize the value of our assets.

We have diversified our revenues beyond our traditional businesses by entering into expanded-rights deals with recording artists in order to partner with artists in other aspects of their careers. Under these agreements, we provide services to and participate in artists’ activities outside the traditional recorded music business such as touring, merchandising and sponsorships. We have built and acquired artist services capabilities and platforms for exploiting this broader set of music-related rights and participating more widely in the monetization of the artist brands we help create. We believe that entering into expanded-rights deals and enhancing our artist services capabilities in areas such as concert promotion and management has permitted us to diversify revenue streams and capitalize on other revenue opportunities. This provides for improved long-term relationships with artists and allows us to more effectively connect artists and fans.

A&R

We have a decades-long history of identifying and contracting with recording artists who become commercially successful. Our ability to select artists who are likely to be successful is a key element of our Recorded Music business strategy and spans all music genres and all major geographies and includes artists who achieve national, regional and international success. We believe that this success is directly attributable to our experienced global team of A&R executives, to the longstanding reputation and relationships that we have developed in the artistic community and to our effective management of this vital business function.

In the United States, our major record labels identify potentially successful recording artists, sign them to recording agreements, collaborate with them to develop recordings of their work and market and sell or license these finished recordings to legitimate digital channels and retail stores. Increasingly, we are also expanding our participation in image and brand rights associated with artists, including merchandising, sponsorships, touring and artist management. Our labels scout and sign talent across all major music genres, including pop, rock, jazz, classical, country, R&B, hip-hop, rap, reggae, Latin, alternative, folk, blues, gospel and other Christian music. Internationally, we market and sell U.S. and local repertoire through our network of affiliates and licensees in more than 50 countries. With a roster of local artists performing in various local languages throughout the world, we have an ongoing commitment to developing local talent aimed at achieving national, regional or international success.

Many of our recording artists continue to appeal to audiences long after we cease to release their new recordings. We have an efficient process for sustaining sales across our catalog releases. Relative to our new releases, we spend comparatively small amounts on marketing for our catalog.

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We maximize the value of our catalog of recorded music through our Rhino business unit and through activities of each of our record labels. We use our catalog as a source of material for re-releases, compilations, box sets and special package releases, which provide consumers with incremental exposure to familiar songs and artists. Rhino also releases new soundtrack albums and new music from legacy artists; as well as exploiting the name and likeness of certain artist estates and brands.

Representative Worldwide Recorded Music Artists

 

A Boogie wit da Hoodie

Deftones

James Blunt

My Chemical Romance

Sigur Rós

A-ha

Jason Derulo

Katherine Jenkins

Nek

Simple Plan

Air

Disturbed

Jane's Addiction

New Order

Skillet

Alt-J

Donkeyboy

Jethro Tull

Nickelback

Skrillex

Andra Day

The Doors

Johnny Hallyday

Stevie Nicks

Slipknot

Jean-Louis Aubert

DRAM

Julien Clerc

Nico and Vinz

The Smiths

Avenged Sevenfold

Dream Theater

k.d. lang

Notorious B.I.G.

Spandau Ballet

Frankie Ballard

Duran Duran

Kehlani

Paolo Nutini

Regina Spektor

The Baseballs

Eagles

Kid Rock

Opeth

Staind

Jeff Beck

Brett Eldrege

Killswitch Engage

Pablo Alborán

Rod Stewart

Gary Clark Jr.

Eliza Doolittle

Kobukuro

Panic! At the Disco

The Streets

Biffy Clyro

Missy Elliott

Kodak Black

Pantera

Sturgill Simpson

Big Smo

The Enemy

Korn

Paramore

Alain Souchon

Billy Talent

Enya

Kraftwerk

Partynextdoor

Stone Sour

Birdy

Jimmy Fallon

Jana Kramer

Laura Pausini

Stone Temple Pilots

The Black Keys

Flaming Lips

Larry the Cable Guy

Pendulum

Superfly

Black Sabbath

Fleetwood Mac

Hugh Laurie

Christina Perri

Cole Swindell

Blur

Flo Rida

Led Zeppelin

Peter Fox

Mariya Takeuchi

Miguel Bosé

Aretha Franklin

Ligabue

Tom Petty

Tegan and Sara

Michelle Branch

Foreigner

Lil Pump

Pink Floyd

Tina Turner

Bruno Mars

fun.

Lil Uzi Vert

Plan B

Tinie Tempah

Michael Bublé

Galantis

Lily Allen

Portugal. The Man

Theory of a Deadman

Cardi B

Kevin Gates

Linkin Park

Primal Scream

Trans-Siberian Orchestra

The Cars

Genesis

Dua Lipa

Prince

Trey Songz

Tracy Chapman

Rhiannon Giddens

Lynyrd Skynyrd

Charlie Puth

Ty Dolla $ign

Ray Charles

Gloriana

M. Pokora

The Ramones

Jolin Tsai

Charlie XCX

Lukas Graham

Machine Head

Randy Travis

Twenty One Pilots

Cher

Gojira

Christophe Maé

Red Hot Chili Peppers

Twisted Sister

Chicago

Goo Goo Dolls

Magic System

Bebe Rexha

Uncle Kracker

Eric Clapton

Josh Groban

Maná

Damien Rice

Van Halen

Kelly Clarkson

Grateful Dead

Melanie Martinez

Kenny Rogers

Westernhagen

Coldplay

Green Day

Mastodon

Roxette

Whitesnake

Ornette Coleman

Gorillaz

matchbox twenty

Rudimental

Wilco

Phil Collins

Gucci Mane

MC Solaar

Rumer

Wiz Khalifa

John Coltrane

David Guetta

Bette Midler

Rush

The Wombats

Alice Cooper

Halestorm

Luis Miguel

Todd Rundgren

Yes

The Corrs

Hard-Fi

Mac Miller

Alejandro Sanz

YFN Lucci

Crosby, Stills & Nash

Emmylou Harris

Kylie Minogue

Seal

Neil Young

Daft Punk

Hunter Hayes

Janelle Monáe

Sean Paul

Young the Giant

Dan + Shay

The Head and the Heart

The Monkees

Seeed

Young Thug

Danger Mouse

Faith Hill

Ashley Monroe

Ed Sheeran

Youssou N’Dour

David Bowie

Nipsey Hussle

Jason Mraz

Blake Shelton

Zac Brown Band

Death Cab for Cutie

Iron Maiden

Muse

Shinedown

ZZ Top

 

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Recording Artists’ Contracts

Our artists’ contracts define the commercial relationship between our recording artists and our record labels. We negotiate recording agreements with artists that define our rights to use the artists’ copyrighted recordings. In accordance with the terms of the contract, the artists receive royalties based on sales and other forms of exploitation of the artists’ recorded works. We customarily provide up-front payments to artists called advances, which are recoupable by us from future royalties otherwise payable to artists. We also typically pay costs associated with the recording and production of albums, which in certain countries are treated as advances recoupable by us from future royalties. Our typical contract for a new artist covers a sufficient number of master recordings to constitute a single initial album and provides us with a series of options to acquire subsequent albums from the artist. Royalty rates and advances are often increased for subsequent albums for which we have exercised our options. Many of our contracts contain a commitment from the record label to fund video production costs, at least a portion of which in certain countries is treated as advances recoupable by us from future royalties.

Our established artists’ contracts generally provide for greater advances and higher royalty rates. Typically, established artists’ contracts entitle us to fewer albums, and, of those, fewer are optional albums. In contrast to new artists’ contracts, which typically give us ownership in the artist’s work for the full term of copyright, some established artists’ contracts provide us with an exclusive license for some fixed period of time. It is not unusual for us to renegotiate contract terms with a successful artist during the term of their existing agreement, sometimes in return for an increase in the number of albums that the artist is required to deliver.

While the duration of the contract may vary, our contracts typically grant us ownership for the duration of copyright. See “Intellectual Property-Copyrights.” United States copyright law permits authors or their estates to terminate an assignment or license of copyright (for the United States only) after a set period of time in certain circumstances. See “Risk Factors—We face a potential loss of catalog to the extent that our recording artists have a right to recapture rights in their recordings under the U.S. Copyright Act.”

We are also continuing to transition to other forms of business models with recording artists to adapt to changing industry conditions. Many of the recording agreements we currently enter into are expanded-rights deals, in which we share in the touring, merchandising, sponsorship/endorsement, fan club or other non-traditional music revenues associated with those artists.

Marketing and Promotion

Our approach to marketing and promoting our artists and their recordings is comprehensive. Our goal is to maximize the likelihood of success for new releases as well as to stimulate the success of catalog releases. We seek to increase the value of music, and help our artists connect with their fans.

The marketing and promotion of recorded music is carefully coordinated to create the greatest sales momentum, while maintaining financial discipline. We have significant experience in our marketing and promotion departments, which we believe allows us to achieve an optimal balance between our marketing expenditure and the eventual sales of our artists’ recordings. We use a budget-based approach to plan marketing and promotions, and we monitor all expenditures related to each release to ensure compliance with the agreed-upon budget. These planning processes are regularly evaluated based on updated artist retail sales reports, streaming service playlists and radio airplay data, so that a promotion plan can be quickly adjusted if necessary.

Manufacturing, Packaging and Physical Distribution

Technicolor SA, a technology provider for the media and entertainment sectors, which acquired in 2015 the North American optical disc manufacturing and distribution assets from Cinram Group Inc., is currently our primary supplier of manufacturing, packaging and physical distribution services in the U.S. and Canada. We also have arrangements with other suppliers and distributors, in addition to Technicolor, as part of our manufacturing, packaging and physical distribution network throughout the rest of the world. We believe that the pricing terms of our manufacturing, packaging and physical distribution agreements reflect market rates.

Sales and Digital Distribution

We generate sales from the new releases of current artists and our catalog of recordings. In addition, we actively repackage music from our catalog to form new compilations. Our sales are generated in digital formats including streaming and downloads, CD format, as well as through historical formats, such as vinyl albums.

Most of our physical sales represent purchases by a wholesale or retail distributor. Our sale and return policies are in accordance with wholesale and retailer requirements, applicable laws and regulations, territory and customer-specific negotiations, and industry practice. We attempt to minimize the return of unsold product by working with retailers to manage inventory and SKU counts as well as monitoring shipments and sell-through data.

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The digital sales channel has become an important sales channel within our business. We currently partner with a broad range of digital service providers, such as Amazon, Apple, Deezer, KKBox, Napster, Spotify, Telefonica, Tencent, YouTube and Google, and are actively seeking to develop and grow our digital business. Online sales also include sales of traditional physical formats through both the online distribution arms of traditional retailers such as fye.com and walmart.com and traditional online physical retailers such as amazon.com, bestbuy.com and barnesandnoble.com. In addition, digital service providers sell digital music on a per-album or per-track basis. Various mobile service providers also offer their subscribers the ability to stream or download music on mobile devices. In digital formats, per-unit costs related directly to physical products such as manufacturing, distribution, inventory and return costs do not apply. While there are some digital-specific variable costs and infrastructure investments needed to produce, market and sell digital products, it is reasonable to expect that we will generally derive a higher contribution margin from digital sales than physical sales.  We sell our physical recorded music products through a variety of different retail and wholesale outlets including music specialty stores, general entertainment specialty stores, supermarkets, mass merchants and discounters, independent retailers and other traditional retailers. Although some of our retailers are specialized, many of our customers offer a substantial range of products other than music.

Our agreements with digital service providers generally last one to three years. We believe that the short-term nature of our agreements enables us to maintain the flexibility that we need given the continuing changes to digital business models.

We enter into agreements with these service providers to make our masters available for access in digital formats (e.g., streaming, and digital downloads). We then provide digital assets for our masters to these service providers in an accessible form. Our agreements with these service providers establish our fees for the distribution of our product, which vary based on the type of product being distributed. We typically receive accounting reports from these service providers on a monthly basis, detailing the distribution activity, with payments rendered on a monthly basis.

Our business has historically been seasonal. In the recorded music business, purchases have historically been heavily weighted towards the last three months of the calendar year. However, since the emergence of digital sales, we have noted our business is becoming less seasonal in nature and driven more by the timing of our releases. As digital revenue continues to increase as a percentage of our total revenue, this may continue to affect the overall seasonality of our business. However, seasonality with respect to the sale of music in new formats, such as digital, is still developing.

Music Publishing (16% of consolidated revenues, before intersegment eliminations, for each of the fiscal years ended September 30, 2018, 2017 and 2016)

While recorded music is focused on exploiting a particular recording of a composition, music publishing is an intellectual property business focused on the exploitation of the composition itself. In return for promoting, placing, marketing and administering the creative output of a songwriter, or engaging in those activities for other rightsholders, our Music Publishing business garners a share of the revenues generated from use of the composition.

Our Music Publishing operations are conducted principally through Warner/Chappell, our global music publishing company headquartered in Los Angeles with operations in over 50 countries through various subsidiaries, affiliates and non-affiliated licensees. We own or control rights to more than one million musical compositions, including pop hits, American standards, folk songs and motion picture and theatrical compositions. Assembled over decades, our award-winning catalog includes over 70,000 songwriters and composers and a diverse range of genres including pop, rock, jazz, classical, country, R&B, hip-hop, rap, reggae, Latin, folk, blues, symphonic, soul, Broadway, techno, alternative and gospel. Warner/Chappell also administers the music and soundtracks of several third-party television and film producers and studios. We have an extensive production music library collectively branded as Warner/Chappell Production Music.  

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Music Publishing Portfolio

Representative Songwriters

 

Rhett Akins

Ben Hayslip

Tim Nichols

Steve Aoki

Brett James

Nickelback

Beyoncé

Jay Z

Paramore

Belly

Juanes

Katy Perry

Brothers Osborne

Ian Kirkpatrick

Plain White T’s

Brody Brown

Kool & the Gang

Cole Porter

James Brown

Kygo

The Ramones

Bruno Mars

Lady Antebellum

Pricilla Renea

Michael Bublé

Kendrick Lamar

Damien Rice

busbee

Led Zeppelin

Rihanna

Captain Cuts

Lil Wayne

Liz Rose

Harry Chapin

Little Big Town

Mort Shuman

Eric Clapton

Tove Lo

Stephen Sondheim

Dido

Madonna

Staind

Dream

Maná

Chris Stapleton

Dr. Dre

Curtis Mayfield

A Thousand Horses

fun.

Johnny Mercer

Justin Tranter

Nicole Galyon

George Michael

Twenty One Pilots

Kenneth Gamble and Leon Huff

Julia Michaels

Kurt Weill

George and Ira Gershwin

Lin-Manuel Miranda

Barry White

Brantley Gilbert

Nick Monson

John Williams

Lukas Graham

Van Morrison

Pharrell Williams

Green Day

Muse

Wiz Kalifa

Halestorm

Kacey Musgraves

Wolf Cousins

Jerome Harmon

Dave Mustaine

Rob Zombie

 

 

 

 

Representative Songs

 

1950s and Prior

 

1960s

 

1970s

As Time Goes By

 

Build Me Up Buttercup

 

A Horse With No Name

Dream A Little Dream Of Me

 

Everyday People

 

Ain’t No Stopping Us Now

Frosty The Snowman

 

For What It’s Worth

 

Cat's In The Cradle

Jingle Bell Rock

 

I Only Want To Be With You

 

Hot Stuff

Misty

 

Save The Last Dance For Me

 

Killing Me Softly

Night And Day

 

This Magic Moment

 

Layla

Summertime

 

Viva Las Vegas

 

Listen To The Music

That's All Right

 

Walk On By

 

Moondance

When I Fall In Love

 

When A Man Loves A Woman

 

Stairway To Heaven

Winter Wonderland

 

Whole Lotta Love

 

Star Wars Theme

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1980s

 

1990s

 

2000s

 

2010 and after

Celebration

 

Believe

 

American Idiot

 

7 Years

Danger Zone

 

Closing Time

 

Crazy

 

Another Day In The Sun

Endless Love

 

Creep

 

Crazy In Love

 

Drunk In Love

Eye Of The Tiger

 

End Of The Road

 

Gotta Be Somebody

 

Firework

Flashdance

 

Gonna Make You Sweat

 

Hey There Delilah

 

Glad You Came

Jump

 

Livin’ La Vida Loca

 

Home

 

Just The Way You Are

Like A Prayer

 

Macarena

 

I Kissed A Girl

 

My Shot

Morning Train

 

MMMBop

 

Rockstar

 

Sorry

Slow Hand

 

Sunny Came Home

 

Umbrella

 

Uptown Funk

The Wind Beneath My Wings

 

This Kiss

 

White Flag

 

We Are Young

 

Music Publishing Royalties

Warner/Chappell, as a copyright owner and/or administrator of copyrighted musical compositions, is entitled to receive royalties for the exploitation of musical compositions. We continually add new musical compositions to our catalog, and seek to acquire rights in songs that will generate substantial revenue over the long term.

Music publishers generally receive royalties pursuant to public performance, digital, mechanical, synchronization, and other licenses. In the United States, music publishers collect and administer mechanical royalties, and statutory rates are established by the U.S. Copyright Act of 1976, as amended, for the royalty rates applicable to musical compositions for sales of recordings embodying those musical compositions. In the United States, public performance royalties are typically administered and collected by performing rights organizations and in most countries outside the United States, collection, administration and allocation of both mechanical and performance income are undertaken and regulated by governmental or quasi-governmental authorities. Throughout the world, each synchronization license is generally subject to negotiation with a prospective licensee and, by contract, music publishers pay a contractually required percentage of synchronization income to the songwriters or their heirs and to any co-publishers.

Warner/Chappell acquires copyrights or portions of copyrights and/or administration rights from songwriters or other third-party holders of rights in compositions. Typically, in either case, the grantor of rights retains a right to receive a percentage of revenues collected by Warner/Chappell. As an owner and/or administrator of compositions, we promote the use of those compositions by others. For example, we encourage recording artists to record and include our songs on their albums, offer opportunities to include our compositions in filmed entertainment, advertisements and digital media and advocate for the use of our compositions in live stage productions. Examples of music uses that generate publishing revenues include:

Performance: performance of the song to the general public

 

Broadcast of music on television, radio and cable

 

Live performance at a concert or other venue (e.g., arena concerts, nightclubs)

 

Broadcast of music at sporting events, restaurants or bars

 

Performance of music in staged theatrical productions

Digital: sale of recorded music in various digital formats and digital performance of songs to the general public

 

Digital recordings such as streaming services and digital downloads

Mechanical: sale of recorded music in various physical formats

 

Physical recordings such as CDs, vinyl and DVDs

Synchronization: use of the song in combination with visual images

 

Films or television programs

 

Television commercials

 

Video games

 

Merchandising, toys or novelty items

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Other:

 

Licensing of copyrights for use in printed sheet music

Composers’ and Lyricists’ Contracts

Warner/Chappell derives its rights through contracts with composers and lyricists (songwriters) or their heirs, and with third-party music publishers. In some instances, those contracts grant either 100% or some lesser percentage of copyright ownership in musical compositions and/or administration rights. In other instances, those contracts only convey to Warner/Chappell rights to administer musical compositions for a period of time without conveying a copyright ownership interest. Our contracts grant us exclusive exploitation rights in the territories concerned excepting any pre-existing arrangements. Many of our contracts grant us rights on a worldwide basis. Warner/Chappell customarily possesses administration rights for every musical composition created by the writer or composer during the duration of the contract.

While the duration of the contract may vary, many of our contracts grant us ownership and/or administration rights for the duration of copyright. See “Intellectual Property-Copyrights.” U.S. copyright law permits authors or their estates to terminate an assignment or license of copyright (for the U.S. only) after a set period of time. See “Risk Factors—We face a potential loss of catalog to the extent that our recording artists have a right to recapture rights in their recordings under the U.S. Copyright Act.”

Competition

In both Recorded Music and Music Publishing we compete based on price (to retailers in recorded music and to various end users in music publishing), on marketing and promotion (including both how we allocate our marketing and promotion resources as well as how much we spend on a dollar basis) and on artist signings. We believe we currently compete favorably in these areas.

Our Recorded Music business is also dependent on technological development, including access to, selection and viability of new technologies, and is subject to potential pressure from competitors as a result of their technological developments. Due to online piracy, we have been forced to compete with illegal channels such as unauthorized, online, peer-to-peer filesharing and CD-R activity. See “Industry Overview—Recorded Music—Piracy.” Additionally, we compete, to a lesser extent, for disposable consumer income with alternative forms of entertainment, content and leisure activities, such as cable and satellite television, motion pictures and video games in physical and digital formats.

The recorded music industry is highly competitive based on consumer preferences, and is rapidly changing. At its core, the recorded music business relies on the exploitation of artistic talent. As such, competitive strength is predicated upon the ability to continually develop and market new artists whose work gains commercial acceptance. According to Music and Copyright, in 2017, the three largest major record companies were Universal Music Group, Sony Music Entertainment and us, which collectively accounted for 68% of worldwide recorded music sales. There are many mid-sized and smaller players in the industry that accounted for the remaining 32%, including independent music companies. Universal Music Group was the market leader with a 30% worldwide market share in 2017 after absorbing the bulk of the recorded music assets of the former EMI in late 2012, followed by Sony Music Entertainment with a 22% share. We held a 16% share of worldwide recorded music sales globally in 2017.

The music publishing business is also highly competitive. The top three music publishers collectively accounted for 59% of the market. Based on Music & Copyright’s most recent estimates published in May 2018, Sony/ATV was the market leader in music publishing in 2017 with a 27% share (reflecting its administration of the EMI music publishing assets).  Universal Music Publishing was the second largest music publisher with a 20% share, followed by us at 12%. There are many mid-sized and smaller players in the industry that account for the remaining 41%, including many individual songwriters who publish their own works.

Intellectual Property

Copyrights

Our business, like that of other companies involved in music publishing and recorded music, rests on our ability to maintain rights in musical works and recordings through copyright protection. In the U.S., copyright protection for works created as “works made for hire” (e.g., works of employees or certain specially commissioned works) on or after January 1, 1978 generally lasts for 95 years from first publication or 120 years from creation, whichever expires first. The period of copyright protection for works created on or after January 1, 1978 that are not “works made for hire” lasts for the life of the author plus 70 years. Works created and published or registered in the U.S. prior to January 1, 1978 generally enjoy a total copyright life of 95 years, subject to compliance with certain statutory provisions including notice and renewal. In the U.S., sound recordings created prior to February 15, 1972 are not subject to federal copyright protection but are protected by common law rights or state statutes, where applicable. The term of copyright in the European Union (“E.U.”) for musical compositions in all member states lasts for the life of the author plus 70 years.

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In the E.U., the term of copyright for sound recordings lasts for 70 years from the date of release in respect of sound recordings that were still in copyright on November 1, 2013 and for 50 years from date of release in respect of sound recordings the copyright in which had expired by that date. The E.U. also recently harmonized the copyright term for joint musical works. In the case of a musical composition with words that is protected by copyright on or after November 1, 2013, E.U. member states are required to calculate the life of the author plus 70 years term from the date of death of the last surviving author of the lyrics and the composer of the musical composition, provided that both contributions were specifically created for the respective song.

We are largely dependent on legislation in each territory in which we operate to protect our rights against unauthorized reproduction, distribution, public performance or rental. In all territories where we operate, our products receive some degree of copyright protection, although the extent of effective protection varies widely. In a number of developing countries, the protection of copyright remains inadequate.

Technological changes have focused attention on the need for new legislation that will adequately protect the rights of producers. We actively lobby in favor of industry efforts to increase copyright protection and support the efforts of organizations such as the Recording Industry Association of America (“RIAA”), IFPI and the World Intellectual Property Organization.

Trademarks

We consider our trademarks to be valuable assets to our business. As such, we endeavor to register our major trademarks in every country where we believe the protection of these trademarks is important for our business. Our major trademarks include Asylum, Atlantic, Elektra, EMP, Parlophone, Reprise, Rhino, Sire, Spinnin’, Warner/Chappell and WEA. We also use certain trademarks pursuant to royalty-free license agreements. Of these, the duration of the license relating to the WARNER and WARNER MUSIC marks and “W” logo is perpetual. The duration of the license relating to the WARNER BROS. RECORDS mark and WB & Shield designs is fifteen years and three months from February 29, 2004. Each of the licenses may be terminated under certain limited circumstances, which may include material breaches of the agreement, certain events of insolvency, and certain change of control events if we were to become controlled by a major filmed entertainment company. We actively monitor and protect against activities that might infringe, dilute, or otherwise harm our trademarks.

Joint Ventures

We have entered into joint venture arrangements pursuant to which we or our various subsidiary companies manufacture, distribute and market (in most cases, domestically and internationally) recordings owned by the joint ventures. An example of this arrangement is Frank Sinatra Enterprises, a joint venture established to administer licenses for use of Frank Sinatra’s name and likeness and manage all aspects of his music, film and stage content.

Employees

As of September 30, 2018, we employed approximately 4,660 persons worldwide, including temporary and part-time employees. None of our employees in the U.S. are subject to a collective bargaining agreement, although certain employees in our non-domestic companies are covered by national labor agreements. We believe that our relationship with our employees is good.  

INDUSTRY OVERVIEW

Recorded Music

Recorded music is one of the primary mediums of entertainment for consumers worldwide and in calendar year 2017, according to IFPI, generated $17.27 billion in trade value of sales. Over time, major recorded music companies have built significant recorded music catalogs, which are long-lived assets that are exploited year after year. The exploitation of catalog material is typically more profitable than that of new releases, given lower development costs and more limited marketing costs. Through the end of the third calendar quarter of 2018 (i.e., the week ending September 27, 2018), according to Nielsen’s Music Connect system, 63% of all calendar year-to-date U.S. album unit sales, plus track-equivalent album sales and stream-equivalent on-demand album consumption, came from recordings more than 18 months old.

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According to IFPI, the top five territories (the U.S., Japan, Germany, the U.K., and France) collectively accounted for 71% of the related sales in the recorded music market in calendar year 2017. The U.S., which is the most significant exporter of music, is also the largest territory for recorded music sales, constituting 34% of total calendar year 2017 recorded music sales on a trade value basis. The U.S. and Japan are largely local music markets, with 93% and 87% of their calendar year 2015 physical music sales consisting of domestic repertoire, respectively. In contrast, markets like the U.K. have higher percentages of international sales, with international repertoire in that territory constituting 42% of physical music sales.

There has been a major shift in distribution of recorded music from specialty shops towards mass-market and online outlets in recent years. Online sales of physical product as well as digital downloads have grown, and according to the market research firm NPD, record/entertainment/electronics stores’ share of U.S. music sales totaled 18% in 2009. U.S. mass-market and other stores’ share grew from 38% in calendar 1999 to 54% in calendar year 2004, and with the subsequent growth of sales via online channels, their share contracted to 28% in calendar year 2008. Mass-market retailers accounted for 15% of total industry unit sales calculated on a total album plus digital track equivalent (ten tracks per album) unit basis in the U.S. in calendar year 2017, according to SoundScan data. In addition, revenues resulting from music streaming services now represent the majority of the overall recorded music market in the U.S. Data published by the RIAA shows that when the streaming category was taken into account, it was responsible for 75% of total year-to-date estimated industry retail value through the first half of calendar year 2018. In terms of genre, R&B/hip-hop remained the most popular style of music in the U.S. overall, representing 31% of the music purchased and consumed on streaming services in the U.S. through the first half of calendar year 2018, as captured and calculated by Nielsen Entertainment, although genres such as rock, pop, and Latin music are also popular and outperform in specific formats.  

According to RIAA, from calendar years 1990 to 1999, the U.S. recorded music industry grew at a compound annual growth rate of 7.6%. This growth, largely paralleled around the world, was driven by demand for music, the replacement of vinyl and cassettes with CDs, price increases and strong economic growth. The industry began experiencing negative growth rates in calendar year 1999, on a global basis, primarily driven by an increase in digital piracy. Other drivers of this decline were and are the overall recessionary economic environment, bankruptcies of record retailers and wholesalers, growing competition for consumer discretionary spending and retail shelf space and the maturation of the CD format, which slowed the historical growth pattern of recorded music sales. Since that time, annual dollar sales of physical music product in the U.S. are estimated to have declined at a compound annual growth rate of 12%, although there was a 2.5% year-over-year increase recorded in 2004. In calendar year 2017, the physical business experienced a 4% year-over-year decline on a value basis.  However, U.S. performance figures for the market overall in calendar year 2017, as well as through the first half of calendar year 2018, reflected year-over-year increases in estimated retail revenues of 17% and 10%, respectively, suggesting that revenues from streaming services are offsetting declines in other formats. While the 8% year-over-year increase in global trade revenues reported by IFPI for calendar year 2017 also indicates that the climate may be improving, the experience varies by market, with some markets still being adversely impacted to varying degrees by differing penetration levels of piracy-enabling technologies, such as broadband access and CD-R technology, and economic conditions.

Notwithstanding these factors, we believe that music industry results could continue to improve based on the continued mobilization of the industry as a whole against piracy and the development and broad adoption of legitimate digital distribution channels.

Piracy

One of the industry’s biggest challenges is combating piracy. Music piracy exists in two primary forms: digital (which includes illegal downloading, streaming piracy and CD-R piracy) and industrial:

 

Digital piracy has grown dramatically, enabled by the increasing penetration of broadband Internet access and the ubiquity of powerful microprocessors, fast optical drives (particularly with writable media, such as CD-R) and large inexpensive disk storage in personal computers. The combination of these technologies has allowed consumers to easily, flawlessly and almost instantaneously make high-quality copies of music using a home computer by “ripping” or converting musical content from CDs into digital files, stored on local disks. These digital files can then be distributed for free over the Internet through anonymous peer-to-peer filesharing networks such as BitTorrent and Frostwire (“illegal downloading”). Alternatively, these files can be burned onto multiple CDs for physical distribution (“CD-R piracy”). IFPI identified nearly 20 million URLs hosting infringing content and actioned them for removal in 2016.  In addition, IFPI states that 339 million requests were sent to Google requiring it to ‘delist’ infringing sites.  These figures represent only a fraction of sites and activity surrounding infringement.

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Industrial piracy (also called counterfeiting or physical piracy) involves mass production of illegal CDs in factories. This form of piracy is largely concentrated in developing regions, and has existed for more than two decades. The sale of legitimate recorded music in these developing territories is limited by the dominance of pirated products, which are sold at substantially lower prices than legitimate products. Based upon most recent data available, the International Intellectual Property Alliance (IIPA) estimated that U.S. trade losses due to physical piracy of records and music in 39 key countries/territories around the world with copyright protection and/or enforcement deficiencies totaled $1.5 billion in 2009. At that time, the IIPA believed that piracy of records and music was most prevalent in territories such as Indonesia, China, the Philippines, Mexico, India and Argentina, where piracy levels were at 60% or above.

In 2003, the industry launched an intensive campaign to limit piracy that focused on four key initiatives:

 

Technological: The technological measures against piracy are geared towards degrading the illegal filesharing process and tracking providers and consumers of pirated music. These measures include spoofing, watermarking, copy protection, the use of automated webcrawlers and access restrictions.

 

Educational: Led by RIAA and IFPI, the industry launched an aggressive campaign of consumer education designed to spread awareness of the illegality of various forms of piracy through aggressive print and television advertisements. These efforts have yielded positive results in impacting consumer behaviors and attitudes with regard to filesharing of music. A survey conducted by MusicWatch, a market research firm, in December 2016 showed that roughly 1 in 5 U.S. Internet users aged 13 or older who stopped or decreased their usage of filesharing services for music in the year covered by the survey were motivated by concerns about being sued and/or the legality of such services, as well as moral implications. Research conducted by Ipsos across 13 countries, as cited in IFPI’s Music Consumer Insight Report 2016, found that a majority (50%+) of respondents in various age groups from 13 – 64 years old agreed that “downloading/streaming music without permission is stealing.”

 

Legal: In conjunction with its educational efforts, the industry has taken aggressive legal action against commercial file-sharing sites, as well as cooperating with law-enforcement when criminal cases are appropriate. In April 2015, the industry reached a settlement agreement with Grooveshark that completely shut down its unauthorized streaming service.  In September, the file-sharing sites Sharebeast and Albumjams.com, which were sources of a large number of pre-release leaks and millions of unpaid downloads, were shut down by the FBI.  In addition, the industry has been successful in obtaining blocking orders in many countries, including the U.K., France, Italy, South Korea, Belgium, Spain and Portugal, that make it more difficult for end users to access infringing sites, such as BitTorrent sites. Finally, in both China and Russia, the courts have been more willing to issue rulings to combat unauthorized distribution.  Such rulings allow for the potential growth of licensed services in these countries, which have been stymied by rampant content piracy.

 

Development of online and mobile alternatives: We believe that the development and success of legitimate digital music channels will be an important driver of recorded music sales and monetization going forward, as they represent both revenue stream and a potential inhibitor of piracy. The music industry has been encouraged by the proliferation and success of legitimate digital music distribution options. We believe that these legitimate online distribution channels offer several advantages to illegal peer-to-peer networks, including greater ease of use, higher quality and more consistent music product, faster downloading and streaming, better search and discovery capabilities and seamless integration with portable digital music players. Legitimate online download stores and streaming music services began to be established in 2001 beginning with the launch of Rhapsody (currently known as Napster) in late 2001 and continuing through the launch of Apple’s iTunes music store in April 2003. Since then, many others (both large and small) have launched download and ad-supported and subscription streaming music services, offering a variety of models, including per-track pricing, per-album pricing and monthly subscriptions. According to Pro-music, a coalition of trade organizations representing record companies, music publishers, artists and musicians, retailers, and others engaged in the music business, including IFPI, there are more than 400 legal digital music services providing alternatives to illegal filesharing in markets around the world, with major international services operating in a multitude of territories. Devices such as smartphones and tablets that are equipped with new capabilities are increasingly offering consumers greater capability to acquire and consume full-track downloads and streaming audio and video through mobile platforms as well as online. These devices are further facilitating usage of legitimate options.

These efforts are incremental to the long-standing push by organizations such as RIAA and IFPI to curb industrial piracy around the world. In addition to these actions, the music industry is increasingly coordinating with other similarly impacted industries (such as software and filmed entertainment) to combat piracy.  

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We believe these actions have contained piracy levels in a number of markets. A survey conducted by MusicWatch covering activity in the second calendar quarter of 2017 showed that incidence of peer-to-peer (P2P) sharing of music among U.S. Internet users aged 13 or older rose slightly during the quarter but remained in single digit percentages. The survey also reflected that other types of unauthorized music sharing, such as the downloading of music via mobile apps, and the transfer of music files to/from hard drives and flash drives, were generally down or stable compared to earlier quarters.

Internationally, we believe governmental initiatives designed to protect intellectual property should also be helpful to the music industry and measures are being adopted in an increasing number of countries to achieve better ISP cooperation. Solutions to online piracy and making progress towards meaningful ISP cooperation against online piracy are also being adopted or pursued through government-sponsored negotiations of codes of practice or cross-industry agreements and remedies arising out of litigation, such as obtaining injunctions requiring ISPs to block access to infringing sites. We believe these actions, as well as other actions also currently being taken in many countries around the world, represent a positive trend internationally and a recognition by governments around the world that urgent action is required to reduce online piracy and in particular unlawful filesharing because of the harm caused to the creative industries. While these governmental actions have not come without some controversy, we continue to lobby for legislative change through music industry bodies and trade associations in jurisdictions where enforcement of copyright in the context of online piracy remains problematic due to existing local laws or prior court decisions.

Music Publishing

Background

Music publishing involves the acquisition of rights to, and licensing of, musical compositions (as opposed to recordings) from songwriters, composers or other rightsholders. Music publishing revenues are derived from five main royalty sources: Mechanical, Performance, Synchronization, Digital and Other.

In the U.S., mechanical royalties are collected by music publishers from recorded music companies or via The Harry Fox Agency, a non-exclusive licensing agent affiliated with SESAC, while outside the U.S., collection societies generally perform this function. Once mechanical royalties reach the publisher (either directly from record companies or from collection societies), percentages of those royalties are paid or credited to the writer or other rightsholder of the copyright in accordance with the underlying rights agreement. Mechanical royalties are paid at a penny rate of 9.1 cents per song per unit in the U.S. for physical formats (e.g., CDs and vinyl albums) and permanent digital downloads (recordings in excess of five minutes attract a higher rate). There are also rates set for interactive streaming and non-permanent downloads based on a formula that takes into account revenues paid by consumers or advertisers with certain minimum royalties that may apply depending on the type of service. “Controlled composition” provisions contained in some recording agreements may apply to the rates mentioned above pursuant to which artist/songwriters license their rights to their record companies for as little as 75% of the statutory rates. The current U.S. statutory mechanical rates will remain in effect through December 31, 2018. In most other territories, mechanical royalties are based on a percentage of wholesale prices for physical product and based on a percentage of consumer prices for digital products. In international markets, these rates are determined by multi-year collective bargaining agreements and rate tribunals.

Throughout the world, performance royalties are typically collected on behalf of publishers and songwriters by performance rights organizations and collection societies. Key performing rights organizations and collection societies include: The American Society of Composers, Authors and Publishers (ASCAP), SESAC and Broadcast Music, Inc. (BMI) in the U.S.; Mechanical-Copyright Protection Society and The Performing Right Society (“MCPS/PRS”) in the U.K.; The German Copyright Society in Germany (“GEMA”) and the Japanese Society for Rights of Authors, Composers and Publishers in Japan (“JASRAC”). The societies pay a percentage (which is set in each country) of the performance royalties to the copyright owner(s) or administrators (i.e., the publisher(s)), and a percentage directly to the songwriter(s), of the composition. Thus, the publisher generally retains the performance royalties it receives other than any amounts attributable to co-publishers.

The music publishing market has proven to be more resilient than the recorded music market in recent years as revenue streams other than mechanical royalties are largely unaffected by piracy, and are benefiting from additional sources of income from digital exploitation of music in streaming and downloads. The worldwide professional music publishing market was estimated to have generated $4.92 billion in revenues in calendar year 2017 according to figures published in May 2018 by Music & Copyright.

In addition, major publishers have the opportunity to generate significant value by the acquisition of other music publishers by extracting cost savings (as acquired libraries can be administered with little incremental cost) and by increasing revenues through more aggressive monetization efforts.  

 

 

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ITEM 1A.

RISK FACTORS

In addition to the other information contained in this Annual Report, certain risk factors should be considered carefully in evaluating our business. The risks and uncertainties described below may not be the only ones facing us. Additional risks and uncertainties that we do not currently know about or that we currently believe are immaterial may also adversely impact our business operations. If any of the following risks actually occur, our business, financial condition or results of operations would likely suffer. This Annual Report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Actual results and the timing of events could differ materially from those projected in forward-looking statements due to a number of factors, including those set forth below and elsewhere in this Annual Report. See “Special Note Regarding Forward-Looking Statements” following this Item 1A. Risk Factors.

Risks Related to Our Business

We may be unable to compete successfully in the highly competitive markets in which we operate and we may suffer reduced profits as a result.

The industries in which we operate are highly competitive, have experienced ongoing consolidation among major music companies and are driven by consumer preferences that are rapidly changing. Additionally, they require substantial human and capital resources. We compete with other recorded music companies and music publishers to identify and sign new recording artists and songwriters who subsequently achieve long-term success and to renew agreements with established artists and songwriters. In addition, our competitors may from time to time increase the amounts they spend to discover, or to market and promote, recording artists and songwriters or reduce the prices of their products in an effort to expand market share. We may lose business if we are unable to sign successful recording artists or songwriters or to match the prices of the products offered by our competitors. Our Recorded Music business competes not only with other recorded music companies, but also with the recorded music efforts of live events companies and recording artists who may choose to distribute their own works and other companies that may choose to sign direct deals with artists or labels, such as Spotify. Our Music Publishing business competes not only with other music publishing companies, but also with songwriters who publish their own works and other service providers such as Kobalt Music. Our Recorded Music business is to a large extent dependent on technological developments, including access to and selection and viability of new technologies, and is subject to potential pressure from competitors as a result of their technological developments. For example, our Recorded Music business may be further adversely affected by technological developments that facilitate the piracy of music, such as Internet peer-to-peer filesharing and CD-R activity, by an inability to enforce our intellectual property rights in digital environments and by a failure to develop successful business models applicable to a digital environment. The Recorded Music business also faces competition from other forms of entertainment and leisure activities, such as cable and satellite television, motion pictures and videogames in physical and digital formats.

If the recorded music industry fails to grow or streaming revenue fails to grow at a sufficient rate to offset download and physical sales declines, our prospects and our results of operations may be adversely affected.

In the last several years, recorded music sales have been increasing following a long period of decline, while legal digital music has experienced rapid growth since 2003, and revenue growth from streaming has emerged. In fact, growth in digital sales offset declines in physical sales in 2015, 2016 and 2017 and continued to do so in 2018. Streaming revenue is important as it is offsetting declines in downloads and physical sales and represents a growing area of our Recorded Music business. According to IFPI, digital downloads accounted for 20% of global digital revenues in 2017. Streaming revenue, which includes revenue from ad-supported and subscription services, accounted for 71% of digital revenues in 2017, up 11 percentage points year-over-year. Although revenues from digital downloads fell by 21% in 2017, the decline was offset by an increase in streaming revenue, helping total digital revenues grow by 19%. Streaming models comprise a range of margins. For some streaming models, our margins are superior to those for downloads and for others, our margins are slightly less. We expect these trends to continue to impact our results for the foreseeable future. There can be no assurance that this growth pattern will persist or that digital revenue will grow at a rate sufficient to offset declines in physical sales. A declining recorded music industry is likely to lead to reduced levels of revenue and operating income generated by our Recorded Music business. Additionally, a declining recorded music industry is also likely to have a negative impact on our Music Publishing business, which generates a significant portion of its revenues from sales and other exploitation of recorded music.  

There may be downward pressure on our pricing and our profit margins and reductions in shelf space.

There are a variety of factors that could cause us to reduce our prices and reduce our profit margins. They are, among others, price competition from the sale of motion pictures and videogames in physical and digital formats, the negotiating leverage of mass merchandisers, big-box retailers and distributors of digital music, the increased costs of doing business with mass merchandisers and big-box retailers as a result of complying with operating procedures that are unique to their needs and any changes in costs or profit margins associated with our digital business, including the impact of ad-supported music services, some of which may be able to avail themselves of “safe harbor” defenses against copyright infringement actions under copyright laws. Due to “safe harbor” defenses, revenue from ad-supported music services do not fully reflect increases in consumption. In addition, we are currently dependent on a

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small number of leading digital music services, which allows them to significantly influence the prices we can charge in connection with the distribution of digital music. Over the course of the last decade, U.S. mass-market and other stores’ share of U.S. physical music sales has continued to grow. While we cannot predict how future competition will impact music retailers, as the music industry continues to transform it is possible that the share of music sales by a small number of leading mass-market retailers such as Walmart and Target, as well as online retailers and digital music services such as Amazon, Apple Music, Spotify and Tencent will continue to grow, which could further increase their negotiating leverage and put pressure on profit margins. Also, some large retailers may reduce or eliminate shelf space dedicated to music, which could negatively impact our revenues. See “—We are substantially dependent on a limited number of digital music services for the online sale or other exploitation of our music and they are able to significantly influence the pricing structure for online music stores and may not correctly calculate royalties under license agreements.”

Our prospects and financial results may be adversely affected if we fail to identify, sign and retain artists and songwriters and by the existence or absence of superstar releases and by local economic conditions in the countries in which we operate.

We are dependent on identifying, signing and retaining recording artists with long-term potential, whose debut albums are well received on release, whose subsequent albums are anticipated by consumers and whose music will continue to generate sales as part of our catalog for years to come. The competition among record companies for such talent is intense. Competition among record companies to sell and otherwise exploit records is also intense. We are also dependent on signing and retaining songwriters who will write the hit songs of today and the classics of tomorrow. Our competitive position is dependent on our continuing ability to attract and develop artists and songwriters whose work can achieve a high degree of public acceptance. Our financial results may be adversely affected if we are unable to identify, sign and retain such artists and songwriters under terms that are economically attractive to us. Our financial results may also be affected by the existence or absence of superstar artist releases during a particular period. Some music industry observers believe that the number of superstar acts with long-term appeal, both in terms of catalog sales and future releases, has declined in recent years. Additionally, our financial results are generally affected by the worldwide economic and retail environment, as well as the appeal of our Recorded Music catalog and our Music Publishing library to consumers.

We may have difficulty addressing the threats to our business associated with digital piracy.

The combined effect of the decreasing cost of electronic and computer equipment and related technology such as the conversion of music into digital formats have made it easier for consumers to obtain and create unauthorized copies of our recordings in the form of, for example, MP3 files. For example, about 95% of the music downloaded in 2008, or more than 40 billion files, were illegal and not paid for, according to IFPI’s 2009 Digital Music Report.  More recently, research conducted by Ipsos, a recognized third-party market research firm, in conjunction with IFPI, reflects that 26% of consumers across 13 key territories used file-sharing /P2P networks and digital locker sites to acquire music in 2017.  In addition, while growth of music-enabled mobile consumers offers distinct opportunities for music companies such as ours, it also opens the market up to risks from behaviors such as “sideloading” and mobile app-based downloading of unauthorized content. As the business shifts to streaming music or access models, piracy in these models is increasing. For example, the practice of “stream-ripping,” where websites or software programs enable end-users to obtain an unauthorized copy of the audio file associated with a music video, is a growing practice among young people and in parts of the world with high mobile data costs. The research conducted by Ipsos in conjunction with IFPI cited above also reflects that 35% of consumers across the 13 key countries engaged in stream-ripping activity in 2017, with incidence rising to 53% among 16 – 24 year olds.  A substantial portion of our revenue comes from the sale of audio products and streaming services that are potentially subject to unauthorized consumer copying and widespread digital dissemination without an economic return to us. The impact of digital piracy on legitimate music sales and subscriptions is hard to quantify but we believe that illegal filesharing and other forms of unauthorized activity have a substantial negative impact on music sales. We are working to control this problem in a variety of ways including by litigation, by lobbying governments for new, stronger copyright protection laws and more stringent enforcement of current laws, through graduated response programs achieved through cooperation with ISPs and legislation being advanced or considered in many countries, through technological measures and by enabling legitimate new media business models. We cannot give any assurances that such measures will be effective. If we fail to obtain appropriate relief through the judicial process or the complete enforcement of judicial decisions issued in our favor (or if judicial decisions are not in our favor), if we are unsuccessful in our efforts to lobby governments to enact and enforce stronger legal penalties for copyright infringement or if we fail to develop effective means of protecting our intellectual property (whether copyrights or other rights such as patents, trademarks and trade secrets) or our entertainment-related products or services, our results of operations, financial position and prospects may suffer.  

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Organized industrial piracy may lead to decreased sales.

The global organized commercial pirate trade is a significant threat to content industries, including the music sector. IFPI’s 2015 Digital Music Report cited research conducted by MediaLink on behalf of the Digital Citizens Alliance that placed advertising revenues generated by 596 piracy sites at $227 million. Unauthorized copies and piracy have contributed to the decrease in the volume of legitimate sales. They have had, and may continue to have, an adverse effect on our business.

Legitimate channels for digital distribution of our creative content are a fairly recent development, and their impact on our business is unclear and may be adverse.

We have positioned ourselves to take advantage of digital technology as a sales distribution channel and believe that the continued development of legitimate channels for digital music distribution holds promise for us. Digital revenue streams of all kinds are important to offset continued declining revenue from physical CD sales. However, legitimate channels for digital distribution have existed for less than 20 years and we cannot predict their long-term impact on our business. In digital formats, certain costs associated with physical products such as manufacturing, distribution, inventory and return costs do not apply. Partially eroding that benefit are increases in mechanical copyright royalties payable to music publishers that only apply in the digital space. While there are some digital-specific variable costs and infrastructure investments necessary to produce and sell music in digital formats, we believe it is reasonable to expect that we will generally derive a higher contribution margin from digital sales than physical sales. However, we cannot be sure that we will generally continue to achieve higher margins from digital sales especially as an ever greater percentage of our digital revenue comes from sources other than downloads. Any legitimate digital distribution channel that does develop may result in lower or less profitable sales for us than comparable physical sales. In addition, the mix of digital services is changing and not all services will be equally remunerative. Ad-supported music services, some of which may be able to avail themselves of “safe harbor” defenses against copyright infringement actions under copyright laws, may be substitutional for more remunerative paid services. Furthermore, as new distribution channels continue to develop, we may have to implement systems to process royalties on new revenue streams for potential future distribution channels that are not currently known. These new distribution channels could also result in increases in the number of transactions that we need to process. If we are not able to successfully expand our processing capability or introduce technology to allow us to determine and pay royalty amounts due on these new types of transactions in a timely manner, we may experience processing delays or reduced accuracy as we increase the volume of our digital sales, which could have a negative effect on our relationships with artists and brand identity.

We are substantially dependent on a limited number of digital music services for the online sale or other exploitation of our music and they are able to significantly influence the pricing structure for online music stores and may not correctly calculate royalties under license agreements.

We derive an increasing portion of our revenues from sales of music through digital distribution channels. We are currently dependent on a small number of leading digital music services that sell consumers digital music. We have limited ability to increase our wholesale prices to digital service providers as a small number of digital service providers control much of the legitimate digital music business. If these providers were to adopt a lower pricing model or if there were structural changes to other pricing models, we may receive substantially less for our music, which could cause a material reduction in our revenues, unless it is offset by a corresponding increase in the number of transactions. We currently enter into short-term contracts with some digital music providers or provide our content on an at will basis to others. There can be no assurance that we will be able to renew or enter into new contracts with any digital music provider.  Additionally, digital music services at present accept and make available for sale or other exploitation all the recordings that we and other distributors deliver to them. However, if digital music services in the future decide to limit the types or amount of music they will accept from music-based content owners like us, our revenues could be significantly reduced.

Under our license agreements and relevant statutes, we receive royalties from digital music services in order to stream or otherwise offer our content. The determination of the amount and timing of such payments is complex and subject to a number of variables, including the revenue generated, the type of content offered and the country in which it is sold, identification of the appropriate license holder, and the service tier on which content is sold, among other variables. As a result, we may not be paid appropriately for the license of our content. Failure to be accurately paid our royalties may adversely affect our business, operating results, and financial condition.

Our involvement in intellectual property litigation could adversely affect our business.

Our business is highly dependent upon intellectual property, an area that has encountered increased litigation in recent years. If we are alleged to infringe the intellectual property rights of a third-party, any litigation to defend the claim could be costly and would divert the time and resources of management, regardless of the merits of the claim. There can be no assurance that we would prevail in any such litigation. If we were to lose a litigation relating to intellectual property, we could be forced to pay monetary damages and to cease the sale of certain products or the use of certain technology. Any of the foregoing may adversely affect our business.

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Due to the nature of our business, our results of operations, cash flows, and valuation of our common stock may fluctuate significantly from period to period.

Our net sales, operating income and profitability, like those of other companies in the music business, are largely affected by the number and quality of albums that we release or that include musical compositions published by us, timing of release schedules and, more importantly, the consumer demand for these releases. We also make advance payments to recording artists and songwriters, which impact our operating cash flows. The timing of album releases and advance payments is largely based on business and other considerations and is made without regard to the impact of the timing of the release on our financial results. In addition, certain of our license agreements with digital music services contain minimum guarantees and/or require that we are paid minimum guarantee payments. We report results of operations quarterly and our results of operations and cash flows in any reporting period may be materially affected by the timing of releases and advance payments and minimum guarantees, which may result in significant fluctuations from period to period. In addition, in 2013, we adopted a senior executive incentive compensation program that pays annual bonuses to certain executives based on our free cash flow and offers participants the opportunity to share in appreciation of our common stock. As the valuation of our common stock fluctuates, this may also result in fluctuations in our operating results from period to period and, as payments related to the equity portion of the program are made beginning in calendar 2018, cash flows.

Our business operations in some foreign countries subject us to trends, developments or other events which may affect us adversely.

We are a global company with strong local presences, which have become increasingly important as the popularity of music originating from a country’s own language and culture has increased in recent years. Our mix of national and international recording artists and songwriters provides a significant degree of diversification for our music portfolio. However, our creative content does not necessarily enjoy universal appeal. As a result, our results can be affected not only by general industry trends, but also by trends, developments or other events in individual countries, including:

 

limited legal protection and enforcement of intellectual property rights;

 

restrictions on the repatriation of capital;

 

fluctuations in interest and foreign exchange rates;

 

differences and unexpected changes in regulatory environment, including environmental, health and safety, local planning, zoning and labor laws, rules and regulations;

 

varying tax regimes which could adversely affect our results of operations or cash flows, including regulations relating to transfer pricing and withholding taxes on remittances and other payments by subsidiaries and joint ventures;

 

exposure to different legal standards and enforcement mechanisms and the associated cost of compliance;

 

difficulties in attracting and retaining qualified management and employees or rationalizing our workforce;

 

tariffs, duties, export controls and other trade barriers;

 

longer accounts receivable settlement cycles and difficulties in collecting accounts receivable;

 

recessionary trends, inflation and instability of the financial markets;

 

higher interest rates; and

 

political instability.

We may not be able to insure or hedge against these risks, and we may not be able to ensure compliance with all of the applicable regulations without incurring additional costs. For example, our results of operations could be impacted by fluctuations of the U.S. dollar against most currencies. See “—Unfavorable currency exchange rate fluctuations could adversely affect our results of operations.” Furthermore, financing may not be available in countries with less than investment-grade sovereign credit ratings. As a result, it may be difficult to create or maintain profit-making operations in developing countries.

In addition, our results can be affected by trends, developments and other events in individual countries. There can be no assurance that in the future other country-specific trends, developments or other events will not have such a significant adverse effect on our business, results of operations or financial condition. Unfavorable conditions can depress sales in any given market and prompt promotional or other actions that affect our margins.

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Our business may be adversely affected by competitive market conditions and we may not be able to execute our business strategy.

We expect to increase revenues and cash flow through a business strategy which requires us, among other things, to continue to maximize the value of our music assets, to significantly reduce costs to maximize flexibility and adjust to new realities of the market, to continue to act to contain digital piracy and to diversify our revenue streams into growing segments of the music business by capitalizing on digital distribution and emerging technologies, entering into expanded-rights deals with recording artists and by operating our artist services businesses.

Each of these initiatives requires sustained management focus, organization and coordination over significant periods of time. Each of these initiatives also requires success in building relationships with third parties and in anticipating and keeping up with technological developments and consumer preferences and may involve the implementation of new business models or distribution platforms. The results of our strategy and the success of our implementation of this strategy will not be known for some time in the future. If we are unable to implement our strategy successfully or properly react to changes in market conditions, our financial condition, results of operations and cash flows could be adversely affected.

Our ability to operate effectively could be impaired if we fail to attract and retain our executive officers.

Our success depends, in part, upon the continuing contributions of our executive officers, however, there is no guarantee that they will not leave. Some of our executive officers have employment arrangements. In fiscal year 2018, we did not have a direct employment arrangement with our CEO and certain of our other executive officers have at-will employment letters. Our CEO and each of our executive officers who have at-will employment letters have elected to participate in our Senior Management Free Cash Flow Plan, and the at-will employment letters were a condition to their participation in the plan. The loss of the services of any of our executive officers or the failure to attract other executive officers could have a material adverse effect on our business or our business prospects.

A significant portion of our revenues are subject to rate regulation either by government entities or by local third-party collection societies throughout the world and rates on other income streams may be set by governmental proceedings, which may limit our profitability.

Mechanical royalties and performance royalties are two of the main sources of income to our Music Publishing business and mechanical royalties are a significant expense to our Recorded Music business. In the United States, mechanical royalty rates are set every five years pursuant to an administrative process under the U.S. Copyright Act, unless rates are determined through industry negotiations, and performance royalty rates are determined by negotiations with performing rights societies, the largest of which, ASCAP and BMI, are subject to a consent decree rate-setting process if negotiations are unsuccessful. Outside the United States, mechanical and performance royalty rates are typically negotiated on an industry-wide basis. In most territories outside the United States, mechanical royalties are based on a percentage of wholesale prices for physical product and based on a percentage of consumer prices for digital products. The mechanical and performance royalty rates set pursuant to such processes may adversely affect us by limiting our ability to increase the profitability of our Music Publishing business. If the mechanical and performance royalty rates are set too high it may also adversely affect us by limiting our ability to increase the profitability of our Recorded Music business. In addition, rates our Recorded Music business receives in the United States for webcasting and satellite radio are set every five years by an administrative process under the U.S. Copyright Act unless rates are determined through industry negotiations. It is important as sales continue to shift from physical to diversified distribution channels that we receive fair value for all of the uses of our intellectual property as our business model now depends upon multiple revenue streams from multiple sources. The rates set for Recorded Music and Music Publishing income sources through collecting societies or legally prescribed rate-setting processes could have a material adverse impact on our business prospects.

An impairment in the carrying value of goodwill or other intangible and long-lived assets could negatively affect our operating results and equity.

As of September 30, 2018, we had $1.692 billion of goodwill and $154 million of indefinite-lived intangible assets. Financial Accounting Standards Codification (“ASC”) Topic 350, Intangibles—Goodwill and other (“ASC 350”) requires that we test these assets for impairment annually (or more frequently should indications of impairment arise) by first assessing qualitative factors and then by quantitatively estimating the fair value of each of our reporting units (calculated using a discounted cash flow method) and comparing that value to the reporting units’ carrying value, if necessary. If the carrying value exceeds the fair value, there is a potential impairment and additional testing must be performed. In performing our annual tests and determining whether indications of impairment exist, we consider numerous factors including actual and projected operating results of each reporting unit, external market factors such as market prices for similar assets and trends in the music industry. We performed an annual assessment, at July 1, 2018, of the recoverability of our goodwill and indefinite-lived intangibles as of September 30, 2018, noting no instances of

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impairment. However, future events may occur that could adversely affect the estimated fair value of our reporting units. Such events may include, but are not limited to, strategic decisions made in response to changes in economic and competitive conditions and the impact of the economic environment on our operating results. Failure to achieve sufficient levels of cash flow at our reporting units could also result in impairment charges on goodwill and indefinite-lived intangible assets. If the value of the acquired goodwill or acquired indefinite-lived intangible assets is impaired, our operating results and shareholders’ equity could be adversely affected.

We also had $1.851 billion of definite-lived intangible assets as of September 30, 2018. Financial Accounting Standard Board (“FASB”) ASC Topic 360-10-35, (“ASC 360-10-35”) requires companies to review these assets for impairment whenever events or changes in circumstances indicate that the carrying amounts may not be recoverable. No such events or circumstances were identified during the year ended September 30, 2018. If similar events occur as enumerated above such that we believe indicators of impairment are present, we would test for recoverability by comparing the carrying value of the asset to the net undiscounted cash flows expected to be generated from the asset. If those net undiscounted cash flows do not exceed the carrying amount, we would perform the next step, which is to determine the fair value of the asset, which could result in an impairment charge. Any impairment charge recorded could negatively affect our operating results and shareholders’ equity.

Unfavorable currency exchange rate fluctuations could adversely affect our results of operations.

The reporting currency for our financial statements is the U.S. dollar. We have substantial assets, liabilities, revenues and costs denominated in currencies other than U.S. dollars. To prepare our consolidated financial statements, we must translate those assets, liabilities, revenues and expenses into U.S. dollars at then-applicable exchange rates. Consequently, increases and decreases in the value of the U.S. dollar versus other currencies will affect the amount of these items in our consolidated financial statements, even if their value has not changed in their original currency. These translations could result in significant changes to our results of operations from period to period. Prior to intersegment eliminations, 56% of our revenues related to operations in foreign territories for the fiscal year ended September 30, 2018. From time to time, we enter into foreign exchange contracts to hedge the risk of unfavorable foreign currency exchange rate movements. During the current fiscal year, we have hedged a portion of our material foreign currency exposures related to royalty payments remitted between our foreign affiliates and our U.S. affiliates.

We may not have full control and ability to direct the operations we conduct through joint ventures.

We currently have interests in a number of joint ventures and may in the future enter into further joint ventures as a means of conducting our business. In addition, we structure certain of our relationships with recording artists and songwriters as joint ventures. We may not be able to fully control the operations and the assets of our joint ventures, and we may not be able to make major decisions or may not be able to take timely actions with respect to our joint ventures unless our joint venture partners agree.

The enactment of legislation limiting the terms by which an individual can be bound under a “personal services” contract could impair our ability to retain the services of key artists.

California Labor Code Section 2855 (“Section 2855”) limits the duration of time any individual can be bound under a contract for “personal services” to a maximum of seven years. In 1987, Subsection (b) was added, which provides a limited exception to Section 2855 for recording contracts, creating a damages remedy for record companies. Legislation was introduced in New York in 2009 to create a statute similar to Section 2855 to limit contracts between artists and record companies to a term of seven years which could be reduced to three years if the artist was not represented in the negotiation and execution of such contracts by qualified counsel experienced with entertainment industry law and practices. Such legislation could result in certain of our existing contracts with artists being declared unenforceable, or may restrict the terms under which we enter into contracts with artists in the future, either of which could adversely affect our results of operations. There is no assurance that California will not introduce legislation in the future seeking to repeal Subsection (b). The repeal of Subsection (b) and/or the passage of legislation similar to Section 2855 by other states could materially adversely affect our results of operations and financial position.

We face a potential loss of catalog to the extent that our recording artists have a right to recapture rights in their recordings under the U.S. Copyright Act.

The U.S. Copyright Act provides authors (or their heirs) a right to terminate U.S. licenses or assignments of rights in their copyrighted works in certain circumstances. This right does not apply to works that are “works made for hire.” Since the effective date of U.S. federal copyright protection for sound recordings (February 15, 1972), virtually all of our agreements with recording artists provide that such recording artists render services under a work-made-for-hire relationship. A termination right exists under the U.S. Copyright Act for U.S. rights in musical compositions that are not “works made for hire.” If any of our commercially available sound recordings were determined not to be “works made for hire,” then the recording artists (or their heirs) could have the right to terminate the U.S. federal copyright rights they granted to us, generally during a five-year period starting at the end of 35 years from the date of

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release of a recording under a post-1977 license or assignment (or, in the case of a pre-1978 grant in a pre-1978 recording, generally during a five-year period starting at the end of 56 years from the date of copyright). A termination of U.S. federal copyright rights could have an adverse effect on our Recorded Music business. From time to time, authors (or their heirs) have the opportunity to terminate our U.S. rights in musical compositions. However, we believe the effect of any potential termination is already reflected in the financial results of our Music Publishing business.

If we acquire, combine with or invest in other businesses, we will face certain risks inherent in such transactions.

We have in the past considered and will continue, from time to time, to consider, opportunistic strategic transactions, which could involve acquisitions, combinations or dispositions of businesses or assets, or strategic alliances or joint ventures with companies engaged in businesses that are similar or complementary to ours. Any such strategic combination could be material, be difficult to implement, disrupt our business or change our business profile significantly.

Any future strategic transaction could involve numerous risks, including:

 

potential disruption of our ongoing business and distraction of management;

 

potential loss of recording artists or songwriters from our rosters;

 

difficulty integrating the acquired businesses or segregating assets to be disposed of;

 

exposure to unknown and/or contingent or other liabilities, including litigation arising in connection with the acquisition, disposition and/or against any businesses we may acquire;

 

reputational or other damages to our business as a result of a failure to consummate such a transaction for, among other reasons, failure to gain anti-trust approval; and

 

changing our business profile in ways that could have unintended consequences.

If we enter into significant strategic transactions in the future, related accounting charges may affect our financial condition and results of operations, particularly in the case of any acquisitions. In addition, the financing of any significant acquisition may result in changes in our capital structure, including the incurrence of additional indebtedness. Conversely, any material disposition could reduce our indebtedness or require the amendment or refinancing of our outstanding indebtedness or a portion thereof. We may not be successful in addressing these risks or any other problems encountered in connection with any strategic transactions. We cannot assure you that if we make any future acquisitions, investments, strategic alliances or joint ventures or enter into any business combination that they will be completed in a timely manner, or at all, that they will be structured or financed in a way that will enhance our creditworthiness or that they will meet our strategic objectives or otherwise be successful. We also may not be successful in implementing appropriate operational, financial and management systems and controls to achieve the benefits expected to result from these transactions. Failure to effectively manage any of these transactions could result in material increases in costs or reductions in expected revenues, or both. In addition, if any new business in which we invest or which we attempt to develop does not progress as planned, we may not recover the funds and resources we have expended and this could have a negative impact on our businesses or our company as a whole.

We have outsourced our information technology infrastructure and certain finance and accounting functions and may outsource other back-office functions, which will make us more dependent upon third parties.

In an effort to make our information technology, or IT, more efficient and increase our IT capabilities and reduce potential disruptions, as well as generate cost savings, we outsource a significant portion of our IT infrastructure functions to third-parties. This outsourcing initiative is a component of our ongoing strategy to monitor our costs and to seek additional cost savings. As a result, we rely on third parties to ensure that our IT needs are sufficiently met. This reliance subjects us to risks arising from the loss of control over IT processes, changes in pricing that may affect our operating results, and potentially, termination of provisions of these services by our supplier. In addition, in an effort to make our finance and accounting functions more efficient, as well as generate cost savings, we outsource certain finance and accounting functions. A failure of our service providers to perform services in a satisfactory manner may have a significant adverse effect on our business. We may outsource other back-office functions in the future, which would increase our reliance on third parties.

22


 

We have engaged in substantial restructuring activities in the past, and may need to implement further restructurings in the future and our restructuring efforts may not be successful or generate expected cost savings.

The recorded music industry continues to undergo substantial change. These changes continue to have a substantial impact on our business. Following the 2004 acquisition of substantially all of the interests of the recorded music and music publishing business of Time Warner, we implemented a broad restructuring plan in order to adapt our cost structure to the changing economics of the music industry. Since then, we have continued to shift resources from our physical sales channels to efforts focused on digital sales channels, emerging technologies and other new revenue streams. In addition, in order to help mitigate the effects of the recorded music transition, we continue our efforts to reduce overhead and manage our variable and fixed-cost structure to minimize any impact. In addition, as PLG had meaningful operational overlap with our existing business we implemented a restructuring and integration plan and achieved cost savings in conjunction with the PLG Acquisition. In fiscal year 2018, we completed the creation of our new center of excellence for U.S. financial shared services in Nashville, Tennessee, which combined our U.S. transactional financial functions in one location. To establish the new center, we moved some of our U.S. departments to Nashville.

We cannot be certain that we will not be required to implement further restructuring activities, make additions or other changes to our management or workforce based on other cost reduction measures or changes in the markets and industry in which we compete. Our inability to structure our operations based on evolving market conditions could impact our business. Restructuring activities can create unanticipated consequences and negative impacts on the business, and we cannot be sure that any ongoing or future restructuring efforts will be successful or generate expected cost savings.

Access, which indirectly owns all of our outstanding capital stock, controls our company and may have conflicts of interest with the holders of our debt or us in the future. Access may also enter into, or cause us to enter into, strategic transactions that could change the nature or structure of our business, capital structure or credit profile.

As a result of the Merger, affiliates of Access indirectly own all of our common stock, and the actions that Access undertakes as our sole ultimate shareholder may differ from or adversely affect the interests of debt holders. Because Access ultimately controls our voting shares and those of all of our subsidiaries, it has the power, among other things, to affect our legal and capital structure and our day-to-day operations, as well as to elect our directors and those of our subsidiaries, to change our management and to approve any other changes to our operations. In addition, Access previously set the compensation for Stephen Cooper, our CEO, pursuant to an arrangement between Mr. Cooper and Access, and we reimbursed Access for any compensation paid to Mr. Cooper pursuant to the Management Agreement (as defined later in this Annual Report). As of October 1, 2016, Mr. Cooper became an employee of ours paid directly by the Company. Access also provides us with financial, investment banking, management, advisory and other services pursuant to the Management Agreement, for which we pay Access a specified annual fee, plus expenses, and a specified transaction fee for certain types of transactions completed by Holdings or one or more of its subsidiaries, plus expenses. Access also has the power to direct us to engage in strategic transactions, with or involving other companies in our industry, including acquisitions, combinations or dispositions, and the acquisition of certain assets that may become available for purchase, and any such transaction could be material. Any such transaction would carry the risks set forth above under “—If we acquire, combine with or invest in other businesses, we will face certain risks inherent in such transactions.”

Additionally, Access is in the business of making investments in companies and is actively seeking to acquire interests in businesses that operate in our industry and may compete, directly or indirectly, with us. Access may also pursue acquisition opportunities that may be complementary to our business, which could have the effect of making such acquisition opportunities unavailable to us. Access could elect to cause us to enter into business combinations or other transactions with any business or businesses in our industry that Access may acquire or control, or we could become part of a group of companies organized under the ultimate common control of Access that may be operated in a manner different from the manner in which we have historically operated. Any such business combination transaction could require that we or such group of companies incur additional indebtedness, and could also require us or any acquired business to make divestitures of assets necessary or desirable to obtain regulatory approval for such transaction. The amounts of such additional indebtedness, and the size of any such divestitures, could be material. Access may also from time to time purchase outstanding debt securities that we issued, and could also subsequently sell any such debt securities. Any such purchase or sale may affect the value of, trading price or liquidity of our debt securities. We may also, from time to time, pay dividends to our stockholders within the requirements of our debt agreements and applicable law. If we were to pay dividends, the funds used to make such dividend payments would not be available to service our indebtedness.

Finally, because neither we nor our parent company have any securities listed on a securities exchange, we are not subject to certain of the corporate governance requirements of any securities exchange, including any requirement to have any independent directors.

23


 

Evolving regulations concerning data privacy may result in increased regulation and different industry standards, which could increase the costs of operations or limit our activities.

We engage in a wide array of online activities and are thus subject to a broad range of related laws and regulations including, for example, those relating to privacy, consumer protection, data retention and data protection, online behavioral advertising, geo-location tracking, text messaging, e-mail advertising, mobile advertising, content regulation, defamation, age verification, the protection of children online, social media and other Internet, mobile and online-related prohibitions and restrictions. The regulatory framework for privacy and data security issues worldwide has become increasingly burdensome and complex, and is likely to continue to be so for the foreseeable future. Practices regarding the collection, use, storage, transmission, security and disclosure of personal information by companies operating over the Internet and mobile platforms are receiving ever-increasing public scrutiny. The U.S. government, including Congress, the Federal Trade Commission and the Department of Commerce, has announced that it is reviewing the need for even greater regulation for the collection of information concerning consumer behavior on the Internet and mobile platforms, including regulation aimed at restricting certain targeted advertising practices, the use of location data and disclosures of privacy practices in the online and mobile environments, including with respect to online and mobile applications. State governments are engaged in similar legislative and regulatory activities. In addition, privacy and data security laws and regulations around the world are being implemented rapidly and evolving. These new and evolving laws (including the European Union General Data Protection Regulation effective on May 25, 2018) are likely to result in greater compliance burdens for companies with global operations. Globally, many government and consumer agencies have also called for new regulation and changes in industry practices with respect to information collected from consumers, electronic marketing and the use of third-party cookies, web beacons, and similar technology for online behavioral advertising.

In October 2012, one of our subsidiaries entered into a consent agreement to settle certain Federal Trade Commission charges that it violated the Children’s Online Privacy Protection Act (“COPPA”) by improperly collecting personal information from children under 13 without their parents’ verifiable consent. While our subsidiary neither admitted nor denied the agency’s allegations, the settlement imposed a $1 million civil penalty, barred future violations of COPPA, and required that our subsidiary delete information allegedly collected in violation of COPPA, among other requirements.

The Federal Trade Commission adopted certain revisions to its rule promulgated pursuant to COPPA, effective as of July 1, 2013, that may impose greater compliance burdens on us. COPPA imposes a number of obligations, such as obtaining verifiable parental permission on operators of websites, apps and other online services to the extent they collect certain information from children who are under 13 years of age. The changes broaden the applicability of COPPA, including by expanding the definition of “personal information” subject to the rule’s parental consent and other obligations.

Our business, including our ability to operate and expand internationally, could be adversely affected if laws or regulations are adopted, interpreted, or implemented in a manner that is inconsistent with our current business practices and that require changes to these practices. Therefore, our business could be harmed by any significant change to applicable laws, regulations or industry practices regarding the collection, use or disclosure of customer data, or regarding the manner in which the express or implied consent of consumers for such collection, use and disclosure is obtained. Such changes may require us to modify our operations, possibly in a material manner, and may limit our ability to develop new products, services, mechanisms, platforms and features that make use of data regarding our customers and potential customers.

If we or our service providers do not maintain the security of information relating to our customers, employees and vendors and our music-based content, security information breaches through cyber security attacks or otherwise could damage our reputation with customers, employees, vendors and artists, and we could incur substantial additional costs, become subject to litigation and our results of operations and financial condition could be adversely affected. Moreover, even if we or our service providers maintain such security, such breaches remain a possibility due to the fact that no data security system is immune from attacks or other incidents.

We receive certain personal information about our customers and potential customers, and we also receive personal information concerning our employees, artists and vendors. In addition, our online operations depend upon the secure transmission of confidential information over public networks. We maintain security measures with respect to such information, but despite these measures, we may be vulnerable to security breaches by computer hackers and others that attempt to penetrate the security measures that we have in place. A compromise of our security systems (through cyber-attacks or otherwise which are rapidly evolving and sophisticated) that results in personal information being obtained by unauthorized persons could adversely affect our reputation with our customers, potential customers, employees, artists and vendors, as well as our operations, results of operations, financial condition and liquidity, and could result in litigation against us or the imposition of governmental penalties. We may also be subject to cyber-attacks that target our music-based content, including not-yet-released songs or albums.  The theft and premature release of this music-based content may adversely affect our reputation with current and potential artists and adversely impact our results of operations and financial condition. In addition, a security breach could require that we expend significant additional resources related to our information security systems and could result in a disruption of our operations.

24


 

We increasingly rely on third-party data storage providers, including cloud storage solution providers, resulting in less direct control over our data. Such third parties may also be vulnerable to security breaches and compromised security systems, which could adversely affect our reputation.

Risks Related to our Leverage

Our substantial leverage on a consolidated basis could adversely affect our ability to raise additional capital to fund our operations, limit our ability to react to changes in the economy or our industry and prevent us from meeting our obligations under our indebtedness.

We are highly leveraged. As of September 30, 2018, our total consolidated indebtedness, net of deferred financing costs, was $2.819 billion. In addition, we would have been able to borrow up to $172 million under our Revolving Credit Facility (as defined later in this Annual Report) as of September 30, 2018 (after giving effect to approximately $8 million of letters of credit outstanding under our Revolving Credit Facility as of September 30, 2018).

Our high degree of leverage could have important consequences for our investors. For example, it may:

 

make it more difficult for us to make payments on our indebtedness;

 

increase our vulnerability to general economic and industry conditions, including recessions and periods of significant inflation and financial market volatility;

 

expose us to the risk of increased interest rates because any borrowings we make under the revolving portion of our Senior Credit Facilities will bear interest at variable rates;

 

require us to use a substantial portion of our cash flow from operations to service our indebtedness, thereby reducing our ability to fund working capital, capital expenditures and other expenses;

 

limit our ability to refinance existing indebtedness on favorable terms or at all or borrow additional funds in the future for, among other things, working capital, acquisitions or debt service requirements;

 

limit our flexibility in planning for, or reacting to, changes in our business and the industries in which we operate;

 

place us at a competitive disadvantage compared to competitors that have less indebtedness; and

 

limit our ability to borrow additional funds that may be needed to operate and expand our business.

We and our subsidiaries may be able to incur substantial additional indebtedness in the future, subject to the restrictions contained in the indentures governing our outstanding notes as well as under the Senior Credit Facilities (as defined later in this Annual Report). If new indebtedness is added to our current debt levels, the related risks that we and our subsidiaries now face could intensify.

The indentures that govern our outstanding notes and the Senior Credit Facilities contain restrictive covenants that limit our ability to engage in activities that may be in our long-term best interests. Those covenants include restrictions on our ability to, among other things, incur more indebtedness, pay dividends, redeem stock or make other distributions, make investments, create liens, transfer or sell assets, merge or consolidate and enter into certain transactions with our affiliates. Our failure to comply with those covenants could result in an event of default, which, if not cured or waived, could result in the acceleration of all of our indebtedness. See also “—Our debt agreements contain restrictions that limit our flexibility in operating our business.”

Acquisition Corp. may not be able to generate sufficient cash to service all of its indebtedness, and may be forced to take other actions to satisfy its obligations under its indebtedness, which may not be successful.

Acquisition Corp.’s ability to make scheduled payments on or to refinance its debt obligations depends on its financial condition and operating performance, which is subject to prevailing economic and competitive conditions and to certain financial, business and other factors beyond our control. Acquisition Corp. may not maintain a level of cash flow from operating activities sufficient to permit us to pay the principal, premium, if any, and interest on our indebtedness.

Acquisition Corp. will rely on its subsidiaries to make payments on its borrowings. If these subsidiaries do not dividend funds to Acquisition Corp. in an amount sufficient to make such payments, if necessary in the future, Acquisition Corp. may default under the indentures or credit facilities governing its borrowings, which would result in all such borrowings becoming due and payable.  

25


 

Our debt agreements contain restrictions that limit our flexibility in operating our business.

The indentures governing our outstanding notes contain various covenants that limit our ability to engage in specified types of transactions. These covenants limit our ability and the ability of our restricted subsidiaries to, among other things:

 

incur additional debt or issue certain preferred shares;

 

create liens on certain debt;

 

pay dividends on or make distributions in respect of our capital stock or make investments or other restricted payments;

 

sell certain assets;

 

pay dividends to us (in the case of our restricted subsidiaries) or make certain other intercompany transfers;

 

enter into certain transactions with our affiliates; and

 

consolidate, merge, sell or otherwise dispose of all or substantially all of our assets.

In addition, the credit agreements governing the Senior Credit Facilities contain a number of covenants that limit our ability and the ability of our restricted subsidiaries to:

 

pay dividends on, and redeem and purchase, equity interests;

 

make other restricted payments;

 

make prepayments on, redeem or repurchase certain debt;

 

incur certain liens;

 

make certain loans and investments;

 

incur certain additional debt;

 

enter into guarantees and hedging arrangements;

 

enter into mergers, acquisitions and asset sales;

 

enter into transactions with affiliates;

 

change the business we and our subsidiaries conduct;

 

pay dividends or make distributions;

 

amend the terms of subordinated debt and unsecured bonds; and

 

make certain capital expenditures.

Our ability to borrow additional amounts under the revolving portion of the Senior Credit Facilities depends upon satisfaction of these covenants. Events beyond our control can affect our ability to meet these covenants. In addition, under the credit agreement governing the revolving portion of our Senior Credit Facilities, a financial maintenance covenant is applicable if at the end of a quarter the outstanding amount of loans and letters of credit is in excess of $54 million.

Our failure to comply with obligations under the instruments governing our indebtedness may result in an event of default under such instruments. We cannot be certain that we will have funds available to remedy these defaults. A default, if not cured or waived, may permit acceleration of our indebtedness. If our indebtedness is accelerated, we cannot be certain that we will have sufficient funds available to pay the accelerated indebtedness or will have the ability to refinance the accelerated indebtedness on terms favorable to us or at all.

All of these restrictions could affect our ability to operate our business or may limit our ability to take advantage of potential business opportunities as they arise.

26


 

If our cash flows and capital resources are insufficient to fund our debt service obligations, we may be forced to reduce or delay investments in recording artists and songwriters, capital expenditures or dividends, or to sell assets, seek additional capital or restructure or refinance our indebtedness. These alternative measures may not be successful and may not permit us to meet our scheduled debt service obligations. In the absence of such operating results and resources, we could face substantial liquidity problems and might be required to dispose of material assets or operations to meet our debt service and other obligations. The indentures governing our outstanding notes restrict our ability to dispose of assets and use the proceeds from dispositions. We may not be able to consummate those dispositions or to obtain the proceeds which we could realize from them and these proceeds may not be adequate to meet any debt service obligations then due. While subject to certain restrictions in our debt agreements, if we were to pay dividends to our shareholders, the funds used to make such dividend payments would not be available to service our indebtedness.

Despite our indebtedness levels, we may be able to incur substantially more indebtedness, which may increase the risks created by our substantial indebtedness.

We may be able to incur substantial additional indebtedness, including additional secured indebtedness, in the future. The indentures governing our outstanding notes and the credit agreements governing the Senior Credit Facilities will not fully prohibit us, Holdings or our subsidiaries from incurring additional indebtedness under certain circumstances. If we, Holdings or our subsidiaries are in compliance with certain incurrence ratios set forth in such indentures, we, Holdings or our subsidiaries may be able to incur substantial additional indebtedness, which may increase the risks created by our current substantial indebtedness.

Our ability to incur secured indebtedness is subject to compliance with certain secured leverage ratios that are calculated as of the date of incurrence. The amount of secured indebtedness that we are able to incur and the timing of any such incurrence under these ratios vary from time to time and are a function of several variables, including our outstanding indebtedness and our results of operations calculated as of specified dates or for certain periods.

A downgrade, suspension or withdrawal of the rating assigned by a rating agency to us could cause the liquidity or market value of our indebtedness to decline and our cost of capital to increase.

Any future lowering of our ratings may make it more difficult or more expensive for us to obtain additional debt financing. Therefore, although reductions in our debt ratings may not have an immediate impact on the cost of debt or our liquidity, they may impact the cost of debt and liquidity over the medium term and future access at a reasonable rate to the debt markets may be adversely impacted.

Special Note Regarding Forward-Looking Statements

We have made various statements in this Annual Report that may constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements may also be made in our other reports filed with or furnished to the SEC, in our press releases and in other documents. In addition, from time to time, we, through our management, may make oral forward-looking statements. Forward-looking statements are subject to risks and uncertainties, including those identified above, which could cause actual results to differ materially from such statements. The words “will likely result,” “are expected to,” “will continue,” “is anticipated,” “estimated,” “believe,” “intend,” “plan,” “may,” “should,” “could,” “would,” “likely,” “projection,” “outlook” and similar expressions are intended to identify forward-looking statements. We caution you that the risk factors described above are not exclusive. There may also be other risks that we are unable to predict at this time that may cause actual results to differ materially from those in forward looking statements. New factors emerge from time to time, and it is not possible for us to predict which will arise or to assess with any precision the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date on which they are made. We undertake no obligation to update publicly or revise any forward-looking statements, except as required by law.

 

ITEM 1B.

UNRESOLVED STAFF COMMENTS

None.

 

 

27


 

ITEM 2.

PROPERTIES

We own studio and office facilities and also lease certain facilities in the ordinary course of business. Our worldwide headquarters are currently located at 1633 Broadway, New York, New York 10019, under a long-term lease ending July 31, 2029. The lease also includes a single option for us to extend the term for either five years or ten years. In addition, under certain conditions, we have the ability to lease additional space in the building and have a right of first refusal with regard to certain additional space.  We also have a long-term lease ending on December 31, 2019, for office space in a building located at 3400 West Olive Avenue, Burbank, California 91505, used primarily by our Recorded Music business. We also have a lease ending on February 28, 2019 for office space at 10585 Santa Monica Boulevard, Los Angeles, California 90025, used primarily by our Music Publishing business. On October 7, 2016, we entered into a lease agreement for new office space located in the Ford Factory Building at 777 S. Santa Fe Avenue, Los Angeles, California, 90021, to be used as our new Los Angeles, California headquarters, beginning on August 1, 2017 for an initial term of 12 years and 9 months with a single option to extend the term of the lease for 10 years. We also own other property and lease facilities elsewhere throughout the world as necessary to operate our businesses. We consider our properties adequate for our current needs.

 

ITEM 3.

LEGAL PROCEEDINGS

Pricing of Digital Music Downloads

On December 20, 2005 and February 3, 2006, the Attorney General of the State of New York served the Company with requests for information in connection with an industry-wide investigation as to the pricing of digital music downloads. On February 28, 2006, the Antitrust Division of the U.S. Department of Justice served us with a Civil Investigative Demand, also seeking information relating to the pricing of digitally downloaded music. Both investigations were ultimately closed, but subsequent to the announcements of the investigations, more than thirty putative class action lawsuits were filed concerning the pricing of digital music downloads. The lawsuits were consolidated in the Southern District of New York. The consolidated amended complaint, filed on April 13, 2007, alleges conspiracy among record companies to delay the release of their content for digital distribution, inflate their pricing of CDs and fix prices for digital downloads. The complaint seeks unspecified compensatory, statutory and treble damages. On October 9, 2008, the District Court issued an order dismissing the case as to all defendants, including us. However, on January 13, 2010, the Second Circuit vacated the judgment of the District Court and remanded the case for further proceedings and on January 10, 2011, the U.S. Supreme Court denied the defendants’ petition for Certiorari.

Upon remand to the District Court, all defendants, including the Company, filed a renewed motion to dismiss challenging, among other things, plaintiffs’ state law claims and standing to bring certain claims. The renewed motion was based mainly on arguments made in defendants’ original motion to dismiss, but not addressed by the District Court. On July 18, 2011, the District Court granted defendants’ motion in part, and denied it in part. Notably, all claims on behalf of the CD-purchaser class were dismissed with prejudice. However, a wide variety of state and federal claims remain for the class of Internet download purchasers. On March 19, 2014, plaintiffs filed a motion for class certification. Plaintiffs filed an operative consolidated amended complaint on September 25, 2015. The Company filed its answer to the fourth amended complaint on October 9, 2015, and filed an amended answer on November 3, 2015. A mediation took place on February 22, 2016, but the parties were unable to reach a resolution. On July 18, 2017, the District Court denied plaintiffs’ motion for class certification. On August 1, 2017, plaintiffs filed a petition with the Second Circuit seeking permission to appeal the district court’s order denying class certification. On August 11, 2017, defendants filed their opposition to plaintiffs’ petition.  On December 8, 2017, the Second Circuit denied plaintiffs’ request for leave to appeal the District Court’s order denying their motion for class certification. On May 8, 2018, the parties filed a joint stipulation to voluntarily dismiss the case with prejudice, and on May 15, 2018, the District Court dismissed the case.

Sirius XM

On September 11, 2013, the Company joined with Capitol Records, LLC, Sony Music Entertainment, UMG Recordings, Inc. and ABKCO Music & Records, Inc. in a lawsuit brought in California Superior Court against Sirius XM Radio Inc., alleging copyright infringement for Sirius XM’s use of pre-1972 sound recordings under California law.  A nation-wide settlement was reached on June 17, 2015 pursuant to which Sirius XM paid the plaintiffs, in the aggregate, $210 million on July 29, 2015 and the plaintiffs dismissed their lawsuit with prejudice.  The settlement resolves all past claims as to Sirius XM’s use of pre-1972 recordings owned or controlled by the plaintiffs and enables Sirius XM, without any additional payment, to reproduce, perform and broadcast such recordings in the United States through December 31, 2017.  The allocation of the settlement proceeds among the plaintiffs was determined and the settlement proceeds were distributed accordingly. This resulted in a cash distribution to the Company of $33 million of which $28 million was recognized in revenue during the 2016 fiscal year and $4 million was recognized in revenue during the 2017 fiscal year. The balance of $1 million was recognized in the first quarter of the 2018 fiscal year. The Company is sharing its allocation of the settlement proceeds with its artists on the same basis as statutory revenue from Sirius XM is shared, i.e., the artist share of our allocation will be paid to artists by SoundExchange.

28


 

As part of the settlement, plaintiffs agreed to negotiate in good faith to grant Sirius XM a license to publicly perform the plaintiffs’ pre-1972 sound recordings for the five-year period running from January 1, 2018 to December 31, 2022.  Pursuant to the settlement, if the parties are unable to reach an agreement on license terms, the royalty rate for each license will be determined by binding arbitration on a willing buyer/willing seller standard.  On December 21, 2017, Sirius XM commenced a single arbitration against all of the plaintiffs in California through JAMS to determine the rate for the five-year period. On May 1, 2018, the Company filed a lawsuit against Sirius XM in New York state court to stay the California arbitration and to compel a separate arbitration in New York solely between Sirius XM and the Company. On August 23, 2018, the Company filed a stipulation of discontinuance without prejudice as to the state court action after Sirius XM agreed to participate in a separate arbitration with the Company in New York which has not yet been scheduled.

Other Matters

In addition to the matter discussed above, the Company is involved in various litigation and regulatory proceedings arising in the normal course of business. Where it is determined, in consultation with counsel based on litigation and settlement risks, that a loss is probable and estimable in a given matter, the Company establishes an accrual. In the currently pending proceedings, the amount of accrual is not material. An estimate of the reasonably possible loss or range of loss in excess of the amounts already accrued cannot be made at this time due to various factors typical in contested proceedings, including (1) the results of ongoing discovery; (2) uncertain damage theories and demands; (3) a less than complete factual record; (4) uncertainty concerning legal theories and their resolution by courts or regulators; and (5) the unpredictable nature of the opposing party and its demands. However, the Company cannot predict with certainty the outcome of any litigation or the potential for future litigation. As such, the Company continuously monitors these proceedings as they develop and adjusts any accrual or disclosure as needed. Regardless of the outcome, litigation could have an adverse impact on the Company, including the Company’s brand value, because of defense costs, diversion of management resources and other factors and it could have a material effect on the Company’s results of operations for a given reporting period.

 

ITEM 4.

MINE SAFETY DISCLOSURES

Not Applicable.

 

 

29


 

PART II

 

ITEM 5.

MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

There is no established public trading market for any class of our common equity. As of December 20, 2018, there were 1,052 shares of our common stock outstanding. Affiliates of Access currently own 100% of our common stock.

Dividend Policy

Our ability to pay dividends is restricted by covenants in the indentures governing our notes and in the credit agreements for our Senior Term Loan Facility and the Revolving Credit Facility.

The Company intends to institute a regular quarterly dividend whereby we would intend to pay modest regular quarterly dividends in each fiscal quarter and a variable dividend for the fourth fiscal quarter in an amount commensurate with cash expected to be generated from operations in such fiscal year, in each case, after taking into account other potential uses for cash, including acquisitions, investment in our business and repayment of indebtedness.  We expect to pay the first dividend under this policy in the second quarter of fiscal 2019.  The declaration of each dividend will continue to be at the discretion of the Board.

30


 

ITEM 6.

SELECTED FINANCIAL DATA

Our summary balance sheet data as of September 30, 2018 and September 30, 2017, and the statement of operations and other data for the fiscal years ended September 30, 2018, September 30, 2017 and September 30, 2016 have been derived from our audited financial statements included in this Annual Report and should be read in conjunction with the audited financial statements and other financial information presented elsewhere herein. The selected financial information set forth below for all other periods has been derived from our audited financial statements that are not included in this Annual Report.

The following table sets forth our selected historical financial and other data as of the dates and for the periods ended:

 

 

 

Fiscal Year

 

 

Fiscal Year

 

 

Fiscal Year

 

 

Fiscal Year

 

 

Fiscal Year

 

 

 

Ended

 

 

Ended

 

 

Ended

 

 

Ended

 

 

Ended

 

 

 

September 30,

 

 

September 30,

 

 

September 30,

 

 

September 30,

 

 

September 30,

 

 

 

2018

 

 

2017

 

 

2016

 

 

2015

 

 

2014

 

 

 

(in millions)

 

Statement of Operations Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

4,005

 

 

$

3,576

 

 

$

3,246

 

 

$

2,966

 

 

$

3,027

 

Net income (loss) attributable to Warner

   Music Group Corp. (1)

 

 

307

 

 

 

143

 

 

 

25

 

 

 

(91

)

 

 

(308

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance Sheet Data (at period end):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and equivalents

 

$

514

 

 

$

647

 

 

$

359

 

 

$

246

 

 

$

157

 

Total assets

 

 

5,344

 

 

 

5,718

 

 

 

5,335

 

 

 

5,574

 

 

 

5,852

 

Total debt (including current portion of long-term debt)

 

 

2,819

 

 

 

2,811

 

 

 

2,778

 

 

 

2,947

 

 

 

2,973

 

Warner Music Group Corp. (deficit) equity

 

 

(334

)

 

 

293

 

 

 

195

 

 

 

221

 

 

 

371

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash Flow Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash flows provided by (used in):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating activities

 

$

425

 

 

$

535

 

 

$

342

 

 

$

222

 

 

$

130

 

Investing activities

 

 

405

 

 

 

(126

)

 

 

(8

)

 

 

(95

)

 

 

(155

)

Financing activities

 

 

(955

)

 

 

(128

)

 

 

(216

)

 

 

(19

)

 

 

37

 

Capital expenditures

 

 

(74

)

 

 

(44

)

 

 

(42

)

 

 

(63

)

 

 

(76

)

 

(1)

Net income attributable to Warner Music Group Corp. for the fiscal year ended September 30, 2018 includes a net loss on extinguishment of debt of $31 million, variable compensation costs associated with our Senior Management Free Cash Flow Plan of $108 million, net gain on Spotify sale of $317 million after taxes, and restructuring charges of $44 million. Net income attributable to Warner Music Group Corp. for the fiscal year ended September 30, 2017 includes a benefit due to the reversal of the U.S. valuation allowance of $125 million, net loss on extinguishment of debt of $35 million, variable compensation costs associated with our Senior Management Free Cash Flow Plan of $102 million and net gain on divestitures primarily related to PLG of $6 million. Net income attributable to Warner Music Group Corp. for the fiscal year ended September 30, 2016 includes net loss on extinguishment of debt of $18 million, gain on sale of real estate of $24 million and net gain on divestitures primarily related to PLG of $9 million. Net loss attributable to Warner Music Group Corp. for the fiscal year ended September 30, 2015 includes $2 million of PLG restructuring charges and $5 million of PLG-related professional fees and integration costs. Net loss attributable to Warner Music Group Corp. for the fiscal year ended September 30, 2014 includes $50 million of PLG restructuring charges, $59 million of PLG-related professional fees and integration costs and loss on extinguishment of debt of $141 million.

 

 

31


 

ITEM 7.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This Annual Report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Actual results and the timing of events could differ materially from those projected in forward-looking statements due to a number of factors, including those described under “Item 1A - Risk Factors” and elsewhere in this Annual Report. See “Special Note Regarding Forward-Looking Statements.”

You should read the following discussion of our results of operations and financial condition with the audited financial statements included elsewhere in this Annual Report for the fiscal year ended September 30, 2018.

INTRODUCTION

The Company was formed on November 21, 2003. The Company is the direct parent of Holdings, which is the direct parent of Acquisition Corp. Acquisition Corp. is one of the world’s major music-based content companies.

The Company and Holdings are holding companies that conduct substantially all of their business operations through their subsidiaries. The terms “we,” “us,” “our,” “ours,” and the “Company” refer collectively to Warner Music Group Corp. and its consolidated subsidiaries, except where otherwise indicated.

Management’s discussion and analysis of results of operations and financial condition (“MD&A”) is provided as a supplement to the audited financial statements and footnotes included elsewhere herein to help provide an understanding of our financial condition, changes in financial condition and results of our operations. MD&A is organized as follows:

 

Overview. This section provides a general description of our business, as well as a discussion of factors that we believe are important in understanding our results of operations and comparability and in anticipating future trends.

 

Results of operations. This section provides an analysis of our results of operations for the fiscal years ended September 30, 2018, September 30, 2017 and September 30, 2016. This analysis is presented on both a consolidated and segment basis.

 

Financial condition and liquidity. This section provides an analysis of our cash flows for the fiscal years ended September 30, 2018, September 30, 2017 and September 30, 2016, as well as a discussion of our financial condition and liquidity as of September 30, 2018. The discussion of our financial condition and liquidity includes recent debt financings and a summary of the key debt covenant compliance measures under our debt agreements.

 

Critical Accounting Policies. This section identifies those accounting policies that are considered important to the Company’s results of operations and financial condition, require significant judgment and involve significant management estimates. The Company’s significant accounting policies, including those considered to be critical accounting policies, are summarized in Note 2 to the accompanying Consolidated Financial Statements.

Use of OIBDA

We evaluate our operating performance based on several factors, including our primary financial measure of operating income (loss) before non-cash depreciation of tangible assets and non-cash amortization of intangible assets (“OIBDA”). We consider OIBDA to be an important indicator of the operational strengths and performance of our businesses. However, a limitation of the use of OIBDA as a performance measure is that it does not reflect the periodic costs of certain capitalized tangible and intangible assets used in generating revenues in our businesses and other non-operating income (loss). Accordingly, OIBDA should be considered in addition to, not as a substitute for, operating income (loss), net income (loss) attributable to Warner Music Group Corp. and other measures of financial performance reported in accordance with United States generally accepted accounting principles (“U.S. GAAP”). In addition, our definition of OIBDA may differ from similarly titled measures used by other companies. A reconciliation of consolidated OIBDA to operating income (loss) and net income (loss) attributable to Warner Music Group Corp. is provided in our “Results of Operations.”

32


 

Use of Constant Currency

As exchange rates are an important factor in understanding period to period comparisons, we believe the presentation of revenue on a constant-currency basis in addition to reported results helps improve the ability to understand our operating results and evaluate our performance in comparison to prior periods. Constant-currency information compares revenue between periods as if exchange rates had remained constant period over period. We use revenue on a constant-currency basis as one measure to evaluate our performance. We calculate constant currency by calculating prior-year revenue using current-year foreign currency exchange rates. We generally refer to such amounts calculated on a constant-currency basis as “excluding the impact of foreign currency exchange rates.” This revenue should be considered in addition to, not as a substitute for, revenue reported in accordance with U.S. GAAP. Revenue on a constant-currency basis, as we present them, may not be comparable to similarly titled measures used by other companies and are not a measure of performance presented in accordance with U.S. GAAP.

OVERVIEW

We are one of the world’s major music-based content companies. We classify our business interests into two fundamental operations: Recorded Music and Music Publishing. A brief description of each of those operations is presented below.

Recorded Music Operations

Our Recorded Music business primarily consists of the discovery and development of artists and the related marketing, distribution and licensing of recorded music produced by such artists. We play an integral role in virtually all aspects of the recorded music value chain from discovering and developing talent to producing music and marketing and promoting artists and their products.

In the United States, our Recorded Music operations are conducted principally through our major record labels—Warner Bros. Records and Atlantic Records. In October 2018, we launched Elektra Music Group in the United States as a standalone label group, which comprises the Elektra, Fueled by Ramen and Roadrunner labels. Our Recorded Music operations also include Rhino, a division that specializes in marketing our music catalog through compilations, reissuances of previously released music and video titles and releasing previously unreleased material from our vault. We also conduct our Recorded Music operations through a collection of additional record labels including Asylum, Big Beat, Canvasback, East West, Erato, FFRR, Nonesuch, Parlophone, Reprise, Sire, Spinnin’, Warner Classics and Warner Music Nashville.

Outside the United States, our Recorded Music activities are conducted in more than 50 countries through various subsidiaries, affiliates and non-affiliated licensees. Internationally, we engage in the same activities as in the United States: discovering and signing artists and distributing, marketing and selling their recorded music. In most cases, we also market and distribute the music of those artists for whom our domestic record labels have international rights. In certain smaller markets, we license the right to distribute our records to non-affiliated third-party record labels. Our international artist services operations include a network of concert promoters through which we provide resources to coordinate tours for our artists and other artists as well as management companies that guide artists with respect to their careers.

Our Recorded Music distribution operations include WEA Corp., which markets and sells music and video products to retailers and wholesale distributors; ADA, which distributes the products of independent labels to retail and wholesale distributors; and various distribution centers and ventures operated internationally.

In addition to our Recorded Music products being sold in physical retail outlets, our Recorded Music products are also sold in physical form to online physical retailers such as Amazon.com, barnesandnoble.com and bestbuy.com and in digital form to an expanded universe of digital partners, including digital streaming services such as Amazon, Apple, Deezer, Napster, SoundCloud, Spotify, Tencent and YouTube, digital radio services such as iHeart Radio, Pandora and Sirius XM and digital download services such as Apple’s iTunes and Google Play.

We have integrated the exploitation of digital content into all aspects of our business, including A&R, marketing, promotion and distribution. Our business development executives work closely with A&R departments to ensure that while music is being produced, digital assets are also created with all distribution channels in mind, including streaming services, social networking sites, online portals and music-centered destinations. We also work side-by-side with our online and mobile partners to test new concepts. We believe existing and new digital businesses will be a significant source of growth and will provide new opportunities to successfully monetize our assets and create new revenue streams. The proportion of digital revenues attributed to each distribution channel varies by region and proportions may change as the roll out of new technologies continues. As an owner of music content, we believe we are well positioned to take advantage of growth in digital distribution and emerging technologies to maximize the value of our assets.

33


 

We have diversified our revenues beyond our traditional businesses by entering into expanded-rights deals with recording artists in order to partner with artists in other aspects of their careers. Under these agreements, we provide services to and participate in artists’ activities outside the traditional recorded music business such as touring, merchandising and sponsorships. We have built and acquired artist services capabilities and platforms for exploiting this broader set of music-related rights and participating more widely in the monetization of the artist brands we help create. We believe that entering into expanded-rights deals and enhancing our artist services capabilities in areas such as concert promotion and management has permitted us to diversify revenue streams and capitalize on other revenue opportunities. This provides for improved long-term relationships with artists and allows us to more effectively connect artists and fans.  

Recorded Music revenues are derived from four main sources:

 

Digital: the rightsholder receives revenues with respect to digital streaming and digital download services;

 

Physical: the rightsholder receives revenues with respect to sales of physical products such as CDs, vinyl and DVDs;

 

Artist services and expanded-rights: the rightsholder receives revenues with respect to artist services businesses and our participation in expanded-rights associated with our artists, including sponsorship, fan clubs, artist websites, merchandising, touring, concert promotion, ticketing and artist and brand management; and

 

Licensing: the rightsholder receives royalties or fees for the right to use sound recordings in combination with visual images such as in films or television programs, television commercials and videogames; the rightsholder also receives royalties if sound recordings are performed publicly through broadcast of music on television, radio and cable, and in public spaces such as shops, workplaces, restaurants, bars and clubs.

The principal costs associated with our Recorded Music operations are as follows:

 

A&R costs—the costs associated with (i) paying royalties to artists, producers, songwriters, other copyright holders and trade unions; (ii) signing and developing artists; and (iii) creating master recordings in the studio;

 

Product costs—the costs to manufacture, package and distribute products to wholesale and retail distribution outlets, the royalty costs associated with distributing products of independent labels to wholesale and retail distribution outlets, as well as the costs related to our artist services business;

 

Selling and marketing expenses—the costs associated with the promotion and marketing of artists and recorded music products, including costs to produce music videos for promotional purposes and artist tour support; and

 

General and administrative expenses—the costs associated with general overhead and other administrative expenses.

Music Publishing Operations

While recorded music is focused on exploiting a particular recording of a composition, music publishing is an intellectual property business focused on the exploitation of the composition itself. In return for promoting, placing, marketing and administering the creative output of a songwriter, or engaging in those activities for other rightsholders, our Music Publishing business garners a share of the revenues generated from use of the composition.

Our Music Publishing operations are conducted principally through Warner/Chappell, our global music publishing company headquartered in Los Angeles with operations in over 50 countries through various subsidiaries, affiliates and non-affiliated licensees. We own or control rights to more than one million musical compositions, including numerous pop hits, American standards, folk songs and motion picture and theatrical compositions. Assembled over decades, our award-winning catalog includes over 70,000 songwriters and composers and a diverse range of genres including pop, rock, jazz, classical, country, R&B, hip-hop, rap, reggae, Latin, folk, blues, symphonic, soul, Broadway, techno, alternative and gospel. Warner/Chappell also administers the music and soundtracks of several third-party television and film producers and studios. We have an extensive production music library collectively branded as Warner/Chappell Production Music.

Music Publishing revenues are derived from five main sources:

 

Performance: the rightsholder receives revenues if the composition is performed publicly through broadcast of music on television, radio and cable, live performance at a concert or other venue (e.g., arena concerts and nightclubs), and performance of music in staged theatrical productions;

 

Digital: the rightsholder receives revenues with respect to compositions embodied in recordings sold in digital streaming services, digital download services and digital performance;

 

Mechanical: the rightsholder receives revenues with respect to compositions embodied in recordings sold in any physical format or configuration such as CDs, vinyl and DVDs;

34


 

 

Synchronization: the rightsholder receives revenues for the right to use the composition in combination with visual images such as in films or television programs, television commercials and videogames as well as from other uses such as in toys or novelty items and merchandise; and

 

Other: the rightsholder receives revenues for use in printed sheet music and other uses.

The principal costs associated with our Music Publishing operations are as follows:

 

A&R costs—the costs associated with (i) paying royalties to songwriters, co-publishers and other copyright holders in connection with income generated from the exploitation of their copyrighted works and (ii) signing and developing songwriters; and

 

Selling and marketing, general overhead and other administrative expenses—the costs associated with selling and marketing, general overhead and other administrative expenses.

Factors Affecting Results of Operations and Comparability

Acquisition of Spinnin’ Records

On September 7, 2017, we acquired Spinnin’ Records, one of the world’s most successful and important dance and electronic music companies. Based in the Netherlands, over the past two decades the label has signed and nurtured a fantastic roster of pioneering recording artists, as well as building prominent music publishing and artist management arms.

Sale of Non-Core Assets

During the fiscal year ended September 30, 2017, we divested certain assets related to the PLG Acquisition. The cash received for these sales was $73 million. The net gain recognized for these sales was $6 million. During the fiscal year ended September 30, 2016, we sold several non-core assets including real estate and divestitures related to the PLG Acquisition. The cash received for these sales was $42 million and $45 million, respectively. The net gain recognized for each of these sales was $24 million and $9 million, respectively. The divestitures related to the PLG Acquisition were completed in the fiscal year ended September 30, 2017.

Management Agreement

Upon completion of the Merger, the Company and Holdings entered into a management agreement with Access, dated as of the Merger Closing Date (the “Management Agreement”), pursuant to which Access will provide the Company and its subsidiaries with financial, investment banking, management, advisory and other services. Pursuant to the Management Agreement, the Company, or one or more of its subsidiaries, will pay Access a specified annual base fee equal to approximately $9 million based on a formula contained in the agreement and reimburse Access for certain expenses incurred performing services under the agreement. The annual fee is payable quarterly. The Company and Holdings agreed to indemnify Access and certain of its affiliates against all liabilities arising out of performance of the Management Agreement.

Such costs incurred by the Company were approximately $16 million, $9 million, and $9 million for the fiscal years ended September 30, 2018, September 30, 2017 and September 30, 2016, respectively. The fiscal year ended September 30, 2018 includes the annual base fee of $9 million and an increase of $7 million calculated pursuant to the Management Agreement. The fiscal year ended September 30, 2016 excludes $2 million of expenses reimbursed related to certain consultants with full time roles at the Company.

35


 

RESULTS OF OPERATIONS

Fiscal Year Ended September 30, 2018 Compared with Fiscal Year Ended September 30, 2017 and Fiscal Year Ended September 30, 2016

Consolidated Results

Revenues

Our revenues were composed of the following amounts (in millions):

 

 

For the Fiscal Year Ended

September 30,

 

 

2018 vs. 2017

 

 

2017 vs. 2016

 

 

2018

 

 

2017

 

 

2016

 

 

$ Change

 

 

% Change

 

 

$ Change

 

 

% Change

 

Revenue by Type

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Digital

$

2,019

 

 

$

1,692

 

 

$

1,364

 

 

$

327

 

 

 

19

%

 

$

328

 

 

 

24

%

Physical

 

630

 

 

 

667

 

 

 

726

 

 

 

(37

)

 

 

-6

%

 

 

(59

)

 

 

-8

%

Total Physical and Digital

 

2,649

 

 

 

2,359

 

 

 

2,090

 

 

 

290

 

 

 

12

%

 

 

269

 

 

 

13

%

Artist services and expanded-rights

 

389

 

 

 

385

 

 

 

368

 

 

 

4

 

 

 

1

%

 

 

17

 

 

 

5

%

Licensing

 

322

 

 

 

276

 

 

 

278

 

 

 

46

 

 

 

17

%

 

 

(2

)

 

 

-1

%

Total Recorded Music

 

3,360

 

 

 

3,020

 

 

 

2,736

 

 

 

340

 

 

 

11

%

 

 

284

 

 

 

10

%

Performance

 

212

 

 

 

197

 

 

 

193

 

 

 

15

 

 

 

8

%

 

 

4

 

 

 

2

%

Digital

 

237

 

 

 

187

 

 

 

141

 

 

 

50

 

 

 

27

%

 

 

46

 

 

 

33

%

Mechanical

 

72

 

 

 

65

 

 

 

70

 

 

 

7

 

 

 

11

%

 

 

(5

)

 

 

-7

%

Synchronization

 

119

 

 

 

112

 

 

 

110

 

 

 

7

 

 

 

6

%

 

 

2

 

 

 

2

%

Other

 

13

 

 

 

11

 

 

 

10

 

 

 

2

 

 

 

18

%

 

 

1

 

 

 

10

%

Total Music Publishing

 

653

 

 

 

572

 

 

 

524

 

 

 

81

 

 

 

14

%

 

 

48

 

 

 

9

%

Intersegment eliminations

 

(8

)

 

 

(16

)

 

 

(14

)

 

 

8

 

 

 

-50

%

 

 

(2

)

 

 

14

%

Total Revenue

$

4,005

 

 

$

3,576

 

 

$

3,246

 

 

$

429

 

 

 

12

%

 

$

330

 

 

 

10

%

Revenue by Geographical Location

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Recorded Music

$

1,460

 

 

$

1,329

 

 

$

1,129

 

 

$

131

 

 

 

10

%

 

$

200

 

 

 

18

%

U.S. Music Publishing

 

294

 

 

 

258

 

 

 

231

 

 

 

36

 

 

 

14

%

 

 

27

 

 

 

12

%

Total U.S.

 

1,754

 

 

 

1,587

 

 

 

1,360

 

 

 

167

 

 

 

11

%

 

 

227

 

 

 

17

%

International Recorded Music

 

1,900

 

 

 

1,691

 

 

 

1,607

 

 

 

209

 

 

 

12

%

 

 

84

 

 

 

5

%

International Music Publishing

 

359

 

 

 

314

 

 

 

293

 

 

 

45

 

 

 

14

%

 

 

21

 

 

 

7

%

Total International

 

2,259

 

 

 

2,005

 

 

 

1,900

 

 

 

254

 

 

 

13

%

 

 

105

 

 

 

6

%

Intersegment eliminations

 

(8

)

 

 

(16

)

 

 

(14

)

 

 

8

 

 

 

-50

%

 

 

(2

)

 

 

14

%

Total Revenue

$

4,005

 

 

$

3,576

 

 

$

3,246

 

 

$

429

 

 

 

12

%

 

$

330

 

 

 

10

%

 

Total Revenue

2018 vs. 2017

Total revenue increased by $429 million, or 12%, to $4.005 billion for the fiscal year ended September 30, 2018 from $3.576 billion for the fiscal year ended September 30, 2017. Prior to intersegment eliminations, Recorded Music and Music Publishing revenues represented 84% and 16% of revenues for both the fiscal year ended September 30, 2018 and the fiscal year ended September 30, 2017. Prior to intersegment eliminations, U.S. and international revenues represented 44% and 56% of total revenues for both the fiscal year ended September 30, 2018 and the fiscal year ended September 30, 2017.

Total digital revenues after intersegment eliminations increased by $382 million, or 20%, to $2.252 billion for the fiscal year ended September 30, 2018 from $1.870 billion for the fiscal year ended September 30, 2017. Total digital revenues represented 56% and 52% of consolidated revenues for the fiscal year ended September 30, 2018 and September 30, 2017, respectively. Prior to intersegment eliminations, total digital revenues for the fiscal year ended September 30, 2018 were comprised of U.S. revenues of $1.169 billion and international revenues of $1.087 billion, or 52% and 48% of total digital revenues, respectively. Prior to intersegment eliminations, total digital revenues for the fiscal year ended September 30, 2017 were comprised of U.S. revenues of $1.005 billion and international revenues of $874 million, or 53% and 47% of total digital revenues, respectively.

36


 

Recorded Music revenues increased by $340 million, or 11%, to $3.360 billion for the fiscal year ended September 30, 2018 from $3.020 billion for the fiscal year ended September 30, 2017. U.S. Recorded Music revenues were $1,460 million and $1,329 million, or 43% and 44% of consolidated Recorded Music revenues for the fiscal year ended September 30, 2018 and September 30, 2017, respectively. International Recorded Music revenues were $1.900 billion and $1.691 billion, or 57% and 56% of consolidated Recorded Music revenues for the fiscal year ended September 30, 2018 and September 30, 2017, respectively.

The overall increase in Recorded Music revenue was driven by increases in digital revenue, licensing revenue and artist services and expanded-rights revenue, partially offset by a decrease in physical revenue. Digital revenue increased by $327 million as a result of the continued growth in streaming services, and a strong release schedule. Revenue from streaming services grew by $391 million to $1.733 billion for the fiscal year ended September 30, 2018 from $1.342 billion for the fiscal year ended September 30, 2017. Digital revenue growth was partially offset by digital download and other digital declines of $64 million to $286 million for the fiscal year ended September 30, 2018 from $350 million for the fiscal year ended September 30, 2017. Licensing revenue increased by $46 million primarily due to higher broadcast fee income, revenue from recent acquisitions, and increased synchronization activity. Artist services and expanded-rights revenue increased by $4 million primarily due to the favorable impact of foreign currency exchange rates of $13 million and higher merchandise revenue, partially offset by certain concert promotion business divestitures and the timing of tours. Physical revenue decreased by $37 million primarily due to underlying market decline as consumption shifts from physical to digital products.

Music Publishing revenues increased by $81 million, or 14%, to $653 million for the fiscal year ended September 30, 2018 from $572 million for the fiscal year ended September 30, 2017. U.S. Music Publishing revenues were $294 million and $258 million, or 45% of consolidated Music Publishing revenues for both the fiscal years ended September 30, 2018 and September 30, 2017. International Music Publishing revenues were $359 million and $314 million, or 55% of consolidated Music Publishing revenues for both the fiscal years ended September 30, 2018 and September 30, 2017.

The overall increase in Music Publishing revenue was mainly driven by increases in digital revenue of $50 million, performance revenue of $15 million, synchronization revenue of $7 million and mechanical revenue of $7 million. The increase in digital revenue was due to an increase in streaming of $60 million, partially offset by digital download and other digital declines of $10 million. Performance revenue increased due to higher distributions. Synchronization revenue increased due to increased television and commercial income. The increase in mechanical revenue was attributable to the timing of distributions.

2017 vs. 2016

Total revenue increased by $330 million, or 10%, to $3.576 billion for the fiscal year ended September 30, 2017 from $3.246 billion for the fiscal year ended September 30, 2016. Excluding the unfavorable impact of foreign currency exchange rates, total revenue increased by $369 million, or 12%. Prior to intersegment eliminations, Recorded Music and Music Publishing revenues represented 84% and 16% of revenues for both the fiscal year ended September 30, 2017 and the fiscal year ended September 30, 2016. Prior to intersegment eliminations, U.S. and international revenues represented 44% and 56% of total revenues for the fiscal year ended September 30, 2017 and 42% and 58% of total revenues for the fiscal year ended September 30, 2016.

Total digital revenues after intersegment eliminations increased by $371 million, or 25%, to $1.870 billion for the fiscal year ended September 30, 2017 from $1.499 billion for the fiscal year ended September 30, 2016. Excluding the unfavorable impact of foreign currency exchange rates, total digital revenue after intersegment eliminations increased by $386 million, or 26%. Total digital revenues represented 52% and 46% of consolidated revenues for the fiscal year ended September 30, 2017 and September 30, 2016, respectively. Prior to intersegment eliminations, total digital revenues for the fiscal year ended September 30, 2017 were comprised of U.S. revenues of $1.005 billion and international revenues of $874 million, or 53% and 47% of total digital revenues, respectively. Prior to intersegment eliminations, total digital revenues for the fiscal year ended September 30, 2016 were comprised of U.S. revenues of $802 million and international revenues of $703 million, or 53% and 47% of total digital revenues, respectively.

Recorded Music revenues increased by $284 million, or 10%, to $3.020 billion for the fiscal year ended September 30, 2017 from $2.736 billion for the fiscal year ended September 30, 2016. Excluding the unfavorable impact of foreign currency exchange rates, Recorded Music revenue increased by $316 million, or 12%.  U.S. Recorded Music revenues were $1,329 million and $1,129 million, or 44% and 41% of consolidated Recorded Music revenues for the fiscal year ended September 30, 2017 and September 30, 2016, respectively. International Recorded Music revenues were $1.691 billion and $1.607 billion, or 56% and 59% of consolidated Recorded Music revenues for the fiscal year ended September 30, 2017 and September 30, 2016, respectively.

37


 

The overall increase in Recorded Music revenue was driven by increases in digital revenue and artist services and expanded-rights revenue, partially offset by a decrease in physical revenue. Digital revenue increased by $328 million as a result of strong new releases from Ed Sheeran and Bruno Mars, the continued successes from Twenty One Pilots, the Hamilton soundtrack and the Ed Sheeran catalog and the continued growth in streaming services. Revenue from streaming services grew by $434 million to $1.342 billion for the fiscal year ended September 30, 2017 from $908 million for the fiscal year ended September 30, 2016 and was partially offset by digital download declines of $106 million to $328 million for the fiscal year ended September 30, 2017 from $434 million for the fiscal year ended September 30, 2016. Artist services and expanded-rights revenue increased by $17 million primarily due to merchandise revenue and ticket sales generated from successful U.S. artists, partially offset by a decline internationally due to strong concert promotion revenue in prior year. Physical revenue decreased by $59 million primarily due to the shift from physical revenue to digital revenue and strong catalog sales in the prior year period. Licensing revenue decreased by $2 million due to the unfavorable impact of foreign currency exchange rates of $7 million, partially offset by increased synchronization activity in the U.S.

Music Publishing revenues increased by $48 million, or 9%, to $572 million for the fiscal year ended September 30, 2017 from $524 million for the fiscal year ended September 30, 2016. Excluding the unfavorable impact of foreign currency exchange rates, Music Publishing revenue increased by $55 million, or 11%.  U.S. Music Publishing revenues were $258 million and $231 million, or 45% and 44%, of consolidated Music Publishing revenues for the fiscal year ended September 30, 2017 and September 30, 2016, respectively. International Music Publishing revenues were $314 million and $293 million, or 55% and 56%, of consolidated Music Publishing revenues for the fiscal year ended September 30, 2017 and September 30, 2016, respectively.

The overall increase in Music Publishing revenue was mainly driven by increases in digital revenue of $46 million, performance revenue of $4 million and synchronization revenue of $2 million, partially offset by a decrease in mechanical revenue of $5 million. The increase in digital revenue was due to an increase in streaming of $58 million, partially offset by digital download and other digital declines of $12 million. Performance revenue increased due to increased market share and distributions. Synchronization revenue increased due to increased film and commercial income in the U.S. The decrease in mechanical revenue was attributable to an ongoing industry shift towards digital product.

Revenue by Geographical Location

2018 vs. 2017

U.S. revenue increased by $167 million, or 11%, to $1.754 billion for the fiscal year ended September 30, 2018 from $1.587 billion for the fiscal year ended September 30, 2017. U.S. Recorded Music revenue increased by $131 million or 10%. The primary driver was the increase in U.S. Recorded Music digital revenue, which increased by $144 million due to the continued growth in streaming services and strong release performance. U.S. licensing revenue increased by $9 million due to higher broadcast fee income and increased synchronization activity. These increases were partially offset by a decline in U.S. physical revenue of $16 million due to the shift from physical revenue to digital revenue, and a decline in artist services and expanded-rights revenue of $6 million. U.S. Music Publishing revenues increased by $36 million or 14%. This was primarily driven by the increase in U.S. Music Publishing digital revenue of $20 million due to an increase in streaming revenue of $32 million from the continued growth in streaming services, partially offset by declines in digital download and other digital revenue of $12 million. U.S. mechanical revenue and U.S. performance revenue increased by $8 million and $3 million, respectively, due to higher distributions. U.S synchronization revenue increased by $4 million due to increased film and commercial income.

International revenue increased by $254 million, or 13%, to $2.259 billion for the fiscal year ended September 30, 2018 from $2.005 billion for the fiscal year ended September 30, 2017. Excluding the favorable impact of foreign currency exchange rates, International revenue increased by $163 million or 8%. International Recorded Music revenue increased $209 million primarily due to increases in digital revenue of $183 million, licensing revenue of $37 million, and artist services and expanded-rights revenue of $10 million, partially offset by a decrease in physical revenue of $21 million. International Recorded Music digital revenue increased due to a $211 million increase in streaming services revenue, partially offset by a $28 million decline in digital download and other digital revenue. The increase in International Recorded Music streaming revenue was due to the continued growth in streaming services internationally and strong release performance from WANIMA in Japan. International Recorded Music licensing revenue increased due to revenue from recent acquisitions, higher broadcast fee income, and the favorable impact of foreign currency exchange rates of $10 million. International Recorded Music artist services and expanded-rights revenue increased due to the favorable impact of foreign currency exchange rates of $13 million, partially offset by successful tours in France in the prior year quarter with no comparable tours in the current year and divestment of certain touring businesses in the prior year. International Recorded Music physical revenue decreased due to the continued shift from physical to digital revenue, partially offset by the favorable impact of foreign currency exchange rates of $27 million. International Music Publishing revenue increased $45 million primarily due to increases in digital revenue of $30 million, in performance revenue of $12 million and in synchronization revenue of $3 million.

38


 

2017 vs. 2016

U.S. revenue increased by $227 million, or 17%, to $1.587 billion for the fiscal year ended September 30, 2017 from $1.360 billion for the fiscal year ended September 30, 2016. U.S. Recorded Music revenue increased by $200 million or 18%. The primary driver was the increase in U.S. Recorded Music digital revenue, which increased by $179 million due to strong new releases from Ed Sheeran and Bruno Mars, the continued successes of the Hamilton soundtrack and Twenty One Pilots and the continued growth in streaming services. U.S. artist services and expanded-rights revenue increased by $42 million primarily due to merchandise revenue generated from successful U.S. artists. U.S. licensing revenue increased by $7 million due to increased synchronization activity and higher broadcast fee income. These increases were partially offset by a decline in U.S. physical revenue of $28 million due to the shift from physical revenue to digital revenue and strong physically-centric releases and catalog sales in the prior year. U.S. Music Publishing revenues increased by $27 million or 12%. This was primarily driven by the increase in U.S. Music Publishing digital revenue of $24 million due an increase in streaming revenue of $35 million due to the continued growth in streaming services, partially offset by declines in digital download and other digital revenue of $11 million. U.S performance revenue increased by $2 million due to an increase in market share and U.S. synchronization revenue increased by $2 million due to increased film and commercial income. U.S. mechanical revenue declined $1 million due to the ongoing shift towards digital products in the industry.

International revenue increased by $105 million, or 6%, to $2.005 billion for the fiscal year ended September 30, 2017 from $1.900 billion for the fiscal year ended September 30, 2016. Excluding the unfavorable impact of foreign currency exchange rates, International revenue increased by $145 million or 8%. International Recorded Music revenue increased $84 million primarily due to increases in digital revenue of $149 million, partially offset by decreases in physical revenue of $31 million, artist services and expanded-rights revenue of $25 million and licensing revenue of $9 million. International Recorded Music digital revenue increased due to a $171 million increase in streaming services revenue and a $1 million increase in other digital revenue, partially offset by a $23 million decline in digital download revenue. The increase in streaming revenue was due to new releases from Ed Sheeran, Bruno Mars and Clean Bandit and the continued success from the Ed Sheeran catalog and the continued growth of streaming services internationally. International Recorded Music physical revenue decreased due to the unfavorable impact of foreign currency exchange rates of $11 million, the continued shift from physical to digital revenue and fewer domestic releases in certain territories. International Recorded Music artist services and expanded-rights revenue decreased due to the timing of concert promotion activity, specifically strong prior year concert promotion revenue in Japan and France, and the divestment of a touring business in the current year.  International Recorded Music licensing revenue decreased due to the unfavorable impact of foreign currency exchange rates of $8 million. International Music Publishing revenue increased $21 million primarily due to an increase in digital revenue of $22 million, increase in performance revenue of $2 million and an increase in other revenue of $1 million, partially offset by a decrease in mechanical revenue of $4 million due to the shift towards digital products in the industry.

Cost of revenues

Our cost of revenues was composed of the following amounts (in millions):

 

 

For the Fiscal Year Ended

September 30,

 

 

2018 vs. 2017

 

 

2017 vs. 2016

 

 

2018

 

 

2017

 

 

2016

 

 

$ Change

 

 

% Change

 

 

$ Change

 

 

% Change

 

Artist and repertoire costs

$

1,471

 

 

$

1,303

 

 

$

1,113

 

 

$

168

 

 

 

13

%

 

$

190

 

 

 

17

%

Product costs

 

700

 

 

 

628

 

 

 

594

 

 

 

72

 

 

 

12

%

 

 

34

 

 

 

6

%

Total cost of revenues

$

2,171

 

 

$

1,931

 

 

$

1,707

 

 

$

240

 

 

 

12

%

 

$

224

 

 

 

13

%

2018 vs. 2017

Our cost of revenues increased by $240 million, or 12%, to $2.171 billion for the fiscal year ended September 30, 2018 from $1.931 billion for the fiscal year ended September 30, 2017. Expressed as a percentage of revenues, cost of revenues remained flat at 54% for both the fiscal year ended September 30, 2018 and the fiscal year ended September 30, 2017.

Artist and repertoire costs increased by $168 million, or 13%, to $1.471 billion for the fiscal year ended September 30, 2018 from $1.303 billion for the fiscal year ended September 30, 2017.  Artist and repertoire costs as a percentage of revenues increased to 37% for the fiscal year ended September 30, 2018 from 36% for the fiscal year ended September 30, 2017. The increase was primarily driven by the mix of revenue and increased investment in artists and songwriters.

Product costs increased by $72 million, or 12%, to $700 million for the fiscal year ended September 30, 2018 from $628 million for the fiscal year ended September 30, 2017.  Product costs as a percentage of revenues remained flat at 18% for both the fiscal year ended September 30, 2018 and the fiscal year ended September 30, 2017.

39


 

2017 vs. 2016

Our cost of revenues increased by $224 million, or 13%, to $1.931 billion for the fiscal year ended September 30, 2017 from $1.707 billion for the fiscal year ended September 30, 2016. Expressed as a percentage of revenues, cost of revenues increased to 54% for the fiscal year ended September 30, 2017 from 53% for the fiscal year ended September 30, 2016.

Artist and repertoire costs increased by $190 million, or 17%, to $1,303 million for the fiscal year ended September 30, 2017 from $1,113 million for the fiscal year ended September 30, 2016.  Artist and repertoire costs as a percentage of revenues increased to 36% for the fiscal year ended September 30, 2017 from 34% for the fiscal year ended September 30, 2016. The increase was primarily driven by the mix of revenue, specifically strong performance from lower margin repertoire, and higher artist related costs and investment.

Product costs increased by $34 million, or 6%, to $628 million for the fiscal year ended September 30, 2017 from $594 million for the fiscal year ended September 30, 2016.  Product costs as a percentage of revenues remained flat at 18% for both the fiscal year ended September 30, 2017 and the fiscal year ended September 30, 2016.

Selling, general and administrative expenses

Our selling, general and administrative expenses are composed of the following amounts (in millions):

 

 

For the Fiscal Year Ended

September 30,

 

 

2018 vs. 2017

 

 

2017 vs. 2016

 

 

2018

 

 

2017

 

 

2016

 

 

$ Change

 

 

% Change

 

 

$ Change

 

 

% Change

 

General and administrative expense (1)

$

814

 

 

$

684

 

 

$

584

 

 

$

130

 

 

 

19

%

 

$

100

 

 

 

17

%

Selling and marketing expense

 

530

 

 

 

472

 

 

 

437

 

 

 

58

 

 

 

12

%

 

 

35

 

 

 

8

%

Distribution expense

 

67

 

 

 

66

 

 

 

61

 

 

 

1

 

 

 

2

%

 

 

5

 

 

 

8

%

Total selling, general and administrative expense

$

1,411

 

 

$

1,222

 

 

$

1,082

 

 

$

189

 

 

 

16

%

 

$

140

 

 

 

13

%

 

(1)

Includes depreciation expense of $55 million, $50 million and $50 million for the fiscal years ended September 30, 2018, 2017 and 2016, respectively.

2018 vs. 2017

Total selling, general and administrative expense increased by $189 million, or 16%, to $1.411 billion for the fiscal year ended September 30, 2018 from $1.222 billion for the fiscal year ended September 30, 2017. Expressed as a percentage of revenues, selling, general and administrative expenses increased to 35% for the fiscal year ended September 30, 2018 from 34% for the fiscal year ended September 30, 2017.

General and administrative expenses increased by $130 million, or 19%, to $814 million for the fiscal year ended September 30, 2018 from $684 million for the fiscal year ended September 30, 2017. The increase in general and administrative expense was primarily due to increases in other employee related compensation expense, including severance and restructuring costs, of $78 million, and an increase in facilities cost due to an overlap in terms on the lease of our new Los Angeles office with our existing office leases of $16 million. The increase was also due to an increase in expense associated with our Senior Management Free Cash Flow Plan of $6 million, which is primarily related to compensation costs associated with higher dividend payments in the current year. Expressed as a percentage of revenue, general and administrative expense increased to 20% for the fiscal year ended September 30, 2018 from 19% for the fiscal year ended September 30, 2017.

Selling and marketing expense increased by $58 million, or 12%, to $530 million for the fiscal year ended September 30, 2018 from $472 million for the fiscal year ended September 30, 2017. Expressed as a percentage of revenues, selling and marketing expense remained flat at 13% for both the fiscal year ended September 30, 2018 and September 30, 2017.

Distribution expense increased by $1 million, or 2%, to $67 million for the fiscal year ended September 30, 2018 from $66 million for the fiscal year ended September 30, 2017. Expressed as a percentage of revenues, distribution expense remained flat at 2% for both the fiscal year ended September 30, 2018 and September 30, 2017.

40


 

2017 vs. 2016

Total selling, general and administrative expense increased by $140 million, or 13%, to $1.222 billion for the fiscal year ended September 30, 2017 from $1.082 billion for the fiscal year ended September 30, 2016. Expressed as a percentage of revenues, selling, general and administrative expenses increased to 34% for the fiscal year ended September 30, 2017 from 33% for the fiscal year ended September 30, 2016.

General and administrative expenses increased by $100 million, or 17%, to $684 million for the fiscal year ended September 30, 2017 from $584 million for the fiscal year ended September 30, 2016. The increase in general and administrative expense was primarily due to increases in expenses associated with our Senior Management Free Cash Flow Plan (the “Plan”) including $47 million of non-cash share-based compensation expense and $29 million of free cash flow compensation expense.  The increase in the Plan’s expenses are directly associated with our improved operating performance and associated fair value of equity. Additionally, increases in other employee related variable compensation and severance costs of $11 million, a one-time, non-recurring net gain on contract termination of $6 million in the prior year, and a net gain on divestitures in the current year of $6 million compared to a net gain on divestitures of $9 million in the prior year. Expressed as a percentage of revenue, general and administrative expense increased to 19% for the fiscal year ended September 30, 2017 from 18% for the fiscal year ended September 30, 2016.

Selling and marketing expense increased by $35 million, or 8%, to $472 million for the fiscal year ended September 30, 2017 from $437 million for the fiscal year ended September 30, 2016. Expressed as a percentage of revenues, selling and marketing expense decreased to 13% for the fiscal year ended September 30, 2017 from 14% for the fiscal year ended September 30, 2016.

Distribution expense increased by $5 million, or 8%, to $66 million for the fiscal year ended September 30, 2017 from $61 million for the fiscal year ended September 30, 2016. Expressed as a percentage of revenues, distribution expense remained flat at 2% for both the fiscal year ended September 30, 2017 and September 30, 2016.

Reconciliation of Net Income (Loss) Attributable to Warner Music Group Corp. and Operating Income to Consolidated OIBDA

As previously described, we use OIBDA as our primary measure of financial performance. The following table reconciles operating income to OIBDA, and further provides the components from net income (loss) attributable to Warner Music Group Corp. to operating income for purposes of the discussion that follows (in millions):

 

 

For the Fiscal Year Ended

September 30,

 

 

2018 vs. 2017

 

 

2017 vs. 2016

 

 

2018

 

 

2017

 

 

2016

 

 

$ Change

 

 

% Change

 

 

$ Change

 

 

% Change

 

Net income attributable to Warner Music Group Corp.

$

307

 

 

$

143

 

 

$

25

 

 

$

164

 

 

 

115

%

 

$

118

 

 

—%

 

Income attributable to noncontrolling interest

 

5

 

 

 

6

 

 

 

5

 

 

 

(1

)

 

 

-17

%

 

 

1

 

 

 

20

%

Net income

 

312

 

 

 

149

 

 

 

30

 

 

 

163

 

 

 

109

%

 

 

119

 

 

—%

 

Income tax expense (benefit)

 

130

 

 

 

(151

)

 

 

11

 

 

 

281

 

 

—%

 

 

 

(162

)

 

—%

 

Income (loss) before income taxes

 

442

 

 

 

(2

)

 

 

41

 

 

 

444

 

 

—%

 

 

 

(43

)

 

 

-105

%

Other (income) expense, net

 

(394

)

 

 

40

 

 

 

(18

)

 

 

(434

)

 

—%

 

 

 

58

 

 

—%

 

Interest expense, net

 

138

 

 

 

149

 

 

 

173

 

 

 

(11

)

 

 

-7

%

 

 

(24

)

 

 

-14

%

Loss on extinguishment of debt

 

31

 

 

 

35

 

 

 

18

 

 

 

(4

)

 

 

-11

%

 

 

17

 

 

 

94

%

Operating income

 

217

 

 

 

222

 

 

 

214

 

 

 

(5

)

 

 

-2

%

 

 

8

 

 

 

4

%

Amortization expense

 

206

 

 

 

201

 

 

 

243

 

 

 

5

 

 

 

3

%

 

 

(42

)

 

 

-17

%

Depreciation expense

 

55

 

 

 

50

 

 

 

50

 

 

 

5

 

 

 

10

%

 

 

 

 

 

%

OIBDA

$

478

 

 

$

473

 

 

$

507

 

 

$

5

 

 

 

1

%

 

$

(34

)

 

 

-7

%

 

OIBDA

2018 vs. 2017

Our OIBDA increased by $5 million, or 1%, to $478 million for the fiscal year ended September 30, 2018 as compared to $473 million for the fiscal year ended September 30, 2017 primarily as a result of higher revenue, partially offset by higher general and administrative expenses. Expressed as a percentage of total revenue, OIBDA decreased to 12% for the fiscal year ended September 30, 2018 from 13% for the fiscal year ended September 30, 2017.

41


 

2017 vs. 2016

Our OIBDA decreased by $34 million, or 7%, to $473 million for the fiscal year ended September 30, 2017 as compared to $507 million for the fiscal year ended September 30, 2016 primarily as a result of higher artist and repertoire costs and higher general and administrative expenses, as noted above. Expressed as a percentage of total revenue, OIBDA decreased to 13% for the fiscal year ended September 30, 2017 from 16% for the fiscal year ended September 30, 2016.

Depreciation expense

2018 vs. 2017

Our depreciation expense increased by $5 million, or 10%, to $55 million for the fiscal year ended September 30, 2018 from $50 million for the fiscal year ended September 30, 2017, primarily due to an increase in technology and facilities capital spending.  

2017 vs. 2016

Our depreciation expense remained consistent at $50 million for both the fiscal year ended September 30, 2017 and the fiscal year ended September 30, 2016.  

Amortization expense

2018 vs. 2017

Amortization expense increased by $5 million, or 3%, to $206 million for the fiscal year ended September 30, 2018 from $201 million for the fiscal year ended September 30, 2017, primarily due to an increase in amortizable intangible assets and the impact of foreign currency exchange rates.

2017 vs. 2016

Amortization expense decreased by $42 million, or 17%, to $201 million for the fiscal year ended September 30, 2017 from $243 million for the fiscal year ended September 30, 2016, primarily due to intangible assets becoming fully amortized and the impact of foreign currency exchange rates.

Operating income

2018 vs. 2017

Our operating income decreased by $5 million to $217 million for the fiscal year ended September 30, 2018 from $222 million for the fiscal year ended September 30, 2017. The decrease in operating income was primarily due to higher general and administrative expenses as noted above, partially offset by higher revenue.

2017 vs. 2016

Our operating income increased by $8 million to $222 million for the fiscal year ended September 30, 2017 from $214 million for the fiscal year ended September 30, 2016. The increase in operating income was due to the increase in revenue and lower amortization expense, partially offset by the higher artist and repertoire costs and higher general and administrative expenses as noted above.

Loss on extinguishment of debt

2018 vs. 2017

We recorded a loss on extinguishment of debt in the amount of $31 million for the fiscal year ended September 30, 2018, which represents the premium paid on early redemption and unamortized deferred financing costs related to the June 2018 Senior Term Loan Credit Agreement Amendment (as defined later in this Annual Report), the redemption of the 6.75% Senior Notes (as defined later in this Annual Report) and the December 2017 Senior Term Loan Credit Agreement Amendment (as defined later in this Annual Report). We recorded a loss on extinguishment of debt in the amount of $35 million for the fiscal year ended September 30, 2017, which represents the premium paid on early redemption and unamortized deferred financing costs related to the refinancing transactions that occurred during fiscal 2017. Please refer to Note 6 of our Consolidated Financial Statements for further discussion.

42


 

2017 vs. 2016

We recorded a loss on extinguishment of debt in the amount of $35 million for the fiscal year ended September 30, 2017, which represents the premium paid on early redemption and unamortized deferred financing costs related to the various refinancing transactions we undertook in October 2016, the 5.625% Secured Notes redemption and the amendment to the Senior Term Loan Credit Agreement entered into in May 2017. We recorded a loss on extinguishment of debt in the amount of $18 million for the fiscal year ended September 30, 2016, which related to the refinancing transactions that occurred in fiscal 2016. Please refer to Note 6 of our Consolidated Financial Statements for further discussion.

Interest expense, net

2018 vs. 2017

Our interest expense, net, decreased by $11 million, or 7% to $138 million for the fiscal year ended September 30, 2018 from $149 million for the fiscal year ended September 30, 2017. This was primarily due to lower interest rates as a result of refinancing transactions and interest income on higher cash balances during the year.

2017 vs. 2016

Our interest expense, net, decreased by $24 million, or 14% to $149 million for the fiscal year ended September 30, 2017 from $173 million for the fiscal year ended September 30, 2016. This was due to lower interest rates as a result of the various refinancing transactions we undertook in October 2016 and refinancing transactions that occurred in the fiscal year ended September 30, 2016.

Other (income) expense, net

2018 vs. 2017

Other (income) expense, net, increased by $434 million to other (income) of $394 million for the fiscal year ended September 30, 2018 from other expense of $40 million for the fiscal year ended September 30, 2017. Other (income) expense, net for the fiscal year ended September 30, 2018, includes the gain on the Spotify share sale, net of estimated artist share and other related costs, of $382 million, gain on investments of $7 million, and foreign currency gains on our Euro denominated debt of $4 million.

Other expense (income), net for the fiscal year ended September 30, 2017, includes currency exchange loss on our Euro denominated debt of $27 million, loss on investments of $21 million, partially offset by foreign currency exchange gains on intercompany loans and derivative liabilities of $5 million.

2017 vs. 2016

Other expense (income), net, increased by $58 million to other expense of $40 million for the fiscal year ended September 30, 2017 from other income of $18 million for the fiscal year ended September 30, 2016. Other expense (income), net for the fiscal year ended September 30, 2017, includes the items listed above.  

Other expense (income), net for the fiscal year ended September 30, 2016, includes a non-recurring gain on a sale of real estate of $24 million, partially offset by losses on our intercompany loans of $7 million for the fiscal year ended September 30, 2016.

Income tax expense (benefit)

2018 vs. 2017

Our income tax expense increased by $281 million to $130 million for the fiscal year ended September 30, 2018 compared to an income tax benefit of $151 million for the fiscal year ended September 30, 2017. The net increase of $281 million in income tax expense primarily relates to higher pre-tax income as a result of the gain on the Spotify shares sale of $77 million and U.S. tax expense of $23 million for the reduction of our net U.S. deferred tax assets as a result of the change in the U.S. corporate statutory tax rate, as compared to a U.S. tax benefit of $125 million related to the reversal of a significant portion of our U.S. deferred tax valuation allowance and a $59 million benefit related to foreign currency losses on intra-entity loans.

43


 

2017 vs. 2016

Our income tax expense decreased by $162 million to a benefit of $151 million for the fiscal year ended September 30, 2017 compared to income tax expense of $11 million for the fiscal year ended September 30, 2016. The net decrease of $162 million primarily relates to a U.S. tax benefit of $125 million related to the reversal of a significant portion of our U.S. deferred tax valuation allowance and a $59 million benefit related to foreign currency losses on intra-entity loans.

Net income

2018 vs. 2017

Our net income increased by $163 million, to $312 million for the fiscal year ended September 30, 2018 from $119 million for the fiscal year ended September 30, 2017 as a result of the factors described above. The increase in income was primarily driven by the factors listed above.

2017 vs. 2016

Our net income increased by $119 million, to $149 million for the fiscal year ended September 30, 2017 from $30 million for the fiscal year ended September 30, 2016 as a result of the factors described above. The increase in income was primarily driven by the increase in income tax benefit as described above.

Noncontrolling interest

2018 vs. 2017

Net income attributable to noncontrolling interests was $5 million for the fiscal year ended September 30, 2018 and $6 million for the fiscal year ended September 30, 2017.

2017 vs. 2016

Net income attributable to noncontrolling interests was $6 million for the fiscal year ended September 30, 2017 and $5 million for the fiscal year ended September 30, 2016.

Business Segment Results

Revenue, operating income (loss) and OIBDA by business segment are as follows (in millions):

 

 

For the Fiscal Year Ended

September 30,

 

 

2018 vs. 2017

 

 

2017 vs. 2016

 

 

2018

 

 

2017

 

 

2016

 

 

$ Change

 

 

% Change

 

 

$ Change

 

 

% Change

 

Recorded Music

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenue

$

3,360

 

 

$

3,020

 

 

$

2,736

 

 

$

340

 

 

 

11

%

 

$

284

 

 

 

10

%

Operating income

 

307

 

 

 

283

 

 

 

247

 

 

 

24

 

 

 

9

%

 

 

36

 

 

 

15

%

OIBDA

 

480

 

 

 

451

 

 

 

459

 

 

 

29

 

 

 

6

%

 

$

(8

)

 

 

-2

%

Music Publishing

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

653

 

 

 

572

 

 

 

524

 

 

 

81

 

 

 

14

%

 

$

48

 

 

 

9

%

Operating income

 

84

 

 

 

81

 

 

 

68

 

 

 

3

 

 

 

4

%

 

 

13

 

 

 

19

%

OIBDA

 

159

 

 

 

152

 

 

 

138

 

 

 

7

 

 

 

5

%

 

$

14

 

 

 

10

%

Corporate expenses and eliminations

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenue elimination

 

(8

)

 

 

(16

)

 

 

(14

)

 

 

8

 

 

 

-50

%

 

$

(2

)

 

 

14

%

Operating loss

 

(174

)

 

 

(142

)

 

 

(101

)

 

 

(32

)

 

 

23

%

 

 

(41

)

 

 

41

%

OIBDA

 

(161

)

 

 

(130

)

 

 

(90

)

 

 

(31

)

 

 

24

%

 

$

(40

)

 

 

44

%

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

4,005

 

 

 

3,576

 

 

 

3,246

 

 

 

429

 

 

 

12

%

 

$

330

 

 

 

10

%

Operating income

 

217

 

 

 

222

 

 

 

214

 

 

 

(5

)

 

 

-2

%

 

 

8

 

 

 

4

%

OIBDA

 

478

 

 

 

473

 

 

 

507

 

 

 

5

 

 

 

1

%

 

$

(34

)

 

 

-7

%

 

44


 

Recorded Music

Revenues

2018 vs. 2017

Recorded Music revenues increased by $340 million, or 11%, to $3.360 billion for the fiscal year ended September 30, 2018 from $3.020 billion for the fiscal year ended September 30, 2017. U.S. Recorded Music revenues were $1.460 billion and $1.329 billion, or 43% and 44% of consolidated Recorded Music revenues for the fiscal year ended September 30, 2018 and September 30, 2017, respectively. International Recorded Music revenues were $1.900 billion and $1.691 billion, or 57% and 56% of consolidated Recorded Music revenues for the fiscal year ended September 30, 2018 and September 30, 2017, respectively.

The overall increase in Recorded Music revenue was mainly driven by streaming revenue growth as described in the “Total Revenues” and “Revenue by Geographical Location” sections above.  

2017 vs. 2016  

Recorded Music revenues increased by $284 million, or 10%, to $3.020 billion for the fiscal year ended September 30, 2017 from $2.736 billion for the fiscal year ended September 30, 2016. U.S. Recorded Music revenues were $1,329 million and $1,129 million, or 44% and 41% of consolidated Recorded Music revenues for the fiscal year ended September 30, 2017 and September 30, 2016, respectively. International Recorded Music revenues were $1.691 billion and $1.607 billion, or 56% and 59% of consolidated Recorded Music revenues for the fiscal year ended September 30, 2017 and September 30, 2016, respectively.

The overall increase in Recorded Music revenue was mainly driven by strong releases and streaming revenue growth as described in the “Total Revenues” and “Revenue by Geographical Location” sections above.

Cost of revenues

Recorded Music cost of revenues was composed of the following amounts (in millions):

 

 

For the Fiscal Year Ended

September 30,

 

 

2018 vs. 2017

 

 

2017 vs. 2016

 

 

2018

 

 

2017

 

 

2016

 

 

$ Change

 

 

% Change

 

 

$ Change

 

 

% Change

 

Artist and repertoire costs

$

1,054

 

 

$

964

 

 

$

810

 

 

$

90

 

 

 

9

%

 

$

154

 

 

 

19

%

Product costs

 

700

 

 

 

628

 

 

 

594

 

 

 

72

 

 

 

12

%

 

 

34

 

 

 

6

%

Total cost of revenues

$

1,754

 

 

$

1,592

 

 

$

1,404

 

 

$

162

 

 

 

10

%

 

$

188

 

 

 

13

%

 

2018 vs. 2017

Recorded Music cost of revenues increased by $162 million, or 10%, to $1.754 billion for the fiscal year ended September 30, 2018 from $1.592 billion for the fiscal year ended September 30, 2017. Artist and repertoire costs as a percentage of revenue decreased to 31% for the fiscal year ended September 30, 2018 from 32% for the fiscal year ended September 30, 2017 primarily due to a shift in revenue mix toward higher margin digital revenues from lower margin physical revenues internationally and a benefit for advance recoveries of $10 million. Product costs as a percentage of revenue remained flat at 21% for both the fiscal year ended September 30, 2018 and the fiscal year ended September 30, 2017. Expressed as a percentage of Recorded Music revenues, cost of revenues decreased to 52% for the fiscal year ended September 30, 2018 from 53% for the fiscal year ended September 30, 2017.

2017 vs. 2016  

Recorded Music cost of revenues increased by $188 million, or 13%, to $1.592 billion for the fiscal year ended September 30, 2017 from $1.404 billion for the fiscal year ended September 30, 2016. Artist and repertoire costs as a percentage of revenue increased to 32% for the fiscal year ended September 30, 2017 from 30% for the fiscal year ended September 30, 2016 due to a change in the revenue mix. Specifically, the increase was driven by strong performance from lower margin repertoire and higher artist related costs and investment. Product costs as a percentage of revenue decreased to 21% for the fiscal year ended September 30, 2017 from 22% for the fiscal year ended September 30, 2016 due to the decline in international concert promotion revenue, which tends to have higher costs and yield lower margins. Expressed as a percentage of Recorded Music revenues, cost of revenues increased to 53% for the fiscal year ended September 30, 2017 from 51% for the fiscal year ended September 30, 2016.

45


 

Selling, general and administrative expense

Recorded Music selling, general and administrative expenses were composed of the following amounts (in millions):

 

 

For the Fiscal Year Ended

September 30,

 

 

2018 vs. 2017

 

 

2017 vs. 2016

 

 

2018

 

 

2017

 

 

2016

 

 

$ Change

 

 

% Change

 

 

$ Change

 

 

% Change

 

General and administrative expense (1)

$

573

 

 

$

478

 

 

$

412

 

 

$

95

 

 

 

20

%

 

$

66

 

 

 

16

%

Selling and marketing expense

 

521

 

 

 

465

 

 

 

432

 

 

 

56

 

 

 

12

%

 

 

33

 

 

 

8

%

Distribution expense

 

67

 

 

 

66

 

 

 

61

 

 

 

1

 

 

 

2

%

 

 

5

 

 

 

8

%

Total selling, general and administrative expense

$

1,161

 

 

$

1,009

 

 

$

905

 

 

$

152

 

 

 

15

%

 

$

104

 

 

 

12

%

 

(1)

Includes depreciation expense of $35 million, $32 million, and $32 million for the fiscal year ended September 30, 2018, 2017 and 2016, respectively.

2018 vs. 2017

Recorded Music selling, general and administrative expense increased by $152 million, or 15%, to $1.161 billion for the fiscal year ended September 30, 2018 from $1.009 billion for the fiscal year ended September 30, 2017. The increase in Recorded Music general and administrative expense was primarily due to increases in other employee related compensation including severance and restructuring costs of $63 million and an increase in facilities cost due to an overlap in terms on the lease of our new Los Angeles office with our existing office leases of $15 million. The increase was also due to an increase in expense of $1 million associated with our Senior Management Free Cash Flow Plan, which is primarily related to compensation costs associated with higher dividend payments in the current year. Selling and marketing expense increased in line with the increase in revenue. Expressed as a percentage of Recorded Music revenue, Recorded Music selling, general and administrative expense increased to 35% for the fiscal year ended September 30, 2018 from 33% for the fiscal year ended September 30, 2017.

2017 vs. 2016

Recorded Music selling, general and administrative expense increased by $104 million, or 12%, to $1.009 billion for the fiscal year ended September 30, 2017 from $905 million for the fiscal year ended September 30, 2016. The increase in Recorded Music general and administrative expense was primarily due to increases in expenses associated with our Senior Management Free Cash Flow Plan including $32 million of non-cash share-based compensation expense and $16 million of free cash flow compensation expense.  The increase in the Plan’s expenses are directly associated with our improved operating performance and associated increase in the fair value of equity. Additionally, increases in other employee related variable compensation, severance and restructuring costs and a net gain on contract termination of $6 million in the prior year. Selling and marketing expense increased in line with the increase in revenue. Expressed as a percentage of Recorded Music revenue, Recorded Music selling, general and administrative expense remained flat at 33% for both the fiscal year ended September 30, 2017 and September 30, 2016.

Operating income and OIBDA

Recorded Music OIBDA included the following amounts (in millions):

 

 

For the Fiscal Year Ended

September 30,

 

 

2018 vs. 2017

 

 

2017 vs. 2016

 

 

2018

 

 

2017

 

 

2016

 

 

$ Change

 

 

% Change

 

 

$ Change

 

 

% Change

 

Operating income

$

307

 

 

$

283

 

 

$

247

 

 

$

24

 

 

 

9

%

 

$

36

 

 

 

15

%

Depreciation and amortization

 

173

 

 

 

168

 

 

 

212

 

 

 

5

 

 

 

3

%

 

 

(44

)

 

 

-21

%

OIBDA

$

480

 

 

$

451

 

 

$

459

 

 

$

29

 

 

 

6

%

 

$

(8

)

 

 

-2

%

 

2018 vs. 2017

Recorded Music OIBDA increased by $29 million, or 6%, to $480 million for the fiscal year ended September 30, 2018 from $451 million for the fiscal year ended September 30, 2017 primarily as a result of higher Recorded Music revenues, partially offset by higher general and administrative expenses. Expressed as a percentage of Recorded Music revenues, Recorded Music OIBDA decreased to 14% for the fiscal year ended September 30, 2018 from 15% for the fiscal year ended September 30, 2017.

46


 

Recorded Music operating income increased by $24 million to $307 million for the fiscal year ended September 30, 2018 from $283 million for the fiscal year ended September 30, 2017 due to the increase in revenue, partially offset by higher general and administrative expenses as noted above.

2017 vs. 2016

Recorded Music OIBDA decreased by $8 million, or 2%, to $451 million for the fiscal year ended September 30, 2017 from $459 million for the fiscal year ended September 30, 2016 primarily as a result of higher artist and repertoire costs and general and administrative expenses, partially offset by higher Recorded Music revenues. Expressed as a percentage of Recorded Music revenues, Recorded Music OIBDA decreased to 15% for the fiscal year ended September 30, 2017 from 17% for the fiscal year ended September 30, 2016.

Recorded Music operating income increased by $36 million to $283 million for the fiscal year ended September 30, 2017 from $247 million for the fiscal year ended September 30, 2016 due to the increase in revenue and lower amortization expense, partially offset by the higher artist and repertoire costs and higher general and administrative expenses as noted above.

Music Publishing

Revenues

2018 vs. 2017

Music Publishing revenues increased by $81 million, or 14%, to $653 million for the fiscal year ended September 30, 2018 from $572 million for the fiscal year ended September 30, 2017. U.S. Music Publishing revenues were $294 million and $258 million, or 45% of Music Publishing revenues for both the fiscal years ended September 30, 2018 and September 30, 2017. International Music Publishing revenues were $359 million and $314 million, or 55% of Music Publishing revenues for both the fiscal years ended September 30, 2018 and September 30, 2017.

The overall increase in Music Publishing revenue was mainly driven by the increase in digital revenue as described in the “Total Revenues” and “Revenue by Geographical Location” sections above.

2017 vs. 2016

Music Publishing revenues increased by $48 million, or 9%, to $572 million for the fiscal year ended September 30, 2017 from $524 million for the fiscal year ended September 30, 2016. U.S. Music Publishing revenues were $258 million and $231 million, or 45% and 44%, of Music Publishing revenues for the fiscal year ended September 30, 2017 and September 30, 2016, respectively. International Music Publishing revenues were $314 million and $293 million, or 55% and 56%, of Music Publishing revenues for the fiscal year ended September 30, 2017 and September 30, 2016, respectively.

The overall increase in Music Publishing revenue was mainly driven by the increase in digital revenue as described in the “Total Revenues” and “Revenue by Geographical Location” sections above.

Cost of revenues

Music Publishing cost of revenues was composed of the following amounts (in millions):

 

 

For the Fiscal Year Ended

September 30,

 

 

2018 vs. 2017

 

 

2017 vs. 2016

 

 

2018

 

 

2017

 

 

2016

 

 

$ Change

 

 

% Change

 

 

$ Change

 

 

% Change

 

Artist and repertoire costs

$

425

 

 

$

355

 

 

$

317

 

 

$

70

 

 

 

20

%

 

$

38

 

 

 

12

%

Total cost of revenues

$

425

 

 

$

355

 

 

$

317

 

 

$

70

 

 

 

20

%

 

$

38

 

 

 

12

%

 

2018 vs. 2017

Music Publishing cost of revenues increased by $70 million, or 20%, to $425 million for the fiscal year ended September 30, 2018 from $355 million for the fiscal year ended September 30, 2017 due to revenue mix and increased A&R investment costs. Expressed as a percentage of Music Publishing revenue, Music Publishing cost of revenues increased to 65% for the fiscal year ended September 30, 2018 from 62% for the fiscal year ended September 30, 2017.

47


 

2017 vs. 2016

Music Publishing cost of revenues increased by $38 million, or 12%, to $355 million for the fiscal year ended September 30, 2017 from $317 million for the fiscal year ended September 30, 2016 due to revenue mix. Expressed as a percentage of Music Publishing revenue, Music Publishing cost of revenues increased to 62% for the fiscal year ended September 30, 2017 from 61% for the fiscal year ended September 30, 2016.

Selling, general and administrative expense

Music Publishing selling, general and administrative expenses were comprised of the following amounts (in millions):

 

 

For the Fiscal Year Ended

September 30,

 

 

2018 vs. 2017

 

 

2017 vs. 2016

 

 

2018

 

 

2017

 

 

2016

 

 

$ Change

 

 

% Change

 

 

$ Change

 

 

% Change

 

General and administrative expense (1)

$

74

 

 

$

69

 

 

$

75

 

 

$

5

 

 

 

7

%

 

$

(6

)

 

 

-8

%

Selling and marketing expense

 

2

 

 

 

2

 

 

 

1

 

 

 

 

 

 

%

 

 

1

 

 

 

100

%

Total selling, general and administrative expense

$

76

 

 

$

71

 

 

$

76

 

 

$

5

 

 

 

7

%

 

$

(5

)

 

 

-7

%

 

(1)

Includes depreciation expense of $7 million, $6 million, and $7 million for the fiscal year ended September 30, 2018, 2017 and 2016, respectively.

2018 vs. 2017

Music Publishing selling, general and administrative expense increased by $5 million, or 7%, to $76 million for the fiscal year ended September 30, 2018 as compared to $71 million for the fiscal year ended September 30, 2017.  The increase in general and administrative expense was due to an increase in compensation expense of $3 million and facilities costs of $2 million. Expressed as a percentage of Music Publishing revenues, Music Publishing selling, general and administrative expense remained flat at 12% for both the fiscal year ended September 30, 2018 and the fiscal year ended September 30, 2017.

2017 vs. 2016

Music Publishing selling, general and administrative expense decreased by $5 million, or 7%, to $71 million for the fiscal year ended September 30, 2017 as compared to $76 million for the fiscal year ended September 30, 2016.  The decrease in general and administrative expense was due to costs related to the Happy Birthday settlement and severance charges taken in the prior year, partially offset by a one-time settlement in the current year of $4 million and one-time gain on asset sale in the prior year of $2 million. Expressed as a percentage of Music Publishing revenues, Music Publishing selling, general and administrative revenues decreased to 12% for the fiscal year ended September 30, 2017 from 15% for the fiscal year ended September 30, 2016.

Operating income and OIBDA

Music Publishing OIBDA includes the following amounts (in millions):

 

 

For the Fiscal Year Ended

September 30,

 

 

2018 vs. 2017

 

 

2017 vs. 2016

 

 

2018

 

 

2017

 

 

2016

 

 

$ Change

 

 

% Change

 

 

$ Change

 

 

% Change

 

Operating income

$

84

 

 

$

81

 

 

$

68

 

 

$

3

 

 

 

4

%

 

$

13

 

 

 

19

%

Depreciation and amortization

 

75

 

 

 

71

 

 

 

70

 

 

 

4

 

 

 

6

%

 

 

1

 

 

 

1

%

OIBDA

$

159

 

 

$

152

 

 

$

138

 

 

$

7

 

 

 

5

%

 

$

14

 

 

 

10

%

 

2018 vs. 2017

Music Publishing OIBDA increased by $7 million, or 5%, to $159 million for the fiscal year ended September 30, 2018 from $152 million for the fiscal year ended September 30, 2017 as a result of higher Music Publishing revenue, partially offset by higher artist and repertoire costs and higher general and administrative costs, as noted above. Expressed as a percentage of Music Publishing revenues, Music Publishing OIBDA margin decreased to 24% for the fiscal year ended September 30, 2018 from 27% for the fiscal year ended September 30, 2017.

48


 

Music Publishing operating income increased by $3 million to $84 million for the fiscal year ended September 30, 2018 from $81 million for the fiscal year ended September 30, 2017 due to the factors that led to the increase in Music Publishing OIBDA noted above.  

2017 vs. 2016  

Music Publishing OIBDA increased by $14 million, or 10%, to $152 million for the fiscal year ended September 30, 2017 from $138 million for the fiscal year ended September 30, 2016 as a result of higher Music Publishing revenue and lower general and administrative expenses, partially offset by higher artist and repertoire costs, as noted above. Expressed as a percentage of Music Publishing revenues, Music Publishing OIBDA margin increased to 27% for the fiscal year ended September 30, 2017 from 26% for the fiscal year ended September 30, 2016.

Music Publishing operating income increased by $13 million to $81 million for the fiscal year ended September 30, 2017 from $68 million for the fiscal year ended September 30, 2016 due to the factors that led to the decrease in Music Publishing OIBDA noted above.

Corporate Expenses and Eliminations

2018 vs. 2017

Our OIBDA loss from corporate expenses and eliminations increased by $31 million to $161 million for the fiscal year ended September 30, 2018 from $130 million for the fiscal year ended September 30, 2017 due to costs associated with United States shared services and other transformation initiatives of $16 million, an increase in our annual Access management fee of $7 million, an increase in variable compensation expense of $5 million associated with our Senior Management Free Cash Flow Plan, which is associated with higher compensation costs on dividend payments in the current year.

Our operating loss from corporate expenses and eliminations increased by $32 million to $174 million for the fiscal year ended September 30, 2018 from $142 million for the fiscal year ended September 30, 2017 due to the factors that led to the increase in operating loss noted above.

2017 vs. 2016

Our OIBDA loss from corporate expenses and eliminations increased by $40 million to $130 million for the fiscal year ended September 30, 2017 from $90 million for the fiscal year ended September 30, 2016 due to increases in expenses associated with our Senior Management Free Cash Flow Plan including $14 million of non-cash share-based compensation expense and $12 million of free cash flow compensation expense.  The increase in the Plan’s expenses are directly associated with our improved operating performance and the associated increase in fair value of equity. The additional increase is primarily due to costs associated with our U.S. shared services relocation and other transformation initiatives of $8 million.

Our operating loss from corporate expenses and eliminations increased by $41 million to $142 million for the fiscal year ended September 30, 2017 from $101 million for the fiscal year ended September 30, 2016 due to the factors that led to the increase in OIBDA loss noted above.

 

49


 

FINANCIAL CONDITION AND LIQUIDITY

Financial Condition at September 30, 2018

At September 30, 2018, we had $2.819 billion of debt (which is net of $28 million of deferred financing costs), $514 million of cash and equivalents (net debt of $2.305 billion, defined as total debt less cash and equivalents and deferred financing costs) and $334 million of Warner Music Group Corp. deficit. This compares to $2.811 billion of debt (which is net of $29 million of deferred financing costs), $647 million of cash and equivalents (net debt of $2.164 billion) and $293 million of Warner Music Group Corp. equity at September 30, 2017.

Cash Flows

The following table summarizes our historical cash flows. The financial data for fiscal years ended September 30, 2018, September 30, 2017 and September 30, 2016 have been derived from our audited financial statements included elsewhere herein.

 

 

For the Fiscal Year Ended

September 30,

 

 

2018

 

 

2017

 

 

2016

 

Cash provided by (used in):

 

 

 

 

 

 

 

 

 

 

 

Operating Activities

$

425

 

 

$

535

 

 

$

342

 

Investing Activities

 

405

 

 

 

(126

)

 

 

(8

)

Financing Activities

 

(955

)

 

 

(128

)

 

 

(216

)

 

Operating Activities

Cash provided by operating activities was $425 million for the fiscal year ended September 30, 2018 compared to $535 million for the fiscal year ended September 30, 2017 and $342 million for the fiscal year ended September 30, 2016. The primary driver of the $110 million decrease in cash provided by operating activities during the current year was the timing of royalty payments, partially offset by improved operating performance.

The increase in results from operating activities for the fiscal year ended September 30, 2017 compared to the fiscal year ended September 30, 2016 reflected the benefit of changes in working capital from operations, including the timing of royalty advances, royalty payables, accounts payable and accrued liabilities, and increased non-cash share-based compensation expense resulting from strong operating performance, partially offset by the timing of collections.

Investing Activities

Cash provided by investing activities was $405 million for the fiscal year ended September 30, 2018, compared to cash used in investing activities of $126 million for the fiscal year ended September 30, 2017 and cash used in investing activities of $8 million for the fiscal year ended September 30, 2016.

Cash provided by investing activities of $405 million for the fiscal year ended September 30, 2018 consisted of $516 million of proceeds from sale of investments which includes the Spotify share sale of $504 million, partially offset by $74 million of capital expenditures, which has increased due to costs incurred related to the build-out of our Los Angeles office of $28 million, $23 million of investments and acquisitions and $14 million to acquire music publishing rights.

Cash used in investing activities of $126 million for the fiscal year ended September 30, 2017 consisted of $139 million of business investments and acquisitions, including the Spinnin’ Records acquisition in September 2017, $16 million to acquire music publishing rights and $44 million of capital expenditures, partially offset by $73 million of proceeds from divestitures.

Cash used in investing activities of $8 million for the fiscal year ended September 30, 2016 consisted of $42 million of capital expenditures mainly related to IT, $28 million of business investments and acquisitions and $25 million to acquire music publishing rights, partially offset by $42 million of proceeds from the sale of real estate and $45 million of proceeds from divestitures.

Financing Activities

Cash used in financing activities was $955 million for the fiscal year ended September 30, 2018 compared to $128 million for the fiscal year ended September 30, 2017 and $216 million for the fiscal year ended September 30, 2016.

50


 

The $955 million of cash used in financing activities for the fiscal year ended September 30, 2018 consisted of the repayment of and deposit for Acquisition Corp.’s 6.750% Senior Notes (as defined below) of $635 million, special cash dividends paid of $925 million, call premiums paid on and redemption deposit for early redemption of $23 million, deferred financing costs paid of $12 million, and a distribution to our non-controlling interest holders of $5 million, partially offset by proceeds from issuance of Acquisition Corp.’s Senior Notes (as defined below) of $325 million, and proceeds from the issuance of Acquisition Corp.’s Senior Term Loan Facility of $320 million.

The $128 million of cash used in financing activities for the fiscal year ended September 30, 2017 consisted of the repayment of Acquisition Corp.’s 6.000% Senior Secured Notes due 2021 of $450 million, repayment of Acquisition Corp.’s 6.250% Senior Secured Notes due 2021 of $173 million, repayment of Acquisition Corp.’s 5.625% Secured Notes (as defined below) of $28 million, call premiums paid on early redemption of $27 million, deferred financing costs paid of $13 million, special cash dividends paid of $84 million, and a distribution to our non-controlling interest holders of $5 million, partially offset by proceeds from issuance of Acquisition Corp.’s 4.125% Secured Notes (as defined below) of €345 million, proceeds from issuance of Acquisition Corp.’s 4.875% Senior Secured Notes (as defined below) of $250 million and proceeds from the amendment of Acquisition Corp.’s Senior Term Loan Facility of $22 million.

The $216 million of cash used in financing activities for the fiscal year ended September 30, 2016 represented the repayment of $150 million of Holdings 13.75% Senior Notes due 2019, $10 million of financing costs paid, open market repurchase of approximately $25 million of Acquisition Corp. 6.750% Senior Notes, repayment of Acquisition Corp. Senior Term Loan Facility of $296 million, $13 million in amortization payments on Acquisition Corp.’s Senior Term Loan Facility, $4 million of deferred financing costs paid, $14 million of repayments on our capital lease obligation and $5 million of distributions to our non-controlling interest holders, partially offset by $300 million of proceeds from the issuance of Acquisition Corp.’s 5.000% Secured Notes.

There were no drawdowns on the Revolving Credit Facility during the fiscal years ended September 30, 2018, September 30, 2017 and September 30, 2016.

Liquidity

Our primary sources of liquidity are the cash flows generated from our subsidiaries’ operations, available cash and equivalents and funds available for drawing under our Revolving Credit Facility. These sources of liquidity are needed to fund our debt service requirements, working capital requirements, capital expenditure requirements, strategic acquisitions and investments, and any dividends, prepayments of debt or repurchases or retirement of our outstanding debt or notes in open market purchases, privately negotiated purchases or otherwise, we may elect to pay or make in the future. We believe that our existing sources of cash will be sufficient to support our existing operations over the next twelve months.

Recent Debt Financings, Redemptions and Amendments

June 2018 Senior Term Loan Credit Agreement Amendment

On June 7, 2018, Acquisition Corp. entered into an amendment (the “June 2018 Senior Term Loan Credit Agreement Amendment”) to the Senior Term Loan Credit Agreement, dated November 1, 2012, among Acquisition Corp., the guarantors party thereto, the lenders party thereto and Credit Suisse AG, as administrative agent, governing Acquisition Corp.’s senior secured term loan facility with Credit Suisse AG, as administrative agent, and the other financial institutions and lenders from time to time party thereto, to, among other things, reduce the pricing terms of its outstanding term loans, change certain incurrence thresholds governing the ability to incur debt and liens and exclude from the definition of “Senior Secured Indebtedness” certain liens that have junior lien priority on the collateral in relation to the outstanding term loans and the relevant guarantees, as applicable. The Company recorded a loss on extinguishment of debt of approximately $2 million, which represented the discount and unamortized deferred financing costs related to the prior tranche of debt of the lenders that was replaced.

5.500% Senior Notes Offering, Tender Offer and 6.750% Senior Notes Redemption

On March 14, 2018, Acquisition Corp. issued $325 million in aggregate principal amount of its 5.500% Senior Notes due 2026 (the “Senior Notes”).  Acquisition Corp. used the net proceeds to pay the consideration in the tender offer for its 6.750% Senior Notes due 2022 (the “6.750% Senior Notes”) and to redeem the remaining 6.750% Senior Notes as described below.  

51


 

On March 14, 2018, Acquisition Corp. accepted for purchase, in connection with the tender offer for the 6.750% Senior Notes, the 6.750% Senior Notes that had been validly tendered and not validly withdrawn at or prior to 5:00 p.m., New York City time on March 13, 2018 (the “Expiration Time”) thereby reducing the aggregate principal amount of the 6.750% Senior Notes by $523 million. Acquisition Corp. then issued a notice of redemption on March 14, 2018 with respect to the remaining $112 million of 6.750% Senior Notes outstanding that were not accepted for payment pursuant to the tender offer. Following payment of the 6.750% Senior Notes tendered at or prior to the Expiration Time, Acquisition Corp. deposited with the Trustee funds of $119 million to satisfy all obligations under the applicable indenture governing the 6.750% Senior Notes, including call premiums and interest through the date of redemption on April 15, 2018, for the remaining 6.750% Senior Notes not accepted for purchase in the tender offer. On April 15, 2018, Acquisition Corp. redeemed the remaining outstanding 6.750% Senior Notes. The Company recorded a loss on extinguishment of debt in connection with the tender offer of approximately $23 million as a result of the partial debt redemption, which represents the premium paid on early redemption and unamortized deferred financing costs in March 2018. The Company incurred an additional loss on extinguishment of approximately $5 million in April 2018 related to the redemption on the remaining 6.750% Senior Notes, which represents the premium paid on early redemption and unamortized deferred financing costs.

March 2018 Senior Term Loan Credit Agreement Amendment

On March 14, 2018, Acquisition Corp. incurred $320 million of supplemental term loans (the “Supplemental Term Loans”) pursuant to an increase supplement (the “March 2018 Senior Term Loan Credit Agreement Supplement”) to the Senior Term Loan Credit Agreement, dated November 1, 2012, among Acquisition Corp., the guarantors party thereto, the lenders party thereto and Credit Suisse AG, as administrative agent, governing Acquisition Corp.’s senior secured term loan facility with Credit Suisse AG, as administrative agent, and the other financial institutions and lenders from time to time party thereto (as amended, the “Senior Term Loan Credit Agreement”). The principal amount outstanding under the Senior Term Loan Credit Agreement including the Supplemental Term Loans is $1.326 billion.

New Revolving Credit Agreement

On January 31, 2018, Acquisition Corp. entered into a new revolving credit agreement (the “Revolving Credit Agreement”) for a senior secured revolving credit facility with Credit Suisse AG, as administrative agent, and the other financial institutions and lenders from time to time party thereto, and terminated its then-existing revolving credit agreement (the “Old Revolving Credit Agreement”). The Revolving Credit Agreement differs from the Old Revolving Credit Agreement in that it, among other things, reduces the interest rate margin applicable to the loans, extends the maturity date thereunder, provides for the option to increase the commitments under Acquisition Corp.’s then existing revolving credit agreement, provides for greater flexibility to amend and extend Acquisition Corp.’s then existing revolving credit agreement and create additional tranches thereunder, provides for greater flexibility over future amendments, increases the springing financial maintenance covenant to 4.75:1.00 and provides that the covenant shall not be tested unless at the end of a fiscal quarter the outstanding amount of loans and drawings under letters of credit which have not been reimbursed exceeds $54 million and aligns the other negative covenants with those of the Senior Term Loan Credit Agreement. See “Revolving Credit Facility” below for additional information.

December 2017 Senior Term Loan Credit Agreement Amendment

On December 6, 2017, Acquisition Corp. entered into an amendment (the “December 2017 Senior Term Loan Credit Agreement Amendment”) to the Senior Term Loan Credit Agreement, dated November 1, 2012, among Acquisition Corp., the guarantors party thereto, the lenders party thereto and Credit Suisse AG, as administrative agent, governing Acquisition Corp.’s senior secured term loan facility with Credit Suisse AG, as administrative agent, and the other financial institutions and lenders from time to time party thereto, to, among other things, reduce the pricing terms of its outstanding term loans, change certain incurrence thresholds governing the ability to incur debt and liens, change certain EBITDA add-backs and increase the thresholds above which the excess cash flow sweep is triggered. The Company recorded a loss on extinguishment of debt of approximately $1 million, which represented the discount and unamortized deferred financing costs related to the prior tranche of debt of the lenders that was replaced.

 

Debt Financing and Redemption Subsequent Events

Partial Redemption of 5.625% Secured Notes

On November 5, 2018, Acquisition Corp. redeemed $26.55 million aggregate principal amount of its 5.625% Senior Secured Notes due 2022 (the “5.625% Secured Notes”).  The redemption price for the 5.625% Secured Notes was approximately $27.38 million, equivalent to 102.813% of the principal amount of the 5.625% Secured Notes, plus accrued but unpaid interest thereon to, but excluding, the redemption date, which was November 5, 2018.  Following the partial redemption of the 5.625% Secured Notes, $220.95 million of the 5.625% Secured Notes remain outstanding.

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Partial Redemption of 4.125% Secured Notes

On October 12, 2018, Acquisition Corp. redeemed €34.5 million aggregate principal amount of its 4.125% Senior Secured Notes due 2024 (the “4.125% Secured Notes”) using a portion of the proceeds from the offering of 3.625% Secured Notes described below.  The redemption price for the 4.125% Secured Notes was approximately €36.17 million, equivalent to 103% of the principal amount of the 4.125% Secured Notes, plus accrued but unpaid interest thereon to, but excluding, the redemption date, which was October 12, 2018. Following the partial redemption of the 4.125% Secured Notes, €310.5 million of the 4.125% Secured Notes remain outstanding.

Open Market Purchase

On October 9, 2018, Acquisition Corp. purchased, in the open market, $30 million aggregate principal amount of its outstanding 4.875% Senior Secured Notes due 2024 (the “4.875% Secured Notes”).  The acquired notes were subsequently retired.  Following retirement of the acquired notes, $220 million of the 4.875% Secured Notes remain outstanding.  

3.625% Secured Notes Offering

On October 9, 2018, Acquisition Corp. issued and sold €250 million in aggregate principal amount of 3.625% Senior Secured Notes due 2026 (the “3.625% Secured Notes”).  Net proceeds of the offering were used to pay the purchase price of the previously announced acquisition of EMP Merchandising and to redeem €34.5 million of the 4.125% Secured Notes (as described above), and the remaining proceeds will be used for general corporate purposes, including open market purchases of a portion of our outstanding debt.

Revolving Credit Facility

On January 31, 2018, Acquisition Corp. entered into the Revolving Credit Agreement for a senior secured revolving credit facility with Credit Suisse AG, as administrative agent, and the other financial institutions and lenders from time to time party thereto (the “Revolving Credit Facility”). The final maturity of the Revolving Credit Facility is January 31, 2023.

Acquisition Corp. is the borrower (the “Revolving Borrower”) under the Revolving Credit Agreement which provides for a revolving credit facility in the amount of up to $180 million (the “Commitments”) and includes a $50 million letter of credit sub-facility. Amounts are available under the Revolving Credit Facility in U.S. dollars, euros or pounds Sterling. The Revolving Credit Agreement permits loans for general corporate purposes and may also be utilized to issue letters of credit. Borrowings under the Revolving Credit Agreement bear interest at the Revolving Borrower’s election at a rate equal to (i) the rate for deposits in the borrowing currency in the London interbank market (adjusted for maximum reserves) for the applicable interest period (“Revolving LIBOR”) plus 1.75% per annum, or (ii) the base rate, which is the highest of (x) the corporate base rate established by the administrative agent from time to time, (y) the overnight federal funds rate plus 0.5% and (z) the one-month Revolving LIBOR plus 1.00% per annum, plus, in each case, 0.75% per annum.

Prepayments

If, at any time, the aggregate amount of outstanding loans (including letters of credit outstanding thereunder) exceeds the commitments under the Revolving Credit Facility, prepayments of the loans (and after giving effect to such prepayment the cash collateralization of letters of credit) will be required in an amount equal to such excess. The application of proceeds from mandatory prepayments shall not reduce the aggregate amount of then effective commitments under the Revolving Credit Facility and amounts prepaid may be reborrowed, subject to then effective commitments under the Revolving Credit Facility.

Voluntary reductions of the unutilized portion of the Commitments under the Revolving Credit Facility are permitted at any time in certain minimum principal amounts, without premium or penalty. Voluntary prepayments of borrowings under the Revolving Credit Facility are permitted at any time in certain minimum principal amounts, subject to reimbursement of the lenders’ redeployment costs actually incurred in the case of a prepayment of LIBOR-based borrowings other than on the last day of the relevant interest period.

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Ranking

The indebtedness incurred under the Revolving Credit Facility constitutes senior secured obligations of the Revolving Borrower, which are secured on an equal and ratable basis with all existing and future indebtedness secured with the same security arrangements as the Revolving Credit Facility, including the Senior Term Loan Facility and the Secured Notes. Indebtedness incurred under the Revolving Credit Facility ranks senior in right of payment to the Revolving Borrower’s subordinated indebtedness; ranks equally in right of payment with all of the Revolving Borrower’s existing and future senior indebtedness, including indebtedness under the Senior Term Loan Credit Agreement, the Secured Notes, and any future senior secured credit facility; is effectively senior to the Revolving Borrower’s existing and future unsecured senior indebtedness, including the Senior Notes, to the extent of the value of the collateral securing the Revolving Credit Facility; and is structurally subordinated in right of payment to all existing and future indebtedness and other liabilities of any of the Revolving Borrower’s non-guarantor subsidiaries (other than indebtedness and liabilities owed to the Revolving Borrower or one of its Subsidiary Guarantors (as defined below)).

Guarantees

All obligations under the Revolving Credit Facility are guaranteed by the Revolving Borrower’s existing subsidiaries that guarantee the Secured Notes and each other direct and indirect wholly owned U.S. subsidiary of the Revolving Borrower, other than certain excluded subsidiaries and are secured by substantially all assets of the Revolving Borrower and each subsidiary guarantor to the extent required under the security agreement securing the Secured Notes including a perfected pledge of all the equity interests of the Revolving Borrower and of any subsidiary guarantor, mortgages on certain real property and certain intellectual property.

Covenants, Representations and Warranties

The Revolving Credit Facility contains customary representations and warranties and customary affirmative and negative covenants. The negative covenants are incurrence-based high yield covenants and limit the ability of the Revolving Borrower and its restricted subsidiaries to:

 

incur additional indebtedness or issue certain preferred shares;

 

pay dividends, redeem stock or make other distributions;

 

repurchase, prepay or redeem subordinated indebtedness;

 

make investments;

 

pay dividends (in the case of the restricted subsidiaries) to the Revolving Borrower or make other intercompany transfers;

 

create liens;

 

transfer or sell assets;

 

consolidate, merge, sell or otherwise dispose of all or substantially all of our assets;

 

enter into certain transactions with affiliates; and

 

designate subsidiaries as unrestricted subsidiaries.

The negative covenants are subject to customary and other specified exceptions.  There are no financial covenants included in the Revolving Credit Agreement, other than a springing leverage ratio of 4.75:1.00 (with no step-down), which shall not be tested unless at the end of a fiscal quarter the outstanding amount of loans and drawings under letters of credit which have not been reimbursed exceeds $54,000,000.  

Events of Default

Events of default under the Revolving Credit Agreement are limited to nonpayment of principal, interest or other amounts, violation of covenants, incorrectness of representations and warranties in any material respect, cross default and cross acceleration of certain material debt, bankruptcy, material judgments, ERISA events, actual or asserted invalidities of the Revolving Credit Agreement, guarantees or security documents and a change of control, in each case subject to customary notice and grace period provisions.

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Senior Term Loan Facility

On November 1, 2012, Acquisition Corp. entered into a $600 million senior secured term loan credit facility, dated November 1, 2012, pursuant to a credit agreement, as amended or supplemented by the amendments and/or supplements dated May 9, 2013, July 13, 2016, November 21, 2016, May 22, 2017, December 6, 2017, March 14, 2018 and June 7, 2018 (the “Senior Term Loan Credit Agreement”) with Credit Suisse AG, as administrative agent and collateral agent, and the other financial institutions and lenders from time to time party thereto (as described below, the “Senior Term Loan Facility” and, together with the Revolving Credit Facility, the “Senior Credit Facilities”). On June 7, 2018, Acquisition Corp. entered into an amendment to the Senior Term Loan Credit Agreement, which, among other things, reduced the pricing terms of its outstanding term loans, changed certain incurrence thresholds governing the ability to incur debt and liens and excluded from the definition of “Senior Secured Indebtedness” certain liens that have junior lien priority on the collateral in relation to the outstanding term loans and the relevant guarantees, as applicable.

General

Acquisition Corp. is the borrower under the Senior Term Loan Facility (the “Term Loan Borrower”). On May 9, 2013, the Term Loan Borrower entered into an amendment to the Senior Term Loan Facility among the Term Loan Borrower, Holdings, the subsidiaries of the Term Loan Borrower party thereto, Credit Suisse AG, as administrative agent, and the other financial institutions and lenders from time to time party thereto, providing for the refinancing of the then outstanding term loan and for a $820 million senior secured incremental term loan facility, which was drawn on July 1, 2013. On July 15, 2016, the Term Loan Borrower entered into an amendment to the Senior Term Loan Credit Agreement with Credit Suisse AG, as administrative agent, and the other financial institutions and lenders from time to time party thereto, providing for (among other changes) conforming certain baskets governing the ability to incur debt and liens to the equivalent provisions applicable to the 5.000% Notes. The effectiveness of such changes to the baskets was subject to certain conditions, which were satisfied by the completed issuance and sale of the 5.000% Notes and the prepayment, pursuant to the prepayment notice dated July 22, 2016, of $295.5 million of the Tranche B Term Loans (as defined in the Senior Term Loan Credit Agreement) with the net proceeds from the sale of the 5.000% Notes. On November 21, 2016, the Term Loan Borrower entered into an amendment to the Senior Term Loan Credit Agreement, which extended the maturity date to November 1, 2023, subject, in certain circumstances to a springing maturity inside the maturity date of certain of the Term Loan Borrower’s other outstanding indebtedness (which springing maturity no longer applies to the outstanding term loans) and increased the principal amount outstanding by $27.5 million to $1,006 million.  On May 22, 2017, the Term Loan Borrower entered into an amendment to the Senior Term Loan Credit Agreement, which, among other things, reduced the pricing terms of its outstanding term loans. On December 6, 2017, the Term Loan Borrower entered into an amendment to the Senior Term Loan Credit Agreement, which, among other things, reduced the pricing terms of its outstanding term loans and changed certain baskets governing the ability to incur debt and liens. On March 14, 2018, Acquisition Corp. incurred supplemental term loans pursuant to which the principal amount outstanding under the Senior Term Loan Credit Agreement was increased by $320 million to $1,326 million.

The loans outstanding under the Senior Term Loan Facility mature on November 1, 2023.

In addition, the Senior Term Loan Credit Agreement provides the right for individual lenders to extend the maturity date of their loans upon the request of the Term Loan Borrower and without the consent of any other lender.

Subject to certain conditions, without the consent of the then existing lenders (but subject to the receipt of commitments), the Senior Term Loan Facility may be expanded (or a new term loan facility entered into) by up to the greater of (i) $300 million and (ii) such additional amount as would not cause the net senior secured leverage ratio, after giving effect to the incurrence of such additional amount and any use of proceeds thereof, to exceed 4.50:1.00.

Interest Rates and Fees

Prior to the June 7, 2018 amendment to the Senior Term Loan Credit Agreement, term loan borrowings under the Senior Term Loan Credit Agreement bore interest at a floating rate measured by reference to, at Acquisition Corp.’s option, either (i) an adjusted London inter-bank offered rate, or “LIBOR,” not less than 0.00% per annum plus a borrowing margin of 2.25% per annum or (ii) an alternate base rate plus a borrowing margin of 1.25% per annum. On and after the June 7, 2018 amendment to the Senior Term Loan Credit Agreement, term loan borrowings under the Senior Term Loan Credit Agreement bear interest at a floating rate measured by reference to, at Acquisition Corp.’s option, either (i) an adjusted LIBOR not less than 0.00% per annum plus a borrowing margin of 2.125% per annum or (ii) an alternative base rate plus a borrowing margin of 1.125% per annum.

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Prepayments

The Senior Term Loan Facility is subject to mandatory prepayment and reduction in an amount equal to (a) 50% of excess cash flow (as defined in the Senior Term Loan Credit Agreement), with reductions to 25% and zero based upon achievement of a net senior secured leverage ratio of less than or equal to 4.50:1.00 or 4.00:1.00, respectively, (b) 100% of the net cash proceeds received from the incurrence of indebtedness by the Term Loan Borrower or any of its restricted subsidiaries (other than indebtedness permitted under the Senior Term Loan Facility), and (c) 100% of the net cash proceeds of all non-ordinary course asset sales or other dispositions of property by the Term Loan Borrower and its restricted subsidiaries (including certain insurance and condemnation proceeds) in excess of $75 million and subject to the right of the Term Loan Borrower and its restricted subsidiaries to reinvest such proceeds within a specified period of time, and other exceptions. Voluntary prepayments of borrowings under the Senior Term Loan Facility are permitted at any time, in minimum principal amounts of $1 million or a whole multiple of $500,000 in excess thereof, subject to reimbursement of the lenders’ redeployment costs actually incurred in the case of a prepayment of adjusted LIBOR borrowings other than on the last day of the relevant interest period.

Guarantee; Security

All obligations under the Senior Term Loan Facility are guaranteed by each direct and indirect U.S. restricted subsidiary of the Term Loan Borrower, other than certain excluded subsidiaries.

All obligations of the Term Loan Borrower and each guarantor are secured on an equal basis with the Secured Notes by a perfected security interest in the capital stock of the Term Loan Borrower and substantially all tangible and intangible assets of the Term Loan Borrower and each guarantor, including the capital stock of each direct material U.S. subsidiary of the Term Loan Borrower and each guarantor, and 65% of each series of capital stock of any non-U.S. subsidiary held directly by the Term Loan Borrower or any guarantor, subject to exceptions for fee owned real property with a value of less than $5 million, leasehold interests including requirements to deliver landlord lien waivers, estoppels and collateral access waivers, assets specifically requiring perfection through control agreements and other customary exceptions.

Covenants, Representations and Warranties

The Senior Term Loan Facility contains customary representations and warranties and customary affirmative and negative covenants. The negative covenants are incurrence-based high yield covenants and limit the ability of the Term Loan Borrower and its restricted subsidiaries to:

 

incur additional indebtedness or issue certain preferred shares;

 

pay dividends, redeem stock or make other distributions;

 

repurchase, prepay or redeem subordinated indebtedness;

 

make investments;

 

create restrictions on the ability of our restricted subsidiaries to pay dividends to us or make other intercompany transfers;

 

create liens;

 

transfer or sell assets;

 

consolidate, merge, sell or otherwise dispose of all or substantially all of our assets;

 

enter into certain transactions with affiliates; and

 

designate subsidiaries as unrestricted subsidiaries.

The negative covenants are subject to customary exceptions. There are no financial covenants included in the Senior Term Loan Credit Agreement.

Events of Default

Events of default under the Senior Term Loan Credit Agreement are limited to nonpayment of principal when due, nonpayment of interest or other amounts, inaccuracy of representations or warranties in any material respect, violation of covenants, cross default and cross acceleration to other material debt, certain bankruptcy or insolvency events, certain ERISA events, certain material judgments, actual or asserted invalidity of security interests in excess of $50 million, and upon a change of control, in each case subject to customary thresholds, notice and grace period provisions.

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Secured Notes

General

On April 9, 2014, Acquisition Corp. issued $275 million in aggregate principal amount of its 5.625% Secured Notes under the Indenture, dated as of November 1, 2012 (the “Senior Secured Base Indenture”), among Acquisition Corp., the guarantors party thereto, Credit Suisse AG, as Notes Authorized Agent and Collateral Agent and Wells Fargo Bank, National Association, as Trustee (the “Trustee”), as supplemented by the Fourth Supplemental Indenture, dated as of April 9, 2014, among Acquisition Corp., the guarantors party thereto and the Trustee (the “5.625% Supplemental Indenture”). On July 27, 2016, Acquisition Corp. issued $300 million in aggregate principal amount of its 5.000% Secured Notes under the Senior Secured Base Indenture, as supplemented by the Fifth Supplemental Indenture, dated as of July 27, 2016, among Acquisition Corp., the guarantors party thereto, Credit Suisse AG, as Notes Authorized Agent and Collateral Agent, and the Trustee (the “5.000% Supplemental Indenture”).  On October 18, 2016, Acquisition Corp. issued $250 million in aggregate principal amount of its 4.875% Secured Notes and €345 million in aggregate principal amount of its 4.125% Secured Notes under the Senior Secured Base Indenture, as supplemented by (i) in the case of the 4.875% Secured Notes, the Sixth Supplemental Indenture, dated as of October 18, 2016 (the “4.875% Supplemental Indenture”) and (ii) in the case of the 4.125% Notes, the Seventh Supplemental Indenture, dated as of October 18, 2016, in each case among Acquisition Corp., the guarantors party thereto and the Trustee (the “4.125% Supplemental Indenture”).  On October 9, 2018, Acquisition Corp. issued €250 million in aggregate principal amount of its 3.625% Secured Notes under the Senior Secured Base Indenture, as supplemented by the Eighth Supplemental Indenture, dated as of October 9, 2018, among Acquisition Corp., the guarantors party thereto and the Trustee (the “3.625% Supplemental Indenture” and, the Senior Secured Base Indenture, collectively with the 5.625% Supplemental Indenture, the 5.000% Supplemental Indenture, the 4.875% Supplemental Indenture, the 4.125% Supplemental Indenture or the 3.625% Supplemental Indenture, as applicable, the “Secured Notes Indenture”).

Interest on the 5.625% Secured Notes accrues at the rate of 5.625% per annum and is payable semi-annually in arrears on April 15 and October 15, commencing on October 15, 2014. Interest on the 5.000% Secured Notes accrues at a rate of 5.000% per annum and is payable semi-monthly in arrears on February 1 and August 1, commencing on February 1, 2017.  Interest on the 4.875% Secured Notes accrues at the rate of 4.875% per annum and is payable semi-annually in arrears on May 1 and November 1, commencing on May 1, 2017. Interest on the 4.125% Secured Notes accrues at the rate of 4.125% per annum and is payable semi-annually in arrears on May 1 and November 1, commencing on May 1, 2017. Interest on the 3.625% Secured Notes accrues at the rate of 3.625% per annum and is payable semi-annually in arrears on April 15 and October 15, commencing on April 15, 2019.

Ranking

The Secured Notes are Acquisition Corp.’s senior secured obligations and are secured on an equal and ratable basis with all existing and future indebtedness secured with the same security arrangements as the Secured Notes, including the Senior Credit Facilities. The Secured Notes rank senior in right of payment to Acquisition Corp.’s subordinated indebtedness; rank equally in right of payment with all of Acquisition Corp.’s existing and future senior indebtedness, including the Senior Notes and indebtedness under Acquisition Corp.’s Senior Credit Facilities and any future senior secured credit facility; are effectively senior to Acquisition Corp.’s unsecured senior indebtedness, including the Senior Notes, to the extent of the value of the collateral securing the Secured Notes; and are structurally subordinated in right of payment to all existing and future indebtedness and other liabilities of any of Acquisition Corp.’s non-guarantor subsidiaries (other than indebtedness and liabilities owed to Acquisition Corp. or one of its subsidiary guarantors (as such term is defined below)).

Guarantees; Security

The Secured Notes are fully and unconditionally guaranteed on a senior secured basis by each of Acquisition Corp.’s existing direct or indirect wholly-owned domestic restricted subsidiaries and by any such subsidiaries that guarantee obligations of Acquisition Corp. under the Senior Credit Facilities, subject to customary exceptions. Such subsidiary guarantors are collectively referred to herein as the “subsidiary guarantors,” and such subsidiary guarantees are collectively referred to herein as the “subsidiary guarantees.” Each subsidiary guarantee is a senior secured obligation of such subsidiary guarantor and is secured on an equal and ratable basis with all existing and future obligations of such subsidiary guarantor that are secured with the same security arrangements as the guarantee of the Secured Notes (including the subsidiary guarantor’s guarantee of obligations under the Senior Credit Facilities). Each subsidiary guarantee ranks senior in right of payment to all subordinated obligations of the subsidiary guarantor; is effectively senior to the subsidiary guarantor’s existing unsecured obligations, including the subsidiary guarantor’s guarantee of the Senior Notes, to the extent of the collateral securing such guarantee; ranks equally in right of payment with all of the subsidiary guarantor’s existing and future senior obligations, including the subsidiary guarantor’s guarantee of the Senior Credit Facilities and any future senior secured credit facility, and the Senior Notes; and is structurally subordinated in right of payment to all existing and future indebtedness and other liabilities of any non-guarantor subsidiary of the subsidiary guarantor (other than indebtedness and liabilities owed to Acquisition Corp. or one of its subsidiary guarantors). Any subsidiary guarantee of the Secured Notes may be released in certain circumstances.

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On May 7, 2014, the Company issued a guarantee whereby it fully and unconditionally guaranteed on a senior secured basis, the payments of Acquisition Corp. on the 5.625% Secured Notes. On July 27, 2016, the Company issued a guarantee whereby it fully and unconditionally guaranteed on a senior secured basis, the payments of Acquisition Corp. on the 5.000% Secured Notes.  On October 18, 2016, the Company issued a guarantee whereby it fully and unconditionally guaranteed on a senior secured basis, the payments of Acquisition Corp. on the 4.125% Secured Notes and the 4.875% Secured Notes.  On October 9, 2018, the Company issued a guarantee whereby it fully and unconditionally guaranteed on a senior secured basis, the payments of Acquisition Corp. on the 3.625% Secured Notes.

Optional Redemption

5.625% Secured Notes

At any time prior to April 15, 2017, Acquisition Corp. may on any one or more occasions redeem up to 40% of the aggregate principal amount of 5.625% Secured Notes (including the aggregate principal amount of any additional notes of the same series) issued under the Secured Notes Indenture, at its option, at a redemption price equal to 105.625% of the principal amount of the 5.625% Secured Notes redeemed, plus accrued and unpaid interest thereon, if any, to the date of redemption (subject to the rights of holders of 5.625% Secured Notes on the relevant record date to receive interest on the relevant interest payment date), with funds in an aggregate amount not exceeding the net cash proceeds of one or more equity offerings by Acquisition Corp. or any contribution to Acquisition Corp.’s common equity capital made with the net cash proceeds of one or more equity offerings by Acquisition Corp.’s direct or indirect parent; provided that:

(1) at least 50% of the aggregate principal amount of 5.625% Secured Notes originally issued under the Secured Notes Indenture (including the aggregate principal amount of any additional notes of the same series) remains outstanding immediately after the occurrence of such redemption; and

(2) the redemption occurs within 90 days of the date of, and may be conditioned upon, the closing of such equity offering.

The 5.625% Secured Notes may be redeemed, in whole or in part, at any time prior to April 15, 2017, at the option of Acquisition Corp., at a redemption price equal to 100% of the principal amount of the 5.625% Secured Notes redeemed plus the applicable make-whole premium as of, and accrued and unpaid interest thereon, if any, to, the applicable redemption date (subject to the right of holders of record on the relevant record date to receive interest due on the relevant interest payment date).

On or after April 15, 2017, Acquisition Corp. may redeem all or a portion of the 5.625% Secured Notes, at its option, at the redemption prices (expressed as percentages of principal amount) set forth below plus accrued and unpaid interest thereon, if any, on the 5.625% Secured Notes to be redeemed to the applicable redemption date, if redeemed during the twelve-month period beginning on April 15 of the years indicated below:

 

Year

 

Percentage

 

2017

 

 

104.219

%

2018

 

 

102.813

%

2019

 

 

101.406

%

2020 and thereafter

 

 

100.000

%

In addition, during any 12-month period prior to April 15, 2017, Acquisition Corp. will be entitled to redeem up to 10% of the original aggregate principal amount of the 5.625% Secured Notes (including the principal amount of any additional notes of the same series) at a redemption price equal to 103.000% of the aggregate principal amount thereof, plus accrued and unpaid interest thereon, if any, to the redemption date (subject to the right of holders of record on the relevant record date to receive interest due on the relevant interest payment date).

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5.000% Secured Notes

At any time prior to August 1, 2019, Acquisition Corp. may on any one or more occasions redeem up to 40% of the aggregate principal amount of the 5.000% Secured Notes (including the aggregate principal amount of any additional notes constituting 5.000% Secured Notes) issued under the Secured Notes Indenture, at its option, at a redemption price equal to 105% of the principal amount of the 5.000% Secured Notes redeemed, plus accrued and unpaid interest thereon, if any, to the date of redemption (subject to the rights of holders of 5.000% Secured Notes on the relevant record date to receive interest on the relevant interest payment date), with funds in an aggregate amount not exceeding the net cash proceeds of one or more equity offerings by Acquisition Corp. or any contribution to Acquisition Corp.’s common equity capital made with the net cash proceeds of one or more equity offerings by Acquisition Corp.’s direct or indirect parent; provided that:

(1) at least 50% of the aggregate principal amount of the 5.000% Secured Notes originally issued under the Secured Notes Indenture (including the aggregate principal amount of any additional securities constituting 5.000% Secured Notes issued under the Secured Notes Indenture) remains outstanding immediately after the occurrence of such redemption; and

(2) the redemption occurs within 180 days of the date of, and may be conditioned upon, the closing of such equity offering.

The 5.000% Secured Notes may be redeemed, in whole or in part, at any time prior to August 1, 2019, at the option of Acquisition Corp., at a redemption price equal to 100% of the principal amount of the 5.000% Secured Notes redeemed plus the applicable make-whole premium as of, and accrued and unpaid interest thereon, if any, to, the applicable redemption date (subject to the right of holders of record on the relevant record date to receive interest due on the relevant interest payment date).

On or after August 1, 2019, Acquisition Corp. may redeem all or a portion of the 5.000% Secured Notes, at its option, at the redemption prices (expressed as percentages of principal amount) set forth below plus accrued and unpaid interest thereon, if any, on the 5.000% Secured Notes to be redeemed to the applicable redemption date, if redeemed during the twelve-month period beginning on August 1 of the years indicated below:

 

 

Year

 

Percentage

 

2019

 

 

102.500

%

2020

 

 

101.250

%

2021 and thereafter

 

 

100.000

%

 

In addition, during any 12-month period prior to August 1, 2019, Acquisition Corp. will be entitled to redeem up to 10% of the original aggregate principal amount of the 5.000% Secured Notes (including the principal amount of any additional notes of the same series) at a redemption price equal to 103.000% of the aggregate principal amount thereof, plus accrued and unpaid interest thereon, if any, to the redemption date (subject to the right of Holders of record on the relevant record date to receive interest due on the relevant interest payment date).

4.875% Secured Notes

At any time prior to November 1, 2019, Acquisition Corp. may on any one or more occasions redeem up to 40% of the aggregate principal amount of the 4.875% Secured Notes (including the aggregate principal amount of any additional securities constituting 4.875% Secured Notes issued under the Secured Notes Indenture), at its option, at a redemption price equal to 104.875% of the principal amount of the 4.875% Secured Notes redeemed, plus accrued and unpaid interest thereon, if any, to the date of redemption (subject to the rights of holders of 4.875% Secured Notes on the relevant record date to receive interest on the relevant interest payment date), with funds in an aggregate amount not exceeding the net cash proceeds of one or more equity offerings by Acquisition Corp. or any contribution to Acquisition Corp.’s common equity capital made with the net cash proceeds of one or more equity offerings by Acquisition Corp.’s direct or indirect parent; provided that:

(1) at least 50% of the aggregate principal amount of the 4.875% Secured Notes originally issued under the Secured Notes Indenture (including the aggregate principal amount of any additional securities constituting 4.875% Secured Notes issued under the Secured Notes Indenture) remains outstanding immediately after the occurrence of such redemption; and

(2) the redemption occurs within 180 days of the date of, and may be conditioned upon, the closing of such equity offering.

The 4.875% Secured Notes may be redeemed, in whole or in part, at any time prior to November 1, 2019, at the option of Acquisition Corp, at a redemption price equal to 100% of the principal amount of the 4.875% Secured Notes redeemed plus the applicable make-whole premium as of, and accrued and unpaid interest thereon, if any, to, the applicable redemption date (subject to the right of holders of record on the relevant record date to receive interest due on the relevant interest payment date).

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On or after November 1, 2019, Acquisition Corp. may redeem all or a portion of the 4.875% Secured Notes, at its option, at the redemption prices (expressed as percentages of principal amount) set forth below plus accrued and unpaid interest thereon, if any, on the 4.875% Secured Notes to be redeemed to the applicable redemption date, if redeemed during the twelve-month period beginning on November 1 of the years indicated below:

 

Year

 

Percentage

 

2019

  

 

103.656

%

2020

  

 

102.438

%

2021

  

 

101.219

2022 and thereafter

  

 

100.000

%

In addition, during any 12-month period prior to November 1, 2019, Acquisition Corp. will be entitled to redeem up to 10% of the original aggregate principal amount of the 4.875% Secured Notes (including the principal amount of any additional securities of the same series) at a redemption price equal to 103.000% of the aggregate principal amount thereof, plus accrued and unpaid interest thereon, if any, to the redemption date (subject to the right of holders of record on the relevant record date to receive interest due on the relevant interest payment date).

4.125% Secured Notes

At any time prior to November 1, 2019, Acquisition Corp. may on any one or more occasions redeem up to 40% of the aggregate principal amount of the 4.125% Secured Notes (including the aggregate principal amount of any additional securities constituting 4.125% Secured Notes) issued under the Secured Notes Indenture, at its option, at a redemption price equal to 104.125% of the principal amount of the 4.125% Secured Notes redeemed, plus accrued and unpaid interest thereon, if any, to the date of redemption (subject to the rights of holders of 4.125% Secured Notes on the relevant record date to receive interest on the relevant interest payment date), with funds in an aggregate amount not exceeding the net cash proceeds of one or more equity offerings by Acquisition Corp. or any contribution to Acquisition Corp.’s common equity capital made with the net cash proceeds of one or more equity offerings by Acquisition Corp.’s direct or indirect parent; provided that:

(1) at least 50% of the aggregate principal amount of the 4.125% Secured Notes originally issued under the Secured Notes Indenture (including the aggregate principal amount of any additional securities constituting 4.125% Secured Notes issued under the Secured Notes Indenture) remains outstanding immediately after the occurrence of such redemption; and

(2) the redemption occurs within 180 days of the date of, and may be conditioned upon, the closing of such equity offering.

The 4.125% Secured Notes may be redeemed, in whole or in part, at any time prior to November 1, 2019, at the option of Acquisition Corp., at a redemption price equal to 100% of the principal amount of the 4.125% Secured Notes redeemed plus the applicable make-whole premium as of, and accrued and unpaid interest thereon, if any, to, the applicable redemption date (subject to the right of holders of record on the relevant record date to receive interest due on the relevant interest payment date).

On or after November 1, 2019, Acquisition Corp. may redeem all or a portion of the 4.125% Secured Notes, at its option, at the redemption prices (expressed as percentages of principal amount) set forth below plus accrued and unpaid interest thereon, if any, on the 4.125% Secured Notes to be redeemed to the applicable redemption date, if redeemed during the twelve-month period beginning on November 1 of the years indicated below:

 

Year

 

Percentage

 

2019

  

 

103.094

%

2020

  

 

102.063

%

2021

  

 

101.031

2022 and thereafter

  

 

100.000

%

In addition, during any 12-month period prior to November 1, 2019, Acquisition Corp. will be entitled to redeem up to 10% of the original aggregate principal amount of the 4.125% Secured Notes (including the principal amount of any additional securities of the same series) at a redemption price equal to 103.000% of the aggregate principal amount thereof, plus accrued and unpaid interest thereon, if any, to the redemption date (subject to the right of holders of record on the relevant record date to receive interest due on the relevant interest payment date).

 

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3.625% Secured Notes

At any time prior to October 15, 2021, Acquisition Corp. may on any one or more occasions redeem up to 40% of the aggregate principal amount of the 3.625% Secured Notes (including the aggregate principal amount of any additional securities constituting 3.625% Secured Notes) issued under the Secured Notes Indenture, at its option, at a redemption price equal to 103.625% of the principal amount of the 3.625% Secured Notes redeemed, plus accrued and unpaid interest thereon, if any, to the date of redemption (subject to the rights of holders of Notes on the relevant record date to receive interest on the relevant interest payment date), with funds in an aggregate amount not exceeding the net cash proceeds of one or more equity offerings by Acquisition Corp. or any contribution to Acquisition Corp.’s common equity capital made with the net cash proceeds of one or more equity offerings by Acquisition Corp.’s direct or indirect parent; provided that:

(1) at least 50% of the aggregate principal amount of the 3.625% Secured Notes originally issued under the Secured Notes Indenture (including the aggregate principal amount of any additional securities constituting 3.625% Secured Notes issued under the Secured Notes Indenture) remains outstanding immediately after the occurrence of such redemption; and

(2) the redemption occurs within 180 days of the date of, and may be conditioned upon, the closing of such equity offering.

The 3.625% Secured Notes may be redeemed, in whole or in part, at any time prior to October 15, 2021, at the option of Acquisition Corp., at a redemption price equal to 100% of the principal amount of the 3.625% Secured Notes redeemed plus the applicable make-whole premium as of, and accrued and unpaid interest thereon, if any, to, the applicable redemption date (subject to the right of holders of record on the relevant record date to receive interest due on the relevant interest payment date).

On or after October 15, 2021, Acquisition Corp. may redeem all or a portion of the 3.625% Secured Notes, at its option, at the redemption prices (expressed as percentages of principal amount) set forth below plus accrued and unpaid interest thereon, if any, on the 3.625% Secured Notes to be redeemed to the applicable redemption date, if redeemed during the twelve-month period beginning on October 15 of the years indicated below:

 

 

 

 

 

 

Year

  

Percentage

 

2021

  

 

101.813

2022

  

 

100.906

2023 and thereafter

 

 

100.000

%

 

In addition, during any 12-month period prior to October 15, 2021, Acquisition Corp. will be entitled to redeem up to 10% of the original aggregate principal amount of the 3.625% Secured Notes (including the principal amount of any additional securities of the same series) at a redemption price equal to 103.000% of the aggregate principal amount thereof, plus accrued and unpaid interest thereon, if any, to the redemption date (subject to the right of holders of record on the relevant record date to receive interest due on the relevant interest payment date).

Change of Control

Upon the occurrence of a change of control, which is defined in the Secured Notes Base Indenture, each holder of the Secured Notes has the right to require Acquisition Corp. to repurchase some or all of such holder’s Secured Notes at a purchase price in cash equal to 101% of the principal amount thereof, plus accrued and unpaid interest, if any, to the repurchase date.

Covenants

The Secured Notes Indenture contains covenants limiting, among other things, Acquisition Corp.’s ability and the ability of most of its subsidiaries to: incur additional indebtedness or issue certain preferred shares; pay dividends on or make distributions in respect of its capital stock or make investments or other restricted payments; create restrictions on the ability of its restricted subsidiaries to pay dividends to it or make certain other intercompany transfers; sell certain assets; create liens; consolidate, merge, sell or otherwise dispose of all or substantially all of its assets; and enter into certain transactions with its affiliates.

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Events of Default

Events of default under the Secured Notes Indenture are limited to: the nonpayment of principal or interest when due, violation of covenants and other agreements contained in the Secured Notes Indenture, cross payment default after final maturity and cross acceleration of certain material debt; certain bankruptcy and insolvency events, material judgment defaults, actual or asserted invalidity of a guarantee of a significant subsidiary, or of security interests in excess of $50 million, subject to customary notice and grace period provisions. The occurrence of an event of default would permit or require the principal of and accrued interest on the Secured Notes to become or to be declared due and payable.

Senior Notes

General

On March 14, 2018, Acquisition Corp. issued $325 million in aggregate principal amount of Senior Notes under the Indenture, dated as of April 9, 2014 (the “Senior Notes Base Indenture”), among Acquisition Corp., the guarantors party thereto and the Trustee, as supplemented by the fifth supplemental indenture thereto, dated as of March 14, 2018 (the “Senior Notes Supplemental Indenture” and, together with the Senior Notes Base Indenture, the “Senior Notes Indenture”), among Acquisition Corp., the guarantors party thereto and the Trustee.

Interest on the Senior Notes accrues at a rate of 5.500% per annum and is payable semi-annually in arrears on April 15 and October 15, commencing on October 15, 2018.

Ranking

The Senior Notes are Acquisition Corp.’s senior unsecured obligations. The Senior Notes rank senior in right of payment to Acquisition Corp.’s subordinated indebtedness; rank equally in right of payment with all of Acquisition Corp.’s existing and future senior indebtedness, including indebtedness outstanding under the Senior Credit Facilities and any future senior secured credit facility; are effectively subordinated to Acquisition Corp.’s secured senior indebtedness, including the Secured Notes and indebtedness under the Senior Credit Facilities and any future senior secured credit facility, to the extent of the value of the collateral securing such indebtedness; and are structurally subordinated in right of payment to all existing and future indebtedness and other liabilities of any of Acquisition Corp.’s non-guarantor subsidiaries (other than indebtedness and liabilities owed to Acquisition Corp. or one of its subsidiary guarantors).

Guarantees

The Senior Notes are fully and unconditionally guaranteed on a senior unsecured basis by the subsidiary guarantors. Each subsidiary guarantee is a senior unsecured obligation of such subsidiary guarantor. Each subsidiary guarantee ranks senior in right of payment to all subordinated obligations of the subsidiary guarantor; is effectively subordinated to the subsidiary guarantor’s existing secured obligations, including the subsidiary guarantor’s guarantee of the Secured Notes, obligations under the Senior Credit Facilities and any future senior secured credit facility, to the extent of the collateral securing such guarantee; ranks equally in right of payment with all of the subsidiary guarantor’s existing and future senior obligations, including the subsidiary guarantor’s guarantee of the Secured Notes, the Senior Credit Facilities and any future senior secured credit facility; and is structurally subordinated in right of payment to all existing and future indebtedness and other liabilities of any non-guarantor subsidiary of the subsidiary guarantor (other than indebtedness and liabilities owed to Acquisition Corp. or one of its subsidiary guarantors). Any subsidiary guarantee of the Senior Notes may be released in certain circumstances. On March 14, 2018, the Company issued a guarantee whereby it fully and unconditionally guaranteed the payments of Acquisition Corp. on the Senior Notes.

Optional Redemption

At any time prior to April 15, 2021, Acquisition Corp. may on any one or more occasions redeem up to 40% of the aggregate principal amount of Senior Notes (including the aggregate principal amount of any additional securities constituting the same series) issued under the Senior Notes Indenture, at its option, at a redemption price equal to 105.500% of the principal amount of the Senior Notes redeemed, plus accrued and unpaid interest thereon, if any, to the date of redemption (subject to the rights of holders of Senior Notes on the relevant record date to receive interest on the relevant interest payment date), with funds in an aggregate amount not exceeding the net cash proceeds of one or more equity offerings by Acquisition Corp. or any contribution to Acquisition Corp.’s common equity capital made with the net cash proceeds of one or more equity offerings by Acquisition Corp.’s direct or indirect parent; provided that: (1) at least 50% of the aggregate principal amount of Senior Notes originally issued under the Senior Notes Indenture (including the aggregate principal amount of any additional securities constituting Senior Notes issued under the Senior Notes Indenture) remains outstanding immediately after the occurrence of such redemption; and (2) the redemption occurs within 180 days of the date of, and may be conditioned upon, the closing of such equity offering.

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The Senior Notes may be redeemed, in whole or in part, at any time prior to April 15, 2021, at the option of Acquisition Corp., at a redemption price equal to 100% of the principal amount of the Senior Notes redeemed plus the applicable make-whole premium as of, and accrued and unpaid interest thereon, if any, to, the applicable redemption date (subject to the right of holders of record on the relevant record date to receive interest due on the relevant interest payment date).

On or after April 15, 2021, Acquisition Corp. may redeem all or a portion of the Senior Notes, at its option, at the redemption prices (expressed as percentages of principal amount) set forth below plus accrued and unpaid interest thereon, if any, on the Senior Notes to be redeemed to the applicable redemption date, if redeemed during the twelve-month period beginning on April 15 of the years indicated below:

 

Year

 

Percentage

 

2021

 

 

102.750

%

2022

 

 

101.375

%

2023 and thereafter

 

 

100.000

%

 

Change of Control

Upon the occurrence of a change of control, which is defined in the Senior Notes Base Indenture, each holder of the Senior Notes has the right to require Acquisition Corp. to repurchase some or all of such holder’s Senior Notes at a purchase price in cash equal to 101% of the principal amount thereof, plus accrued and unpaid interest, if any, to the repurchase date.

Covenants

The Senior Notes Indenture contains covenants limiting, among other things, Acquisition Corp.’s ability and the ability of most of its subsidiaries to: incur additional indebtedness or issue certain preferred shares; pay dividends on or make distributions in respect of its capital stock or make investments or other restricted payments; create restrictions on the ability of its restricted subsidiaries to pay dividends to it or make certain other intercompany transfers; sell certain assets; create liens; consolidate, merge, sell or otherwise dispose of all or substantially all of its assets; and enter into certain transactions with its affiliates.

Events of Default

The Senior Notes Indenture also provides for events of default which, if any of them occurs, would permit or require the principal of and accrued interest on Senior Notes to become or to be declared due and payable.

Existing Debt as of September 30, 2018

As of September 30, 2018, our long-term debt was as follows (in millions):

 

Revolving Credit Facility—Acquisition Corp. (a)

 

$

 

Senior Term Loan Facility due 2023—Acquisition Corp. (b)

 

 

1,310

 

5.625% Senior Secured Notes due 2022—Acquisition Corp. (c)

 

 

246

 

5.00% Senior Secured Notes due 2023—Acquisition Corp. (d)

 

 

297

 

4.125% Senior Secured Notes due 2024—Acquisition Corp. (e)

 

 

399

 

4.875% Senior Secured Notes due 2024—Acquisition Corp. (f)

 

 

247

 

5.50% Senior Notes due 2026—Acquisition Corp. (g)

 

 

320

 

Total debt (h)

 

$

2,819

 

 

(a)

Reflects $180 million of commitments under the Revolving Credit Facility, less letters of credit outstanding of approximately $8 million at September 30, 2018. There were no loans outstanding under the Revolving Credit Facility at September 30, 2018.

(b)

Principal amount of $1.326 billion less unamortized discount of $4 million and unamortized deferred financing costs of $12 million at September 30, 2018.

(c)

Principal amount of $248 million less unamortized deferred financing costs of $2 million at September 30, 2018.

(d)

Principal amount of $300 million less unamortized deferred financing costs of $3 million at September 30, 2018.

(e)

Face amount of €345 million. Above amounts represent the dollar equivalent of such notes at September 30, 2018. Principal amount of $402 million less unamortized deferred financing costs of $3 million at September 30, 2018.

(f)

Principal amount of $250 million less unamortized deferred financing costs of $3 million at September 30, 2018.

(g)

Principal amount of $325 million less unamortized deferred financing costs of $5 million at September 30, 2018.

(h)

Principal amount of debt of $2.851 billion less unamortized discount of $4 million and unamortized deferred financing costs of $28 million at September 30, 2018.

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Dividends

On December 2, 2016, the Company’s Board of Directors approved a special cash dividend of $54 million which was paid on January 3, 2017 to stockholders of record as of December 30, 2016.

On June 5, 2017, the Company’s Board of Directors approved a special cash dividend of $30 million which was paid on July 31, 2017 to stockholders of record as of June 30, 2017.

On January 8, 2018, the Company’s Board of Directors approved a special cash dividend of $125 million which was paid on January 12, 2018 to stockholders of record as of January 11, 2018.

On May 7, 2018, the Company’s Board of Directors approved a special cash dividend of $300 million which was paid on May 11, 2018 to stockholders of record as of May 7, 2018.

On August 7, 2018, the Company’s Board of Directors approved a special cash dividend of $500 million which was paid on August 10, 2018 to stockholders of record as of August 7, 2018.

Our ability to pay dividends is restricted by covenants in the indentures governing our notes and in the credit agreements for our Senior Term Loan Facility and the Revolving Credit Facility.

The Company intends to institute a regular quarterly dividend whereby we would intend to pay modest regular quarterly dividends in each fiscal quarter and a variable dividend for the fourth fiscal quarter in an amount commensurate with cash expected to be generated from operations in such fiscal year, in each case, after taking into account other potential uses for cash, including acquisitions, investment in our business and repayment of indebtedness.  We expect to pay the first dividend under this policy in the second quarter of fiscal 2019.  The declaration of each dividend will continue to be at the discretion of the Board.

Covenant Compliance

The Company was in compliance with its covenants under its outstanding notes, Revolving Credit Facility and Senior Term Loan Facility as of September 30, 2018.

Our Revolving Credit Facility contains a springing leverage ratio that is tied to a ratio based on Consolidated EBITDA, which is defined under the Credit Agreement governing the Revolving Credit Facility. Our ability to borrow funds under our Revolving Credit Facility may depend upon our ability to meet the leverage ratio test at the end of a fiscal quarter to the extent we have drawn a certain amount of revolving loans. Consolidated EBITDA differs from the term “EBITDA” as it is commonly used. For example, the definition of Consolidated EBITDA, in addition to adjusting net income to exclude interest expense, income taxes, and depreciation and amortization, also adjusts net income by excluding items or expenses not typically excluded in the calculation of “EBITDA” such as, among other items, (1) the amount of any restructuring charges or reserves; (2) any non-cash charges (including any impairment charges); (3) any net loss resulting from hedging currency exchange risks; (4) the amount of management, monitoring, consulting and advisory fees paid to Access under the Management Agreement (as defined in the Credit Agreement); (5) business optimization expenses (including consolidation initiatives, severance costs and other costs relating to initiatives aimed at profitability improvement); (6) transaction expenses and (7) equity-based compensation expense. It also includes an adjustment for the pro forma impact of certain projected cost-savings and synergies. The indentures governing our notes and our Senior Term Loan Facility use financial measures called “Consolidated EBITDA” or “EBITDA” that have the same definition as Consolidated EBITDA as defined under the Credit Agreement governing the Revolving Credit Facility.

Consolidated EBITDA is presented herein because it is a material component of the leverage ratio contained in our Revolving Credit Agreement. Non-compliance with the leverage ratio could result in the inability to use our Revolving Credit Facility, which could have a material adverse effect on our results of operations, financial position and cash flow. Consolidated EBITDA does not represent net income or cash from operating activities as those terms are defined by U.S. GAAP and does not necessarily indicate whether cash flows will be sufficient to fund cash needs. While Consolidated EBITDA and similar measures are frequently used as measures of operations and the ability to meet debt service requirements, these terms are not necessarily comparable to other similarly titled captions of other companies due to the potential inconsistencies in the method of calculation. Consolidated EBITDA does not reflect the impact of earnings or charges resulting from matters that we may consider not to be indicative of our ongoing operations. In particular, the definition of Consolidated EBITDA in the Revolving Credit Agreement allows us to add back certain non-cash, extraordinary, unusual or non-recurring charges that are deducted in calculating net income. However, these are expenses that may recur, vary greatly and are difficult to predict.

64


 

Consolidated EBITDA as presented below is not a measure of the performance of our business and should not be used by investors as an indicator of performance for any future period. Further, our debt instruments require that it be calculated for the most recent four fiscal quarters. As a result, the measure can be disproportionately affected by a particularly strong or weak quarter. Further, it may not be comparable to the measure for any subsequent four quarter period or any complete fiscal year. In addition, our debt instruments require that the leverage ratio be calculated on a pro forma basis for certain transactions including acquisitions as if such transactions had occurred on the first date of the measurement period and may include expected cost savings and synergies resulting from or related to any such transaction. There can be no assurances that any such cost savings or synergies will be achieved in full.

The following is a reconciliation of net income, which is a U.S. GAAP measure of our operating results, to Consolidated EBITDA as defined, and the calculation of the Senior Secured Indebtedness to Consolidated EBITDA ratio, which we refer to as the Leverage Ratio, under our Revolving Credit Agreement for the most recently ended four fiscal quarters, or twelve months ended September 30, 2018. The terms and related calculations are defined in the Revolving Credit Agreement. All amounts in the reconciliation below reflect Acquisition Corp. (in millions, except ratios):

 

 

 

Twelve Months

Ended September

30, 2018

 

Net Income

 

$

312

 

Income tax expense

 

 

130

 

Interest expense, net

 

 

138

 

Depreciation and amortization

 

 

261

 

Loss on extinguishment of debt (a)

 

 

31

 

Net gain on divestitures and sale of securities (b)

 

 

(6

)

Restructuring costs (c)

 

 

66

 

Net hedging and foreign exchange gains (d)

 

 

(7

)

Management fees (e)

 

 

16

 

Business optimization expenses (f)

 

 

21

 

Equity based compensation expense (g)

 

 

62

 

Pro forma impact of cost saving initiatives (h)

 

 

9

 

Pro Forma Consolidated EBITDA (i)

 

$

1,033

 

Senior Secured Indebtedness (j)

 

$

2,326

 

Leverage Ratio (k)

 

2.25x

 

 

(a)

Reflects net loss incurred on the early extinguishment of our debt incurred as part of the December 2017 and June 2018 Senior Term Loan Credit Agreement Amendments and the redemption of the 6.75% Senior Notes.

(b)

Reflects net gain on divestitures and sale of securities.

(c)

Reflects severance costs and other restructuring related expenses.

(d)

Reflects net gains from hedging activities and unrealized net gains due to foreign exchange on our Euro denominated debt and intercompany transactions.

(e)

Reflects Access management fees, including an annual fee and related expenses. Pursuant to the Company’s and Holdings’ management agreement with Access, the base amount of the annual fee is approximately $9 million, subject to certain potential upward adjustments, in addition to a $7 million increase in fiscal 2018.

(f)

Reflects primarily costs associated with IT systems updates and U.S. shared services relocation and other transformation initiatives.

(g)

Reflects equity based compensation expense related to the Warner Music Group Corp. Senior Management Free Cash Flow Plan.

(h)

Reflects expected savings resulting from our specified cost saving initiatives.

(i)

The Pro Forma Consolidated EBITDA as of the twelve months ended September 30, 2018 includes a net gain of $389 million, pre-tax, related to the sale of the Spotify shares acquired in the ordinary course of business.

(j)

Reflects the principal balance of senior secured debt at Acquisition Corp. of approximately $2.526 billion, less cash of $200 million.

(k)

Reflects the ratio of Senior Secured Indebtedness, including Revolving Credit Agreement Indebtedness, to Pro Forma Consolidated EBITDA as of the twelve months ended September 30, 2018. This is calculated net of cash and equivalents of the Company as of September 30, 2018 not exceeding $200 million. If the outstanding aggregate principal amount of borrowings and drawings under letters of credit which have not been reimbursed under our Revolving Credit Facility is greater than $54 million at the end of a fiscal quarter, the maximum leverage ratio permitted under our Revolving Credit Facility is 4.75:1.00. The Company’s Revolving Credit Facility does not impose any “leverage ratio” restrictions on the Company when the aggregate principal amount of borrowings and drawings under letters of credit, which have not been reimbursed under the Revolving Credit Facility, is less than or equal to $54 million at the end of a fiscal quarter.

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Summary

Management believes that funds generated from our operations and borrowings under our Revolving Credit Facility will be sufficient to fund our debt service requirements, working capital requirements and capital expenditure requirements for the foreseeable future. We also have additional borrowing capacity under our indentures and Senior Term Loan Facility. However, our ability to continue to fund these items and to reduce debt may be affected by general economic, financial, competitive, legislative and regulatory factors, as well as other industry-specific factors such as the ability to control music piracy and the continued transition from physical to digital sales in the recorded music and music publishing businesses. We and our affiliates continue to evaluate opportunities to, from time to time depending on market conditions and prices, contractual restrictions, our financial liquidity and other factors, seek to pay dividends or prepay outstanding debt or repurchase or retire Acquisition Corp.’s outstanding debt or debt securities in open market purchases, privately negotiated purchases or otherwise. The amounts involved in any such transactions, individually or in the aggregate, may be material and may be funded from available cash or from additional borrowings. In addition, we may from time to time, depending on market conditions and prices, contractual restrictions, our financial liquidity and other factors, seek to refinance our Senior Credit Facilities or our outstanding debt or debt securities with existing cash and/or with funds provided from additional borrowings.

 

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Contractual and Other Obligations

Firm Commitments

The following table summarizes the Company’s aggregate contractual obligations at September 30, 2018, and the estimated timing and effect that such obligations are expected to have on the Company’s liquidity and cash flow in future periods.

 

 

 

Less than

 

 

1-3

 

 

4-5

 

 

After 5

 

 

 

 

 

Firm Commitments and Outstanding Debt

 

1 year

 

 

years

 

 

years

 

 

years

 

 

Total

 

 

 

(in millions)

 

Senior Secured Notes (1)

 

$

 

 

$

 

 

$

548

 

 

$

652

 

 

$

1,200

 

Interest on Senior Secured Notes (1)

 

 

58

 

 

 

115

 

 

 

101

 

 

 

43

 

 

 

317

 

Senior Notes (1)

 

 

 

 

 

 

 

 

 

 

 

325

 

 

 

325

 

Interest on Senior Notes (1)

 

 

20

 

 

 

36

 

 

 

36

 

 

 

54

 

 

 

146

 

Senior Term Loan Facility (1)

 

 

 

 

 

 

 

 

 

 

 

1,326

 

 

 

1,326

 

Interest on Senior Term Loan Facility (1)

 

 

64

 

 

 

137

 

 

 

137

 

 

 

6

 

 

 

344

 

Operating leases (2)

 

 

56

 

 

 

97

 

 

 

91

 

 

 

245

 

 

 

489

 

Artist, songwriter and co-publisher commitments (3)

 

 

340

 

 

*

 

 

*

 

 

*

 

 

 

340

 

Management Fees (4)

 

 

9

 

 

 

18

 

 

 

18

 

 

**

 

 

 

45

 

Minimum funding commitments to investees and other obligations (5)

 

 

2

 

 

 

2

 

 

 

 

 

 

 

 

 

4

 

Total firm commitments and outstanding debt

 

$

549

 

 

$

405

 

 

$

931

 

 

$

2,651

 

 

$

4,536

 

 

The following is a description of our firmly committed contractual obligations at September 30, 2018:

(1)

Outstanding debt obligations consist of the Senior Term Loan Facility, Senior Secured Notes and Senior Notes. These obligations have been presented based on the principal amounts due, current and long term as of September 30, 2018. Amounts do not include any fair value adjustments, bond premiums, discounts or unamortized deferred financing costs.

(2)

Operating lease obligations primarily relate to the minimum lease rental obligations for our real estate and operating equipment in various locations around the world. These obligations have been presented without the benefit of $3 million of total sublease income expected to be received under non-cancelable agreements.

(3)

The Company routinely enters into long-term commitments with artists, songwriters and publishers for the future delivery of music product. Such commitments generally become due only upon delivery and Company acceptance of albums from the artists or future musical compositions by songwriters and publishers. Additionally, such commitments are typically cancelable at the Company’s discretion, generally without penalty. Based on contractual obligations, aggregate firm commitments to such talent approximate $340 million at September 30, 2018. The aggregate firm commitments expected for the next 12 month period based on contractual obligations and the Company’s expected release schedule approximates $186 million at September 30, 2018.

(4)

Pursuant to the Management Agreement, the Company, or one or more of its subsidiaries, will pay Access an annual fee initially equal to the greater of (i) the sum of (x) a base amount of approximately $9 million and (y) 1.5% of the aggregate amount of Acquired EBITDA (as defined in the Management Agreement) as at such time and (ii) 1.5% of the EBITDA (as defined in the indenture governing the redeemed WMG Holdings Corp. 13.75% Senior Notes due 2019 as required by the Management Agreement) of the Company for the applicable fiscal year, plus expenses. The Company or one or more of its subsidiaries will also pay Access a specified transaction fee for certain types of transactions completed by Holdings or one or more of its subsidiaries, plus expenses. The future balances disclosed are representative of the base amount of the annual fee only.

(5)

We have minimum funding commitments and other related obligations to support the operations of various investments, which are reflected in the table above. Other long-term liabilities include $15 million and $15 million of liabilities for uncertain tax positions as of September 30, 2018 and September 30, 2017, respectively. We are unable to accurately predict when these amounts will be realized or released.

*

Because the timing of payment, and even whether payment occurs, is dependent upon the timing of delivery of albums and musical compositions, the timing and amount of payment of these commitments as presented in the above summary can vary significantly.

**

Per the above explanation, the minimum annual fee will be approximately $9 million per year. This amount may vary based on the terms described above; and will continue as long as the Management Agreement remains unmodified and effective.

 

 

67


 

CRITICAL ACCOUNTING POLICIES

The SEC’s Financial Reporting Release No. 60, “Cautionary Advice Regarding Disclosure About Critical Accounting Policies” (“FRR 60”), suggests companies provide additional disclosure and commentary on those accounting policies considered most critical. FRR 60 considers an accounting policy to be critical if it is important to our financial condition and results, and requires significant judgment and estimates on the part of management in our application. We believe the following list represents critical accounting policies as contemplated by FRR 60. For a summary of all of our significant accounting policies, see Note 2 to our audited Consolidated Financial Statements included elsewhere herein.

Business Combinations

We account for our business acquisitions under the FASB ASC Topic 805, Business Combinations (“ASC 805”) guidance for business combinations. The total cost of acquisitions is allocated to the underlying identifiable net assets based on their respective estimated fair values. The excess of the purchase price over the estimated fair values of the net assets acquired is recorded as goodwill. Determining the fair value of assets acquired and liabilities assumed requires management’s judgment and often involves the use of significant estimates and assumptions, including assumptions with respect to future cash inflows and outflows, discount rates, asset lives and market multiples, among other items. If our assumptions or estimates in the fair value calculation change, the fair value of our acquired intangible assets could change; this would also change the value of our goodwill.

Accounting for Goodwill and Other Intangible Assets

We account for our goodwill and other indefinite-lived intangible assets as required by FASB ASC Topic 350, Intangibles—Goodwill and Other (“ASC 350”). Under ASC 350, we do not amortize goodwill, including the goodwill included in the carrying value of investments accounted for using the equity method of accounting, and certain other intangible assets deemed to have an indefinite useful life. ASC 350 requires that goodwill and certain intangible assets be assessed for impairment using fair value measurement techniques on an annual basis and when events occur that may suggest that the fair value of such assets cannot support the carrying value. ASC 350 gives an entity the option to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step impairment test is unnecessary. However, if an entity concludes otherwise, then it is required to perform the step one of the two-step process. The first step of the goodwill impairment test is used to identify potential impairment by comparing the fair value of a reporting unit with its net book value (or carrying amount), including goodwill.

In performing the first step, management determines the fair value of its reporting units using a discounted cash flow (“DCF”) analysis. Determining fair value requires significant judgment concerning the assumptions used in the valuation model, including discount rates, the amount and timing of expected future cash flows and, growth rates. The cash flows employed in the DCF analysis are based on management’s most recent budgets and business plans and when applicable, various growth rates have been assumed for years beyond the current business plan periods. Any forecast contains a degree of uncertainty and modifications to these cash flows could significantly increase or decrease the fair value of a reporting unit. For example, if revenue from sales of physical products continues to decline and the revenue from sales of digital products does not continue to grow as expected and we are unable to adjust costs accordingly, it could have a negative impact on future impairment tests.

If the fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is considered not impaired and the second step of the impairment test is unnecessary. If the carrying amount of a reporting unit exceeds its fair value, the second step of the goodwill impairment test is performed to measure the amount of impairment loss, if any. The second step of the goodwill impairment test compares the implied fair value of the reporting unit’s goodwill with the carrying amount of that goodwill. If the carrying amount of the reporting unit’s goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess. The implied fair value of goodwill is determined in the same manner as the amount of goodwill recognized in a business combination. That is, the fair value of the reporting unit is allocated to all of the assets and liabilities of that unit (including any unrecognized intangible assets) as if the reporting unit had been acquired in a business combination and the fair value of the reporting unit was the purchase price paid to acquire the reporting unit.

As of September 30, 2018, we had recorded goodwill in the amount of $1.692 billion, including $1.228 billion and $464 million for Recorded Music and Music Publishing, respectively, primarily related to the Merger and PLG Acquisition. We test our goodwill and other indefinite-lived intangible assets for impairment on an annual basis in the fourth quarter of each fiscal year as of July 1. The performance of our fiscal 2018 impairment analysis did not result in an impairment of the Company’s goodwill and other indefinite-lived intangible assets.

68


 

The impairment test for other intangible assets not subject to amortization involves a comparison of the estimated fair value of the intangible asset with its carrying value. If the carrying value of the intangible asset exceeds its fair value, an impairment loss is recognized in an amount equal to that excess. The estimates of fair value of intangible assets not subject to amortization are determined using a DCF analysis. Common among such approaches is the “relief from royalty” methodology, which is used in estimating the fair value of the Company’s trademarks. Discount rate assumptions are based on an assessment of the risk inherent in the projected future cash flows generated by the respective intangible assets. Also subject to judgment are assumptions about royalty rates, which are based on the estimated rates at which similar trademarks are being licensed in the marketplace.

See Note 5 to the Consolidated Financial Statements for a further discussion of our goodwill and intangible assets.

Revenue and Cost Recognition

Sales Returns and Uncollectible Accounts

In accordance with practice in the recorded music industry and as customary in many territories, certain physical products (such as CDs and DVDs) are sold to customers with the right to return unsold items. Under FASB ASC Topic 605, Revenue Recognition, revenues from such sales are recognized when the products are shipped based on gross sales less a provision for future estimated returns.

In determining the estimate of physical product sales that will be returned, management analyzes vendor sales of product historical returns trend, current economic conditions, changes in customer demand and commercial acceptance of our products. Based on this information, management reserves a percentage of each dollar of physical product sales that provide the customer with the right of return.

Similarly, management evaluates accounts receivables to determine if they will ultimately be collected. In performing this evaluation, significant judgments and estimates are involved, including an analysis of specific risks on a customer-by-customer basis for larger accounts and customers, and a receivables aging analysis that determines the percent that has historically been uncollected by aged category. Based on this information, management provides a reserve for the estimated amounts believed to be uncollectible.

Based on management’s analysis of sales returns and uncollectible accounts, reserves totaling $45 million and $50 million were established at September 30, 2018 and September 30, 2017, respectively. The ratio of our receivable allowances to gross accounts receivables was 9% at September 30, 2018 and 11% at September 30, 2017.

Gross Versus Net Revenue Classification

In the normal course of business, we act as an intermediary or agent with respect to certain payments received from third parties. For example, we distribute music product on behalf of third-party record labels.

The accounting issue encountered in these arrangements is whether we should report revenue based on the “gross” amount billed to the customer or on the “net” amount received from the customer after participation and other royalties paid to third parties. To the extent revenues are recorded gross (in the full amount billed), any participations and royalties paid to third parties are recorded as expenses so that the net amount (gross revenues, less expenses) flows through operating income. Accordingly, the impact on operating income is the same, whether we record the revenue on a gross basis or net basis (less related participations and royalties).

Determining whether revenue should be reported gross or net is based on an assessment of whether we are acting as the “principal” in a transaction or acting as an “agent” in the transaction. To the extent we are acting as a principal in a transaction, we report as revenue the payments received on a gross basis. To the extent we are acting as an agent in a transaction, we report as revenue the payments received less participations and royalties paid to third parties, i.e., on a net basis. The determination of whether we are serving as principal or agent in a transaction is judgmental in nature and based on an evaluation of the terms of an arrangement.

In determining whether we serve as principal or agent in these arrangements, we follow the guidance in FASB ASC Subtopic 605-45, Principal Agent Considerations (“ASC 605-45”). Pursuant to such guidance, we serve as the principal in transactions where we have the substantial risks and rewards of ownership. The indicators that we have substantial risks and rewards of ownership are as follows:

 

we are the supplier of the products or services to the customer;

 

we have latitude in establishing prices;

 

we have the contractual relationship with the ultimate customer;

 

we modify and service the product purchased to meet the ultimate customer specifications;

69


 

 

we have discretion in supplier selection; and

 

we have credit risk.

Conversely, pursuant to ASC 605-45, we serve as agent in arrangements where we do not have substantial risks and rewards of ownership. The indicators that we do not have substantial risks and rewards of ownership are as follows:

 

the supplier (not the Company) is responsible for providing the product or service to the customer;

 

the supplier (not the Company) has latitude in establishing prices;

 

the amount we earn is fixed;

 

the supplier (not the Company) has credit risk; and

 

the supplier (not the Company) has general inventory risk for a product before it is sold.

Based on the above criteria and for the more significant transactions that we have evaluated, we record the distribution of product on behalf of third-party record labels on a gross basis, subject to the terms of the contract. Recorded music compilations distributed by other record companies where we have a right to participate in the profits are recorded on a net basis.

Accounting for Royalty Advances

We regularly commit to and pay royalty advances to our recording artists and songwriters in respect of future sales. We account for these advances under the related guidance in FASB ASC Topic 928, Entertainment—Music (“ASC 928”). Under ASC 928, we capitalize as assets certain advances that we believe are recoverable from future royalties to be earned by the recording artist or songwriter. Advances vary in both amount and expected life based on the underlying recording artist or songwriter. Advances to recording artists or songwriters with a history of successful commercial acceptability will typically be larger than advances to a newer or unproven recording artist or songwriter. In addition, in most cases these advances represent a multi-album release or multi-song obligation and the number of albums releases and songs will vary by recording artist or songwriter.

Management’s decision to capitalize an advance to a recording artist or songwriter as an asset requires significant judgment as to the recoverability of the advance. The recoverability is assessed upon initial commitment of the advance based upon management’s forecast of anticipated revenue from the sale of future and existing albums or songs. In determining whether the advance is recoverable, management evaluates the current and past popularity of the recording artist or songwriter, the sales history of the recording artist or songwriter, the initial or expected commercial acceptability of the product, the current and past popularity of the genre of music that the product is designed to appeal to, and other relevant factors. Based upon this information, management expenses the portion of any advance that it believes is not recoverable. In most cases, advances to recording artists or songwriters without a history of success and evidence of current or past popularity will be expensed immediately. Advances are individually assessed for recoverability continuously and at minimum on a quarterly basis. As part of the ongoing assessment of recoverability, we monitor the projection of future sales based on the current environment, the recording artist’s or songwriter’s ability to meet their contractual obligations as well as our intent to support future album releases or songs from the recording artist or songwriter. To the extent that a portion of an outstanding advance is no longer deemed recoverable, that amount will be expensed in the period the determination is made.

We had $276 million and $313 million of advances in our balance sheet at September 30, 2018 and September 30, 2017, respectively. We believe such advances are recoverable through future royalties to be earned by the applicable recording artists and songwriters.

Accounting for Income Taxes

As part of the process of preparing the Consolidated Financial Statements, we are required to estimate income taxes payable in each of the jurisdictions in which we operate. This process involves estimating the actual current tax expense together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within our consolidated balance sheets. FASB ASC Topic 740, Income Taxes (“ASC 740”), requires a valuation allowance be established when it is more likely than not that all or a portion of deferred tax assets will not be realized. In circumstances where there is sufficient negative evidence, establishment of a valuation allowance must be considered. We believe that cumulative losses in the most recent three-year period generally represent sufficient negative evidence to consider a valuation allowance under the provisions of ASC 740. As a result, we determined that certain of our deferred tax assets required the establishment of a valuation allowance.

70


 

The realization of the remaining deferred tax assets is primarily dependent on forecasted future taxable income. Any reduction in estimated forecasted future taxable income may require that we record additional valuation allowances against our deferred tax assets on which a valuation allowance has not previously been established. The valuation allowance that has been established will be maintained until there is sufficient positive evidence to conclude that it is more likely than not that such assets will be realized. An ongoing pattern of profitability will generally be considered as sufficient positive evidence. Our income tax expense recorded in the future may be reduced to the extent of offsetting decreases in our valuation allowance. The establishment and reversal of valuation allowances could have a significant negative or positive impact on our future earnings.

From time to time, the Company engages in transactions in which the tax consequences may be subject to uncertainty. Significant judgment is required in assessing and estimating the tax consequences of these transactions. The Company prepares and files tax returns based on its interpretation of tax laws and regulations. In the normal course of business, the Company’s tax returns are subject to examination by various taxing authorities. Such examinations may result in future tax and interest assessments by these taxing authorities. In determining the Company’s tax provision for financial reporting purposes, the Company establishes a reserve for uncertain tax positions unless such positions are determined to be more likely than not of being sustained upon examination based on their technical merits. There is considerable judgment involved in determining whether positions taken on the Company’s tax returns are more likely than not of being sustained.

Accounting for Share-based Compensation

Share-based compensation represents compensation payment for which the amounts are based on the fair market value of the Company’s common stock. The Company’s Senior Management Free Cash Flow Plan is classified as a liability rather than equity under ASC 718. Liability classified share-based compensation costs are measured at fair value each reporting date until settlement. Because it is not practical for the Company to estimate the volatility of its share price needed to use the fair value approach since our stock is not currently publically traded, the Company has made a policy election that whenever share-based payment awards are required to be measured as a liability, the Company will use the intrinsic value method to measure the costs. Under the intrinsic value method, the Company obtains a valuation of our presumed stock price quarterly and re-measures the related awards using this new price, recognizing compensation costs for the difference between the existing price and new price.

Determining fair value requires significant judgment concerning the assumptions used in the valuation model, including discount rates, the amount and timing of expected future cash flows and growth rates. The cash flows employed in the discounted cash flows analysis are based on management’s most recent budget and business plans and when applicable, various growth rates have been assumed for years beyond the current business plan periods. Any forecast contains a degree of uncertainty and modifications to these cash flows could significantly increase or decrease the fair value of the presumed share price. For example, if revenue from sales of physical products continues to decline and the revenue from sales of digital products does not continue to grow as expected and we are unable to adjust costs accordingly, it could have a negative impact on future pricing. In determining which discount rate to utilize, management determines the appropriate weighted average cost of capital (“WACC”) for the Company. Management considers many factors in selecting a WACC, including the market view of risk, the appropriate capital structure and the appropriate borrowing rates for the Company. The selection of a WACC is subjective and modification to this rate could significantly increase or decrease the fair value of our presumed stock price.

New Accounting Principles

In addition to the critical accounting policies discussed above, we adopted several new accounting policies during the past three years. None of these new accounting principles had a material effect on our audited financial statements. We will adopt ASC 606, Revenue from Contracts with Customers, on October 1, 2018 which will have a material transition adjustment to accumulated deficit upon adoption. See Note 2 to our audited Consolidated Financial Statements included elsewhere herein for a complete summary of all our significant accounting policies.

71


 

ITEM 7A.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

As discussed in Note 12 to our audited Consolidated Financial Statements included herein, the Company is exposed to market risk arising from changes in market rates and prices, including movements in foreign currency exchange rates and interest rates. As of September 30, 2018, other than as described below, there have been no material changes to the Company’s exposure to market risk since September 30, 2017.

Foreign Currency Risk

Within our global business operations we have transactional exposures that may be adversely affected by changes in foreign currency exchange rates relative to the U.S. dollar. We may at times choose to use foreign exchange currency derivatives, primarily forward contracts, to manage the risk associated with the volatility of future cash flows denominated in foreign currencies, such as unremitted or future royalties and license fees owed to our U.S. domestic companies for the sale, or anticipated sale, of U.S.- copyrighted products sold abroad that may be adversely affected by changes in foreign currency exchange rates. We focus on managing the level of exposure to the risk of foreign currency exchange rate fluctuations on major currencies, which can include the British Pound, Euro, Japanese Yen, Canadian Dollar, Swedish Krona, and Australian Dollar, and in many cases we have natural hedges where we have expenses associated with local operations in the local currency that offset the revenue in local currency and our Euro-denominated debt, which can offset declines in the Euro. As of September 30, 2018, the Company had no outstanding hedge contracts.

The fair value of foreign exchange contracts is subject to changes in foreign currency exchange rates. For the purpose of assessing the specific risks, we use a sensitivity analysis to determine the effects that market risk exposures may have on the fair value of our financial instruments. For foreign exchange forward contracts outstanding at fiscal year end, we typically perform a sensitivity analysis assuming a hypothetical 10% depreciation of the U.S. dollar against foreign currencies from prevailing foreign currency exchange rates and assuming no change in interest rates. As we have no hedge contracts outstanding as of September 30, 2018, the fair value of the foreign exchange forward contracts would have no impact. Hypothetically, even if there was a decrease in the fair value of the forward contracts, because our foreign exchange contracts are entered into for hedging purposes, these losses would be largely offset by gains on the underlying transactions.

Interest Rate Risk

We had $2.851 billion of principal debt outstanding at September 30, 2018, of which $1.326 billion was variable-rate debt and $1.525 billion was fixed-rate debt. As such, we are exposed to changes in interest rates. At September 30, 2018, 53% of the Company’s debt was at a fixed-rate. In addition, at September 30, 2018, we have the option under all of our floating rate debt under our Senior Term Loan Facility to select a one, two, three or six month LIBOR rate. To manage interest rate risk on $320 million of U.S. dollar denominated variable-rate debt, the Company entered into interest rate swaps to effectively convert the floating interest rates to a fixed interest rate on a portion of its variable-rate debt.

Based on the level of interest rates prevailing at September 30, 2018, the fair value of the fixed-rate and variable-rate debt was approximately $2.862 billion. Further, based on the amount of its fixed-rate debt, a 25 basis point increase or decrease in the level of interest rates would decrease the fair value of the fixed-rate debt by approximately $12 million or increase the fair value of the fixed-rate debt by approximately $15 million. This potential increase or decrease is based on the simplified assumption that the level of fixed-rate debt remains constant with an immediate across the board increase or decrease in the level of interest rates with no subsequent changes in rates for the remainder of the period.

 

 

 

72


 

ITEM 8.

FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

WARNER MUSIC GROUP CORP.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

Contents

 

Audited Financial Statements:

 

 

 

Management’s Report on Internal Control Over Financial Reporting

 

74

  

Report of Independent Registered Public Accounting Firm on Consolidated Financial Statements

 

75

  

Consolidated Balance Sheets as of September 30, 2018 and September 30, 2017

 

76

  

Consolidated Statements of Operations for the fiscal years ended September 30, 2018, September 30, 2017 and September 30, 2016

 

77

  

Consolidated Statements of Comprehensive Income (Loss) for the fiscal years ended September 30, 2018, September 30, 2017 and September 30, 2016

 

78

  

Consolidated Statements of Cash Flows for the fiscal years ended September 30, 2018, September 30, 2017 and September 30, 2016

 

79

  

Consolidated Statements of (Deficit) Equity for the fiscal years ended September 30, 2018, September 30, 2017 and September 30, 2016

 

80

  

Notes to Consolidated Audited Financial Statements

 

81

  

Quarterly Financial Information

 

108

  

Supplementary Information—Consolidating Financial Statements

 

110

  

Schedule II—Valuation and Qualifying Accounts

 

122

  

 

 

 

73


 

MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER

FINANCIAL REPORTING

Management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) under the Exchange Act. Management designed our internal control systems in order to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. GAAP. Our internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. GAAP, and that receipts and expenditures are being made only in accordance with authorizations of management and directors and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on the financial statements.

Our internal control systems include the controls themselves, monitoring and internal auditing practices and actions taken to correct deficiencies as identified and are augmented by written policies, an organizational structure providing for division of responsibilities, careful selection and training of qualified financial personnel and a program of internal audits.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 Framework). Based on its evaluation, our management concluded that our internal control over financial reporting was effective as of September 30, 2018.

 

 

74


 

Report of Independent Registered Public Accounting Firm

 

To the Stockholders and Board of Directors of Warner Music Group Corp.:

Opinion on the Consolidated Financial Statements

We have audited the accompanying consolidated balance sheets of Warner Music Group Corp. and subsidiaries (the Company) as of September 30, 2018 and 2017, the related consolidated statements of operations, comprehensive income (loss), cash flows, and (deficit) equity, for each of the years in the three‑year period ended September 30, 2018, and the related notes, and the related supplementary information, and financial statement schedule II as listed in the accompanying index to Item 8 (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of September 30, 2018 and 2017, and the results of its operations and its cash flows for each of the years in the three‑year period ended September 30, 2018, in conformity with U.S. generally accepted accounting principles.

Basis for Opinion

These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB and in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.

Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.

/s/ KPMG LLP

We have served as the Company’s auditor since 2015.

New York, New York
December 20, 2018

 

 

 

75


 

Warner Music Group Corp.

Consolidated Balance Sheets

 

 

 

September 30,

 

 

September 30,

 

 

 

2018

 

 

2017

 

 

 

(in millions)

 

Assets

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

Cash and equivalents

 

$

514

 

 

$

647

 

Accounts receivable, net of allowances of $45 million and $50 million

 

 

447

 

 

 

404

 

Inventories

 

 

42

 

 

 

39

 

Royalty advances expected to be recouped within one year

 

 

123

 

 

 

141

 

Prepaid and other current assets

 

 

50

 

 

 

44

 

Total current assets

 

 

1,176

 

 

 

1,275

 

Royalty advances expected to be recouped after one year

 

 

153

 

 

 

172

 

Property, plant and equipment, net

 

 

229

 

 

 

213

 

Goodwill

 

 

1,692

 

 

 

1,685

 

Intangible assets subject to amortization, net

 

 

1,851

 

 

 

2,090

 

Intangible assets not subject to amortization

 

 

154

 

 

 

117

 

Deferred tax assets, net

 

 

11

 

 

 

97

 

Other assets

 

 

78

 

 

 

69

 

Total assets

 

$

5,344

 

 

$

5,718

 

Liabilities and Equity

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

Accounts payable

 

$

281

 

 

$

208

 

Accrued royalties

 

 

1,396

 

 

 

1,263

 

Accrued liabilities

 

 

423

 

 

 

365

 

Accrued interest

 

 

31

 

 

 

41

 

Deferred revenue

 

 

208

 

 

 

197

 

Other current liabilities

 

 

34

 

 

 

26

 

Total current liabilities

 

 

2,373

 

 

 

2,100

 

Long-term debt

 

 

2,819

 

 

 

2,811

 

Deferred tax liabilities, net

 

 

165

 

 

 

190

 

Other noncurrent liabilities

 

 

307

 

 

 

309

 

Total liabilities

 

$

5,664

 

 

$

5,410

 

Equity:

 

 

 

 

 

 

 

 

Common stock ($0.001 par value; 10,000 shares authorized; 1,052 shares issued and

  outstanding)

 

$

 

 

$

 

Additional paid-in capital

 

 

1,128

 

 

 

1,128

 

Accumulated deficit

 

 

(1,272

)

 

 

(654

)

Accumulated other comprehensive loss, net

 

 

(190

)

 

 

(181

)

Total Warner Music Group Corp. (deficit) equity

 

 

(334

)

 

 

293

 

Noncontrolling interest

 

 

14

 

 

 

15

 

Total equity

 

 

(320

)

 

 

308

 

Total liabilities and equity

 

$

5,344

 

 

$

5,718

 

 

See accompanying notes

 

 

 

76


 

Warner Music Group Corp.

Consolidated Statements of Operations

 

 

 

Fiscal Year Ended

September 30,

 

 

Fiscal Year Ended

September 30,

 

 

Fiscal Year Ended

September 30,

 

 

 

2018

 

 

2017

 

 

2016

 

 

 

(in millions)

 

Revenues

 

$

4,005

 

 

$

3,576

 

 

$

3,246

 

Costs and expenses:

 

 

 

 

 

 

 

 

 

 

 

 

Cost of revenue

 

 

(2,171

)

 

 

(1,931

)

 

 

(1,707

)

Selling, general and administrative expenses (a)

 

 

(1,411

)

 

 

(1,222

)

 

 

(1,082

)

Amortization expense

 

 

(206

)

 

 

(201

)

 

 

(243

)

Total costs and expenses

 

 

(3,788

)

 

 

(3,354

)

 

 

(3,032

)

Operating income

 

 

217

 

 

 

222

 

 

 

214

 

Loss on extinguishment of debt

 

 

(31

)

 

 

(35

)

 

 

(18

)

Interest expense, net

 

 

(138

)

 

 

(149

)

 

 

(173

)

Other income (expense)

 

 

394

 

 

 

(40

)

 

 

18

 

Income (loss) before income taxes

 

 

442

 

 

 

(2

)

 

 

41

 

Income tax (expense) benefit

 

 

(130

)

 

 

151

 

 

 

(11

)

Net income

 

 

312

 

 

 

149

 

 

 

30

 

Less: Income attributable to noncontrolling interest

 

 

(5

)

 

 

(6

)

 

 

(5

)

Net income attributable to Warner Music Group Corp.

 

$

307

 

 

$

143

 

 

$

25

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(a) Includes depreciation expense of:

 

$

(55

)

 

$

(50

)

 

$

(50

)

 

See accompanying notes

 

 

 

77


 

Warner Music Group Corp.

Consolidated Statements of Comprehensive Income (Loss)

 

 

 

Fiscal Year Ended

September 30,

 

 

Fiscal Year Ended

September 30,

 

 

Fiscal Year Ended

September 30,

 

 

 

2018

 

 

2017

 

 

2016

 

 

 

(in millions)

 

Net income

 

$

312

 

 

$

149

 

 

$

30

 

Other comprehensive (loss) income, net of tax

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency adjustment

 

 

(13

)

 

 

30

 

 

 

(44

)

Deferred gains on derivative financial instruments

 

 

3

 

 

 

 

 

 

 

Minimum pension liability

 

 

1

 

 

 

7

 

 

 

(7

)

Other comprehensive (loss) income, net of tax

 

 

(9

)

 

 

37

 

 

 

(51

)

Total comprehensive income (loss)

 

 

303

 

 

 

186

 

 

 

(21

)

Less: Income attributable to noncontrolling interest

 

 

(5

)

 

 

(6

)

 

 

(5

)

Comprehensive income (loss) attributable to Warner Music Group Corp.

 

$

298

 

 

$

180

 

 

$

(26

)

 

See accompanying notes

 

 

 

78


 

Warner Music Group Corp.

Consolidated Statements of Cash Flows

 

 

 

Fiscal Year Ended

September 30,

 

 

Fiscal Year Ended

September 30,

 

 

Fiscal Year Ended

September 30,

 

 

 

2018

 

 

2017

 

 

2016

 

 

 

(in millions)

 

Cash flows from operating activities

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

312

 

 

$

149

 

 

$

30

 

Adjustments to reconcile net income to net cash provided by operating

   activities:

 

 

 

 

 

 

 

 

 

 

 

 

Depreciation and amortization

 

 

261

 

 

 

251

 

 

 

293

 

Unrealized losses and remeasurement of foreign denominated loans

 

 

(3

)

 

 

24

 

 

 

 

Deferred income taxes

 

 

66

 

 

 

(192

)

 

 

(26

)

Loss on extinguishment of debt

 

 

31

 

 

 

35

 

 

 

18

 

Net (gain) loss on investments

 

 

(389

)

 

 

17

 

 

 

(9

)

Gain on sale of real estate

 

 

 

 

 

 

 

 

(24

)

Non-cash interest expense

 

 

6

 

 

 

8

 

 

 

11

 

Equity-based compensation expense

 

 

62

 

 

 

70

 

 

 

23

 

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

Accounts receivable

 

 

(43

)

 

 

(60

)

 

 

17

 

Inventories

 

 

(3

)

 

 

1

 

 

 

 

Royalty advances

 

 

31

 

 

 

17

 

 

 

(13

)

Accounts payable and accrued liabilities

 

 

82

 

 

 

48

 

 

 

23

 

Royalty payables

 

 

22

 

 

 

136

 

 

 

49

 

Accrued interest

 

 

(10

)

 

 

3

 

 

 

(20

)

Deferred revenue

 

 

(4

)

 

 

22

 

 

 

(35

)

Other balance sheet changes

 

 

4

 

 

 

6

 

 

 

5

 

Net cash provided by operating activities

 

 

425

 

 

 

535

 

 

 

342

 

Cash flows from investing activities

 

 

 

 

 

 

 

 

 

 

 

 

Acquisition of music publishing rights, net

 

 

(14

)

 

 

(16

)

 

 

(25

)

Capital expenditures

 

 

(74

)

 

 

(44

)

 

 

(42

)

Investments and acquisitions of businesses, net

 

 

(23

)

 

 

(139

)

 

 

(28

)

Proceeds from the sale of investments

 

 

516

 

 

 

73

 

 

 

45

 

Proceeds from the sale of real estate

 

 

 

 

 

 

 

 

42

 

Net cash provided by (used in) investing activities

 

 

405

 

 

 

(126

)

 

 

(8

)

Cash flows from financing activities

 

 

 

 

 

 

 

 

 

 

 

 

Proceeds from issuance of Acquisition Corp. 4.125% Senior Secured Notes

 

 

 

 

 

380

 

 

 

 

Proceeds from issuance of Acquisition Corp. 4.875% Senior Secured Notes

 

 

 

 

 

250

 

 

 

 

Proceeds from issuance of Acquisition Corp. 5.50% Senior Notes

 

 

325

 

 

 

 

 

 

 

Proceeds from issuance of Acquisition Corp. Senior Term Loan Facility

 

 

320

 

 

 

22

 

 

 

 

Proceeds from issuance of Acquisition Corp. 5.00% Senior Secured Notes

 

 

 

 

 

 

 

 

300

 

Repayment of Acquisition Corp. Senior Term Loan Facility

 

 

 

 

 

 

 

 

(309

)

Repayment of Acquisition Corp. 6.00% Senior Secured Notes

 

 

 

 

 

(450

)

 

 

 

Repayment of Acquisition Corp. 6.25% Senior Secured Notes

 

 

 

 

 

(173

)

 

 

 

Repayment of Acquisition Corp. 5.625% Senior Secured Notes

 

 

 

 

 

(28

)

 

 

 

Repayment of Holdings 13.75% Senior Notes

 

 

 

 

 

 

 

 

(150

)

Repayment of Acquisition Corp. 6.75% Senior Notes

 

 

(635

)

 

 

 

 

 

(24

)

Call premiums paid on early redemption of debt

 

 

(23

)

 

 

(27

)

 

 

(10

)

Deferred financing costs paid

 

 

(12

)

 

 

(13

)

 

 

(4

)

Distribution to noncontrolling interest holder

 

 

(5

)

 

 

(5

)

 

 

(5

)

Dividends paid

 

 

(925

)

 

 

(84

)

 

 

 

Repayment of capital lease obligations

 

 

 

 

 

 

 

 

(14

)

Net cash used in financing activities

 

 

(955

)

 

 

(128

)

 

 

(216

)

Effect of exchange rate changes on cash and equivalents

 

 

(8

)

 

 

7

 

 

 

(5

)

Net increase in cash and equivalents

 

 

(133

)

 

 

288

 

 

 

113

 

Cash and equivalents at beginning of period

 

 

647

 

 

 

359

 

 

 

246

 

Cash and equivalents at end of period

 

$

514

 

 

$

647

 

 

$

359

 

See accompanying notes

79


 

Warner Music Group Corp.

Consolidated Statements of (Deficit) Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Additional

 

 

 

 

 

 

Other

 

 

Warner Music

 

 

 

 

 

 

Total

 

 

Common Stock

 

 

Paid-in

 

 

Accumulated

 

 

Comprehensive

 

 

Group Corp.

 

 

Noncontrolling

 

 

(Deficit)

 

 

Shares

 

 

Value

 

 

Capital

 

 

Deficit

 

 

Loss

 

 

Equity

 

 

Interest

 

 

Equity

 

 

(in millions, except share amounts)

 

Balance at September 30, 2015

 

1,055

 

 

$

 

 

$

1,128

 

 

$

(740

)

 

$

(167

)

 

$

221

 

 

$

18

 

 

$

239

 

Net income

 

 

 

 

 

 

 

 

 

 

25

 

 

 

 

 

 

25

 

 

 

5

 

 

 

30

 

Other comprehensive (loss)

   income, net of tax

 

 

 

 

 

 

 

 

 

 

 

 

 

(51

)

 

 

(51

)

 

 

 

 

 

(51

)

Disposal of noncontrolling

   interest related to

   divestiture

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(3

)

 

 

(3

)

Distribution to

   noncontrolling interest

   holders

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(5

)

 

 

(5

)

Balance at September 30, 2016

 

1,055

 

 

$

 

 

$

1,128

 

 

$

(715

)

 

$

(218

)

 

$

195

 

 

$

15

 

 

$

210

 

Net income

 

 

 

 

 

 

 

 

 

 

143

 

 

 

 

 

 

143

 

 

 

6

 

 

 

149

 

Dividends

 

 

 

 

 

 

 

 

 

 

(84

)

 

 

 

 

 

(84

)

 

 

 

 

 

(84

)

Other comprehensive (loss)

   income, net of tax

 

 

 

 

 

 

 

 

 

 

 

 

 

37

 

 

 

37

 

 

 

 

 

 

37

 

Disposal of noncontrolling

   interest related to

   divestiture

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(3

)

 

 

(3

)

Distribution to

   noncontrolling interest

   holders

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(5

)

 

 

(5

)

Other

 

 

 

 

 

 

 

 

 

 

2

 

 

 

 

 

 

2

 

 

 

2

 

 

 

4

 

Balance at September 30, 2017

 

1,055

 

 

$

 

 

$

1,128

 

 

$

(654

)

 

$

(181

)

 

$

293

 

 

$

15

 

 

$

308

 

Net income

 

 

 

 

 

 

 

 

 

 

307

 

 

 

 

 

 

307

 

 

 

5

 

 

 

312

 

Dividends

 

 

 

 

 

 

 

 

 

 

(925

)

 

 

 

 

 

(925

)

 

 

 

 

 

(925

)

Other comprehensive (loss)

   income, net of tax

 

 

 

 

 

 

 

 

 

 

 

 

 

(9

)

 

 

(9

)

 

 

 

 

 

(9

)

Disposal of noncontrolling

   interest related to

   divestiture

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Distribution to

   noncontrolling interest

   holders

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(6

)

 

 

(6

)

Other

 

(3

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at September 30, 2018

 

1,052

 

 

$

 

 

$

1,128

 

 

$

(1,272

)

 

$

(190

)

 

$

(334

)

 

$

14

 

 

$

(320

)

 

See accompanying notes

 

 

 

80


 

Warner Music Group Corp.

Notes to Consolidated Audited Financial Statements

 

1. Description of Business

Warner Music Group Corp. (the “Company”) was formed on November 21, 2003. The Company is the direct parent of WMG Holdings Corp. (“Holdings”), which is the direct parent of WMG Acquisition Corp. (“Acquisition Corp.”). Acquisition Corp. is one of the world’s major music-based content companies.

Acquisition of Warner Music Group by Access Industries

Pursuant to an Agreement and Plan of Merger, dated as of May 6, 2011 (the “Merger Agreement”), by and among the Company, AI Entertainment Holdings LLC (formerly Airplanes Music LLC), a Delaware limited liability company (“Parent”) and an affiliate of Access Industries, Inc. (“Access”), and Airplanes Merger Sub, Inc., a Delaware corporation and a wholly owned subsidiary of Parent (“Merger Sub”), on July 20, 2011 (the “Merger Closing Date”), Merger Sub merged with and into the Company with the Company surviving as a wholly owned subsidiary of Parent (the “Merger”). In connection with the Merger, the Company delisted its common stock from the NYSE. The Company continues voluntarily to file with the SEC current and periodic reports that would be required to be filed with the SEC pursuant to Section 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) as provided for in certain covenants contained in the instruments covering its outstanding indebtedness.

Recorded Music Operations

The Company’s Recorded Music business primarily consists of the discovery and development of artists and the related marketing, distribution and licensing of recorded music produced by such artists. The Company plays an integral role in virtually all aspects of the recorded music value chain from discovering and developing talent to producing music and promoting artists and their products.

In the United States, Recorded Music operations are conducted principally through the Company’s major record labels— Atlantic Records and Warner Bros. Records. In October 2018, the Company launched Elektra Music Group in the United States as a standalone label group, which comprises the Elektra, Fueled by Ramen and Roadrunner labels. The Company’s Recorded Music operations also include Rhino, a division that specializes in marketing the Company’s music catalog through compilations and reissuances of previously released music and video titles. The Company also conducts its Recorded Music operations through a collection of additional record labels, including, Asylum, Big Beat, Canvasback, East West, Erato, FFRR, Nonesuch, Parlophone, Reprise, Sire, Spinnin’, Warner Classics and Warner Music Nashville.

Outside the United States, Recorded Music activities are conducted in more than 50 countries through various subsidiaries, affiliates and non-affiliated licensees. Internationally, the Company engages in the same activities as in the United States: discovering and signing artists and distributing, marketing and selling their recorded music. In most cases, the Company also markets and distributes the music of those artists for whom the Company’s domestic record labels have international rights. In certain smaller markets, the Company licenses the right to distribute the Company’s records to non-affiliated third-party record labels. The Company’s international artist services operations include a network of concert promoters through which it provides resources to coordinate tours for the Company’s artists and other artists as well as management companies that guide artists with respect to their careers.

The Company’s Recorded Music distribution operations include Warner-Elektra-Atlantic Corporation (“WEA Corp.”), which markets and sells music and video products to retailers and wholesale distributors; Alternative Distribution Alliance (“ADA”), which distributes the products of independent labels to retail and wholesale distributors; and various distribution centers and ventures operated internationally.

The Company’s Recorded Music products are sold in digital form to an expanded universe of digital partners, including digital streaming services such as Amazon, Apple Music, Deezer, Napster, Soundcloud, Spotify, Tencent and YouTube, digital radio services such as iHeart Radio, Pandora and Sirius XM and digital download services such as Apple’s iTunes and Google Play. In addition, Recorded Music products are also sold in physical retail outlets and in physical form to online physical retailers such as Amazon.com and bestbuy.com.

81


 

The Company has integrated the exploitation of digital content into all aspects of its business, including A&R, marketing, promotion and distribution. The Company’s business development executives work closely with A&R departments to ensure that while music is being produced, digital assets are also created with all distribution channels in mind, including streaming services, social networking sites, online portals and music-centered destinations. The Company also works side by side with its digital partners to test new concepts. The Company believes existing and new digital businesses will be a significant source of growth and will provide new opportunities to successfully monetize its assets and create new revenue streams. The proportion of digital revenues attributed to each distribution channel varies by region and proportions may change as the roll out of new technologies continues. As an owner of music content, the Company believes it is well positioned to take advantage of growth in digital distribution and emerging technologies to maximize the value of its assets.

The Company has diversified its revenues beyond its traditional businesses by entering into expanded-rights deals with recording artists in order to partner with artists in other aspects of their careers. Under these agreements, the Company provides services to and participates in artists’ activities outside the traditional recorded music business such as touring, merchandising and sponsorships. The Company has built artist services capabilities and platforms for exploiting this broader set of music-related rights and participating more widely in the monetization of the artist brands it helps create. The Company believes that entering into expanded-rights deals and enhancing its artist services capabilities in areas such as concert promotion and management have permitted it to diversify revenue streams and capitalize on other revenue opportunities. This provides for improved long-term relationships with artists and allows the Company to more effectively connect artists and fans.

Music Publishing Operations

While recorded music is focused on exploiting a particular recording of a composition, music publishing is an intellectual property business focused on the exploitation of the composition itself. In return for promoting, placing, marketing and administering the creative output of a songwriter, or engaging in those activities for other rightsholders, the Company’s Music Publishing business garners a share of the revenues generated from use of the composition.

The Company’s Music Publishing operations are conducted principally through Warner/Chappell, its global Music Publishing company, headquartered in Los Angeles with operations in over 50 countries through various subsidiaries, affiliates and non-affiliated licensees. The Company owns or controls rights to more than one million musical compositions, including numerous pop hits, American standards, folk songs and motion picture and theatrical compositions. Assembled over decades, its award-winning catalog includes over 70,000 songwriters and composers and a diverse range of genres including pop, rock, jazz, classical, country, R&B, hip-hop, rap, reggae, Latin, folk, blues, symphonic, soul, Broadway, techno, alternative and gospel. Warner/Chappell also administers the music and soundtracks of several third-party television and film producers and studios. The Company has an extensive production music library collectively branded as Warner/Chappell Production Music.

 

 

2. Summary of Significant Accounting Policies

Basis of Presentation

The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”). In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included.

The Company maintains a 52-53 week fiscal year ending on the last Friday in each reporting period. The fiscal year ended September 30, 2018 ended on September 28, 2018, the fiscal year ended September 30, 2017 ended on September 29, 2017, and the fiscal year ended September 30, 2016 ended on September 30, 2016. For convenience purposes, the Company continues to date its financial statements as of September 30.

Basis of Consolidation

The accompanying financial statements present the consolidated accounts of all entities in which the Company has a controlling voting interest and/or variable interest required to be consolidated in accordance with U.S. GAAP. All intercompany balances and transactions have been eliminated.

82


 

Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 810, Consolidation (“ASC 810”) requires the Company first evaluate its investments to determine if any investments qualify as a variable interest entity (“VIE”). A VIE is consolidated if the Company is deemed to be the primary beneficiary of the VIE, which is the party involved with the VIE that has both (i) the power to control the most significant activities of the VIE and (ii) either the obligation to absorb losses or the right to receive benefits that could potentially be significant to the VIE. If an entity is not deemed to be a VIE, the Company consolidates the entity if the Company has a controlling voting interest.

Reclassifications

Certain reclassifications have been made to the prior fiscal years’ consolidated financial statements to conform to the current fiscal-year presentation.

Use of Estimates

The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the Consolidated Financial Statements and the accompanying notes. Actual results could differ from those estimates.

Business Combinations

The Company accounts for its business acquisitions under the FASB ASC Topic 805, Business Combinations (“ASC 805”) guidance for business combinations. The total cost of acquisitions is allocated to the underlying identifiable net assets based on their respective estimated fair values. The excess of the purchase price over the estimated fair values of the net assets acquired is recorded as goodwill. Determining the fair value of assets acquired and liabilities assumed requires management’s judgment and often involves the use of significant estimates and assumptions, including assumptions with respect to future cash inflows and outflows, discount rates, asset lives and market multiples, among other items.

Cash and Equivalents

The Company considers all highly liquid investments with maturities of three months or less at the date of purchase to be cash equivalents. The Company includes checks outstanding at year end as a component of accounts payable, instead of a reduction in its cash balance where there is not a right of offset in the related bank accounts.

Accounts Receivable

Credit is extended to customers based upon an evaluation of the customer’s financial condition. Accounts receivable are recorded at net realizable value.

Sales Returns and Allowance for Doubtful Accounts

Management’s estimate of Recorded Music physical products that will be returned, and the amount of receivables that will ultimately be collected is an area of judgment affecting reported revenues and operating income. In determining the estimate of physical product sales that will be returned, management analyzes vendor sales of product, historical return trends, current economic conditions, changes in customer demand and commercial acceptance of our products. Based on this information, management reserves a percentage of each dollar of physical product sales that provide the customer with the right of return. The provision for such sales returns is reflected as a reduction in the revenues from the related sale.

Similarly, the Company monitors customer credit risk related to accounts receivable. Significant judgments and estimates are involved in evaluating if such amounts will ultimately be fully collected. On an ongoing basis, the Company tracks customer exposure based on news reports, ratings agency information, reviews of customer financial data and direct dialogue with customers. Counterparties that are determined to be of a higher risk are evaluated to assess whether the payment terms previously granted to them should be modified. The Company also monitors payment levels from customers, and a provision for estimated uncollectible amounts is maintained based on such payment levels, historical experience, management’s views on trends in the overall receivable agings and, for larger accounts, analyses of specific risks on a customer specific basis.

83


 

Concentration of Credit Risk

Customer credit risk represents the potential for financial loss if a customer is unwilling or unable to meet its agreed upon contractual payment obligations. As of September 30, 2018 and September 30, 2017, Spotify represented 18% and 15%, respectively, of the Company’s accounts receivable balance. No other single customer accounted for more than 10% of accounts receivable in either period. The Company, by policy, routinely assesses the financial strength of its customers. As such, the Company does not believe there is any significant collection risk.

In the Music Publishing business, the Company collects a significant portion of its royalties from copyright collection societies around the world. Collection societies and associations generally are not-for-profit organizations that represent composers, songwriters and music publishers. These organizations seek to protect the rights of their members by licensing, collecting license fees and distributing royalties for the use of the members’ works. Accordingly, the Company does not believe there is any significant collection risk from such societies.

Inventories

Inventories consist of DVDs, CDs, Vinyl and related music products. Inventories are stated at the lower of cost or estimated realizable value. Cost is determined using first-in, first-out (“FIFO”) and average cost methods, which approximate cost under the FIFO method. Returned goods included in inventory are valued at estimated realizable value, but not in excess of cost.

Derivative and Financial Instruments

The Company accounts for these investments as required by the FASB ASC Topic 815, Derivatives and Hedging (“ASC 815”), which requires that all derivative instruments be recognized on the balance sheet at fair value. ASC 815 also provides that, for derivative instruments that qualify for hedge accounting, changes in the fair value are either (a) offset against the change in fair value of the hedged assets, liabilities, or firm commitments through earnings or (b) recognized in equity until the hedged item is recognized in earnings, depending on whether the derivative is being used to hedge changes in fair value or cash flows. In addition, the ineffective portion of a derivative’s change in fair value is immediately recognized in earnings.

The carrying value of the Company’s financial instruments approximates fair value, except for certain differences relating to long-term, fixed-rate debt (see Note 15) 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 an over-the-counter market. In cases where quoted market prices are not available, fair value is based on estimates using present value or other valuation techniques.

Property, Plant and Equipment

Property, plant and equipment existing at the date of the Merger or acquired in conjunction with subsequent business combinations are recorded at fair value. All other additions are recorded at historical cost. Depreciation is calculated using the straight-line method based upon the estimated useful lives of depreciable assets as follows: five to seven years for furniture and fixtures, periods of up to five years for computer equipment and periods of up to five years for machinery and equipment. Buildings are depreciated over periods of up to forty years. Leasehold improvements are depreciated over the life of the lease or estimated useful lives of the improvements, whichever period is shorter.

 

 

Accounting for Goodwill and Other Intangible Assets

In accordance with FASB ASC Topic 350, Intangibles-Goodwill and Other (“ASC 350”), the Company accounts for business combinations using the acquisition method of accounting and accordingly, the assets and liabilities of the acquired entities are recorded at their estimated fair values at the acquisition date. Goodwill represents the excess of the purchase price over the fair value of net assets, including the amount assigned to identifiable intangible assets. Pursuant to this guidance, the Company does not amortize the goodwill balance and instead, performs an annual impairment test to assess the fair value of goodwill over its carrying value. Identifiable intangible assets with finite lives are amortized over their useful lives.

84


 

Goodwill is tested annually for impairment as of July 1 and at any time upon the occurrence of certain events or changes in circumstances. The Company has the option to perform a qualitative assessment to determine if an impairment is more likely than not to have occurred. If the Company can support the conclusion that it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, the Company would not need to perform the two-step impairment test for that reporting unit. If the Company cannot support such a conclusion or the Company does not elect to perform the qualitative assessment then the first step of the goodwill impairment test is used to identify potential impairment by comparing the fair value of a reporting unit with its carrying amount, including goodwill. If the estimated fair value of the reporting unit exceeds its carrying amount, its goodwill is not impaired and the second step of the impairment test is not necessary. If the carrying amount of the reporting unit exceeds its estimated fair value, then the second step of the goodwill impairment test must be performed. The second step of the goodwill impairment test compares the implied fair value of the reporting unit goodwill with its carrying amount to measure the amount of impairment, if any. The implied fair value of goodwill is determined in the same manner as the amount of goodwill recognized in a business combination. If the carrying amount of the reporting unit goodwill exceeds the implied fair value of that goodwill, an impairment is recognized in an amount equal to that excess.

The Company performs an annual impairment test of its indefinite-lived intangible assets as of July 1 of each fiscal year, unless events occur which trigger the need for an earlier impairment test. The Company has the option to perform a qualitative assessment to determine if an impairment is more likely than not to have occurred. In the qualitative assessment, the Company must evaluate the totality of qualitative factors, including any recent fair value measurements, that impact whether an indefinite-lived intangible asset other than goodwill has a carrying amount that more likely than not exceeds its fair value. The Company must proceed to conduct a quantitative analysis if the Company (i) determines that such an impairment is more likely than not to exist, or (ii) foregoes the qualitative assessment entirely. Under the quantitative assessment, the impairment test for identifiable indefinite-lived intangible assets consists of a comparison of the estimated fair value of the intangible asset with its carrying value. If the carrying value of the intangible asset exceeds its fair value, then an impairment loss is recognized in an amount equal to that excess. The Company generally determines the fair value of an indefinite-lived intangible asset using a DCF analysis, such as the relief from royalty method, which is used in estimating the fair value of the Company’s trademarks. Discount rate assumptions are based on an assessment of the risk inherent in the projected future cash flows generated by the respective intangible assets. Also subject to judgment are assumptions about royalty rates, which are based on the estimated rates at which similar trademarks are being licensed in the marketplace.

The impairment tests require management to make assumptions about future conditions impacting the value of the indefinite-lived intangible assets, including projected growth rates, cost of capital, effective tax rates, tax amortization periods, royalty rates, market share and others.

Valuation of Long-Lived Assets

The Company periodically reviews the carrying value of its long-lived assets, including finite lived intangibles, property, plant and equipment and amortizable intangible assets, whenever events or changes in circumstances indicate that the carrying value may not be recoverable or that the lives assigned may no longer be appropriate. To the extent the estimated future cash inflows attributable to the asset, less estimated future cash outflows, are less than the carrying amount, an impairment loss is recognized in an amount equal to the difference between the carrying value of such asset and its fair value. Assets to be disposed of and for which there is a committed plan to dispose of the assets, whether through sale or abandonment, are reported at the lower of carrying value or fair value less costs to sell. If it is determined that events and circumstances warrant a revision to the remaining period of amortization, an asset’s remaining useful life would be changed, and the remaining carrying amount of the asset would be amortized prospectively over that revised remaining useful life.

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 are included in the accompanying consolidated statements of equity as a component of accumulated other comprehensive loss.

Revenues

Recorded Music

As required by FASB ASC Topic 605, Revenue Recognition (“ASC 605”), the Company recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable and collection is probable.

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Revenues from the sale of physical Recorded Music products are recognized upon delivery, which occurs once the product has been shipped and title and risk of loss have been transferred. In accordance with industry practice and as is customary in many territories, certain products, such as CDs and DVDs, are sold to customers with the right to return unsold items. Revenues from such sales are generally recognized upon shipment based on gross sales less a provision for future estimated returns. Revenues from the sale of Recorded Music products through digital distribution channels are recognized when the products are sold and related sales accounting reports are delivered by the providers.

Music Publishing

Music Publishing revenues are earned from the receipt of royalties relating to the licensing of rights in musical compositions, and the sale of published sheet music and songbooks. The receipt of royalties principally relates to amounts earned from the public performance of copyrighted material, the mechanical reproduction of copyrighted material on recorded media including digital formats, and the use of copyrighted material in synchronization with visual images. Music publishing royalties, except for synchronization royalties, generally are recognized as revenue when cash is received. Synchronization revenue is typically recognized as revenue on an accrual basis when all revenue recognition criteria are met in accordance with ASC 605.

Gross Versus Net Revenue Classification

In the normal course of business, the Company acts as an intermediary or agent with respect to certain payments received from third parties. For example, the Company distributes music product on behalf of third-party record labels. As required by FASB ASC Subtopic 605-45, Principal Agent Considerations, such transactions are recorded on a “gross” or “net” basis depending on whether the Company is acting as the “principal” in the transaction or acting as an “agent” in the transaction. The Company serves as the principal in transactions in which it has substantial risks and rewards of ownership and, accordingly, revenues are recorded on a gross basis. For those transactions in which the Company does not have substantial risks and rewards of ownership, the Company is considered an agent and, accordingly, revenues are recorded on a net basis.

To the extent revenues are recorded on a gross basis, any participations and royalties paid to third parties are recorded as expenses so that the net amount (gross revenues less expenses) flows through operating income. To the extent revenues are recorded on a net basis, revenues are reported based on the amounts received, less participations and royalties paid to third parties. In both cases, the impact on operating income is the same whether the Company records the revenues on a gross or net basis.

Based on an evaluation of the individual terms of each contract and whether the Company is acting as principal or agent, the Company generally records revenues from the distribution of recorded music product on behalf of third-party record labels on a gross basis. However, revenues are recorded on a net basis for recorded music compilations distributed by other record companies where the Company has a right to participate in the profits.

Royalty Advances and Royalty Costs

The Company regularly commits to and pays royalty advances to its recording artists and songwriters in respect of future sales. The Company accounts for these advances under the related guidance in FASB ASC Topic 928, Entertainment—Music (“ASC 928”). Under ASC 928, the Company capitalizes as assets certain advances that it believes are recoverable from future royalties to be earned by the recording artist or songwriter. Advances vary in both amount and expected life based on the underlying recording artist or songwriter.

The Company’s decision to capitalize an advance to a recording artist or songwriter as an asset requires significant judgment as to the recoverability of the advance. The recoverability is assessed upon initial commitment of the advance based upon the Company’s forecast of anticipated revenue from the sale of future and existing albums or songs. In determining whether the advance is recoverable, the Company evaluates the current and past popularity of the recording artist or songwriter, the sales history of the recording artist or songwriter, the initial or expected commercial acceptability of the product, the current and past popularity of the genre of music that the product is designed to appeal to, and other relevant factors. Based upon this information, the Company expenses the portion of any advance that it believes is not recoverable. In most cases, advances to recording artists or songwriters without a history of success and evidence of current or past popularity will be expensed immediately. Significant advances are individually assessed for recoverability continuously and at minimum on a quarterly basis. As part of the ongoing assessment of recoverability, the Company monitors the projection of future sales based on the current environment, the recording artist’s or songwriter’s ability to meet their contractual obligations as well as the Company’s intent to support future album releases or songs from the recording artist or songwriter. To the extent that a portion of an outstanding advance is no longer deemed recoverable, that amount will be expensed in the period the determination is made.

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Advertising

As required by the FASB ASC Subtopic 720-35, Advertising Costs (“ASC 720-35”), advertising costs, including costs to produce music videos used for promotional purposes, are expensed as incurred. Advertising expense amounted to approximately $104 million, $97 million, and $91 million for the fiscal years ended September 30, 2018, 2017 and 2016, respectively. Deferred advertising costs, which principally relate to advertisements that have been paid for but not been exhibited or services that have not been received, were not material for all periods presented.

Share-Based Compensation

The Company accounts for share-based payments as required by FASB ASC Topic 718, Compensation-Stock Compensation (“ASC 718”). ASC 718 requires all share-based payments to employees, including grants of employee stock options, to be recognized as compensation expense. Under the fair value recognition provision of ASC 718, equity classified share-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense over the vesting period.

Under the recognition provision of ASC 718, liability classified share-based compensation costs are measured each reporting date until settlement. The Company’s policy is to measure share-based compensation costs using the intrinsic value method instead of fair value as it is not practical to estimate the volatility of its share price. During fiscal year 2013, the Company initiated a long term incentive plan that has liability classification for share-based compensation awards and continues to be effective through September 30, 2018.

Income Taxes

Income taxes are provided using the asset and liability method presented by FASB ASC Topic 740, Income Taxes (“ASC 740”). Under this method, income taxes (i.e., deferred tax assets, deferred tax liabilities, taxes currently payable/refunds receivable and tax expense) are recorded based on amounts refundable or payable in the current fiscal year and include the results of any differences between U.S. GAAP and tax reporting. Deferred income taxes reflect the tax effect of net operating loss, capital loss and general business credit carryforwards and the net tax effects of temporary differences between the carrying amount of assets and liabilities for financial statements and income tax purposes, as determined under enacted tax laws and rates. Valuation allowances are established when management determines that it is more likely than not that some portion or the entire deferred tax asset will not be realized. The financial effect of changes in tax laws or rates is accounted for in the period of enactment. On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the “Tax Act”).  In accordance with ASC 740, the Company recorded the impacts in the period of enactment.

From time to time, the Company engages in transactions in which the tax consequences may be subject to uncertainty. Significant judgment is required in assessing and estimating the tax consequences of these transactions. The Company prepares and files tax returns based on its interpretation of tax laws and regulations. In the normal course of business, the Company’s tax returns are subject to examination by various taxing authorities. Such examinations may result in future tax and interest assessments by these taxing authorities. In determining the Company’s tax provision for financial reporting purposes, the Company establishes a reserve for uncertain tax positions unless such positions are determined to be more likely than not of being sustained upon examination based on their technical merits. There is considerable judgment involved in determining whether positions taken on the Company’s tax returns are more likely than not of being sustained.

New Accounting Pronouncements   

In October 2017, the Company adopted ASU 2016-09, Compensation - Stock Compensation ("ASU 2016-09"). This ASU provides amended guidance which simplifies the accounting for share-based payment transactions involving multiple aspects of the accounting for share-based transactions, including income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. The adoption of ASU 2016-09 did not have any effect on the Company’s consolidated financial statements and footnote disclosures as of September 30, 2018.

In May 2014, the FASB issued guidance codified in ASC 606, Revenue from Contracts with Customers (“ASC 606”), which replaces the guidance in former ASC 605, Revenue Recognition and ASC 928-605, Entertainment – Music. The amendment was the result of a joint effort by the FASB and the International Accounting Standards Board to improve financial reporting by creating common revenue recognition guidance for U.S. GAAP and international financial reporting standards ("IFRS"). The joint project clarifies the principles for recognizing revenue and develops a common revenue standard for U.S. GAAP and IFRS. ASC 606 is effective for annual periods beginning after December 15, 2017, and interim periods within those years. The update may be applied using one of two methods: full retrospective application to each prior reporting period presented, or modified retrospective application with the cumulative effect of initially applying the update recognized at the date of initial application. The Company will adopt ASC 606 on October 1, 2018 under the modified retrospective method.

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The Company has substantially completed its assessment of the impact of adoption of this new guidance and believes the most significant impact will be a change in the timing of revenue recognition in its Music Publishing segment as well as international broadcast rights within Recorded Music. The Company generally records revenues from the licensing of publishing rights and international broadcast fees when cash is received.  Under the new revenue recognition rules, revenues will be recorded based on best estimates available in the period of sales or usage. Additionally, for certain licenses where the consideration is fixed and the intellectual property being licensed is static, revenue will be recognized at the point in time when control of the license is transferred to the customer.  The Company’s evaluation of the impact this standard will have on its consolidated financial statements is ongoing and primarily relates to the quantification of the adoption date licensing accrual. Based on efforts to date, the cumulative-effect adjustment upon adoption of the new revenue recognition standard as of October 1, 2018, which primarily relates to the aforementioned accrual of licensing revenue, is expected to decrease the opening balance of accumulated deficit by approximately $150 million, net of tax.

In January 2016, the FASB issued ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities (“ASU 2016-01”). This ASU will require that equity investments, except those investments under the equity method of accounting, are measured at fair value with changes in fair value recognized in net income. The Company may elect to measure equity investments that do not have a readily determinable fair value at cost minus impairment, if any, plus or minus changes resulting from observable price. The Company will adopt ASU 2016-01 beginning October 1, 2018 and this adoption is not expected to have a significant impact on the Company’s financial statements.

In February 2016, the FASB issued ASU 2016-02, Leases (“ASU 2016-02”). This ASU establishes a right-of-use (“ROU”) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the statement of operations. ASU 2016-02 will be effective for annual periods beginning after December 15, 2018, and interim periods within those years. Earlier adoption is permitted. The Company is evaluating the impact of the adoption of this standard on its financial statements and disclosures.

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows: Classification of Certain Cash Receipts and Cash Payments ("ASU 2016-15"). This ASU provides specific guidance of how certain cash receipts and cash payments should be presented and classified in the statement of cash flows. ASU 2016-15 is effective for annual periods beginning after December 15, 2017, and interim periods within those years. The adoption of this standard is not expected to have an impact on the Company’s financial statements.

In October 2016, the FASB issued ASU 2016-16, Income Taxes: Intra-Entity Transfers of Assets Other Than Inventory ("ASU 2016-16").  This ASU requires the recognition of current and deferred income taxes for intra-entity asset transfers when the transaction occurs. ASU 2016-16 is effective for annual periods beginning after December 15, 2017, and interim periods within those years.  The Company will adopt ASU 2016-16 beginning October 1, 2018 and this adoption is not expected to have a significant impact on the Company’s financial statements.

In January of 2017, the FASB issued ASU 2017-01, Business Combinations, to clarify the definition of a business, which establishes a process to determine when an integrated set of assets and activities can be deemed a business combination. The Company will adopt the new standard on October 1, 2018. The adoption of this standard is not expected to have a significant impact on the Company’s financial statements.

In August 2017, the FASB issued ASU 2017-12, Targeted Improvements to Accounting for Hedging Activities (“ASU 2017-12”). This ASU improves certain aspects of the hedge accounting model including making more risk management strategies eligible for hedge accounting and simplifying the assessment of hedge effectiveness. ASU 2017-12 is effective for all annual periods beginning after December 15, 2018 and interim periods within those fiscal years.  Early adoption is permitted and requires a prospective adoption with a cumulative-effect adjustment to accumulated deficit as of the beginning of the fiscal year of adoption for existing hedging relationships. The Company is evaluating the impact of the adoption of this standard on its financial statements and disclosures.

In February 2018, FASB issued ASU 2018-02, Income Statement – Reporting Comprehensive Income (“ASU 2018-02”). This ASU allows a reclassification from accumulated other comprehensive income to accumulated deficit for stranded tax effects resulting from the Tax Act. ASU 2018-02 is effective for all entities for fiscal years beginning after December 15, 2018 and interim periods within those fiscal years. Early adoption is permitted, including adoption in any interim period. The Company is evaluating the impact of the adoption of this standard on its financial statements and disclosures.

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In March 2018, the FASB issued ASU 2018-05, Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118 (“ASU 2018-05”). This ASU allows companies, for one year following the enactment date, to consider the impact of the Tax Act as “provisional” when a company can make a reasonable estimate but does not have the necessary information available, prepared or analyzed in reasonable detail to finalize its accounting for the impact of the Tax Act. A company may need to reflect adjustments to its provisional amounts upon obtaining, preparing or analyzing additional information about facts and circumstances that existed at the period of enactment. The Company has adopted this standard on its financial statements and disclosures.

 

 

3. Comprehensive (Loss) Income

Comprehensive (loss) income, which is reported in the accompanying consolidated statements of equity, consists of net (loss) income and other gains and losses affecting equity that, under U.S. GAAP, are excluded from net (loss) income. For the Company, the components of other comprehensive loss primarily consist of foreign currency translation losses, minimum pension liabilities, and deferred gains and losses on financial instruments designated as hedges under ASC 815, which include foreign exchange contracts. The following summary sets forth the changes in the components of accumulated other comprehensive loss, net of related taxes of less than $1 million:

 

 

 

Foreign

 

 

Minimum

 

 

Deferred Gains

 

 

Accumulated

 

 

 

Currency

 

 

Pension

 

 

On Derivative

 

 

Other

 

 

 

Translation

 

 

Liability

 

 

Financial

 

 

Comprehensive

 

 

 

Loss

 

 

Adjustment

 

 

Instruments

 

 

Loss, net

 

 

 

(in millions)

 

Balance at September 30, 2015

 

$

(157

)

 

$

(10

)

 

$

 

 

$

(167

)

Other comprehensive loss (a)

 

 

(44

)

 

 

(6

)

 

 

 

 

 

(50

)

Amounts reclassified from accumulated other

   comprehensive income

 

 

 

 

 

(1

)

 

 

 

 

 

(1

)

Balance at September 30, 2016

 

$

(201

)

 

$

(17

)

 

$

 

 

$

(218

)

Other comprehensive income (a)

 

 

30

 

 

 

8

 

 

 

 

 

 

38

 

Amounts reclassified from accumulated other

   comprehensive income

 

 

 

 

 

(1

)

 

 

 

 

 

(1

)

Balance at September 30, 2017

 

$

(171

)

 

$

(10

)

 

$

 

 

$

(181

)

Other comprehensive loss (a)

 

 

(13

)

 

 

1

 

 

 

3

 

 

 

(9

)

Amounts reclassified from accumulated other

   comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

Balance at September 30, 2018

 

$

(184

)

 

$

(9

)

 

$

3

 

 

$

(190

)

 

(a)

Includes historical foreign currency translation related to certain intra-entity transactions that are no longer of a long-term investment nature of $0 million, $(19) million and $(109) million during the fiscal year ended September 30, 2018, 2017 and 2016, respectively.

 

 

4. Property, Plant and Equipment

Property, plant and equipment consist of the following:

 

 

 

September 30,

 

 

September 30,

 

 

 

2018

 

 

2017

 

 

 

(in millions)

 

Land

 

$

11

 

 

$

11

 

Buildings and improvements

 

 

109

 

 

 

99

 

Furniture and fixtures

 

 

11

 

 

 

10

 

Computer hardware and software

 

 

302

 

 

 

262

 

Construction in progress

 

 

42

 

 

 

30

 

Machinery and equipment

 

 

11

 

 

 

11

 

Gross Property, Plant and Equipment

 

$

486

 

 

$

423

 

Less accumulated depreciation

 

 

(257

)

 

 

(210

)

Net Property, Plant and Equipment

 

$

229

 

 

$

213

 

 

 

89


 

5. Goodwill and Intangible Assets

Goodwill

The following analysis details the changes in goodwill for each reportable segment:

 

 

 

Recorded

 

 

Music

 

 

 

 

 

 

 

Music

 

 

Publishing

 

 

Total

 

 

 

(in millions)

 

Balance at September 30, 2016

 

$

1,163

 

 

$

464

 

 

$

1,627

 

Acquisitions

 

 

58

 

 

 

 

 

 

58

 

Dispositions

 

 

(10

)

 

 

 

 

 

(10

)

Other adjustments

 

 

10

 

 

 

 

 

 

10

 

Balance at September 30, 2017

 

$

1,221

 

 

$

464

 

 

$

1,685

 

Acquisitions

 

 

12

 

 

 

 

 

 

12

 

Dispositions

 

 

 

 

 

 

 

 

 

Other adjustments

 

 

(5

)

 

 

 

 

 

(5

)

Balance at September 30, 2018

 

$

1,228

 

 

$

464

 

 

$

1,692

 

 

The increase in goodwill during the fiscal year ended September 30, 2018 primarily relates to finalizing the purchase accounting allocation for the Spinnin’ Records acquisition, which resulted in an increase in goodwill of $10 million, as discussed below. The increase in goodwill during the fiscal year ended September 30, 2017 primarily relates to the Spinnin’ Records acquisition in September 2017. The decrease in goodwill during the fiscal year ended September 30, 2017 includes goodwill associated with immaterial dispositions. The other adjustments during both the fiscal years ended September 30, 2018 and 2017 primarily represent foreign currency movements.

 

The Company accounted for the acquisition of Spinnin’ Records as a business combination under ASC 805, which requires the acquisition method of accounting. At September 30, 2017, the Company performed a preliminary purchase allocation under the acquisition method of accounting, which resulted in goodwill, intangibles, deferred tax liabilities and other insignificant assets and liabilities assumed. The preliminary purchase accounting was subject to revision based on final determinations of fair value and allocations of purchase price to the identifiable assets and liabilities acquired. At September 30, 2018, the Company finalized the allocation recorded at September 30, 2017 based on a final determination of fair market valuation of certain intangible assets. The updated allocation resulted in an increase in goodwill of $10 million, a decrease in intangible assets of $13 million, and a decrease in deferred tax liabilities of $3 million during the current year.

 

For the fiscal year ended September 30, 2017, the cash paid of $139 million includes the acquisition of Spinnin’ Records, which was acquired on September 7, 2017.  Based in the Netherlands, Spinnin’ Records is a dance and electronic music company.  The results of operations for Spinnin’ Records are reported in our Recorded Music segment following the acquisition date.

The Company performs its annual goodwill impairment test in accordance with ASC 350 during the fourth quarter of each fiscal year as of July 1. The Company may conduct an earlier review if events or circumstances occur that would suggest the carrying value of the Company’s goodwill may not be recoverable. The performance of the annual fiscal 2018 impairment analysis did not result in an impairment of the Company’s goodwill.

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Intangible Assets

Intangible assets consist of the following:

 

 

 

Weighted

 

 

 

 

 

 

 

 

 

 

Average

 

September 30,

 

 

September 30,

 

 

 

Useful Life

 

2018

 

 

2017

 

 

 

 

 

(in millions)

 

Intangible assets subject to amortization:

 

 

 

 

 

 

 

 

 

 

Recorded music catalog

 

10 years

 

$

870

 

 

$

898

 

Music publishing copyrights

 

26 years

 

 

1,540

 

 

 

1,534

 

Artist and songwriter contracts

 

13 years

 

 

864

 

 

 

904

 

Trademarks

 

6 years

 

 

12

 

 

 

14

 

Other intangible assets

 

5 years

 

 

26

 

 

 

10

 

Total gross intangible asset subject to amortization

 

 

 

 

3,312

 

 

 

3,360

 

Accumulated amortization

 

 

 

 

(1,461

)

 

 

(1,270

)

Total net intangible assets subject to amortization

 

 

 

 

1,851

 

 

 

2,090

 

Intangible assets not subject to amortization:

 

 

 

 

 

 

 

 

 

 

Trademarks and tradenames

 

Indefinite

 

 

154

 

 

 

117

 

Total net other intangible assets

 

 

 

$

2,005

 

 

$

2,207

 

 

The Company performs its annual indefinite-lived intangible assets impairment test in accordance with ASC 350 during the fourth quarter of each fiscal year as of July 1. The Company may conduct an earlier review if events or circumstances occur that would suggest the carrying value of the Company’s indefinite-lived intangible assets may not be recoverable. The performance of the annual fiscal 2018 impairment analysis did not result in an impairment of the Company’s indefinite-lived intangible assets.

 

For the fiscal year ended September 30, 2017, the intangible balances presented include a preliminary purchase accounting allocation resulting from the acquisition of Spinnin’ Records in September 2017.    

Amortization

Based on the amount of intangible assets subject to amortization at September 30, 2018, the expected amortization for each of the next five fiscal years and thereafter are as follows:

 

 

 

 

 

 

 

Fiscal Years Ended

 

 

 

 

 

 

 

September 30,

 

 

 

 

 

 

 

(in millions)

 

2019

 

 

 

 

 

$

204

 

2020

 

 

 

 

 

 

175

 

2021

 

 

 

 

 

 

174

 

2022

 

 

 

 

 

 

166

 

2023

 

 

 

 

 

 

131

 

Thereafter

 

 

 

 

 

 

1,001

 

 

 

 

 

 

 

$

1,851

 

 

The life of all acquired intangible assets is evaluated based on the expected future cash flows associated with the asset. The expected amortization expense above reflects estimated useful lives assigned to the Company’s identifiable, finite-lived intangible assets primarily established in the accounting for the Merger and the PLG Acquisition.

 

 

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6. Debt

Debt Capitalization

Long-term debt consists of the following:

 

 

September 30,

 

 

September 30,

 

 

2018

 

 

2017

 

 

(in millions)

 

Revolving Credit Facility—Acquisition Corp. (a)

$

 

 

$

 

Senior Term Loan Facility due 2023—Acquisition Corp. (b)

 

1,310

 

 

 

990

 

5.625% Senior Secured Notes due 2022—Acquisition Corp. (c)

 

246

 

 

 

246

 

5.00% Senior Secured Notes due 2023—Acquisition Corp. (d)

 

297

 

 

 

297

 

4.125% Senior Secured Notes due 2024—Acquisition Corp. (e)

 

399

 

 

 

402

 

4.875% Senior Secured Notes due 2024—Acquisition Corp. (f)

 

247

 

 

 

246

 

6.75% Senior Notes due 2022—Acquisition Corp. (g)

 

 

 

 

630

 

5.50% Senior Notes due 2026—Acquisition Corp. (h)

 

320

 

 

 

 

Total debt (i)

$

2,819

 

 

$

2,811

 

 

(a)

Reflects $180 million and $150 million of commitments under the Revolving Credit Facility, less letters of credit outstanding of approximately $8 million and $12 million at September 30, 2018 and September 30, 2017, respectively. There were no loans outstanding under the Revolving Credit Facility at September 30, 2018 or September 30, 2017.

(b)

Principal amount of $1.326 billion and $1.006 billion less unamortized discount of $4 million and $6 million and unamortized deferred financing costs of $12 million and $10 million at September 30, 2018 and September 30, 2017, respectively.

(c)

Principal amount of $248 million less unamortized deferred financing costs of $2 million at both September 30, 2018 and September 30, 2017.

(d)

Principal amount of $300 million less unamortized deferred financing costs of $3 million at both September 30, 2018 and September 30, 2017.

(e)

Face amount of €345 million. Above amounts represent the dollar equivalent of such notes at September 30, 2018 and September 30, 2017. Principal amount of $402 million and $407 million less unamortized deferred financing costs of $3 million and $5 million at September 30, 2018 and September 30, 2017, respectively.

(f)

Principal amount of $250 million at both September 30, 2018 and September 30, 2017 less unamortized deferred financing costs of $3 million and $4 million at September 30, 2018 and September 30, 2017, respectively.

(g)

Principal amount of $635 million less unamortized deferred financing costs of $5 million at September 30, 2017.

(h)

Principal amount of $325 million less unamortized deferred financing costs of $5 million at September 30, 2018.

(i)

Principal amount of debt of $2.851 billion and $2.846 billion less unamortized discount of $4 million and $6 million and unamortized deferred financing costs of $28 million and $29 million at September 30, 2018 and September 30, 2017, respectively.  

December 2017 Senior Term Loan Credit Agreement Amendment

On December 6, 2017, Acquisition Corp. entered into an amendment (the “December 2017 Senior Term Loan Credit Agreement Amendment”) to the Senior Term Loan Credit Agreement, dated November 1, 2012, among Acquisition Corp., the guarantors party thereto, the lenders party thereto and Credit Suisse AG, as administrative agent, governing Acquisition Corp.’s senior secured term loan facility with Credit Suisse AG, as administrative agent, and the other financial institutions and lenders from time to time party thereto, to, among other things, reduce the pricing terms of its outstanding term loans, change certain incurrence thresholds governing the ability to incur debt and liens, change certain EBITDA add-backs and increase the thresholds above which the excess cash flow sweep is triggered. The Company recorded a loss on extinguishment of debt of approximately $1 million, which represented the discount and unamortized deferred financing costs related to the prior tranche of debt of the lenders that was replaced.

New Revolving Credit Agreement

On January 31, 2018, the Company entered into a new revolving credit agreement (the “Revolving Credit Agreement”) for its Revolving Credit Facility, and terminated its existing revolving credit agreement (the “Old Revolving Credit Agreement”). The Revolving Credit Agreement differs from the Old Revolving Credit Agreement in that it, among other things, reduces the interest rate margin applicable to the loans, extends the maturity date thereunder, provides for the option to increase the commitments under the Company’s then existing revolving credit agreement, provides for greater flexibility to amend and extend the Company’s then existing revolving credit agreement and create additional tranches thereunder, provides for greater flexibility over future amendments, increases the springing financial maintenance covenant to 4.75:1.00 and provides that the covenant shall not be tested unless at the end

92


 

of a fiscal quarter the outstanding amount of loans and drawings under letters of credit which have not been reimbursed exceeds $54 million and aligns the other negative covenants with those of the Senior Term Loan Credit Agreement. References to “Revolving Credit Facility” below in this Note 5 are to our new revolving credit facility.

March 2018 Senior Term Loan Credit Agreement Amendment

On March 14, 2018, Acquisition Corp. incurred $320 million of supplemental term loans (the “Supplemental Term Loans”) pursuant to an increase supplement (the “March 2018 Senior Term Loan Credit Agreement Supplement”) to the Senior Term Loan Credit Agreement, dated November 1, 2012, among Acquisition Corp., the guarantors party thereto, the lenders party thereto and Credit Suisse AG, as administrative agent, governing Acquisition Corp.’s senior secured term loan facility with Credit Suisse AG, as administrative agent, and the other financial institutions and lenders from time to time party thereto (as amended, the “Senior Term Loan Credit Agreement”). The principal amount outstanding under the Senior Term Loan Credit Agreement including the Supplemental Term Loans is $1.326 billion.

Notes Offering

On March 14, 2018, Acquisition Corp. issued $325 million in aggregate principal amount of its 5.50% Senior Notes due 2026.  Acquisition Corp. used the net proceeds to pay the consideration in the tender offer for its 6.75% Senior Notes due 2022 (the “6.75% Senior Notes”) and to redeem the remaining 6.75% Senior Notes as described below.  

Tender Offer and Notes Redemption

On March 14, 2018, Acquisition Corp. accepted for purchase in connection with the tender offer for the 6.75% Senior Notes that had been validly tendered and not validly withdrawn at or prior to 5:00 p.m., New York City time on March 13, 2018 (the “Expiration Time”) thereby reducing the aggregate principal amount of the 6.75% Senior Notes by $523 million. Acquisition Corp. then issued a notice of redemption on March 14, 2018 with respect to the remaining $112 million of 6.75% Senior Notes outstanding that were not accepted for payment pursuant to the tender offer. Following payment of the 6.75% Senior Notes tendered at or prior to the Expiration Time, Acquisition Corp. deposited with the Trustee funds of $119 million to satisfy all obligations under the applicable indenture governing the 6.75% Senior Notes, including call premiums and interest through the date of redemption on April 15, 2018, for the remaining 6.75% Senior Notes not accepted for purchase in the tender offer. On April 15, 2018, Acquisition Corp. redeemed the remaining outstanding 6.75% Senior Notes. The Company recorded a loss on extinguishment of debt in connection with the tender offer of approximately $23 million as a result of the partial debt redemption, which represents the premium paid on early redemption and unamortized deferred financing costs in March 2018. The Company incurred an additional loss on extinguishment of approximately $5 million in April 2018 related to the redemption on the remaining 6.75% Senior Notes, which represents the premium paid on early redemption and unamortized deferred financing costs.

June 2018 Senior Term Loan Credit Agreement Amendment

On June 7, 2018, Acquisition Corp. entered into an amendment (the “June 2018 Senior Term Loan Credit Agreement Amendment”) to the Senior Term Loan Credit Agreement, dated November 1, 2012, among Acquisition Corp., the guarantors party thereto, the lenders party thereto and Credit Suisse AG, as administrative agent, governing Acquisition Corp.’s senior secured term loan facility with Credit Suisse AG, as administrative agent, and the other financial institutions and lenders from time to time party thereto, to, among other things, reduce the pricing terms of its outstanding term loans, change certain incurrence thresholds governing the ability to incur debt and liens and exclude from the definition of “Senior Secured Indebtedness” certain liens that have junior lien priority on the collateral in relation to the outstanding term loans and the relevant guarantees, as applicable. The Company recorded a loss on extinguishment of debt of approximately $2 million, which represented the discount and unamortized deferred financing costs related to the prior tranche of debt of the lenders that was replaced.

Open Market Purchases

On March 11, 2016, Acquisition Corp. purchased, in the open market, approximately $25 million of its $660 million outstanding 6.75% Senior Notes due 2022. The acquired notes were subsequently retired.  Following retirement of the acquired notes, approximately $635 million of the 6.75% Senior Notes due 2022 remain outstanding. 

93


 

Notes Offering

On July 27, 2016, Acquisition Corp. issued $300 million in aggregate principal amount of its 5.00% Senior Secured Notes due 2023 (the “Notes Offering”). Acquisition Corp. used the net proceeds for the prepayment of $295.5 million of its outstanding Senior Term Loan Facility due 2020.

Interest Rates

The loans under the Revolving Credit Facility bear interest at Acquisition Corp.’s election at a rate equal to (i) the rate for deposits in the borrowing currency in the London interbank market (adjusted for maximum reserves) for the applicable interest period (“Revolving LIBOR”) subject to a zero floor, plus 1.75% per annum, or (ii) the base rate, which is the highest of (x) the corporate base rate established by the administrative agent from time to time, (y) 0.50% in excess of the overnight federal funds rate and (z) the one-month Revolving LIBOR plus 1.0% per annum, plus, in each case, 0.75% per annum. If there is a payment default at any time, then the interest rate applicable to overdue principal will be the rate otherwise applicable to such loan plus 2.0% per annum. Default interest will also be payable on other overdue amounts at a rate of 2.0% per annum above the amount that would apply to an alternative base rate loan.

The loans under the Senior Term Loan Facility bear interest at Acquisition Corp.’s election at a rate equal to (i) the rate for deposits in U.S. dollars in the London interbank market (adjusted for maximum reserves) for the applicable interest period (“Term Loan LIBOR”) subject to a zero floor, plus 2.125% per annum, or (ii) the base rate, which is the highest of (x) the corporate base rate established by the administrative agent as its prime rate in effect at its principal office in New York City from time to time, (y) 0.50% in excess of the overnight federal funds rate and (z) one-month Term Loan LIBOR, plus 1.00% per annum, plus, in each case, 1.125% per annum. If there is a payment default at any time, then the interest rate applicable to overdue principal and interest will be the rate otherwise applicable to such loan plus 2.0% per annum. Default interest will also be payable on other overdue amounts at a rate of 2.0% per annum above the amount that would apply to an alternative base rate loan.

 

The Company has entered into, and in the future may enter into, interest rate swaps to manage interest rate risk. Please refer to Note 12 of our Consolidated Financial Statements for further discussion.

Maturity of Senior Term Loan Facility

The loans outstanding under the Senior Term Loan Facility mature on November 1, 2023.

Maturity of Revolving Credit Facility

The maturity date of the Revolving Credit Facility is January 31, 2023.

Maturities of Senior Notes and Senior Secured Notes

As of September 30, 2018, there are no scheduled maturities of notes until 2022, when $248 million is scheduled to mature. Thereafter, $1.277 billion is scheduled to mature.

Interest Expense, net

Total interest expense, net, was $138 million, $149 million, and $173 million for the fiscal years ended September 30, 2018, 2017 and 2016, respectively. The weighted-average interest rate of the Company’s total debt was 4.7% at September 30, 2018, 4.9% at September 30, 2017 and 5.3% at September 30, 2016.

 

 

7. Income Taxes

On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (“Tax Act”).  The Tax Act contains significant revisions to U.S. federal corporate income tax provisions, including, but not limited to, a reduction of the U.S. federal corporate statutory tax rate from 35% to 21%, a one-time transition tax on accumulated foreign earnings, an income inclusion of global intangible low-taxed income (“GILTI”), and a new minimum tax, the base erosion anti-abuse tax (“BEAT”).  In accordance with ASC 740, the Company recorded the effects of the Tax Act during the three months ended December 31, 2017.  The effect of the tax rate change was recorded in the period of enactment as provisional in accordance with the guidance under ASU 2018-05 and was finalized as of September 30, 2018.

94


 

The reduction in U.S. federal corporate statutory tax rate from 35% to 21% was effective January 1, 2018.  The Tax Act requires companies with a fiscal year that begins before and ends after the effective date of the rate change to calculate a blended tax rate based on the pro rata number of days in the fiscal year before and after the effective date. As a result, for the fiscal year ending September 30, 2018, the Company’s U.S. federal statutory income tax rate was 24.5%. For the fiscal year ending September 30, 2019, the Company will be subject to the U.S. federal corporate statutory tax rate of 21%.

The reduction in the U.S. federal corporate statutory tax rate required the Company to adjust its U.S. deferred tax assets and liabilities using the newly enacted tax rate of 21%.  As a result, the Company has recorded a U.S. income tax expense of $23 million for the reduction of its net U.S. deferred tax assets in the period ended September 30, 2018.

The Company reasonably estimates that there is no income tax impact related to the one-time transition tax on accumulated foreign earnings (“Transition Tax”) and recorded no income tax liability for the fiscal year ended September 30, 2018 due to an estimated overall deficit in accumulated foreign earnings.  This estimate is provisional since the Company has not obtained and analyzed information necessary to finalize its accounting for the impact of the Transition Tax. The final impacts of the Transition Tax may differ from the estimate due to changes in interpretations of the Tax Act and updates or changes to the information that the Company has used to estimate the transition impact, including, but not limited to, the impacts from changes to foreign earnings estimates and foreign exchange rates.

GILTI and BEAT are effective for the Company’s fiscal year ending September 30, 2019. The Company is in the process of assessing the impact of GILTI and BEAT on its consolidated financial statements.  At this time, the Company expects that GILTI will increase its U.S. taxable income and that, after its U.S. net operating loss carryforwards are used, the Company will incur incremental U.S. cash tax on such GILTI inclusions due to expense allocations required by U.S. foreign tax credit rules.  The Company has elected to recognize the impact of GILTI in the specific period in which it occurs.  

The domestic and foreign pretax (loss) income from continuing operations is as follows:

 

 

 

Fiscal Year Ended

 

 

Fiscal Year Ended

 

 

Fiscal Year Ended

 

 

 

September 30,

 

 

September 30,

 

 

September 30,

 

 

 

2018

 

 

2017

 

 

2016

 

 

 

(in millions)

 

Domestic

 

$

347

 

 

$

(37

)

 

$

35

 

Foreign

 

 

95

 

 

 

35

 

 

 

6

 

Total

 

$

442

 

 

$

(2

)

 

$

41

 

 

Current and deferred income taxes (tax benefits) provided are as follows:

 

 

 

Fiscal Year Ended

 

 

Fiscal Year Ended

 

 

Fiscal Year Ended

 

 

 

September 30,

 

 

September 30,

 

 

September 30,

 

 

 

2018

 

 

2017

 

 

2016

 

 

 

(in millions)

 

Federal:

 

 

 

 

 

 

 

 

 

 

 

 

Current

 

$

 

 

$

 

 

$

 

Deferred

 

 

91

 

 

 

(169

)

 

 

3

 

Foreign:

 

 

 

 

 

 

 

 

 

 

 

 

Current (a)

 

 

58

 

 

 

41

 

 

 

39

 

Deferred

 

 

(26

)

 

 

(12

)

 

 

(30

)

U.S. State:

 

 

 

 

 

 

 

 

 

 

 

 

Current

 

 

6

 

 

 

2

 

 

 

3

 

Deferred

 

 

1

 

 

 

(13

)

 

 

(4

)

Total

 

$

130

 

 

$

(151

)

 

$

11

 

 

 

(a)

Includes withholding taxes of $15 million, $13 million and $17 million for the fiscal years ended September 30, 2018, September 30, 2017, and September 30, 2016, respectively.

95


 

The differences between the U.S. federal statutory income tax rate of 24.5%, 35.0% and 35.0% for the fiscal year ended September 30, 2018, September 30, 2017 and September 30, 2016, respectively, and income taxes provided are as follows:

 

 

 

Fiscal Year Ended

 

 

Fiscal Year Ended

 

 

Fiscal Year Ended

 

 

 

September 30,

 

 

September 30,

 

 

September 30,

 

 

 

2018

 

 

2017

 

 

2016

 

 

 

(in millions)

 

Taxes on income at the U.S. federal statutory rate

 

$

108

 

 

$

(1

)

 

$

14

 

U.S. state and local taxes

 

 

7

 

 

 

3

 

 

 

(1

)

Foreign income taxed at different rates, including

   withholding taxes

 

 

19

 

 

 

11

 

 

 

12

 

Increase in valuation allowance

 

 

4

 

 

 

18

 

 

 

19

 

Release of valuation allowance

 

 

(14

)

 

 

(134

)

 

 

(26

)

Change in tax rates

 

 

23

 

 

 

(1

)

 

 

(10

)

Intergroup transfer

 

 

(30

)

 

 

 

 

 

 

Foreign currency losses on intra-entity loans

 

 

 

 

 

(59

)

 

 

 

Non-deductible long term incentive plan

 

 

8

 

 

 

10

 

 

 

1

 

Other

 

 

5

 

 

 

2

 

 

 

2

 

Total income tax (benefit) expense

 

$

130

 

 

$

(151

)

 

$

11

 

 

During the year ended September 30, 2018, the Company recognized a U.S. tax expense of $23 million related to the reduction of net U.S deferred tax assets as a result of the Tax Act. In addition, the Company recognized a net tax benefit of $30 million related to a prior year intergroup transfer. During the year ended September 30, 2017, the Company recognized a U.S. tax benefit of $59 million related to foreign currency losses on intra-entity loans. The foreign currency loss was previously reported in accumulated other comprehensive loss as the intra-entity loans were previously considered long-term in nature.  

 

For the fiscal year ended September 30, 2018 and for the fiscal year ended September 30, 2017, the Company incurred losses in certain foreign territories and has offset the tax benefit associated with these losses with a valuation allowance as the Company has determined that it is more likely than not that these losses will not be utilized. For the fiscal year ended September 30, 2017, the Company released $125 million of the U.S. valuation allowance related to U.S. tax attributes. Significant components of the Company’s net deferred tax assets (liabilities) are summarized below:

 

 

 

September 30,

 

 

September 30,

 

 

 

2018

 

 

2017

 

 

 

(in millions)

 

Deferred tax assets:

 

 

 

 

 

 

 

 

Allowances and reserves

 

$

26

 

 

$

35

 

Employee benefits and compensation

 

 

86

 

 

 

91

 

Other accruals

 

 

56

 

 

 

68

 

Tax attribute carryforwards

 

 

314

 

 

 

482

 

Other

 

 

4

 

 

 

13

 

Total deferred tax assets

 

 

486

 

 

 

689

 

Valuation allowance

 

 

(206

)

 

 

(193

)

Net deferred tax assets

 

 

280

 

 

 

496

 

Deferred tax liabilities:

 

 

 

 

 

 

 

 

Depreciation, amortization and artist advances

 

 

 

 

 

(15

)

Intangible assets

 

 

(434

)

 

 

(574

)

Total deferred tax liabilities

 

 

(434

)

 

 

(589

)

Net deferred tax liabilities

 

$

(154

)

 

$

(93

)

 

Of the valuation allowance of $206 million at September 30, 2018, $149 million relates to U.S. tax attributes, of which $133 million relates to foreign tax credit carryforwards, $12 million relates to U.S. state NOL carryforwards and $4 million relates to outside basis differences in investments.

 

96


 

At September 30, 2018, the Company has U.S. federal tax net operating loss carryforwards of $175 million, which will begin to expire in fiscal year 2033. The Company also has tax net operating loss carryforwards, with no expiration date, in the U.K., France and Spain of $20 million, $106 million and $39 million, respectively, and other tax net operating loss carryforwards in state, local and foreign jurisdictions that expire in various periods. In addition, the Company has foreign tax credit carryforwards for U.S. tax purposes of $169 million. The U.S. foreign tax credits will begin to expire in fiscal year 2019.

Deferred income taxes have not been recorded on indefinitely reinvested earnings of certain foreign subsidiaries of approximately $193 million at September 30, 2018. Distribution of these earnings may result in foreign withholding taxes and U.S. state taxes.  However, variables existing if and when remittance occurs make it impracticable to estimate the amount of the ultimate tax liability, if any, on these accumulated foreign earnings.  

The Company classifies interest and penalties related to uncertain tax position as a component of income tax expense.  As of September 30, 2018 and September 30, 2017, the Company had accrued $2 million and $3 million of interest and penalties, respectively.

A reconciliation of the beginning and ending amount of unrecognized tax benefits, including interest and penalties, are as follows (in millions):

 

Balance at September 30, 2015

 

$

35

 

Additions for current year tax positions

 

 

7

 

Additions for prior year tax positions

 

 

1

 

Subtractions for prior year tax positions

 

 

(13

)

Balance at September 30, 2016

 

$

30

 

Additions for current year tax positions

 

 

2

 

Additions for prior year tax positions

 

 

1

 

Subtractions for prior year tax positions

 

 

(14

)

Balance at September 30, 2017

 

$

19

 

Additions for current year tax positions

 

 

3

 

Additions for prior year tax positions

 

 

3

 

Subtractions for prior year tax positions

 

 

(7

)

Balance at September 30, 2018

 

$

18

 

 

Included in the total unrecognized tax benefits at September 30, 2018 and 2017 are $18 million and $19 million, respectively, that if recognized, would reduce the effective income tax rate. The Company’s gross unrecognized tax benefits decreased during the year ended September 30, 2018 by $7 million due primarily to a final court decision in Austria. The Company has determined that is reasonably possible that its existing reserve for uncertain tax positions as of September 30, 2018 could decrease by up to approximately $3 million related to various ongoing audits and settlement discussions in various foreign jurisdictions.

The Company and its subsidiaries file income tax returns in the U.S. and various foreign jurisdictions. The Company has completed tax audits in the U.S. for tax years ended through September 30, 2013, in the U.K. for the tax years ending through September 30, 2014, in Canada for tax years ended through September 30, 2013, in Germany for the tax years ending through September 30, 2009 and in Japan for the tax years ending through September 30, 2012. The Company is at various stages in the tax audit process in certain foreign and local jurisdictions.

 

 

8. Employee Benefit Plans

Certain international employees, such as those in Germany and Japan, participate in locally sponsored defined benefit plans, which are not considered to be material either individually or in the aggregate and have a combined projected benefit obligation of approximately $73 million and $75 million as of September 30, 2018 and September 30, 2017, respectively. Pension benefits under the plans are based on formulas that reflect the employees’ years of service and compensation levels during their employment period. The Company had unfunded pension liabilities relating to these plans of approximately $50 million recorded in its balance sheets as of both September 30, 2018 and September 30, 2017. The Company uses a September 30 measurement date for its plans. For each of the fiscal years ended September 30, 2018, September 30, 2017, and September 30, 2016, pension expense amounted to $4 million.

97


 

Certain employees also participate in defined contribution plans. The Company’s contributions to the defined contribution plans are based upon a percentage of the employees’ elected contributions. The Company’s defined contribution plan expense amounted to approximately $5 million for the fiscal year ended September 30, 2018, $5 million for the fiscal year ended September 30, 2017, and $5 million for the fiscal year ended September 30, 2016.

 

 

9. Share-Based Compensation Plans

Effective January 1, 2013, eligible individuals were invited to participate in the Senior Management Free Cash Flow Plan (as amended, the “Plan”). Eligible individuals include any employee, consultant or officer of the Company or any of its affiliates, who is selected by the Company’s Compensation Committee to participate in the Plan. In 2017, the Company’s Compensation Committee invited two additional employees to participate in the Plan. Under the Plan, participants are allocated a specific portion of the Company’s free cash flow to use to purchase the equivalent of Company stock through the acquisition of deferred equity units. Participants also receive a grant of profit interests in a purposely established LLC holding company (the “LLC”) that represent an economic entitlement to future appreciation over an equivalent number of shares of Company stock (“matching units”). The Company’s Board of Directors authorized the issuance of up to 82.1918 shares of the Company’s common stock pursuant to the Plan, 41.0959 in respect of deferred equity units and 41.0959 in respect of matching units. The LLC currently owns 52 issued and outstanding shares. Each deferred equity unit is equivalent to 1/10,000 of a share of Company stock. The Company will allocate units to active participants each Plan year at the time that annual free cash flow bonuses for such Plan year are determined and may grant unallocated units under the Plan to certain members of current or future management. At the time that annual free cash flow bonuses for such Plan year are determined, a participant shall be credited a number of deferred equity units based on their respective allocation divided by the grant date intrinsic value and an equal number of the related matching units will be allocated. The redemption price of the deferred equity units will equal the fair market value of a fractional share of the Company’s stock on the date of the settlement and the redemption price for the matching units will equal the excess, if any, of the then fair market value of one Company fractional share over the grant date intrinsic value of one fractional share.

The Company accounts for share-based payments as required by ASC 718. ASC 718 requires all share-based payments to employees to be recognized as compensation expense. Under the recognition provision of ASC 718, liability classified share-based compensation costs are measured each reporting date until settlement. The Company’s policy is to measure share-based compensation costs to employees using the intrinsic value method instead of fair value as it is not practical to estimate the volatility of its share price on the grant date.

The intrinsic value method utilized by the Company is based on the estimated fair value of equity divided by the number of shares outstanding to determine a price per share.  The Company’s estimated fair value of equity is derived from a discounted cash flow model with adjustments for non-operating assets, less the estimated fair value of debt.

For accounting purposes, the grant date was established at the point the Company and the participant reached a mutual understanding of the key terms and conditions, in this case the date at which the participant accepted the invitation to participate in the Plan. For accounting purposes, deferred equity units are deemed to generally vest between one and seven years and matching equity units granted under the Plan are deemed to vest two years after the allocation to the participant’s account. The deferred and matching equity units have cash settlement dates that begin in December 2018. The deferred units will be settled at the participant’s election for cash equal to the fair market value of one fractional company share or a fractional company share. The matching units will be settled for cash equal to the redemption price or fractional company shares of equivalent value. At the end of the redemption period, all outstanding units become mandatorily redeemable at the then redemption price. Due to this mandatory redemption clause, the Company has classified the awards under the Plan as liability awards. Dividend distributions, if any, are also paid out on vested deferred equity units and are calculated on the same basis as the Company’s common shares. The Company has applied a graded (tranche-by-tranche) attribution method and expenses share-based compensation on an accelerated basis over the vesting period of the share award.

98


 

The following is a summary of the Company’s share awards:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Matching

 

 

Deferred Equity

 

 

Matching Equity

 

 

 

 

 

 

 

 

 

 

 

Deferred

 

 

Equity Units

 

 

Units Weighted-

 

 

Units Weighted-

 

 

 

 

 

 

 

 

 

 

 

Equity Units

 

 

Weighted-

 

 

Average

 

 

Average

 

 

 

 

 

 

 

 

 

 

 

Weighted-

 

 

Average

 

 

Grant-Date

 

 

Grant-Date

 

 

 

Deferred

 

 

Matching

 

 

Average

 

 

Intrinsic

 

 

Intrinsic

 

 

Intrinsic

 

 

 

Equity Units

 

 

Equity Units

 

 

Fair Value

 

 

Value

 

 

Value

 

 

Value

 

Unvested units at September 30, 2016

 

 

19

 

 

 

28

 

 

$

142.21

 

 

$

35.08

 

 

$

107.13

 

 

$

 

Granted

 

 

11

 

 

 

11

 

 

 

241.75

 

 

 

90.06

 

 

 

146.86

 

 

 

 

Vested

 

 

(17

)

 

 

(3

)

 

 

241.75

 

 

 

134.62

 

 

 

107.13

 

 

 

 

Forfeited

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unvested units at September 30, 2017

 

 

13

 

 

 

36

 

 

$

241.75

 

 

$

111.23

 

 

$

140.04

 

 

$

 

Granted

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Vested

 

 

(7

)

 

 

(9

)

 

 

304.22

 

 

 

193.83

 

 

 

133.05

 

 

 

 

Forfeited

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unvested units at September 30, 2018

 

 

6

 

 

 

27

 

 

$

304.22

 

 

$

167.15

 

 

$

148.69

 

 

$

 

 

The weighted-average grant date intrinsic value of deferred equity unit awards for the fiscal year ended September 30, 2018 was $148.69. The fair value of these deferred equity units at September 30, 2018 was $304.22. The weighted-average grant date intrinsic value of deferred equity unit awards for the period ended September 30, 2017 was $140.04. The fair value of these deferred equity units at September 30, 2017 was $241.75. The weighted-average grant date intrinsic value of deferred equity unit awards for the period ended September 30, 2016 was $107.13. The fair value of these deferred equity units at September 30, 2016 was $142.21.

Compensation Expense

The Company recognized non-cash share-based compensation expense of $62 million, free cash flow compensation expense of $19 million and dividend expense related to the equity units of $27 million for the fiscal year ended September 30, 2018. The Company recognized non-cash share-based compensation expense of $70 million, free cash flow compensation expense of $30 million and dividend expense related to the equity units of $2 million for the fiscal year ended September 30, 2017. The Company recognized non-cash share-based compensation of $23 million for the fiscal year ended September 30, 2016. Of the $23 million, $13 million related to awards for employees and $10 million related to awards for non-employees for the fiscal year ended September 30, 2016.

In addition, at September 30, 2018, September 30, 2017 and September 30, 2016, the Company had approximately $18 million, $34 million and $2 million, respectively, of unrecognized compensation costs related to its unvested share awards. As of September 30, 2018, the remaining weighted average period over which total compensation related to unvested awards is expected to be recognized is 2 years.

 

 

10. Related Party Transactions

Management Agreement

Upon completion of the Merger, the Company and Holdings entered into a management agreement with Access, dated as of the Merger Closing Date (the “Management Agreement”), pursuant to which Access will provide the Company and its subsidiaries, with financial, investment banking, management, advisory and other services. Pursuant to the Management Agreement, the Company, or one or more of its subsidiaries, will pay Access a specified annual fee equal to a base amount of approximately $9 million or based on a formula contained in the agreement and reimburse Access for certain expenses incurred performing services under the agreement. The annual fee is payable quarterly. The Company and Holdings agreed to indemnify Access and certain of its affiliates against all liabilities arising out of performance of the Management Agreement.

Such costs incurred by the Company were approximately $16 million, $9 million and $9 million for the fiscal years ended September 30, 2018, September 30, 2017 and September 30, 2016, respectively, which includes the annual fee, but excludes $2 million of expenses reimbursed related to certain consultants with full time roles at the Company for the fiscal year ended September 30, 2016. Such amounts have been included as a component of selling, general and administrative expense in the accompanying statements of operations.

99


 

Lease Arrangements with Related Party

On July 29, 2014, AI Wrights Holdings Limited, an affiliate of Access, entered into a lease and related agreements with Warner/Chappell Music Limited and WMG Acquisition (UK) Limited, subsidiaries of the Company, for the lease of 27 Wrights Lane, Kensington, London.  The Company had been the tenant of the building, which Access acquired during the fiscal year 2014.  Subsequent to the change in ownership, the Company entered into the new lease arrangements.  Pursuant to the agreements, on January 1, 2015, the rent in the lease was increased to £3,460,250 per year, the term was extended for an additional five years from December 24, 2020 to December 24, 2025, with a market rate rent review that would begin December 25, 2020.  

On August 13, 2015, a subsidiary of the Company, Warner Music Inc., entered into a license agreement with Access Industries, Inc., an affiliate of Access, for the use of office space in our corporate headquarters at 1633 Broadway, New York, New York. The license fee of $2,775 per month, plus an IT support fee of $1,000 per month, was based on the per foot lease costs to the Company of its headquarters space, which represented market terms. For the fiscal year ended September 30, 2018, an immaterial amount was recorded as rental income. The space is occupied by The Blavatnik Archive, which is dedicated to the discovery and preservation of historically distinctive and visually compelling artifacts, images and stories that contribute to the study of 20th century Jewish, WWI and WWII history.  

On July 15, 2016, a subsidiary of the Company, Warner Music Inc., entered into a license agreement with Cooper Investment Partners LLC, for the use of office space in our corporate headquarters at 1633 Broadway, New York, New York. The license fee of $16,967.21 per month, was based on the per foot lease costs to the Company of its headquarters space, which represented market terms. For the fiscal year ended September 30, 2016, an immaterial amount was recorded as rental income. The space is occupied by Cooper Investment Partners LLC, which is a private equity fund that pursues a wide range of investment opportunities. Mr. Cooper, CEO and director of the Company, is the Managing Partner of Cooper Investment Partners LLC.

Deezer

Access owns a controlling equity interest in Deezer S.A., which was formerly known as Odyssey Music Group (“Odyssey”), a French company that controls and operates a digital music streaming service, formerly through Odyssey’s subsidiary, Blogmusik SAS (“Blogmusik”), under the name Deezer (“Deezer”), and is represented on Deezer S.A.’s Board of Directors. Subsidiaries of the Company, Warner Music Inc. and WEA International Inc. have been a party to license arrangements with Deezer since 2008 (Warner Music Inc. was added as a party to the license in 2014 in respect of the U.S.), which provide for the use of the Company’s sound recording content on Deezer’s ad-supported and subscription streaming services worldwide (excluding Japan) in exchange for fees paid by Deezer.  Warner Music Inc. and WEA International Inc. have also authorized Deezer to include Warner content in Deezer’s streaming services where such services are offered as a bundle with third-party services or products (e.g., telco services or hardware products), for which Deezer is also required to make payments to Warner Music Inc. and WEA International Inc. Deezer paid to WEA International Inc. an aggregate amount of approximately $39 million and $36 million in connection with the foregoing arrangements during the fiscal year ended September 30, 2018 and 2017, respectively. In addition, in connection with these arrangements, (i) the Company was issued, and currently holds, warrants to purchase shares of Deezer S.A. and (ii) the Company purchased a small number of shares of Deezer S.A., which collectively represent a small minority interest in Deezer S.A.  

Acquisition of Selected Assets of Songkick

As of July 12, 2017, we acquired selected assets from Songkick, including the concert discovery app and website and the Songkick trademark, for a purchase price of $5 million. Access owns a significant minority interest in the seller.

Investment in Tencent Music Entertainment Group 

On October 1, 2018, WMG China LLC (“WMG China”), an affiliate of the Company, entered into a share subscription agreement with Tencent Music Entertainment Group pursuant to which WMG China agreed to purchase 37,162,288 ordinary shares of Tencent Music Entertainment Group for $100 million.  WMG China is 80% owned by AI New Holdings 5 LLC, an affiliate of Access, and 20% owned by the Company. On October 3, 2018, WMG China acquired the shares pursuant to the share subscription agreement.

Loan Agreement with Max Lousada

On April 16, 2018, the Company loaned $227,000 to Mr. Lousada in exchange for a promissory note, all of which remains outstanding as of December 20, 2018.  Mr. Lousada must repay this loan upon the earliest of specified events, including April 30, 2019, termination of his employment, the event of a default (as specified therein) or if the Company or its affiliate becomes an issuer of publicly-traded stock.

 

100


 

 

11. Commitments and Contingencies

Leases

The Company occupies various facilities and uses certain equipment under operating leases. Net rent expense was approximately $80 million, $62 million and $60 million for the fiscal years ended September 30, 2018, September 30, 2017 and September 30, 2016, respectively.

At September 30, 2018, future minimum payments under non-cancelable operating leases are as follows:

 

 

 

Operating

 

Years

 

Leases

 

 

(in millions)

 

2019

 

$

56

 

2020

 

 

50

 

2021

 

 

47

 

2022

 

 

46

 

2023

 

 

45

 

Thereafter

 

 

245

 

Total

 

$

489

 

 

The future minimum payments reflect the amounts owed under lease arrangements and do not include any fair market value adjustments that may have been recorded as a result of the Merger.

Talent Advances

The Company routinely enters into long-term commitments with artists, songwriters and publishers for the future delivery of music product. Such commitments generally become due only upon delivery and Company acceptance of albums from the artists or future musical compositions by songwriters and publishers. Additionally, such commitments are typically cancelable at the Company’s discretion, generally without penalty. Based on contractual obligations and the Company’s expected release schedule, aggregate firm commitments to such talent approximated $340 million and $305 million as of September 30, 2018 and September 30, 2017, respectively.

Other

Other off-balance sheet, firm commitments, which primarily include minimum funding commitments to investees, amounted to approximately $4 million and $3 million at September 30, 2018 and September 30, 2017, respectively.

Litigation

Pricing of Digital Music Downloads

On December 20, 2005 and February 3, 2006, the Attorney General of the State of New York served the Company with requests for information in connection with an industry-wide investigation as to the pricing of digital music downloads. On February 28, 2006, the Antitrust Division of the U.S. Department of Justice served us with a Civil Investigative Demand, also seeking information relating to the pricing of digitally downloaded music. Both investigations were ultimately closed, but subsequent to the announcements of the investigations, more than thirty putative class action lawsuits were filed concerning the pricing of digital music downloads. The lawsuits were consolidated in the Southern District of New York. The consolidated amended complaint, filed on April 13, 2007, alleges conspiracy among record companies to delay the release of their content for digital distribution, inflate their pricing of CDs and fix prices for digital downloads. The complaint seeks unspecified compensatory, statutory and treble damages. On October 9, 2008, the District Court issued an order dismissing the case as to all defendants, including us. However, on January 13, 2010, the Second Circuit vacated the judgment of the District Court and remanded the case for further proceedings and on January 10, 2011, the U.S. Supreme Court denied the defendants’ petition for Certiorari.

Upon remand to the District Court, all defendants, including the Company, filed a renewed motion to dismiss challenging, among other things, plaintiffs’ state law claims and standing to bring certain claims. The renewed motion was based mainly on arguments made in defendants’ original motion to dismiss, but not addressed by the District Court. On July 18, 2011, the District Court granted defendants’ motion in part, and denied it in part. Notably, all claims on behalf of the CD-purchaser class were dismissed with prejudice. However, a wide variety of state and federal claims remain for the class of Internet download purchasers. On March 19, 2014, plaintiffs filed a motion for class certification. Plaintiffs filed an operative consolidated amended complaint on September 25,

101


 

2015. The Company filed its answer to the fourth amended complaint on October 9, 2015, and filed an amended answer on November 3, 2015. A mediation took place on February 22, 2016, but the parties were unable to reach a resolution. On July 18, 2017, the District Court denied plaintiffs’ motion for class certification. On August 1, 2017, plaintiffs filed a petition with the Second Circuit seeking permission to appeal the district court’s order denying class certification. On August 11, 2017, defendants filed their opposition to plaintiffs’ petition.  On December 8, 2017, the Second Circuit denied plaintiffs’ request for leave to appeal the District Court’s order denying their motion for class certification. On May 8, 2018, the parties filed a joint stipulation to voluntarily dismiss the case with prejudice, and on May 15, 2018, the District Court dismissed the case.

Sirius XM

On September 11, 2013, the Company joined with Capitol Records, LLC, Sony Music Entertainment, UMG Recordings, Inc. and ABKCO Music & Records, Inc. in a lawsuit brought in California Superior Court against Sirius XM Radio Inc., alleging copyright infringement for Sirius XM’s use of pre-1972 sound recordings under California law.  A nation-wide settlement was reached on June 17, 2015 pursuant to which Sirius XM paid the plaintiffs, in the aggregate, $210 million on July 29, 2015 and the plaintiffs dismissed their lawsuit with prejudice.  The settlement resolves all past claims as to Sirius XM’s use of pre-1972 recordings owned or controlled by the plaintiffs and enables Sirius XM, without any additional payment, to reproduce, perform and broadcast such recordings in the United States through December 31, 2017.  The allocation of the settlement proceeds among the plaintiffs was determined and the settlement proceeds were distributed accordingly. This resulted in a cash distribution to the Company of $33 million of which $28 million was recognized in revenue during the 2016 fiscal year and $4 million was recognized in revenue during the 2017 fiscal year. The balance of $1 million was recognized in the first quarter of the 2018 fiscal year. The Company is sharing its allocation of the settlement proceeds with its artists on the same basis as statutory revenue from Sirius XM is shared, i.e., the artist share of our allocation will be paid to artists by SoundExchange.

As part of the settlement, plaintiffs agreed to negotiate in good faith to grant Sirius XM a license to publicly perform the plaintiffs’ pre-1972 sound recordings for the five-year period running from January 1, 2018 to December 31, 2022.  Pursuant to the settlement, if the parties are unable to reach an agreement on license terms, the royalty rate for each license will be determined by binding arbitration on a willing buyer/willing seller standard.  On December 21, 2017, Sirius XM commenced a single arbitration against all of the plaintiffs in California through JAMS to determine the rate for the five-year period. On May 1, 2018, the Company filed a lawsuit against Sirius XM in New York state court to stay the California arbitration and to compel a separate arbitration in New York solely between Sirius XM and the Company. On August 23, 2018, the Company filed a stipulation of discontinuance without prejudice as to the state court action after Sirius XM agreed to participate in a separate arbitration with the Company in New York, which has not yet been scheduled.

Other Matters

In addition to the matter discussed above, the Company is involved in various litigation and regulatory proceedings arising in the normal course of business. Where it is determined, in consultation with counsel based on litigation and settlement risks, that a loss is probable and estimable in a given matter, the Company establishes an accrual. In the currently pending proceedings, the amount of accrual is not material. An estimate of the reasonably possible loss or range of loss in excess of the amounts already accrued cannot be made at this time due to various factors typical in contested proceedings, including (1) the results of ongoing discovery; (2) uncertain damage theories and demands; (3) a less than complete factual record; (4) uncertainty concerning legal theories and their resolution by courts or regulators; and (5) the unpredictable nature of the opposing party and its demands. However, the Company cannot predict with certainty the outcome of any litigation or the potential for future litigation. As such, the Company continuously monitors these proceedings as they develop and adjusts any accrual or disclosure as needed. Regardless of the outcome, litigation could have an adverse impact on the Company, including the Company’s brand value, because of defense costs, diversion of management resources and other factors and it could have a material effect on the Company’s results of operations for a given reporting period.

 

 

12. Derivative Financial Instruments

The Company uses derivative financial instruments, primarily foreign currency forward exchange contracts and interest rate swaps, for the purposes of managing foreign currency exchange rate risk and interest rate risk on expected future cash flows. However, the Company may choose not to hedge certain exposures for a variety of reasons including, but not limited to, accounting considerations and the prohibitive economic cost of hedging particular exposures. There can be no assurance the hedges will offset more than a portion of the financial impact resulting from movements in foreign currency exchange or interest rates.

The Company enters into foreign currency forward exchange contracts primarily to hedge the risk that unremitted or future royalties and license fees owed to its 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. The Company focuses on managing the level of exposure to the risk of foreign currency exchange rate fluctuations on its major currencies, which include the Euro, British pound sterling, Japanese yen, Canadian dollar, Swedish krona and Australian dollar. The foreign currency forward exchange contracts related to royalties are

102


 

designated and qualify as cash flow hedges under the criteria prescribed in ASC 815, Derivatives and Hedging. The Company records these contracts at fair value on its balance sheet and gains or losses on these contracts are deferred in equity (as a component of comprehensive loss). 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 the statement of operations.

The Company may at times choose to hedge foreign currency risk associated with financing transactions such as third-party debt and other balance sheet items. The foreign currency forward exchange contracts related to balance sheet items denominated in foreign currency are reviewed on a contract-by-contract basis and are designated accordingly. If these foreign currency forward exchange contracts do not qualify for hedge accounting, then the Company records these contracts at fair value on its balance sheet and the related gains and losses are immediately recognized in the statement of operations where there is an equal and offsetting entry related to the underlying exposure.

The Company has entered into, and in the future may enter into, interest rate swaps to manage interest rate risk. These instruments may offset a portion of changes in income or expense, or changes in fair value of the Company’s long-term debt. The interest rate swap instruments are designated and qualify as cash flow hedges under the criteria prescribed in ASC 815, Derivatives and Hedging. The Company records these contracts at fair value on its balance sheet and gains or losses on these contracts are deferred in equity (as a component of comprehensive loss).

The fair value of foreign currency forward exchange contracts is determined by using observable market transactions of spot and forward rates (i.e., Level 2 inputs) which is discussed further in Note 11. Additionally, netting provisions are provided for in existing International Swap and Derivative Association Inc. agreements in situations where the Company executes multiple contracts with the same counterparty. As a result, net assets or liabilities resulting from foreign exchange derivatives subject to these netting agreements are classified within other current assets or other current liabilities in the Company’s consolidated balance sheets.

The Company’s hedged interest rate transactions as of September 30, 2018 are expected to be recognized within 5 years. The fair value of interest rate swaps is based on dealer quotes of market rates (i.e., Level 2 inputs) which is discussed further in Note 15. Interest income or expense related to interest rate swaps is recognized in interest income, net in the same period as the related expense is recognized. The ineffective portions of interest rate swaps is recognized in other income/(expense), net in the period measured.

The Company monitors its positions with, and the credit quality of, the financial institutions that are party to any of its financial transactions.

As of September 30, 2018, the Company had no outstanding hedge contracts and no deferred gains or losses in comprehensive loss related to foreign exchange hedging. As of September 30, 2017, the Company had no outstanding hedge contracts and no deferred gains or losses in comprehensive loss related to foreign exchange hedging.

As of September 30, 2018, the Company had outstanding $320 million in pay-fixed receive-variable interest rate swaps with $3 million of unrealized deferred gains in comprehensive income related to the interest rate swap. As of September 30, 2017, the Company had no outstanding interest rate swaps and no deferred gains or losses in comprehensive income or losses related to interest rate swaps.

The pre-tax gains of the Company’s derivative interest rate swaps designated as cash flow hedges recorded in other comprehensive income and the Consolidated Statement of Comprehensive Income during the twelve months ended September 30, 2018 and September 30, 2017 were $4 million and $0 million, respectively.

The following is a summary of amounts recorded in the Consolidated Balance Sheet pertaining to the Company’s designated cash flows hedges at September 30, 2018 and September 30, 2017:

 

 

 

September 30,

 

 

September 30,

 

 

 

2018 (a)

 

 

2017

 

 

 

(in millions)

 

Other noncurrent assets

 

 

4

 

 

 

 

Other noncurrent liabilities

 

 

 

 

 

 

 

(a)

$4 million of interest rate swap in an asset position.

 

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13. Segment Information

As discussed more fully in Note 1, based on the nature of its products and services, the Company classifies its business interests into two fundamental operations: Recorded Music and Music Publishing, which also represent the reportable segments of the Company. Information as to each of these operations is set forth below. The Company evaluates performance based on several factors, of which the primary financial measure is operating income (loss) before non-cash depreciation of tangible assets and non-cash amortization of intangible assets (“OIBDA”). The Company has supplemented its analysis of OIBDA results by segment with an analysis of operating income (loss) by segment.

The accounting policies of the Company’s business segments are the same as those described in the summary of significant accounting policies included elsewhere herein. The Company accounts for intersegment sales at fair value as if the sales were to third parties. While intercompany transactions are treated like third-party transactions to determine segment performance, the revenues (and corresponding expenses recognized by the segment that is counterparty to the transaction) are eliminated in consolidation, and therefore, do not themselves impact consolidated results.

 

 

 

 

 

 

 

 

 

 

 

Corporate

 

 

 

 

 

 

 

Recorded

 

 

Music

 

 

expenses and

 

 

 

 

 

 

 

Music

 

 

Publishing

 

 

eliminations

 

 

Total

 

 

 

(in millions)

 

2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

3,360

 

 

$

653

 

 

$

(8

)

 

$

4,005

 

Operating income (loss)

 

 

307

 

 

 

84

 

 

 

(174

)

 

 

217

 

Amortization of intangible assets

 

 

138

 

 

 

68

 

 

 

 

 

 

206

 

Depreciation of property, plant and equipment

 

 

35

 

 

 

7

 

 

 

13

 

 

 

55

 

OIBDA

 

 

480

 

 

 

159

 

 

 

(161

)

 

 

478

 

Total assets

 

 

1,999

 

 

 

2,423

 

 

 

922

 

 

 

5,344

 

Capital expenditures

 

 

20

 

 

 

3

 

 

 

51

 

 

 

74

 

2017

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

3,020

 

 

$

572

 

 

$

(16

)

 

$

3,576

 

Operating income (loss)

 

 

283

 

 

 

81

 

 

 

(142

)

 

 

222

 

Amortization of intangible assets

 

 

136

 

 

 

65

 

 

 

 

 

 

201

 

Depreciation of property, plant and equipment

 

 

32

 

 

 

6

 

 

 

12

 

 

 

50

 

OIBDA

 

 

451

 

 

 

152

 

 

 

(130

)

 

 

473

 

Total assets

 

 

2,085

 

 

 

2,510

 

 

 

1,123

 

 

 

5,718

 

Capital expenditures

 

 

21

 

 

 

5

 

 

 

18

 

 

 

44

 

2016

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

2,736

 

 

$

524

 

 

$

(14

)

 

$

3,246

 

Operating income (loss)

 

 

247

 

 

 

68

 

 

 

(101

)

 

 

214

 

Amortization of intangible assets

 

 

180

 

 

 

63

 

 

 

 

 

 

243

 

Depreciation of property, plant and equipment

 

 

32

 

 

 

7

 

 

 

11

 

 

 

50

 

OIBDA

 

 

459

 

 

 

138

 

 

 

(90

)

 

 

507

 

Capital expenditures

 

 

18

 

 

 

7

 

 

 

17

 

 

 

42

 

 

Revenues relating to operations in different geographical areas are set forth below for the fiscal years ended September 30, 2018, September 30, 2017 and September 30, 2016. Total assets relating to operations in different geographical areas are set forth below as of September 30, 2018 and September 30, 2017.

 

 

 

2018

 

 

2017

 

 

2016

 

 

 

 

 

 

 

Long-lived

 

 

 

 

 

 

Long-lived

 

 

 

 

 

 

 

Revenue

 

 

Assets

 

 

Revenue

 

 

Assets

 

 

Revenue

 

 

 

(in millions)

 

United States

 

$

1,754

 

 

$

156

 

 

$

1,587

 

 

$

139

 

 

$

1,360

 

United Kingdom

 

 

593

 

 

 

23

 

 

 

522

 

 

 

26

 

 

 

491

 

All other territories

 

 

1,658

 

 

 

50

 

 

 

1,467

 

 

 

48

 

 

 

1,395

 

Total

 

$

4,005

 

 

$

229

 

 

$

3,576

 

 

$

213

 

 

$

3,246

 

 

104


 

Customer Concentration

In the fiscal year ended September 30, 2018, the Company had two customers that individually represented 10% or more of total revenues, whereby one customer represented 15%, and the other represented 14% of total revenues. In the fiscal years ended September 30, 2017 and September 30, 2016, one customer represented 14% of total revenues in each year. These customers’ revenues are included in both the Recorded Music and Music Publishing segments.

 

14. Additional Financial Information

Cash Interest and Taxes

The Company made interest payments of approximately $148 million, $138 million and $181 million during the fiscal years ended September 30, 2018, September 30, 2017 and September 30, 2016, respectively. The Company paid approximately $49 million, $40 million and $41 million of foreign income and withholding taxes, net of refunds, for the fiscal years ended September 30, 2018, September 30, 2017 and September 30, 2016, respectively.

Special Cash Dividends

On December 2, 2016, the Company’s Board of Directors approved a special cash dividend of $54 million which was paid on January 3, 2017 to stockholders of record as of December 30, 2016.

On June 5, 2017, the Company’s Board of Directors approved a special cash dividend of $30 million which was paid on July 31, 2017 to stockholders of record as of June 30, 2017.

On January 8, 2018, the Company’s Board of Directors approved a special cash dividend of $125 million which was paid on January 12, 2018 to stockholders of record as of January 11, 2018.

On May 7, 2018, the Company’s Board of Directors approved a special cash dividend of $300 million which was paid on May 11, 2018 to stockholders of record as of May 7, 2018.

On August 7, 2018, the Company’s Board of Directors approved a special cash dividend of $500 million which was paid on August 10, 2018 to stockholders of record as of August 7, 2018.

Our ability to pay dividends is restricted by covenants in the indentures governing our notes and in the credit agreements for our Senior Term Loan Facility and the Revolving Credit Facility.

The Company intends to institute a regular quarterly dividend whereby it would intend to pay modest regular quarterly dividends in each fiscal quarter and a variable dividend for the fourth fiscal quarter in an amount commensurate with cash expected to be generated from operations in such fiscal year, in each case, after taking into account other potential uses for cash, including acquisitions, investment in our business and repayment of indebtedness.  The Company expects to pay the first dividend under this policy in the second quarter of fiscal 2019.  The declaration of each dividend will continue to be at the discretion of the Board.

 

Spotify Share Sale

The Company sold all of its shares of common stock in Spotify Technology S.A. (“Spotify”) for cash proceeds of $504 million during the fiscal year ended September 30, 2018. In February 2016, the Company publicly announced that it would pay royalties in connection with these proceeds. The sale of shares resulted in an estimated pre-tax gain, net of the estimated royalty expense and other related costs, of $382 million, which has been recorded as other income (expense). As of September 30, 2018, the estimated royalty expense and other related costs have been accrued, and have largely been paid at September 30, 2018. The Company has calculated the advance recoveries to be $12 million, and has recorded these advance recoveries as a credit within operating expense in the twelve months ended September 30, 2018. The Company also recorded estimated tax expense of $77 million associated with the net income on the sale of shares in fiscal year ended September 30, 2018.

Additionally, the cash proceeds received in connection with the sale of shares have been reflected as an investing activity on the statement of cash flows within proceeds from the sale of investments. 

 

 

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15. Fair Value Measurements

ASC 820 defines fair value as the price that would be received upon sale of an asset or paid upon transfer of a liability in an orderly transaction between market participants at the measurement date and in the principal or most advantageous market for that asset or liability. The fair value should be calculated based on assumptions that market participants would use in pricing the asset or liability, not on assumptions specific to the entity.

In addition to defining fair value, ASC 820 expands the disclosure requirements around fair value and establishes a fair value hierarchy for valuation inputs. The hierarchy prioritizes the inputs into three levels based on the extent to which inputs used in measuring fair value are observable in the market. Each fair value measurement is reported in one of the three levels which is determined by the lowest level input that is significant to the fair value measurement in its entirety. These levels are:

 

Level 1—inputs are based upon unadjusted quoted prices for identical instruments traded in active markets.

 

Level 2—inputs are based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-based valuation techniques for which all significant assumptions are observable in the market or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

 

Level 3—inputs are generally unobservable and typically reflect management’s estimates of assumptions that market participants would use in pricing the asset or liability. The fair values are therefore determined using model-based techniques that include option pricing models, discounted cash flow models and similar techniques.

In accordance with the fair value hierarchy, described above, the following table shows the fair value of the Company’s financial instruments that are required to be measured at fair value as of September 30, 2018 and September 30, 2017.

 

 

 

Fair Value Measurements as of  September 30, 2018

 

 

 

(Level 1)

 

 

(Level 2)

 

 

(Level 3)

 

 

Total

 

 

 

(in millions)

 

Other Current Liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Contractual Obligations (a)

 

 

 

 

 

 

 

 

(2

)

 

 

(2

)

Other Non-Current Assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest Rate Swap (b)

 

 

 

 

 

4

 

 

 

 

 

 

4

 

Other Non-Current Liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Contractual Obligations (a)

 

 

 

 

 

 

 

 

(6

)

 

 

(6

)

Interest Rate Swap (b)

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

 

 

$

4

 

 

$

(8

)

 

$

(4

)

 

 

 

Fair Value Measurements as of  September 30, 2017

 

 

 

(Level 1)

 

 

(Level 2)

 

 

(Level 3)

 

 

Total

 

 

 

(in millions)

 

Other Current Liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Contractual Obligations (a)

 

 

 

 

 

 

 

 

 

 

 

 

Other Non-Current Liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Contractual Obligations (a)

 

 

 

 

 

 

 

 

(5

)

 

 

(5

)

Total

 

$

 

 

$

 

 

$

(5

)

 

$

(5

)

 

(a)

This represents purchase obligations and contingent consideration related to the Company’s various acquisitions. This is based on a probability weighted performance approach and it is adjusted to fair value on a recurring basis and any adjustments are included as a component of operating income in the statement of operations. These amounts were mainly calculated using unobservable inputs such as future earnings performance of the Company’s various acquisitions and the expected timing of the payment.

(b)

The fair value of the interest rate swap is based on dealer quotes of market forward rates and reflects the amount that the Company would receive or pay as of September 30, 2018 for contracts involving the same attributes and maturity dates.

106


 

The following table reconciles the beginning and ending balances of net assets and liabilities classified as Level 3:

 

 

 

Total

 

 

 

(in millions)

 

Balance at September 30, 2017

 

$

(5

)

Additions

 

 

(3

)

Reductions

 

 

 

Payments

 

 

 

Balance at September 30, 2018

 

$

(8

)

 

The majority of the Company’s non-financial instruments, which include goodwill, intangible assets, inventories, and property, plant, and equipment, are not required to be re-measured to fair value on a recurring basis. These assets are evaluated for impairment if certain triggering events occur. If such evaluation indicates that impairment exists, the asset is written down to its fair value. In addition, an impairment analysis is performed at least annually for goodwill and indefinite-lived intangible assets.

Fair Value of Debt

Based on the level of interest rates prevailing at September 30, 2018, the fair value of the Company’s debt was $2.862 billion. Based on the level of interest rates prevailing at September 30, 2017, the fair value of the Company’s debt was $2.936 billion. The fair value of the Company’s debt instruments are determined using quoted market prices from less active markets or by using quoted market prices for instruments with identical terms and maturities; both approaches are considered a Level 2 measurement.

 

 

16. Subsequent Events

E.M.P. Acquisition

On October 10, 2018, the Company acquired certain shares of E.M.P Merchandising Handelsgesellschaft mbH (“EMP Merchandising”), all of the share capital of MIG Merchandising Investment GmbH (“MIG”), certain shares of Large Popmerchandising BVBA (“Large”), and each of EMP Merchandising and MIG’s direct and indirect subsidiaries (collectively referred to as “EMP” or the “Acquired Companies”). EMP is a leading European music and entertainment e-tailer. The cash consideration paid at closing was approximately €166 million, which reflects an agreed enterprise value of the Acquired Companies of approximately €155 million (equivalent to approximately $180 million), as adjusted for, among other items, net debt and working capital of the Acquired Companies.   

3.625% Secured Notes Offering

On October 9, 2018, Acquisition Corp. issued and sold €250 million in aggregate principal amount of 3.625% Senior Secured Notes due 2026 (the “3.625% Secured Notes”).  Net proceeds of the offering were used to pay the purchase price of the previously announced acquisition of E.M.P Merchandising and to redeem €34.5 million of the 4.125% Secured Notes (as described above), and the remaining proceeds were used, or will be used, for general corporate purposes including open market purchases of a portion of our outstanding 4.875% Secured Notes and the partial redemption of the 5.625% Secured Notes. 

Open Market Purchases

On October 9, 2018, Acquisition Corp. purchased, in the open market, $30 million aggregate principal amount of its outstanding 4.875% Senior Secured Notes due 2024 (the “4.875% Secured Notes”).  The acquired notes were subsequently retired.  Following retirement of the acquired notes, $220 million of the 4.875% Secured Notes remain outstanding.

Partial Redemption of 4.125% Secured Notes

On October 12, 2018, Acquisition Corp. redeemed €34.5 million aggregate principal amount of its 4.125% Senior Secured Notes due 2024 (the “4.125% Secured Notes”) using a portion of the proceeds from the offering of 3.625% Secured Notes described below.  The redemption price for the 4.125% Secured Notes was approximately €36.17 million, equivalent to 103% of the principal amount of the 4.125% Secured Notes, plus accrued but unpaid interest thereon to, but excluding, the redemption date, which was October 12, 2018. Following the partial redemption of the 4.125% Secured Notes, €310.5 million of the 4.125% Secured Notes remain outstanding. 

Partial Redemption of 5.625% Secured Notes

On November 5, 2018, Acquisition Corp. redeemed $26.55 million aggregate principal amount of its 5.625% Senior Secured Notes due 2022 (the “5.625% Secured Notes”).  The redemption price for the 5.625% Secured Notes was approximately $27 million, equivalent to 102.813% of the principal amount of the 5.625% Secured Notes, plus accrued but unpaid interest thereon to, but excluding, the redemption date, which was November 5, 2018. Following the partial redemption of the 5.625% Secured Notes, $220.95 million of the 5.625% Secured Notes remain outstanding.

107


 

WARNER MUSIC GROUP CORP.

2018 QUARTERLY FINANCIAL INFORMATION

(unaudited)

The following table sets forth the quarterly information for Warner Music Group Corp.

 

 

 

Three months ended

 

 

 

September 30,

 

 

June 30,

 

 

March 31,

 

 

December 31,

 

 

 

2018

 

 

2018

 

 

2018

 

 

2017

 

 

(in millions)

 

Revenues

 

$

1,039

 

 

$

958

 

 

$

963

 

 

$

1,045

 

Costs and expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of revenue

 

 

(583

)

 

 

(531

)

 

 

(488

)

 

 

(569

)

Selling, general and administrative expenses (a)

 

 

(398

)

 

 

(343

)

 

 

(337

)

 

 

(333

)

Amortization expense

 

 

(42

)

 

 

(56

)

 

 

(55

)

 

 

(53

)

Total costs and expenses

 

 

(1,023

)

 

 

(930

)

 

 

(880

)

 

 

(955

)

Operating income

 

 

16

 

 

 

28

 

 

 

83

 

 

 

90

 

Loss on extinguishment of debt

 

 

 

 

 

(7

)

 

 

(23

)

 

 

(1

)

Interest expense, net

 

 

(33

)

 

 

(33

)

 

 

(36

)

 

 

(36

)

Other (expense) income

 

 

2

 

 

 

394

 

 

 

(6

)

 

 

4

 

(Loss) income before income taxes

 

 

(15

)

 

 

382

 

 

 

18

 

 

 

57

 

Income tax (expense) benefit

 

 

2

 

 

 

(61

)

 

 

(19

)

 

 

(52

)

Net (loss) income

 

 

(13

)

 

 

321

 

 

 

(1

)

 

 

5

 

Less: income attributable to noncontrolling interest

 

 

(1

)

 

 

(1

)

 

 

(2

)

 

 

(1

)

Net (loss) income attributable to Warner Music Group Corp.

 

$

(14

)

 

$

320

 

 

$

(3

)

 

$

4

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(a) Includes depreciation expense of:

 

$

(14

)

 

$

(15

)

 

$

(14

)

 

$

(12

)

 

Quarterly operating results can be disproportionately affected by a particularly strong or weak quarter. Therefore, these quarterly operating results are not necessarily indicative of the results that may be expected for the full fiscal year.

 

 

 

108


 

WARNER MUSIC GROUP CORP.

2017 QUARTERLY FINANCIAL INFORMATION

(unaudited)

The following table sets forth the quarterly information for Warner Music Group Corp.

 

 

 

Three months ended

 

 

 

September 30,

 

 

June 30,

 

 

March 31,

 

 

December 31,

 

 

 

2017

 

 

2017

 

 

2017

 

 

2016

 

 

(in millions)

 

Revenues

 

$

917

 

 

$

917

 

 

$

825

 

 

$

917

 

Costs and expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of revenue

 

 

(501

)

 

 

(519

)

 

 

(415

)

 

 

(496

)

Selling, general and administrative expenses (a)

 

 

(368

)

 

 

(296

)

 

 

(282

)

 

 

(276

)

Amortization expense

 

 

(49

)

 

 

(51

)

 

 

(50

)

 

 

(51

)

Total costs and expenses

 

 

(918

)

 

 

(866

)

 

 

(747

)

 

 

(823

)

Operating income

 

 

(1

)

 

 

51

 

 

 

78

 

 

 

94

 

Loss on extinguishment of debt

 

 

 

 

 

(3

)

 

 

 

 

 

(32

)

Interest expense, net

 

 

(37

)

 

 

(36

)

 

 

(36

)

 

 

(40

)

Other (expense) income

 

 

(19

)

 

 

(21

)

 

 

(19

)

 

 

19

 

(Loss) income before income taxes

 

 

(57

)

 

 

(9

)

 

 

23

 

 

 

41

 

Income tax benefit (expense)

 

 

19

 

 

 

152

 

 

 

(3

)

 

 

(17

)

Net (loss) income

 

 

(38

)

 

 

143

 

 

 

20

 

 

 

24

 

Less: income attributable to noncontrolling interest

 

 

(1

)

 

 

(2

)

 

 

(1

)

 

 

(2

)

Net (loss) income attributable to Warner Music Group Corp.

 

$

(39

)

 

$

141

 

 

$

19

 

 

$

22

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(a) Includes depreciation expense of:

 

$

(12

)

 

$

(13

)

 

$

(13

)

 

$

(12

)

 

Quarterly operating results can be disproportionately affected by a particularly strong or weak quarter. Therefore, these quarterly operating results are not necessarily indicative of the results that may be expected for the full fiscal year.

 

 

 

109


 

WARNER MUSIC GROUP CORP.

Supplementary Information

Consolidating Financial Statements

The Company is the direct parent of Holdings, which is the direct parent of Acquisition Corp. As of September 30, 2018 Acquisition Corp. had issued and outstanding the 5.625% Senior Secured Notes due 2022, the 5.00% Senior Secured Notes due 2023, the 4.125% Senior Secured Notes due 2024, the 4.875% Senior Secured Notes due 2024, and the 5.50% Senior Notes due 2026 (together, the “Acquisition Corp. Notes”).

The Acquisition Corp. Notes are guaranteed by the Company and, in addition, are guaranteed by all of Acquisition Corp.’s domestic wholly-owned subsidiaries. The secured notes are guaranteed on a senior secured basis and the unsecured notes are guaranteed on an unsecured senior basis. The Company’s guarantee of the Acquisition Corp. Notes is full and unconditional.  The guarantee of the Acquisition Corp. Notes by Acquisition Corp.’s domestic, wholly-owned subsidiaries is full, unconditional and joint and several. The following condensed consolidating financial statements are also presented for the information of the holders of the Acquisition Corp. Notes and present the results of operations, financial position and cash flows of (i) Acquisition Corp., which is the issuer of the Acquisition Corp. Notes, (ii) the guarantor subsidiaries of Acquisition Corp., (iii) the non-guarantor subsidiaries of Acquisition Corp. and (iv) the eliminations necessary to arrive at the information for Acquisition Corp. on a consolidated basis. Investments in consolidated subsidiaries are presented under the equity method of accounting. There are no restrictions on Acquisition Corp.’s ability to obtain funds from any of its wholly-owned subsidiaries through dividends, loans or advances.

The Company and Holdings are holding companies that conduct substantially all of their business operations through Acquisition Corp. Accordingly, the ability of the Company and Holdings to obtain funds from their subsidiaries is restricted by the indentures for the Acquisition Corp. Notes and the credit agreements for the Acquisition Corp. Senior Credit Facilities, including the Revolving Credit Facility and Senior Term Loan Facility.

 

 

 

110


 

Consolidating Balance Sheet

September 30, 2018

 

 

WMG

 

 

 

 

 

 

 

 

 

 

 

 

 

 

WMG

 

 

WMG

 

 

Warner

 

 

 

 

 

 

Warner

 

 

Acquisition

 

 

 

 

 

 

Non-

 

 

 

 

 

 

Acquisition

 

 

Holdings

 

 

Music

 

 

 

 

 

 

Music

 

 

Corp.

 

 

Guarantor

 

 

Guarantor

 

 

 

 

 

 

Corp.

 

 

Corp.

 

 

Group

 

 

 

 

 

 

Group Corp.

 

 

(issuer)

 

 

Subsidiaries

 

 

Subsidiaries

 

 

Eliminations

 

 

Consolidated

 

 

(issuer)

 

 

Corp.

 

 

Eliminations

 

 

Consolidated

 

 

(in millions)

 

Assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and equivalents

$

 

 

$

169

 

 

$

345

 

 

$

 

 

$

514

 

 

$

 

 

$

 

 

$

 

 

$

514

 

Accounts receivable, net

 

 

 

 

262

 

 

 

185

 

 

 

 

 

 

447

 

 

 

 

 

 

 

 

 

 

 

 

447

 

Inventories

 

 

 

 

18

 

 

 

24

 

 

 

 

 

 

42

 

 

 

 

 

 

 

 

 

 

 

 

42

 

Royalty advances expected to be recouped within one year

 

 

 

 

79

 

 

 

44

 

 

 

 

 

 

123

 

 

 

 

 

 

 

 

 

 

 

 

123

 

Prepaid and other current assets

 

 

 

 

15

 

 

 

35

 

 

 

 

 

 

50

 

 

 

 

 

 

 

 

 

 

 

 

50

 

Total current assets

 

 

 

 

543

 

 

 

633

 

 

 

 

 

 

1,176

 

 

 

 

 

 

 

 

 

 

 

 

1,176

 

Due from (to) parent companies

 

488

 

 

 

(214

)

 

 

(274

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investments in and advances to consolidated subsidiaries

 

2,018

 

 

 

2,192

 

 

 

 

 

 

(4,210

)

 

 

 

 

 

675

 

 

 

675

 

 

 

(1,350

)

 

 

 

Royalty advances expected to be recouped after one year

 

 

 

 

93

 

 

 

60

 

 

 

 

 

 

153

 

 

 

 

 

 

 

 

 

 

 

 

153

 

Property, plant and equipment, net

 

 

 

 

155

 

 

 

74

 

 

 

 

 

 

229

 

 

 

 

 

 

 

 

 

 

 

 

229

 

Goodwill

 

 

 

 

1,370

 

 

 

322

 

 

 

 

 

 

1,692

 

 

 

 

 

 

 

 

 

 

 

 

1,692

 

Intangible assets subject to amortization, net

 

 

 

 

956

 

 

 

895

 

 

 

 

 

 

1,851

 

 

 

 

 

 

 

 

 

 

 

 

1,851

 

Intangible assets not subject to amortization

 

 

 

 

71

 

 

 

83

 

 

 

 

 

 

154

 

 

 

 

 

 

 

 

 

 

 

 

154

 

Deferred tax assets, net

 

 

 

 

 

 

 

11

 

 

 

 

 

 

11

 

 

 

 

 

 

 

 

 

 

 

 

11

 

Other assets

 

12

 

 

 

55

 

 

 

11

 

 

 

 

 

 

78

 

 

 

 

 

 

 

 

 

 

 

 

78

 

Total assets

$

2,518

 

 

$

5,221

 

 

$

1,815

 

 

$

(4,210

)

 

$

5,344

 

 

$

675

 

 

$

675

 

 

$

(1,350

)

 

$

5,344

 

Liabilities and Deficit:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accounts payable

$

 

 

$

200

 

 

$

81

 

 

$

 

 

$

281

 

 

$

 

 

$

 

 

$

 

 

$

281

 

Accrued royalties

 

 

 

 

869

 

 

 

527

 

 

 

 

 

 

1,396

 

 

 

 

 

 

 

 

 

 

 

 

1,396

 

Accrued liabilities

 

 

 

 

195

 

 

 

228

 

 

 

 

 

 

423

 

 

 

 

 

 

 

 

 

 

 

 

423

 

Accrued interest

 

31

 

 

 

 

 

 

 

 

 

 

 

 

31

 

 

 

 

 

 

 

 

 

 

 

 

31

 

Deferred revenue

 

 

 

 

94

 

 

 

114

 

 

 

 

 

 

208

 

 

 

 

 

 

 

 

 

 

 

 

208

 

Other current liabilities

 

 

 

 

2

 

 

 

32

 

 

 

 

 

 

34

 

 

 

 

 

 

 

 

 

 

 

 

34

 

Total current liabilities

 

31

 

 

 

1,360

 

 

 

982

 

 

 

 

 

 

2,373

 

 

 

 

 

 

 

 

 

 

 

 

2,373

 

Long-term debt

 

2,819

 

 

 

 

 

 

 

 

 

 

 

 

2,819

 

 

 

 

 

 

 

 

 

 

 

 

2,819

 

Deferred tax liabilities, net

 

 

 

 

3

 

 

 

162

 

 

 

 

 

 

165

 

 

 

 

 

 

 

 

 

 

 

 

165

 

Other noncurrent liabilities

 

2

 

 

 

197

 

 

 

108

 

 

 

 

 

 

307

 

 

 

 

 

 

 

 

 

 

 

 

307

 

Total liabilities

 

2,852

 

 

 

1,560

 

 

 

1,252

 

 

 

 

 

 

5,664

 

 

 

 

 

 

 

 

 

 

 

 

5,664

 

Total Warner Music Group Corp. equity

 

(334

)

 

 

3,656

 

 

 

554

 

 

 

(4,210

)

 

 

(334

)

 

 

675

 

 

 

675

 

 

 

(1,350

)

 

 

(334

)

Noncontrolling interest

 

 

 

 

5

 

 

 

9

 

 

 

 

 

 

14

 

 

 

 

 

 

 

 

 

 

 

 

14

 

Total equity

 

(334

)

 

 

3,661

 

 

 

563

 

 

 

(4,210

)

 

 

(320

)

 

 

675

 

 

 

675

 

 

 

(1,350

)

 

 

(320

)

Total liabilities and equity

$

2,518

 

 

$

5,221

 

 

$

1,815

 

 

$

(4,210

)

 

$

5,344

 

 

$

675

 

 

$

675

 

 

$

(1,350

)

 

$

5,344

 

 

 

111


 

Consolidating Balance Sheet

September 30, 2017

 

 

WMG

 

 

 

 

 

 

 

 

 

 

 

 

 

 

WMG

 

 

WMG

 

 

Warner

 

 

 

 

 

 

Warner

 

 

Acquisition

 

 

 

 

 

 

Non-

 

 

 

 

 

 

Acquisition

 

 

Holdings

 

 

Music

 

 

 

 

 

 

Music

 

 

Corp.

 

 

Guarantor

 

 

Guarantor

 

 

 

 

 

 

Corp.

 

 

Corp.

 

 

Group

 

 

 

 

 

 

Group Corp.

 

 

(issuer)

 

 

Subsidiaries

 

 

Subsidiaries

 

 

Eliminations

 

 

Consolidated

 

 

(issuer)

 

 

Corp.

 

 

Eliminations

 

 

Consolidated

 

 

(in millions)

 

Assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and equivalents

$

 

 

$

347

 

 

$

300

 

 

$

 

 

$

647

 

 

$

 

 

$

 

 

$

 

 

$

647

 

Accounts receivable, net

 

 

 

 

214

 

 

 

190

 

 

 

 

 

 

404

 

 

 

 

 

 

 

 

 

 

 

 

404

 

Inventories

 

 

 

 

12

 

 

 

27

 

 

 

 

 

 

39

 

 

 

 

 

 

 

 

 

 

 

 

39

 

Royalty advances expected to be recouped within one year

 

 

 

 

89

 

 

 

52

 

 

 

 

 

 

141

 

 

 

 

 

 

 

 

 

 

 

 

141

 

Prepaid and other current assets

 

 

 

 

15

 

 

 

29

 

 

 

 

 

 

44

 

 

 

 

 

 

 

 

 

 

 

 

44

 

Total current assets

 

 

 

 

677

 

 

 

598

 

 

 

 

 

 

1,275

 

 

 

 

 

 

 

 

 

 

 

 

1,275

 

Due from (to) parent companies

 

418

 

 

 

96

 

 

 

(514

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investments in and advances to consolidated subsidiaries

 

2,721

 

 

 

1,312

 

 

 

 

 

 

(4,033

)

 

 

 

 

 

377

 

 

 

377

 

 

 

(754

)

 

 

 

Royalty advances expected to be recouped after one year

 

 

 

 

109

 

 

 

63

 

 

 

 

 

 

172

 

 

 

 

 

 

 

 

 

 

 

 

172

 

Property, plant and equipment, net

 

 

 

 

139

 

 

 

74

 

 

 

 

 

 

213

 

 

 

 

 

 

 

 

 

 

 

 

213

 

Goodwill

 

 

 

 

1,368

 

 

 

317

 

 

 

 

 

 

1,685

 

 

 

 

 

 

 

 

 

 

 

 

1,685

 

Intangible assets subject to amortization, net

 

 

 

 

1,029

 

 

 

1,061

 

 

 

 

 

 

2,090

 

 

 

 

 

 

 

 

 

 

 

 

2,090

 

Intangible assets not subject to amortization

 

 

 

 

71

 

 

 

46

 

 

 

 

 

 

117

 

 

 

 

 

 

 

 

 

 

 

 

117

 

Deferred tax assets, net

 

 

 

 

89

 

 

 

8

 

 

 

 

 

 

97

 

 

 

 

 

 

 

 

 

 

 

 

97

 

Other assets

 

7

 

 

 

45

 

 

 

17

 

 

 

 

 

 

69

 

 

 

 

 

 

 

 

 

 

 

 

69

 

Total assets

$

3,146

 

 

$

4,935

 

 

$

1,670

 

 

$

(4,033

)

 

$

5,718

 

 

$

377

 

 

$

377

 

 

$

(754

)

 

$

5,718

 

Liabilities and Deficit:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accounts payable

$

 

 

$

135

 

 

$

73

 

 

$

 

 

$

208

 

 

$

 

 

$

 

 

$

 

 

$

208

 

Accrued royalties

 

 

 

 

732

 

 

 

531

 

 

 

 

 

 

1,263

 

 

 

 

 

 

 

 

 

 

 

 

1,263

 

Accrued liabilities

 

 

 

 

144

 

 

 

221

 

 

 

 

 

 

365

 

 

 

 

 

 

 

 

 

 

 

 

365

 

Accrued interest

 

41

 

 

 

 

 

 

 

 

 

 

 

 

41

 

 

 

 

 

 

 

 

 

 

 

 

41

 

Deferred revenue

 

 

 

 

125

 

 

 

72

 

 

 

 

 

 

197

 

 

 

 

 

 

 

 

 

 

 

 

197

 

Other current liabilities

 

 

 

 

3

 

 

 

23

 

 

 

 

 

 

26

 

 

 

 

 

 

 

 

 

 

 

 

26

 

Total current liabilities

 

41

 

 

 

1,139

 

 

 

920

 

 

 

 

 

 

2,100

 

 

 

 

 

 

 

 

 

 

 

 

2,100

 

Long-term debt

 

2,811

 

 

 

 

 

 

 

 

 

 

 

 

2,811

 

 

 

 

 

 

 

 

 

 

 

 

2,811

 

Deferred tax liabilities, net

 

 

 

 

 

 

 

190

 

 

 

 

 

 

190

 

 

 

 

 

 

 

 

 

 

 

 

190

 

Other noncurrent liabilities

 

1

 

 

 

196

 

 

 

112

 

 

 

 

 

 

309

 

 

 

 

 

 

 

 

 

 

 

 

309

 

Total liabilities

 

2,853

 

 

 

1,335

 

 

 

1,222

 

 

 

 

 

 

5,410

 

 

 

 

 

 

 

 

 

 

 

 

5,410

 

Total Warner Music Group Corp. equity

 

293

 

 

 

3,596

 

 

 

437

 

 

 

(4,033

)

 

 

293

 

 

 

377

 

 

 

377

 

 

 

(754

)

 

 

293

 

Noncontrolling interest

 

 

 

 

4

 

 

 

11

 

 

 

 

 

 

15

 

 

 

 

 

 

 

 

 

 

 

 

15

 

Total equity

 

293

 

 

 

3,600

 

 

 

448

 

 

 

(4,033

)

 

 

308

 

 

 

377

 

 

 

377

 

 

 

(754

)

 

 

308

 

Total liabilities and equity

$

3,146

 

 

$

4,935

 

 

$

1,670

 

 

$

(4,033

)

 

$

5,718

 

 

$

377

 

 

$

377

 

 

$

(754

)

 

$

5,718

 

 

112


 

Consolidating Statement of Operations

For The Fiscal Year Ended September 30, 2018

 

 

WMG

 

 

 

 

 

 

 

 

 

 

 

 

 

 

WMG

 

 

WMG

 

 

Warner

 

 

 

 

 

 

Warner

 

 

Acquisition

 

 

 

 

 

 

Non-

 

 

 

 

 

 

Acquisition

 

 

Holdings

 

 

Music

 

 

 

 

 

 

Music

 

 

Corp.

 

 

Guarantor

 

 

Guarantor

 

 

 

 

 

 

Corp.

 

 

Corp.

 

 

Group

 

 

 

 

 

 

Group Corp.

 

 

(issuer)

 

 

Subsidiaries

 

 

Subsidiaries

 

 

Eliminations

 

 

Consolidated

 

 

(issuer)

 

 

Corp.

 

 

Eliminations

 

 

Consolidated

 

 

(in millions)

 

Revenues

$

 

 

$

2,284

 

 

$

2,245

 

 

$

(524

)

 

$

4,005

 

 

$

 

 

$

 

 

$

 

 

$

4,005

 

Costs and expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of revenue

 

 

 

 

(1,090

)

 

 

(1,442

)

 

 

361

 

 

 

(2,171

)

 

 

 

 

 

 

 

 

 

 

 

(2,171

)

Selling, general and administrative expenses

 

 

 

 

(1,040

)

 

 

(534

)

 

 

163

 

 

 

(1,411

)

 

 

 

 

 

 

 

 

 

 

 

(1,411

)

Amortization of intangible assets

 

 

 

 

(96

)

 

 

(110

)

 

 

 

 

 

(206

)

 

 

 

 

 

 

 

 

 

 

 

(206

)

Total costs and expenses

 

 

 

 

(2,226

)

 

 

(2,086

)

 

 

524

 

 

 

(3,788

)

 

 

 

 

 

 

 

 

 

 

 

(3,788

)

Operating income (loss)

 

 

 

 

58

 

 

 

159

 

 

 

 

 

 

217

 

 

 

 

 

 

 

 

 

 

 

 

217

 

Loss on extinguishment of debt

 

(31

)

 

 

 

 

 

 

 

 

 

 

 

(31

)

 

 

 

 

 

 

 

 

 

 

 

(31

)

Interest (expense) income, net

 

(116

)

 

 

4

 

 

 

(26

)

 

 

 

 

 

(138

)

 

 

 

 

 

 

 

 

 

 

 

(138

)

Equity gains from consolidated subsidiaries

 

207

 

 

 

122

 

 

 

 

 

 

(329

)

 

 

 

 

 

307

 

 

 

307

 

 

 

(614

)

 

 

 

Other expense, net

 

377

 

 

 

7

 

 

 

10

 

 

 

 

 

 

394

 

 

 

 

 

 

 

 

 

 

 

 

394

 

(Loss) income before income taxes

 

437

 

 

 

191

 

 

 

143

 

 

 

(329

)

 

 

442

 

 

 

307

 

 

 

307

 

 

 

(614

)

 

 

442

 

Income tax benefit (expense)

 

(130

)

 

 

(130

)

 

 

(39

)

 

 

169

 

 

 

(130

)

 

 

 

 

 

 

 

 

 

 

 

(130

)

Net income

 

307

 

 

 

61

 

 

 

104

 

 

 

(160

)

 

 

312

 

 

 

307

 

 

 

307

 

 

 

(614

)

 

 

312

 

Less: income attributable to noncontrolling interest

 

 

 

 

(1

)

 

 

(4

)

 

 

 

 

 

(5

)

 

 

 

 

 

 

 

 

 

 

 

(5

)

Net income attributable to Warner Music Group Corp.

$

307

 

 

$

60

 

 

$

100

 

 

$

(160

)

 

$

307

 

 

$

307

 

 

$

307

 

 

$

(614

)

 

$

307

 

 

 

113


 

Consolidating Statement of Operations

For The Fiscal Year Ended September 30, 2017

 

 

WMG

 

 

 

 

 

 

 

 

 

 

 

 

 

 

WMG

 

 

WMG

 

 

Warner

 

 

 

 

 

 

Warner

 

 

Acquisition

 

 

 

 

 

 

Non-

 

 

 

 

 

 

Acquisition

 

 

Holdings

 

 

Music

 

 

 

 

 

 

Music

 

 

Corp.

 

 

Guarantor

 

 

Guarantor

 

 

 

 

 

 

Corp.

 

 

Corp.

 

 

Group

 

 

 

 

 

 

Group Corp.

 

 

(issuer)

 

 

Subsidiaries

 

 

Subsidiaries

 

 

Eliminations

 

 

Consolidated

 

 

(issuer)

 

 

Corp.

 

 

Eliminations

 

 

Consolidated

 

 

(in millions)

 

Revenues

$

 

 

$

1,978

 

 

$

2,008

 

 

$

(410

)

 

$

3,576

 

 

$

 

 

$

 

 

$

 

 

$

3,576

 

Costs and expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of revenue

 

 

 

 

(922

)

 

 

(1,275

)

 

 

266

 

 

 

(1,931

)

 

 

 

 

 

 

 

 

 

 

 

(1,931

)

Selling, general and administrative expenses

 

(1

)

 

 

(900

)

 

 

(464

)

 

 

143

 

 

 

(1,222

)

 

 

 

 

 

 

 

 

 

 

 

(1,222

)

Amortization of intangible assets

 

 

 

 

(100

)

 

 

(101

)

 

 

 

 

 

(201

)

 

 

 

 

 

 

 

 

 

 

 

(201

)

Total costs and expenses

 

(1

)

 

 

(1,922

)

 

 

(1,840

)

 

 

409

 

 

 

(3,354

)

 

 

 

 

 

 

 

 

 

 

 

(3,354

)

Operating income (loss)

 

(1

)

 

 

56

 

 

 

168

 

 

 

(1

)

 

 

222

 

 

 

 

 

 

 

 

 

 

 

 

222

 

Loss on extinguishment of debt

 

(35

)

 

 

 

 

 

 

 

 

 

 

 

(35

)

 

 

 

 

 

 

 

 

 

 

 

(35

)

Interest (expense) income, net

 

(95

)

 

 

2

 

 

 

(56

)

 

 

 

 

 

(149

)

 

 

 

 

 

 

 

 

 

 

 

(149

)

Equity gains from consolidated subsidiaries

 

124

 

 

 

87

 

 

 

 

 

 

(210

)

 

 

1

 

 

 

143

 

 

 

143

 

 

 

(286

)

 

 

1

 

Other expense, net

 

(1

)

 

 

(17

)

 

 

(23

)

 

 

 

 

 

(41

)

 

 

 

 

 

 

 

 

 

 

 

(41

)

(Loss) income before income taxes

 

(8

)

 

 

128

 

 

 

89

 

 

 

(211

)

 

 

(2

)

 

 

143

 

 

 

143

 

 

 

(286

)

 

 

(2

)

Income tax benefit (expense)

 

151

 

 

 

154

 

 

 

(30

)

 

 

(124

)

 

 

151

 

 

 

 

 

 

 

 

 

 

 

 

151

 

Net income

 

143

 

 

 

282

 

 

 

59

 

 

 

(335

)

 

 

149

 

 

 

143

 

 

 

143

 

 

 

(286

)

 

 

149

 

Less: income attributable to noncontrolling interest

 

 

 

 

(1

)

 

 

(5

)

 

 

 

 

 

(6

)

 

 

 

 

 

 

 

 

 

 

 

(6

)

Net income attributable to Warner Music Group Corp.

$

143

 

 

$

281

 

 

$

54

 

 

$

(335

)

 

$

143

 

 

$

143

 

 

$

143

 

 

$

(286

)

 

$

143

 

 

 

114


 

Consolidating Statement of Operations

For The Fiscal Year Ended September 30, 2016

 

 

WMG

 

 

 

 

 

 

 

 

 

 

 

 

 

 

WMG

 

 

WMG

 

 

Warner

 

 

 

 

 

 

Warner

 

 

Acquisition

 

 

 

 

 

 

Non-

 

 

 

 

 

 

Acquisition

 

 

Holdings

 

 

Music

 

 

 

 

 

 

Music

 

 

Corp.

 

 

Guarantor

 

 

Guarantor

 

 

 

 

 

 

Corp.

 

 

Corp.

 

 

Group

 

 

 

 

 

 

Group Corp.

 

 

(issuer)

 

 

Subsidiaries

 

 

Subsidiaries

 

 

Eliminations

 

 

Consolidated

 

 

(issuer)

 

 

Corp.

 

 

Eliminations

 

 

Consolidated

 

 

(in millions)

 

Revenues

$

 

 

$

1,668

 

 

$

1,887

 

 

$

(309

)

 

$

3,246

 

 

$

 

 

$

 

 

$

 

 

$

3,246

 

Costs and expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of revenue

 

 

 

 

(703

)

 

 

(1,192

)

 

 

188

 

 

 

(1,707

)

 

 

 

 

 

 

 

 

 

 

 

(1,707

)

Selling, general and administrative expenses

 

 

 

 

(739

)

 

 

(464

)

 

 

121

 

 

 

(1,082

)

 

 

 

 

 

 

 

 

 

 

 

(1,082

)

Amortization of intangible assets

 

 

 

 

(118

)

 

 

(125

)

 

 

 

 

 

(243

)

 

 

 

 

 

 

 

 

 

 

 

(243

)

Total costs and expenses

 

 

 

 

(1,560

)

 

 

(1,781

)

 

 

309

 

 

 

(3,032

)

 

 

 

 

 

 

 

 

 

 

 

(3,032

)

Operating income

 

 

 

 

108

 

 

 

106

 

 

 

 

 

 

214

 

 

 

 

 

 

 

 

 

 

 

 

214

 

Loss on extinguishment of debt

 

(4

)

 

 

 

 

 

 

 

 

 

 

 

(4

)

 

 

(14

)

 

 

 

 

 

 

 

 

(18

)

Interest (expense) income, net

 

(84

)

 

 

3

 

 

 

(79

)

 

 

1

 

 

 

(159

)

 

 

(14

)

 

 

 

 

 

 

 

 

(173

)

Equity gains (losses) from consolidated subsidiaries

 

162

 

 

 

74

 

 

 

 

 

 

(236

)

 

 

 

 

 

53

 

 

 

25

 

 

 

(78

)

 

 

 

Other income (expense), net

 

(10

)

 

 

2

 

 

 

26

 

 

 

 

 

 

18

 

 

 

 

 

 

 

 

 

 

 

 

18

 

Income (loss) before income taxes

 

64

 

 

 

187

 

 

 

53

 

 

 

(235

)

 

 

69

 

 

 

25

 

 

 

25

 

 

 

(78

)

 

 

41

 

Income tax (expense) benefit

 

(11

)

 

 

(20

)

 

 

1

 

 

 

19

 

 

 

(11

)

 

 

 

 

 

 

 

 

 

 

 

(11

)

Net income (loss)

 

53

 

 

 

167

 

 

 

54

 

 

 

(216

)

 

 

58

 

 

 

25

 

 

 

25

 

 

 

(78

)

 

 

30

 

Less: income attributable to noncontrolling interest

 

 

 

 

(1

)

 

 

(4

)

 

 

 

 

 

(5

)

 

 

 

 

 

 

 

 

 

 

 

(5

)

Net income (loss) attributable to Warner Music Group Corp.

$

53

 

 

$

166

 

 

$

50

 

 

$

(216

)

 

$

53

 

 

$

25

 

 

$

25

 

 

$

(78

)

 

$

25

 

 

115


 

Consolidating Statement of Comprehensive Income

For The Fiscal Year Ended September 30, 2018

 

 

 

WMG

 

 

 

 

 

 

 

 

 

 

 

 

 

 

WMG

 

 

WMG

 

 

Warner

 

 

 

 

 

 

Warner

 

 

Acquisition

 

 

 

 

 

 

Non-

 

 

 

 

 

 

Acquisition

 

 

Holdings

 

 

Music

 

 

 

 

 

 

Music

 

 

Corp.

 

 

Guarantor

 

 

Guarantor

 

 

 

 

 

 

Corp.

 

 

Corp.

 

 

Group

 

 

 

 

 

 

Group Corp.

 

 

(issuer)

 

 

Subsidiaries

 

 

Subsidiaries

 

 

Eliminations

 

 

Consolidated

 

 

(issuer)

 

 

Corp.

 

 

Eliminations

 

 

Consolidated

 

 

(in millions)

 

Net income

$

307

 

 

$

61

 

 

$

104

 

 

$

(160

)

 

$

312

 

 

$

307

 

 

$

307

 

 

$

(614

)

 

$

312

 

Other comprehensive income (loss), net of tax:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency adjustment

 

(13

)

 

 

 

 

 

13

 

 

 

(13

)

 

 

(13

)

 

 

(13

)

 

 

(13

)

 

 

26

 

 

 

(13

)

Minimum pension liability

 

1

 

 

 

 

 

 

1

 

 

 

(1

)

 

 

1

 

 

 

1

 

 

 

1

 

 

 

(2

)

 

 

1

 

Deferred (loss) on derivative financial instruments

 

3

 

 

 

 

 

 

3

 

 

 

(3

)

 

 

3

 

 

 

3

 

 

 

3

 

 

 

(6

)

 

 

3

 

Other comprehensive income (loss), net of tax:

 

(9

)

 

 

 

 

 

17

 

 

 

(17

)

 

 

(9

)

 

 

(9

)

 

 

(9

)

 

 

18

 

 

 

(9

)

Total comprehensive income

 

298

 

 

 

61

 

 

 

121

 

 

 

(177

)

 

 

303

 

 

 

298

 

 

 

298

 

 

 

(596

)

 

 

303

 

Less: income attributable to noncontrolling interest

 

 

 

 

(1

)

 

 

(4

)

 

 

 

 

 

(5

)

 

 

 

 

 

 

 

 

 

 

 

(5

)

Comprehensive income attributable to Warner Music Group

   Corp.

$

298

 

 

$

60

 

 

$

117

 

 

$

(177

)

 

$

298

 

 

$

298

 

 

$

298

 

 

$

(596

)

 

$

298

 

 

 

 

116


 

Consolidating Statement of Comprehensive Income

For The Fiscal Year Ended September 30, 2017

 

 

 

WMG

 

 

 

 

 

 

 

 

 

 

 

 

 

 

WMG

 

 

WMG

 

 

Warner

 

 

 

 

 

 

Warner

 

 

Acquisition

 

 

 

 

 

 

Non-

 

 

 

 

 

 

Acquisition

 

 

Holdings

 

 

Music

 

 

 

 

 

 

Music

 

 

Corp.

 

 

Guarantor

 

 

Guarantor

 

 

 

 

 

 

Corp.

 

 

Corp.

 

 

Group

 

 

 

 

 

 

Group Corp.

 

 

(issuer)

 

 

Subsidiaries

 

 

Subsidiaries

 

 

Eliminations

 

 

Consolidated

 

 

(issuer)

 

 

Corp.

 

 

Eliminations

 

 

Consolidated

 

 

(in millions)

 

Net income

$

143

 

 

$

282

 

 

$

59

 

 

$

(335

)

 

$

149

 

 

$

143

 

 

$

143

 

 

$

(286

)

 

$

149

 

Other comprehensive income (loss), net of tax:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency adjustment

 

30

 

 

 

 

 

 

(30

)

 

 

30

 

 

 

30

 

 

 

32

 

 

 

32

 

 

 

(64

)

 

 

30

 

Minimum pension liability

 

7

 

 

 

 

 

 

7

 

 

 

(7

)

 

 

7

 

 

 

7

 

 

 

7

 

 

 

(14

)

 

 

7

 

Deferred (loss) on derivative financial instruments

 

 

 

 

(1

)

 

 

 

 

 

1

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income (loss), net of tax:

 

37

 

 

 

(1

)

 

 

(23

)

 

 

24

 

 

 

37

 

 

 

39

 

 

 

39

 

 

 

(78

)

 

 

37

 

Total comprehensive income

 

180

 

 

 

281

 

 

 

36

 

 

 

(311

)

 

 

186

 

 

 

182

 

 

 

182

 

 

 

(364

)

 

 

186

 

Less: income attributable to noncontrolling interest

 

 

 

 

(1

)

 

 

(5

)

 

 

 

 

 

(6

)

 

 

 

 

 

 

 

 

 

 

 

(6

)

Comprehensive income attributable to Warner Music Group

   Corp.

$

180

 

 

$

280

 

 

$

31

 

 

$

(311

)

 

$

180

 

 

$

182

 

 

$

182

 

 

$

(364

)

 

$

180

 

 

 

117


 

Consolidating Statement of Comprehensive Income

For The Fiscal Year Ended September 30, 2016

 

 

WMG

 

 

 

 

 

 

 

 

 

 

 

 

 

 

WMG

 

 

WMG

 

 

Warner

 

 

 

 

 

 

Warner

 

 

Acquisition

 

 

 

 

 

 

Non-

 

 

 

 

 

 

Acquisition

 

 

Holdings

 

 

Music

 

 

 

 

 

 

Music

 

 

Corp.

 

 

Guarantor

 

 

Guarantor

 

 

 

 

 

 

Corp.

 

 

Corp.

 

 

Group

 

 

 

 

 

 

Group Corp.

 

 

(issuer)

 

 

Subsidiaries

 

 

Subsidiaries

 

 

Eliminations

 

 

Consolidated

 

 

(issuer)

 

 

Corp.

 

 

Eliminations

 

 

Consolidated

 

 

(in millions)

 

Net income

$

53

 

 

$

167

 

 

$

54

 

 

$

(216

)

 

$

58

 

 

$

25

 

 

$

25

 

 

$

(78

)

 

$

30

 

Other comprehensive (loss) income, net of tax:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency adjustment

 

(44

)

 

 

 

 

 

(44

)

 

 

44

 

 

 

(44

)

 

 

(44

)

 

 

(44

)

 

 

88

 

 

 

(44

)

Minimum pension liability

 

(7

)

 

 

 

 

 

(7

)

 

 

7

 

 

 

(7

)

 

 

(7

)

 

 

(7

)

 

 

14

 

 

 

(7

)

Deferred (loss) gain on derivative financial instruments

 

 

 

 

(1

)

 

 

 

 

 

1

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive (loss) income , net of tax:

 

(51

)

 

 

(1

)

 

 

(51

)

 

 

52

 

 

 

(51

)

 

 

(51

)

 

 

(51

)

 

 

102

 

 

 

(51

)

Total comprehensive (loss) income

 

2

 

 

 

166

 

 

 

3

 

 

 

(164

)

 

 

7

 

 

 

(26

)

 

 

(26

)

 

 

24

 

 

 

(21

)

Less: income attributable to noncontrolling interest

 

 

 

 

(1

)

 

 

(4

)

 

 

 

 

 

(5

)

 

 

 

 

 

 

 

 

 

 

 

(5

)

Comprehensive (loss) income attributable to Warner Music Group

   Corp.

$

2

 

 

$

165

 

 

$

(1

)

 

$

(164

)

 

$

2

 

 

$

(26

)

 

$

(26

)

 

$

24

 

 

$

(26

)

118


 

Consolidating Statement of Cash Flows

For The Fiscal Year Ended September 30, 2018

 

 

WMG

 

 

 

 

 

 

 

 

 

 

 

 

 

 

WMG

 

 

WMG

 

 

Warner

 

 

 

 

 

 

Warner

 

 

Acquisition

 

 

 

 

 

 

Non-

 

 

 

 

 

 

Acquisition

 

 

Holdings

 

 

Music

 

 

 

 

 

 

Music

 

 

Corp.

 

 

Guarantor

 

 

Guarantor

 

 

 

 

 

 

Corp.

 

 

Corp.

 

 

Group

 

 

 

 

 

 

Group Corp.

 

 

(issuer)

 

 

Subsidiaries

 

 

Subsidiaries

 

 

Eliminations

 

 

Consolidated

 

 

(issuer)

 

 

Corp.

 

 

Eliminations

 

 

Consolidated

 

 

(in millions)

 

Cash flows from operating activities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

$

307

 

 

$

61

 

 

$

104

 

 

$

(160

)

 

$

312

 

 

$

307

 

 

$

307

 

 

$

(614

)

 

$

312

 

Adjustments to reconcile net income to net cash provided by

   operating activities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Depreciation and amortization

 

 

 

 

136

 

 

 

125

 

 

 

 

 

 

261

 

 

 

 

 

 

 

 

 

 

 

 

261

 

Unrealized gains/losses and remeasurement of foreign denominated loans

 

(3

)

 

 

 

 

 

 

 

 

 

 

 

(3

)

 

 

 

 

 

 

 

 

 

 

 

(3

)

Deferred income taxes

 

 

 

 

 

 

 

66

 

 

 

 

 

 

66

 

 

 

 

 

 

 

 

 

 

 

 

66

 

Loss on extinguishment of debt

 

31

 

 

 

 

 

 

 

 

 

 

 

 

31

 

 

 

 

 

 

 

 

 

 

 

 

31

 

Net loss (gain) on divestitures and investments

 

(504

)

 

 

78

 

 

 

37

 

 

 

 

 

 

(389

)

 

 

 

 

 

 

 

 

 

 

 

(389

)

Non-cash interest expense

 

6

 

 

 

 

 

 

 

 

 

 

 

 

6

 

 

 

 

 

 

 

 

 

 

 

 

6

 

Equity-based compensation expense

 

 

 

 

62

 

 

 

 

 

 

 

 

 

62

 

 

 

 

 

 

 

 

 

 

 

 

62

 

Equity losses (gains), including distributions

 

(207

)

 

 

(122

)

 

 

 

 

 

329

 

 

 

 

 

 

(307

)

 

 

(307

)

 

 

614

 

 

 

 

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accounts receivable

 

 

 

 

(48

)

 

 

5

 

 

 

 

 

 

(43

)

 

 

 

 

 

 

 

 

 

 

 

(43

)

Inventories

 

 

 

 

(5

)

 

 

2

 

 

 

 

 

 

(3

)

 

 

 

 

 

 

 

 

 

 

 

(3

)

Royalty advances

 

 

 

 

24

 

 

 

7

 

 

 

 

 

 

31

 

 

 

 

 

 

 

 

 

 

 

 

31

 

Accounts payable and accrued liabilities

 

 

 

 

449

 

 

 

(198

)

 

 

(169

)

 

 

82

 

 

 

 

 

 

 

 

 

 

 

 

82

 

Royalty payables

 

 

 

 

48

 

 

 

(26

)

 

 

 

 

 

22

 

 

 

 

 

 

 

 

 

 

 

 

22

 

Accrued interest

 

(10

)

 

 

 

 

 

 

 

 

 

 

 

(10

)

 

 

 

 

 

 

 

 

 

 

 

(10

)

Deferred revenue

 

 

 

 

(48

)

 

 

44

 

 

 

 

 

 

(4

)

 

 

 

 

 

 

 

 

 

 

 

(4

)

Other balance sheet changes

 

 

 

 

89

 

 

 

(85

)

 

 

 

 

 

4

 

 

 

 

 

 

 

 

 

 

 

 

4

 

Net cash provided by (used in) operating activities

 

(380

)

 

 

724

 

 

 

81

 

 

 

 

 

 

425

 

 

 

 

 

 

 

 

 

 

 

 

425

 

Cash flows from investing activities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Acquisition of music publishing rights, net

 

 

 

 

(11

)

 

 

(3

)

 

 

 

 

 

(14

)

 

 

 

 

 

 

 

 

 

 

 

(14

)

Capital expenditures

 

 

 

 

(60

)

 

 

(14

)

 

 

 

 

 

(74

)

 

 

 

 

 

 

 

 

 

 

 

(74

)

Investments and acquisitions of businesses, net

 

 

 

 

(17

)

 

 

(6

)

 

 

 

 

 

(23

)

 

 

 

 

 

 

 

 

 

 

 

(23

)

Divestitures, net

 

504

 

 

 

12

 

 

 

 

 

 

 

 

 

516

 

 

 

 

 

 

 

 

 

 

 

 

516

 

Advance to Issuer

 

(99

)

 

 

 

 

 

 

 

 

99

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net cash (used in) provided by investing activities

 

405

 

 

 

(76

)

 

 

(23

)

 

 

99

 

 

 

405

 

 

 

 

 

 

 

 

 

 

 

 

405

 

Cash flows from financing activities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Dividend by Acquisition Corp. to Holdings Corp.

 

 

 

 

(925

)

 

 

 

 

 

 

 

 

(925

)

 

 

 

 

 

 

 

 

 

 

 

(925

)

Proceeds from issuance of Acquisition Corp. 5.50% Senior Notes

 

325

 

 

 

 

 

 

 

 

 

 

 

 

325

 

 

 

 

 

 

 

 

 

 

 

 

325

 

Proceeds from issuance of Acquisition Corp. Senior Term Loan Facility

 

320

 

 

 

 

 

 

 

 

 

 

 

 

320

 

 

 

 

 

 

 

 

 

 

 

 

320

 

Repayment of Acquisition Corp. 6.75% Senior Notes

 

(635

)

 

 

 

 

 

 

 

 

 

 

 

(635

)

 

 

 

 

 

 

 

 

 

 

 

(635

)

Call premiums paid on early redemption of debt

 

(23

)

 

 

 

 

 

 

 

 

 

 

 

(23

)

 

 

 

 

 

 

 

 

 

 

 

(23

)

Deferred financing costs paid

 

(12

)

 

 

 

 

 

 

 

 

 

 

 

(12

)

 

 

 

 

 

 

 

 

 

 

 

(12

)

Distribution to noncontrolling interest holder

 

 

 

 

 

 

 

(5

)

 

 

 

 

 

(5

)

 

 

 

 

 

 

 

 

 

 

 

(5

)

Change in due (from) to issuer

 

 

 

 

99

 

 

 

 

 

 

(99

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net cash (used in) provided by financing activities

 

(25

)

 

 

(826

)

 

 

(5

)

 

 

(99

)

 

 

(955

)

 

 

 

 

 

 

 

 

 

 

 

(955

)

Effect of exchange rate changes on cash and equivalents

 

 

 

 

 

 

 

(8

)

 

 

 

 

 

(8

)

 

 

 

 

 

 

 

 

 

 

 

(8

)

Net increase in cash and equivalents

 

 

 

 

(178

)

 

 

45

 

 

 

 

 

 

(133

)

 

 

 

 

 

 

 

 

 

 

 

(133

)

Cash and equivalents at beginning of period

 

 

 

 

347

 

 

 

300

 

 

 

 

 

 

647

 

 

 

 

 

 

 

 

 

 

 

 

647

 

Cash and equivalents at end of period

$

 

 

$

169

 

 

$

345

 

 

$

 

 

$

514

 

 

$

 

 

$

 

 

$

 

 

$

514

 

 

 

119


 

Consolidating Statement of Cash Flows

For The Fiscal Year Ended September 30, 2017

 

 

WMG

 

 

 

 

 

 

 

 

 

 

 

 

 

 

WMG

 

 

WMG

 

 

Warner

 

 

 

 

 

 

Warner

 

 

Acquisition

 

 

 

 

 

 

Non-

 

 

 

 

 

 

Acquisition

 

 

Holdings

 

 

Music

 

 

 

 

 

 

Music

 

 

Corp.

 

 

Guarantor

 

 

Guarantor

 

 

 

 

 

 

Corp.

 

 

Corp.

 

 

Group

 

 

 

 

 

 

Group Corp.

 

 

(issuer)

 

 

Subsidiaries

 

 

Subsidiaries

 

 

Eliminations

 

 

Consolidated

 

 

(issuer)

 

 

Corp.

 

 

Eliminations

 

 

Consolidated

 

 

(in millions)

 

Cash flows from operating activities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

$

143

 

 

$

282

 

 

$

59

 

 

$

(335

)

 

$

149

 

 

$

143

 

 

$

143

 

 

$

(286

)

 

$

149

 

Adjustments to reconcile net income to net cash provided by

   operating activities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Depreciation and amortization

 

 

 

 

137

 

 

 

114

 

 

 

 

 

 

251

 

 

 

 

 

 

 

 

 

 

 

 

251

 

Unrealized gains/losses and remeasurement of foreign denominated loans

 

27

 

 

 

 

 

 

(3

)

 

 

 

 

 

24

 

 

 

 

 

 

 

 

 

 

 

 

24

 

Deferred income taxes

 

2

 

 

 

 

 

 

(194

)

 

 

 

 

 

(192

)

 

 

 

 

 

 

 

 

 

 

 

(192

)

Loss on extinguishment of debt

 

35

 

 

 

 

 

 

 

 

 

 

 

 

35

 

 

 

 

 

 

 

 

 

 

 

 

35

 

Net loss (gain) on divestitures and investments

 

 

 

 

33

 

 

 

(16

)

 

 

 

 

 

17

 

 

 

 

 

 

 

 

 

 

 

 

17

 

Non-cash interest expense

 

8

 

 

 

 

 

 

 

 

 

 

 

 

8

 

 

 

 

 

 

 

 

 

 

 

 

8

 

Equity-based compensation expense

 

 

 

 

70

 

 

 

 

 

 

 

 

 

70

 

 

 

 

 

 

 

 

 

 

 

 

70

 

Equity losses (gains), including distributions

 

(124

)

 

 

(86

)

 

 

 

 

 

210

 

 

 

 

 

 

(143

)

 

 

(143

)

 

 

286

 

 

 

 

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accounts receivable

 

 

 

 

(37

)

 

 

(23

)

 

 

 

 

 

(60

)

 

 

 

 

 

 

 

 

 

 

 

(60

)

Inventories

 

 

 

 

2

 

 

 

(1

)

 

 

 

 

 

1

 

 

 

 

 

 

 

 

 

 

 

 

1

 

Royalty advances

 

 

 

 

2

 

 

 

15

 

 

 

 

 

 

17

 

 

 

 

 

 

 

 

 

 

 

 

17

 

Accounts payable and accrued liabilities

 

(120

)

 

 

(4

)

 

 

47

 

 

 

125

 

 

 

48

 

 

 

 

 

 

 

 

 

 

 

 

48

 

Royalty payables

 

 

 

 

126

 

 

 

10

 

 

 

 

 

 

136

 

 

 

 

 

 

 

 

 

 

 

 

136

 

Accrued interest

 

3

 

 

 

 

 

 

 

 

 

 

 

 

3

 

 

 

 

 

 

 

 

 

 

 

 

3

 

Deferred revenue

 

 

 

 

(6

)

 

 

28

 

 

 

 

 

 

22

 

 

 

 

 

 

 

 

 

 

 

 

22

 

Other balance sheet changes

 

5

 

 

 

(204

)

 

 

205

 

 

 

 

 

 

6

 

 

 

 

 

 

 

 

 

 

 

 

6

 

Net cash provided by (used in) operating activities

 

(21

)

 

 

315

 

 

 

241

 

 

 

 

 

 

535

 

 

 

 

 

 

 

 

 

 

 

 

535

 

Cash flows from investing activities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Acquisition of music publishing rights, net

 

 

 

 

(9

)

 

 

(7

)

 

 

 

 

 

(16

)

 

 

 

 

 

 

 

 

 

 

 

(16

)

Capital expenditures

 

 

 

 

(31

)

 

 

(13

)

 

 

 

 

 

(44

)

 

 

 

 

 

 

 

 

 

 

 

(44

)

Investments and acquisitions of businesses, net

 

 

 

 

(6

)

 

 

(133

)

 

 

 

 

 

(139

)

 

 

 

 

 

 

 

 

 

 

 

(139

)

Divestitures, net

 

 

 

 

42

 

 

 

31

 

 

 

 

 

 

73

 

 

 

 

 

 

 

 

 

 

 

 

73

 

Advance to Issuer

 

60

 

 

 

 

 

 

 

 

 

(60

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net cash (used in) provided by investing activities

 

60

 

 

 

(4

)

 

 

(122

)

 

 

(60

)

 

 

(126

)

 

 

 

 

 

 

 

 

 

 

 

(126

)

Cash flows from financing activities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Dividend by Acquisition Corp. to Holdings Corp.

 

 

 

 

(84

)

 

 

 

 

 

 

 

 

(84

)

 

 

84

 

 

 

 

 

 

 

 

 

 

Proceeds from issuance of Acquisition Corp. 4.125% Senior Secured Notes

 

380

 

 

 

 

 

 

 

 

 

 

 

 

380

 

 

 

 

 

 

 

 

 

 

 

 

380

 

Proceeds from issuance of Acquisition Corp. 4.875% Senior Secured Notes

 

250

 

 

 

 

 

 

 

 

 

 

 

 

250

 

 

 

 

 

 

 

 

 

 

 

 

250

 

Proceeds from issuance of Acquisition Corp. Senior Term Loan Facility

 

22

 

 

 

 

 

 

 

 

 

 

 

 

22

 

 

 

 

 

 

 

 

 

 

 

 

22

 

Repayment of Acquisition Corp. 6.00% Senior Secured Notes

 

(450

)

 

 

 

 

 

 

 

 

 

 

 

(450

)

 

 

 

 

 

 

 

 

 

 

 

(450

)

Repayment of Acquisition Corp. 6.25% Senior Secured Notes

 

(173

)

 

 

 

 

 

 

 

 

 

 

 

(173

)

 

 

 

 

 

 

 

 

 

 

 

(173

)

Repayment of Acquisition Corp. 5.625% Senior Secured Notes

 

(28

)

 

 

 

 

 

 

 

 

 

 

 

(28

)

 

 

 

 

 

 

 

 

 

 

 

(28

)

Call premiums paid on early redemption of debt

 

(27

)

 

 

 

 

 

 

 

 

 

 

 

(27

)

 

 

 

 

 

 

 

 

 

 

 

(27

)

Deferred financing costs paid

 

(13

)

 

 

 

 

 

 

 

 

 

 

 

(13

)

 

 

 

 

 

 

 

 

 

 

 

(13

)

Distribution to noncontrolling interest holder

 

 

 

 

 

 

 

(5

)

 

 

 

 

 

(5

)

 

 

 

 

 

 

 

 

 

 

 

(5

)

Dividends paid

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(84

)

 

 

 

 

 

 

 

 

(84

)

Change in due (from) to issuer

 

 

 

 

(60

)

 

 

 

 

 

60

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net cash (used in) provided by financing activities

 

(39

)

 

 

(144

)

 

 

(5

)

 

 

60

 

 

 

(128

)

 

 

 

 

 

 

 

 

 

 

 

(128

)

Effect of exchange rate changes on cash and equivalents

 

 

 

 

 

 

 

7

 

 

 

 

 

 

7

 

 

 

 

 

 

 

 

 

 

 

 

7

 

Net increase in cash and equivalents

 

 

 

 

167

 

 

 

121

 

 

 

 

 

 

288

 

 

 

 

 

 

 

 

 

 

 

 

288

 

Cash and equivalents at beginning of period

 

 

 

 

180

 

 

 

179

 

 

 

 

 

 

359

 

 

 

 

 

 

 

 

 

 

 

 

359

 

Cash and equivalents at end of period

$

 

 

$

347

 

 

$

300

 

 

$

 

 

$

647

 

 

$

 

 

$

 

 

$

 

 

$

647

 

 

 

120


 

Consolidating Statement of Cash Flows

For The Fiscal Year Ended September 30, 2016

 

 

WMG

 

 

 

 

 

 

 

 

 

 

 

 

 

 

WMG

 

 

WMG

 

 

Warner

 

 

 

 

 

 

Warner

 

 

Acquisition

 

 

 

 

 

 

Non-

 

 

 

 

 

 

Acquisition

 

 

Holdings

 

 

Music

 

 

 

 

 

 

Music

 

 

Corp.

 

 

Guarantor

 

 

Guarantor

 

 

 

 

 

 

Corp.

 

 

Corp.

 

 

Group

 

 

 

 

 

 

Group Corp.

 

 

(issuer)

 

 

Subsidiaries

 

 

Subsidiaries

 

 

Eliminations

 

 

Consolidated

 

 

(issuer)

 

 

Corp.

 

 

Eliminations

 

 

Consolidated

 

 

(in millions)

 

Cash flows from operating activities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

$

53

 

 

$

167

 

 

$

54

 

 

$

(216

)

 

$

58

 

 

$

25

 

 

$

25

 

 

$

(78

)

 

$

30

 

Adjustments to reconcile net income to net cash provided by

   operating activities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Depreciation and amortization

 

 

 

 

156

 

 

 

137

 

 

 

 

 

 

293

 

 

 

 

 

 

 

 

 

 

 

 

293

 

Unrealized gains/losses and remeasurement of foreign denominated loans

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deferred income taxes

 

 

 

 

 

 

 

(26

)

 

 

 

 

 

(26

)

 

 

 

 

 

 

 

 

 

 

 

(26

)

Loss on extinguishment of debt

 

4

 

 

 

 

 

 

 

 

 

 

 

 

4

 

 

 

14

 

 

 

 

 

 

 

 

 

18

 

Net gain on divestitures

 

 

 

 

(3

)

 

 

(6

)

 

 

 

 

 

(9

)

 

 

 

 

 

 

 

 

 

 

 

(9

)

Gain on sale of real estate

 

 

 

 

 

 

 

(24

)

 

 

 

 

 

(24

)

 

 

 

 

 

 

 

 

 

 

 

(24

)

Non-cash interest expense

 

10

 

 

 

 

 

 

 

 

 

 

 

 

10

 

 

 

1

 

 

 

 

 

 

 

 

 

11

 

Equity-based compensation expense

 

 

 

 

23

 

 

 

 

 

 

 

 

 

23

 

 

 

 

 

 

 

 

 

 

 

 

23

 

Equity losses (gains), including distributions

 

(162

)

 

 

(74

)

 

 

 

 

 

236

 

 

 

 

 

 

(53

)

 

 

(25

)

 

 

78

 

 

 

 

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accounts receivable

 

 

 

 

(7

)

 

 

24

 

 

 

 

 

 

17

 

 

 

 

 

 

 

 

 

 

 

 

17

 

Inventories

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Royalty advances

 

 

 

 

1

 

 

 

(14

)

 

 

 

 

 

(13

)

 

 

 

 

 

 

 

 

 

 

 

(13

)

Accounts payable and accrued liabilities

 

 

 

 

142

 

 

 

(99

)

 

 

(20

)

 

 

23

 

 

 

 

 

 

 

 

 

 

 

 

23

 

Royalty payables

 

 

 

 

93

 

 

 

(44

)

 

 

 

 

 

49

 

 

 

 

 

 

 

 

 

 

 

 

49

 

Accrued interest

 

(10

)

 

 

 

 

 

 

 

 

 

 

 

(10

)

 

 

(10

)

 

 

 

 

 

 

 

 

(20

)

Deferred revenue

 

 

 

 

(4

)

 

 

(31

)

 

 

 

 

 

(35

)

 

 

 

 

 

 

 

 

 

 

 

(35

)

Other balance sheet changes

 

(4

)

 

 

(10

)

 

 

19

 

 

 

 

 

 

5

 

 

 

 

 

 

 

 

 

 

 

 

5

 

Net cash (used in) provided by operating activities

 

(109

)

 

 

484

 

 

 

(10

)

 

 

 

 

 

365

 

 

 

(23

)

 

 

 

 

 

 

 

 

342

 

Cash flows from investing activities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Acquisition of music publishing rights, net

 

 

 

 

(16

)

 

 

(9

)

 

 

 

 

 

(25

)

 

 

 

 

 

 

 

 

 

 

 

(25

)

Capital expenditures

 

 

 

 

(30

)

 

 

(12

)

 

 

 

 

 

(42

)

 

 

 

 

 

 

 

 

 

 

 

(42

)

Investments and acquisitions of businesses, net

 

 

 

 

(10

)

 

 

(18

)

 

 

 

 

 

(28

)

 

 

 

 

 

 

 

 

 

 

 

(28

)

Divestitures, net

 

 

 

 

8

 

 

 

37

 

 

 

 

 

 

45

 

 

 

 

 

 

 

 

 

 

 

 

45

 

Proceeds from the sale of real estate

 

 

 

 

 

 

 

42

 

 

 

 

 

 

42

 

 

 

 

 

 

 

 

 

 

 

 

42

 

Advance to Issuer

 

329

 

 

 

 

 

 

 

 

 

(329

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net cash (used in) provided by investing activities

 

329

 

 

 

(48

)

 

 

40

 

 

 

(329

)

 

 

(8

)

 

 

 

 

 

 

 

 

 

 

 

(8

)

Cash flows from financing activities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Dividend by Acquisition Corp. to Holdings Corp.

 

(183

)

 

 

 

 

 

 

 

 

 

 

 

(183

)

 

 

183

 

 

 

 

 

 

 

 

 

 

Repayment of Acquisition Corp. Senior Term Loan Facility

 

(309

)

 

 

 

 

 

 

 

 

 

 

 

(309

)

 

 

 

 

 

 

 

 

 

 

 

(309

)

Proceeds from issuance of Acquisition Corp. 5.00% Senior Secured Notes

 

300

 

 

 

 

 

 

 

 

 

 

 

 

300

 

 

 

 

 

 

 

 

 

 

 

 

300

 

Repayment of Holdings 13.75% Senior Notes

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(150

)

 

 

 

 

 

 

 

 

(150

)

Repayment of Acquisition Corp. 6.75% Senior Notes

 

(24

)

 

 

 

 

 

 

 

 

 

 

 

(24

)

 

 

 

 

 

 

 

 

 

 

 

(24

)

Financing costs paid

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(10

)

 

 

 

 

 

 

 

 

(10

)

Deferred financing costs paid

 

(4

)

 

 

 

 

 

 

 

 

 

 

 

(4

)

 

 

 

 

 

 

 

 

 

 

 

(4

)

Distribution to noncontrolling interest holder

 

 

 

 

 

 

 

(5

)

 

 

 

 

 

(5

)

 

 

 

 

 

 

 

 

 

 

 

(5

)

Repayment of capital lease obligations

 

 

 

 

 

 

 

(14

)

 

 

 

 

 

(14

)

 

 

 

 

 

 

 

 

 

 

 

(14

)

Change in due (from) to issuer

 

 

 

 

(329

)

 

 

 

 

 

329

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net cash (used in) provided by financing activities

 

(220

)

 

 

(329

)

 

 

(19

)

 

 

329

 

 

 

(239

)

 

 

23

 

 

 

 

 

 

 

 

 

(216

)

Effect of exchange rate changes on cash and equivalents

 

 

 

 

 

 

 

(5

)

 

 

 

 

 

(5

)

 

 

 

 

 

 

 

 

 

 

 

(5

)

Net increase in cash and equivalents

 

 

 

 

107

 

 

 

6

 

 

 

 

 

 

113

 

 

 

 

 

 

 

 

 

 

 

 

113

 

Cash and equivalents at beginning of period

 

 

 

 

73

 

 

 

173

 

 

 

 

 

 

246

 

 

 

 

 

 

 

 

 

 

 

 

246

 

Cash and equivalents at end of period

$

 

 

$

180

 

 

$

179

 

 

$

 

 

$

359

 

 

$

 

 

$

 

 

$

 

 

$

359

 

 

 

121


 

WARNER MUSIC GROUP CORP.

Schedule II — Valuation and Qualifying Accounts

 

 

 

 

 

 

 

Additions

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at

 

 

Charged to

 

 

 

 

 

 

 

 

 

 

Balance at

 

 

 

Beginning

 

 

Cost and

 

 

 

 

 

 

 

 

 

 

End of

 

Description

 

of Period

 

 

Expenses

 

 

Deductions

 

 

Other (a)

 

 

Period

 

 

 

(in millions)

 

Year Ended September 30, 2018

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Allowance for doubtful accounts

 

$

18

 

 

$

4

 

 

$

(4

)

 

$

 

 

$

18

 

Reserves for sales returns

 

 

33

 

 

 

108

 

 

 

(113

)

 

 

 

 

 

28

 

Allowance for deferred tax asset

 

 

193

 

 

 

33

 

 

 

(20

)

 

 

 

 

 

206

 

Year Ended September 30, 2017

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Allowance for doubtful accounts

 

$

19

 

 

$

3

 

 

$

(4

)

 

$

 

 

$

18

 

Reserves for sales returns

 

 

33

 

 

 

119

 

 

 

(119

)

 

 

 

 

 

33

 

Allowance for deferred tax asset

 

 

310

 

 

 

23

 

 

 

(140

)

 

 

 

 

 

193

 

Year Ended September 30, 2016

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Allowance for doubtful accounts

 

$

12

 

 

$

6

 

 

$

 

 

$

1

 

 

$

19

 

Reserves for sales returns

 

 

44

 

 

 

131

 

 

 

(142

)

 

 

 

 

 

33

 

Allowance for deferred tax asset

 

 

344

 

 

 

27

 

 

 

(61

)

 

 

 

 

 

310

 

 

 

(a)

Other changes due to acquisitions and dispositions.

 

 

 

122


 

ITEM 9.

CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

 

ITEM 9A.

CONTROLS AND PROCEDURES

Certification

The certifications of the principal executive officer and the principal financial officer (or persons performing similar functions) required by Rules 13a-14(a) and 15d-14(a) of the Exchange Act (the “Certifications”) are filed as exhibits to this report. This section of the report contains the information concerning the evaluation of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) (“Disclosure Controls”) and changes to internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) (“Internal Controls”) referred to in the Certifications and this information should be read in conjunction with the Certifications for a more complete understanding of the topics presented.

Introduction

The SEC’s rules define “disclosure controls and procedures” as controls and procedures that are designed to ensure that information required to be disclosed by public companies in the reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by public companies in the reports that they file or submit under the Exchange Act is accumulated and communicated to a company’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

The SEC’s rules define “internal control over financial reporting” as a process designed by, or under the supervision of, a public company’s principal executive and principal financial officers, or persons performing similar functions, and effected by our board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles, or U.S. GAAP, including those policies and procedures that: (i) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company, (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. GAAP, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements.

Our management, including the principal executive officer and principal financial officer, does not expect that our Disclosure Controls or Internal Controls will prevent or detect all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of the limitations in any and all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our company have been detected. Further, the design of any control system is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Because of these inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected even when effective Disclosure Controls and Internal Controls are in place.

123


 

Evaluation of Disclosure Controls and Procedures

Based on our management’s evaluation (with the participation of our principal executive officer and principal financial officer), as of the end of the period covered by this report, our principal executive officer and principal financial officer have concluded that our Disclosure Controls are effective to provide reasonable assurance that information required to be disclosed by us in reports that we file or submit under the Exchange Act will be recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, including that such information is accumulated and communicated to management, including the principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting

There have been no changes in our Internal Controls over financial reporting or other factors during the fiscal year ended September 30, 2018 that have materially affected, or are reasonably likely to materially affect, our Internal Controls.

Management’s Report on Internal Control Over Financial Reporting

Management’s report on internal control over financial reporting is located on page 74 of this report.

 

ITEM 9B.

OTHER INFORMATION

Not Applicable

 

124


 

PART III

 

ITEM 10.

DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERANCE

The following is a list of our current executive officers and directors, their ages as of December 20, 2018, and their positions and offices.

 

Name

  

Age

  

Position

Stephen Cooper

  

72

  

CEO and Director

Max Lousada

  

45

  

CEO, Warner Recorded Music and Director

Jon Platt

 

54

 

Chairman and CEO, Warner/Chappell Music

Eric Levin

  

56

  

Executive Vice President and Chief Financial Officer

Ole Obermann

 

47

 

Executive Vice President, Business Development and Chief Digital Officer

Maria Osherova

  

53

  

Executive Vice President, Chief Human Resources Officer

Paul M. Robinson

  

60

  

Executive Vice President and General Counsel and Secretary

James Steven

 

41

 

Executive Vice President, Chief Communications Officer

Len Blavatnik

  

61

  

Vice Chairman of the Board

Lincoln Benet

  

55

  

Director

Alex Blavatnik

  

54

  

Director

Mathias Döpfner

  

55

  

Director

Noreena Hertz

  

51

  

Director

Ynon Kreiz

  

53

  

Director

Thomas H. Lee

  

74

  

Director

Donald A. Wagner

  

55

  

Director

 

Our executive officers are appointed by, and serve at the discretion of, the Board of Directors. Each executive officer is an employee of the Company or one of its subsidiaries. The following information provides a brief description of the business experience of each of our executive officers and directors.

Stephen Cooper, 72, has served as a director since July 20, 2011 and as our CEO since August 18, 2011. Previously, Mr. Cooper was our Chairman of the Board from July 20, 2011 to August 18, 2011. Mr. Cooper is a member of the Supervisory Board of Directors for LyondellBasell, one of the world’s largest olefins, polyolefins, chemicals and refining companies. He has more than 30 years of experience as a financial advisor, and has served as Vice Chairman and member of the office of Chief Executive Officer of Metro-Goldwyn-Mayer, Inc.; Chief Executive Officer of Hawaiian Telcom; Executive Chairman of Blue Bird Corporation; Chairman of the Board of Collins & Aikman Corporation; Chief Executive Officer of Krispy Kreme Doughnuts; and Chief Executive Officer and Chief Restructuring Officer of Enron Corporation. Mr. Cooper also serves on the Board of Directors of LyondellBasell Industries N.V. Mr. Cooper is also the Managing Partner of Cooper Investment Partners, a private equity firm.

Max Lousada, 45, has served as a director since October 1, 2017 and as our CEO, Recorded Music, Warner Music Group, since October 1, 2017. He oversees all of the Company’s global recorded music operations, including Atlantic, Warner Bros., Parlophone, Warner Music Nashville, Global Catalog/Rhino and Warner Classics, as well as the Company’s international Recorded Music affiliates and WMG’s Artist & Label Services divisions, WEA Corp. and ADA. Mr. Lousada was, for the previous four years, the Chairman & CEO of Warner Music UK, where he was responsible for overseeing the Company’s UK family of labels and imprints, including Atlantic Records, Asylum, East West, FFRR, Nonesuch, One More Tune, Parlophone, Reprise, Roadrunner, Rhino and Warner Bros Records, as well as the UK arm of ADA and WMG’s Artist & Label Services division. Mr. Lousada previously headed up Atlantic Records UK for nine years, during which time he built an award-winning team and a strong roster of artists, including: Ed Sheeran, Paolo Nutini, James Blunt, Rudimental, Plan B, Lykke Li, Rumer, Marina and the Diamonds and Birdy. Mr. Lousada also presided over the UK success of Atlantic’s international roster including acts such as Bruno Mars, Paramore, Death Cab For Cutie, Jason Mraz and Janelle Monáe. Prior to his tenure at Atlantic UK, Mr. Lousada was head of A&R at Mushroom Records where he signed ambient dance act Zero 7 and played a key role in the development of their 2001 debut album “Simple Things.” Mr. Lousada was also involved in the careers of Mushroom acts such as Muse, Ash and Garbage. From 2014 to 2016, Mr. Lousada served as Chairman of the BRITs Committee, responsible for the creative direction of the show, management of the Award categories, artist line up, Voting Academy and the digital and media strategy.

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Jon Platt, 54, has served as the Chairman and CEO of Warner/Chappell Music since May 2016, and he is expected to resign from this position effective no later than December 31, 2018. Mr. Platt had previously served as our director from October 1, 2017 to September 12, 2018, the effective date of his resignation from the Board.  In his role as CEO, Mr. Platt oversees all aspects of the company’s global operations, roster of songwriters, creative services, and growth strategy.

Eric Levin, 56, has served as our Executive Vice President and Chief Financial Officer since October 13, 2014. From October 2012 to June 2014, he served as the financial director of Ecolab (China) Investment Co. Ltd, a multinational technology and manufacturing group in China. From May 1988 to December 2001, he worked in various financial functions at Home Box Office, Inc., a subsidiary of Time Warner, and was promoted to CFO from January 2000 to December 2001. Thereafter and until 2011, he served in various operational and financial roles in companies in the media and publishing industry. From 2004 to 2007, he was the Co-Founder and CEO of City on Demand, LLC, a television production company. From 2009 to 2011, Mr. Levin was CFO at SCMP Group Limited, a company listed on the Hong Kong Stock Exchange, which is a leading Asia media holding company, and joined the board of The Post Publishing Public Company Limited, a company listed on the Stock Exchange of Thailand, which publishes newspapers and magazines. Mr. Levin obtained a B.S. in Electrical Engineering from the University of Pennsylvania in May 1984 and an M.B.A. in finance and economics from the University of Chicago Graduate School of Business in March 1988.

Ole Obermann, 47, has served as our Executive Vice President, Business Development and Chief Digital Officer since November 2016. Mr. Obermann oversees the company’s global business development strategy, with a focus on exploring new forms of commercial innovation and creating new digital revenue opportunities. From 2006 to 2016, Mr. Obermann worked at Sony Music Entertainment, where he was most recently Executive VP, Digital Partner Development and Sales. During his Sony tenure, he negotiated and implemented deals with Sony’s network of global digital partners including iTunes, Spotify, Google, and Vevo. He was instrumental in Sony’s audio and video streaming strategy and oversaw the buildout of Sony’s digital analytics infrastructure. Prior to his employment at Sony, Mr. Obermann was Managing Director of Liquid Digital Media, a leading digital music infrastructure provider. He also previously worked at McKinsey & Co. He began his career as a Product Manager for RCA Records. He holds a BA degree in International Relations from Colgate University and an MBA from Northwestern University’s Kellogg School of Management.

Maria Osherova, 53, has served as our Executive Vice President, Chief Human Resources Officer since July 29, 2014. Ms. Osherova joined Warner Music Group in 2006 as Vice President, Human Resources for Warner Music International, based in London.  Advancing to Senior Vice President of Warner Music International, she played a pivotal role in the successful integration of Parlophone Label Group within Warner Music Group. Prior to joining Warner Music Group, Ms. Osherova was Global HR Manager for a division of Shell International Petroleum, where she headed a department responsible for employees in over 120 countries. She previously held several posts at The Coca-Cola Company, based variously in Copenhagen, Oslo, and St. Petersburg. Osherova studied at St. Petersburg State Technical University, where she was awarded a Master of Sciences degree.

Paul M. Robinson, 60, has served as our Executive Vice President and General Counsel and Secretary since December 2006. He is responsible for our worldwide legal and business affairs and public policy functions. Mr. Robinson joined Warner Music Group’s legal department in 1995. From 1995 to December 2006, Mr. Robinson held various positions with Warner Music Group, including Acting General Counsel and Senior Vice President, Deputy General Counsel. Before joining Warner Music Group, Mr. Robinson was a partner in the New York City law firm Mayer, Katz, Baker, Leibowitz & Roberts. Mr. Robinson has a B.A. in English from Williams College and a J.D. from Fordham University School of Law.

James Steven, 41, has served as Executive Vice President, Chief Communications Officer since January 1, 2015. He is responsible for our worldwide communications and corporate marketing functions, including external and internal communications, investor relations, social responsibility and special events.  He also oversees the interaction and coordination of the communications functions of our operating companies.  Mr. Steven joined the Company in 2007 as part of the Company’s international communications team based in London.  He relocated to New York in 2012, becoming Senior Vice President, Communications and Marketing.  Prior to Warner Music Group, Mr. Steven held various roles at public relations and marketing agencies, including Cow PR and Consolidated PR, working with clients in the film, TV, technology, retail, beverages and automobile industries. Mr. Steven holds an M.A. (Honors) degree from the University of Edinburgh.

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Len Blavatnik, 61, has served as a director and as Vice Chairman of the Board of Warner Music Group since July 20, 2011. Mr. Blavatnik is the founder and Chairman of Access, a privately held, U.S. industrial group with global strategic investments. He previously served as a member of the board of directors of Warner Music Group from March 2004 to January 2008. Mr. Blavatnik provides financial support to, and remains engaged in, many educational pursuits.  Mr. Blavatnik is a member of boards at Oxford University and Tel Aviv University, and is a member of Harvard University’s Committee on University Resources, Global Advisory Council and the Task Force on Science and Engineering. In 2010, the Blavatnik Family Foundation committed £75 million to establish the Blavatnik School of Government at the University of Oxford.  Mr. Blavatnik and the Blavatnik Family Foundation have also been generous supporters of other leading educational, scientific, cultural and charitable institutions throughout the world. Mr. Blavatnik is a member of the board of directors of the 92nd Street Y in New York, The Mariinsky Foundation of America, The Carnegie Hall Society, Inc. and The Center for Jewish History in New York. He is also a Trustee of the State Hermitage Museum in St. Petersburg, Russia. Mr. Blavatnik emigrated to the U.S. in 1978 and became a U.S. citizen in 1984. He received his Master’s degree from Columbia University in 1981 and his M.B.A from Harvard Business School in 1989. Mr. Blavatnik is the brother of Alex Blavatnik.

Lincoln Benet, 55, has served as a director since July 20, 2011. Mr. Benet is the Chief Executive Officer of Access. Prior to joining Access in 2006, Mr. Benet spent 17 years at Morgan Stanley, most recently as a Managing Director. His experience spans corporate finance, mergers and acquisitions, fixed income and capital markets. Mr. Benet is a member of the Supervisory Board of Directors for LyondellBasell Industries N.V. and a member of the board of Clal Industries Ltd. and Perform Group Limited. Mr. Benet graduated summa cum laude with a B.A. in Economics from Yale University and received his M.B.A. from Harvard Business School.

Alex Blavatnik, 54, has served as a director since July 20, 2011. Mr. Blavatnik is an Executive Vice President and Vice Chairman of Access. A 1993 graduate of Columbia University, Mr. Blavatnik joined Access in 1996 to manage the Company’s growing activities in Russia. Currently, he oversees Access’ operations out of its New York-based headquarters and serves as a director of various companies in the Access global portfolio. In addition, Mr. Blavatnik is engaged in numerous philanthropic pursuits and sits on the boards of several educational and charitable institutions. Mr. Blavatnik is the brother of Len Blavatnik.

Mathias Döpfner, 55, has served as a director since May 1, 2014. Mr. Döpfner is Chairman and CEO of German media group Axel Springer SE in Berlin. Holding a stake of about 3%, Mr. Döpfner is also one of the company’s largest shareholders. Axel Springer is the leading digital publisher in Europe and is active in more than 40 countries. Publishing brands include BILD, DIE WELT and BUSINESS INSIDER. Since Mr. Döpfner became CEO in 2002, Axel Springer revenues from digital activities increased from €117 million to €2.5 billion with EBITDA from digital increasing from €-12 million to €582 million. Worldwide digital audience expanded to more than 300 million users. Mr. Döpfner is also a member of the Board of Directors of Netflix Inc.

Noreena Hertz, 51, has served as a director since September 15, 2017 and previously served as a director from May 1, 2014 through May 22, 2016. Professor Hertz advises some of the biggest organizations and most senior figures in the world on strategy, decision-making, corporate social responsibility and global economic and geo-political trends. Her best-selling books, Eyes Wide Open, the Silent Takeover and IOU: The Debt Threat, have been published in 22 countries. Professor Hertz served as a member of Citigroup’s Politics and Economics Global Advisory Board between 2007 and 2008 and as a member of the Advisory Group steering McKinsey CEO Dominic Barton’s Inclusive Capitalism Taskforce between 2012 and 2013. A much sought-after commentator on television and radio Hertz contributes to a wide range of publications and networks including The BBC, CNN, CNBC, CBS, ITV, The New York Times, The Wall Street Journal, The Daily Beast, the Financial Times, the GuardianThe Washington PostThe Times of London, Wired, and Nature. She has given Keynote Speeches at TED and The World Economic Forum, as well as for leading global corporations, and has shared platforms with such luminaries as President Bill Clinton and James Wolfensohn. An influential economist on the international stage, Professor Hertz also played a pivotal role in the development of (RED), an innovative commercial model to raise money for people with AIDS in Africa, having inspired Bono (co-founder of the project) with her writings. Professor Hertz has been described by the Observer as “one of the world’s leading young thinkers,” Vogue as “one of the world’s most inspiring women” and was featured on the cover of Newsweek’s September 30, 2013 issue in Europe, Asia and the Middle East. She has an M.B.A from the Wharton School of the University of Pennsylvania and a Ph.D. from the University of Cambridge. Having spent 10 years at the University of Cambridge as Associate Director of the Centre for International Business and Management, in 2014 she moved to University College London where she is a Visiting Professor at the Institute for Global Prosperity.

 

 

 

 

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Ynon Kreiz, 53, has served as a director since May 9, 2016. Since April 26, 2018, Mr. Kreiz has been the Chairman and CEO of Mattel, Inc., one of the world’s largest toy companies. From March 2012 to January 2016, Mr. Kreiz served as the Chairman and CEO of Maker Studios, a global leader in online short-form video and one of the largest content networks on YouTube. Before joining Maker, from June 2008 to June 2011, Mr. Kreiz was Chairman and CEO of Endemol Group, one of the world’s largest independent television production companies, with major international programming franchises including “Big Brother” and “Deal or No Deal.” Prior to Endemol, from 2005 to 2007, Mr. Kreiz was a General Partner at Balderton Capital (formerly Benchmark Capital Europe). Prior to that, from 1996 to 2002, Mr. Kreiz was co-founder, Chairman and CEO of Fox Kids Europe N.V., a leading pay-TV channel in Europe and the Middle East, broadcasting in 56 countries. FKE was listed on the Euronext Stock Exchange in Amsterdam in 1999. Mr. Kreiz holds a B.A. in Economics and Management from Tel Aviv University and an M.B.A. from UCLA’s Anderson School of Management, where he currently serves on the Board of Advisors.

Thomas H. Lee, 74, has served as a director since August 17, 2011. Mr. Lee had previously served as our director from March 4, 2004 to July 20, 2011. He is Chairman and CEO of Thomas H. Lee Capital, LLC and Lee Equity Partners, LLC. Lee Equity Partners, LLC is engaged in the private equity business in New York City. In 1974, Mr. Lee founded the Thomas H. Lee Company, the predecessor of Thomas H. Lee Partners, L.P., and from that time until March 2006 served as its Chairman and CEO. From 1966 through 1974, Mr. Lee was with First National Bank of Boston where he directed the bank’s high technology lending group from 1968 to 1974 and became a Vice President in 1973. Prior to 1966, Mr. Lee was a securities analyst in the institutional research department of L.F. Rothschild in New York. Mr. Lee serves or has served, including during the past five years, as a director of numerous public and private companies in which he and his affiliates have invested, including MidCap Financial LLC, Papa Murphy’s International, LLC, Edelman Financial Services, LLC, SEC Bell Investor Holdings LLC and Aimbridge Hospitality Holdings LLC. Mr. Lee is currently a Trustee of Lincoln Center for the Performing Arts, NYU Langone Medical Center and the New York City Police Foundation among other civic and charitable organizations. He also serves on the Executive Committee for Harvard University’s Committee on University Resources. Mr. Lee is a 1965 graduate of Harvard College.

Donald A. Wagner, 55, has served as a director since July 20, 2011. Mr. Wagner is a Managing Director of Access, having been with Access since 2010. He is responsible for sourcing and executing new investment opportunities in North America. From 2000 to 2009, Mr. Wagner was a Senior Managing Director of Ripplewood Holdings L.L.C., responsible for investments in several areas and heading the industry group focused on investments in basic industries. Previously, Mr. Wagner was a Managing Director of Lazard Freres & Co. LLC and had a 15-year career at that firm and its affiliates in New York and London. He is a board member of EP Energy, Calpine Corporation and BMC Software and was on the board of NYSE-listed RSC Holdings from November 2006 until August 2009. Mr. Wagner graduated summa cum laude with an A.B. in physics from Harvard College.

Board of Directors

Our business and affairs are managed under the direction of our Board of Directors. Our Board of Directors currently consists of ten members. Under our amended and restated certificate of incorporation and by-laws, our Board of Directors shall consist of such number of directors as determined from time to time by resolution adopted by the Board. Our directors hold office until their successors have been elected and qualified or until the earlier of their resignation or removal.

When considering whether directors have the experience, qualifications, attributes or skills, taken as a whole, to enable the Board of Directors to satisfy its oversight responsibilities effectively in light of our business and structure, the Board of Directors focuses primarily on each person’s background and experience as reflected in the information discussed in each of the directors’ individual biographies set forth above. In the view of the Board of Directors, its directors provide an appropriate mix of experience and skills relevant to the size and nature of our business. In particular, each of our directors brings specific experience, qualifications, attributes and skills to our Board of Directors.

The directors affiliated with Access, Messrs. Len Blavatnik, Benet, Alex Blavatnik, and Wagner, each brings beneficial experience and attributes to our Board. Len Blavatnik has extensive experience advising companies, particularly as founder and Chairman of Access and in his role as a former director of UC Rusal plc and TNK-BP Limited. Mr. Benet has extensive experience in advising companies, particularly as the CEO of Access and in his role as a director of Clal Industries Ltd. and LyondellBasell Industries N.V. Alex Blavatnik has extensive experience advising companies, particularly as Vice Chairman of Access and previously as a director of OGIP Ventures, Ltd. Mr. Wagner has served as a director of various companies, including public companies, and has over 25 years of experience in investing, banking and private equity. In addition to their individual attributes, each of the directors affiliated with Access possesses experience in advising and managing publicly traded and privately held enterprises and is familiar with the corporate finance and strategic business planning activities that are unique to highly leveraged companies like us.  

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Mr. Cooper has more than 30 years of experience as a financial advisor, and has served as chairman or chief executive officer of various businesses, including Vice Chairman and member of the office of Chief Executive Officer of Metro-Goldwyn-Mayer, Inc. and Chief Executive Officer of Hawaiian Telcom.

Mr. Lousada is involved in managing the day-to-day business of our company, providing him with intimate knowledge of our operations, and he has significant experiences in the entertainment industry, advising and managing companies.

Mr. Döpfner has extensive experience in the media industry. Through his positions as Chairman and CEO of Axel Springer, he has a profound understanding of the challenges and developments of today’s business, such as content creation and monetization or distribution and digital platforms.  

Professor Hertz has over 25 years of experience in advising companies in a variety of sectors and geographies on strategic and policy decisions, intelligence gathering and analysis, millennials and post-millennials and stakeholder management and corporate social responsibility. She has also held senior academic positions where her research has focused on decision-making, risk assessment and management, globalization, innovation and corporate social responsibility.

Mr. Kreiz has extensive experience advising and managing companies, having served as Chairman and CEO of Maker Studios and the Endemol Group and also as a general partner at Balderton Capital (formerly Benchmark Capital Europe).

Mr. Lee has extensive experience advising and managing companies, serving as the Chairman and CEO of Thomas H. Lee Capital, LLC, Thomas H. Lee Capital Management, LLC and Lee Equity Partners, LLC and serving as or having served as a director of numerous public and private companies. Mr. Lee was also part of the investor group that acquired Warner Music Group from Time Warner in the 2004 Acquisition and was a director of our company from March 2004 until July 2011, before subsequently rejoining the Board in August 2011, and has a detailed understanding of our company.

Our Board of Directors believes that the qualifications described above bring a broad set of complementary experience to the Board of Directors’ discharge of its responsibilities, coupled with a strong alignment with the interests of the stockholder of our company.  

Committees of the Board of Directors

Following consummation of the Merger, we became a privately held company. As a result, we are no longer subject to any stock exchange listing or SEC rules requiring a majority of our Board of Directors to be independent or relating to the formation and functioning of the various Board committees. The Board of Directors of the Company has an Audit Committee, a Compensation Committee, a Finance Committee and a Dividend Committee, all of which report to the Board of Directors as they deem appropriate, and as the Board may request. Affiliates of Access own 100% of our common stock and have the power to elect our directors. Thus the Board has determined that it is not necessary for us to have a Nominating Committee or a committee performing similar functions. The Board of Directors does not have a policy with regard to the consideration of any director candidates recommended by our debt holders or other parties.

The Audit Committee is responsible for overseeing the accounting and financial reporting processes of the Company and audits of the financial statements of the Company and its subsidiaries. The Audit Committee is responsible for assisting the Board of Directors’ oversight of (a) the quality and integrity of the Company’s financial statements and related disclosure; (b) the independent auditor’s qualifications and independence; (c) the evaluation and management of the Company’s financial risks; (d) the performance of the Company’s internal audit function and independent auditor; and (e) the Company’s compliance with legal and regulatory requirements. The Audit Committee’s duties include, when appropriate, as permitted under applicable law, amending or supplementing the Company’s Delegation of Authority Policy without the prior approval of the Board. The current members of the Company’s audit committee are Messrs. Wagner, Kreiz and Lee. Mr. Wagner serves as the chairman of the committee. Messrs. Kreiz and Wagner qualify as “audit committee financial experts,” as defined by SEC rules, based on their education, experience and background.

The Compensation Committee discharges the responsibilities of the Board of Directors of the Company relating to all compensation, including equity compensation, of the Company’s executives. The Compensation Committee has overall responsibility for evaluating and making recommendations to the Board regarding director and officer compensation, compensation under the Company’s long-term incentive plans and other compensation policies and programs. The current members of the Company’s Compensation Committee are Messrs. Benet, Lee and Wagner and Alex Blavatnik and Len Blavatnik. Mr. Benet serves as the chairman of the committee.

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As of September 26, 2017, the Finance Committee discharges the responsibilities of the Board of Directors of the Company relating to all debt financing transactions. The current members of the Company’s Finance Committee are Messrs. Benet, Cooper, Wagner and Alex Blavatnik.  

As of November 30, 2016, the Dividend Committee discharges the responsibilities of the Board of Directors of the Company relating to all dividend and dividend equivalent declarations and payments. The current members of the Company’s Dividend Committee are Messrs. Benet, Cooper, Wagner and Alex Blavatnik.

Oversight of Risk Management

On behalf of the Board of Directors, our Audit Committee is responsible for oversight of the Company’s risk management and assessment guidelines and policies. We are exposed to a number of risks including financial risks, operational risks and risks relating to regulatory and legal compliance. The Audit Committee discusses with management and the independent auditors the Company’s major financial risk exposures and the steps management has taken to monitor and control such exposures, including the guidelines and policies to govern the process by which risk assessment and risk management are undertaken. The Company’s Chief Compliance Officer and Head of Internal Audit are responsible for the Company’s risk management function and regularly work closely with the Company’s senior executives to identify risks material to the Company. Both the Chief Compliance Officer and the Head of Internal Audit report regularly to the Chief Financial Officer, the Chief Executive Officer and the Audit Committee regarding the Company’s risk management policies and procedures. In that regard, both the Chief Compliance Officer and Head of Internal Audit regularly meet with the Audit Committee to discuss the risks facing the Company, highlighting any new risks that may have arisen since they last met. The Audit Committee also reports to the Board of Directors to apprise them of their discussions with the Chief Compliance Officer and Head of Internal Audit regarding the Company’s risk management efforts. In addition, the Board of Directors receives management updates on our business operations, financial results and strategy and, as appropriate, discusses and provides feedback with respect to risks related to those topics.

Section 16(a) Beneficial Ownership Reporting Compliance

Subsequent to the consummation of the Merger, as the Company no longer has a class of securities registered pursuant to Section 12 of the Exchange Act, none of its directors, officers or stockholders is subject to the reporting requirements of Section 16(a) of the Exchange Act.

Code of Conduct

The Company has adopted a Code of Conduct as our “code of ethics” as defined by regulations promulgated under the Securities Act, and the Exchange Act (and in accordance with the NYSE requirements for a “code of conduct”), which applies to all of the Company’s directors, officers and employees, including our principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions. A current copy of the Code of Conduct is available on the Company’s website at www.wmg.com by clicking on “Investor Relations” and then on “Corporate Governance.” A copy of the Code of Conduct may also be obtained free of charge, from the Company upon a request directed to Warner Music Group Corp., 1633 Broadway, New York, NY 10019, Attention: Investor Relations. The Company will disclose within four business days any substantive changes in or waivers of the Code of Conduct granted to our principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions, by posting such information on our website as set forth above rather than by filing a Form 8-K.

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ITEM 11.

EXECUTIVE COMPENSATION

Compensation Discussion and Analysis

This compensation discussion and analysis provides information about the material elements of compensation that are paid, awarded to, or earned by our “named executive officers,” who consist of our principal executive officer, principal financial officer and our three other most highly compensated executive officers for fiscal year 2018. Our named executive officers (“NEOs”) for fiscal year 2018 are:

 

Stephen Cooper (our CEO);

 

Eric Levin (our CFO);

 

Max Lousada;

 

Jon Platt; and

 

Paul M. Robinson.

Role of the Compensation Committee

The Compensation Committee is responsible for overseeing our compensation programs. As part of that responsibility, the Compensation Committee determines all compensation for the Company’s executive officers. For executive officers other than the CEO, the Compensation Committee considers the recommendation of the CEO and the Executive Vice President, Human Resources in making its compensation determinations. The Committee interacts regularly with management regarding our executive compensation initiatives and programs. The Compensation Committee has the authority to engage its own advisors and had done so prior to the consummation of the Merger. However, during fiscal year 2018, no independent compensation advisor provided any advice or recommendations on the amount or form of executive and director compensation to the Compensation Committee and since the consummation of the Merger, we have not retained a compensation consultant to assist in determining or recommending the amount or form of executive compensation. The Compensation Committee may elect in the future to retain a compensation consultant if it determines that doing so would assist it in implementing and maintaining our compensation programs.

Our executive team consists of individuals with extensive industry expertise, creative vision, strategic and operational skills, in-depth company knowledge, financial acumen and high ethical standards. We are committed to providing competitive compensation packages to ensure that we retain these executives and maintain and strengthen our position as a leading global music-based content company. Our executive compensation programs and the decisions made by the Compensation Committee are designed to achieve these goals. The compensation for the Company’s NEOs (the executive officers for whom disclosure of compensation is provided in the tables below) consists of base salary and annual bonuses. In addition, two of our NEOs, Messrs. Cooper and Lousada, have elected to participate in the Second Amended and Restated Warner Music Group Corp. Senior Management Free Cash Flow Plan (the “Plan”), our long-term incentive program. The NEOs do not receive any other compensation or benefits other than standard benefits available to all U.S. employees, which primarily consist of health plans, the opportunity to participate in the Company’s 401(k) and deferred compensation plans, basic life insurance and accidental death insurance coverage.  Additionally, because Mr. Lousada is located in the United Kingdom, he participates in our defined contribution pension scheme for our U.K. employees, and he also receives a car allowance and is reimbursed for certain tax preparation costs.

For the 2018 fiscal year, in determining the compensation of the NEOs, the Compensation Committee sought to establish a level of compensation that is (a) appropriate for the size and financial condition of the Company, (b) structured so as to attract and retain qualified executives and (c) tied to annual financial performance and long-term shareholder value creation.

The Company has entered into employment arrangements with each of our NEOs (other than Mr. Cooper), which establish each executive’s base salary and for Mr. Lousada his entitlement to a percentage of our annual free cash flow under the Plan and, in the case of Messrs. Platt, Levin and Robinson, their annual bonus.  The Company has not entered into an employment agreement with Mr. Cooper because, among other reasons, as a participant in the Plan (with an entitlement to a percentage of our annual free cash flow under the Plan), the Company believes he already has retention incentives to remain employed at the Company.

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Executive Compensation Objectives and Philosophy

We design our executive compensation programs to attract talented executives to join the Company and to motivate them to position us for long-term success, achieve superior operating results and increase stockholder value. To realize these objectives, the Compensation Committee and management focus on the following key factors when considering the amount and structure of the compensation arrangements for our executives:

 

Alignment of executive and stockholder interests by providing incentives linked to operating performance and achievement of cash flow and strategic objectives. We are committed to creating stockholder value and believe that our executives and employees should be provided incentives through our compensation programs that align their interests with those of our stockholders. Accordingly, we provide our executives with annual cash bonus incentives linked to our operating performance. In addition, in 2013, we adopted the Plan, which, as described below, is an incentive compensation program that pays annual bonuses based on our free cash flow and offers participants the opportunity to share in appreciation of our common stock. For information on the components of our executive compensation programs and the reasons why each is used, see “Components of Executive Compensation” below.

 

A clear link between an executive’s compensation and Company-wide performance. Two of our NEOs (Messrs. Cooper and Lousada) and some of our other senior executives have elected to participate in the Plan. As further discussed below, the Plan, which is a significant part of our executive compensation program, is designed to reward our executives’ contributions to our free cash flow and long-term value. For other executives, their compensation is designed to reward their achievement of specified key goals, which include, among other things, the successful implementation of strategic initiatives, realizing superior operating and financial performance, and other factors that we believe are important, such as the promotion of an ethical work environment and teamwork within the Company. We believe our compensation structure motivates our executives to achieve these goals and rewards them for their significant efforts and contributions to the Company and the results they achieve.

 

The extremely competitive nature of the media and entertainment industry, and our need to attract and retain the most creative and talented industry leaders. We compete for talented executives in relatively high-priced markets, and the Compensation Committee takes this into consideration when making compensation decisions. For example, we compete for executives with other recorded music and music publishing companies, other entertainment, media and technology companies, law firms, private ventures, investment banks and many other companies that offer high levels of compensation. We believe that our senior management team is among the best in the industry and is the right team to lead us to long-term success. Our commitment to ensuring that we are led by the right executives is a high priority, and we make our compensation decisions accordingly.  

Components of Executive Compensation

Employment Arrangements

With the exception of Mr. Cooper as described above, we have employment arrangements with all of our NEOs, the key terms of which are described below under “Summary of NEO Employment Arrangements.” We believe that having employment arrangements with certain of our executives can be beneficial to us because it provides retentive value, requires them to comply with key restrictive covenants, and may give us some competitive advantage in the recruiting process over a company that does not offer employment arrangements. Our employment arrangements set forth the terms and conditions of employment and establish the components of an executive’s compensation, which generally include the following:

 

Base salary;

 

Participation in the free cash flow bonus pool of the Plan or a discretionary or target annual cash bonus;

 

Severance payable upon a qualifying termination of employment; and

 

Benefits, including participation in a defined contribution plan and health, life insurance and disability insurance plans.

Key Considerations in Determining Executive Compensation

The following describes the components of our NEO compensation arrangements and why each is included in our executive compensation programs.

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Base Salary

The cash base salary an NEO receives is determined by the Compensation Committee after considering the individual’s compensation history, the range of salaries for similar positions, the individual’s expertise and experience, and other factors the Compensation Committee believes are important, such as whether we are trying to attract the executive from another opportunity. The Compensation Committee believes it is appropriate for executives to receive a competitive level of guaranteed compensation in the form of base salary and determines the initial base salary by taking into account recommendations from management and, if deemed necessary, the Compensation Committee’s independent compensation consultant.

Each of our NEOs (other than Mr. Cooper) was paid base salary in accordance with the terms of their respective employment arrangement for fiscal year 2018.  Mr. Cooper was paid annual base salary of $1,000,000 for fiscal year 2018.

Effective October 1, 2017, Mr. Lousada was paid an annual base salary of $5,180,000 (£4,000,000) for fiscal year 2018.

Annual Cash Bonus

Our Compensation Committee directly links the amount of the annual cash bonuses we pay to our financial performance for the particular year. Messrs. Cooper and Lousada have elected to participate in the annual free cash flow bonus pool in the Plan, as described below.

Annual Free Cash Flow Bonus Pool

Messrs. Cooper and Lousada have elected to participate in the Plan, which is also a non-qualified deferred compensation plan that allows the participants to defer receipt of all or a portion of their annual bonuses until future dates prescribed by the Plan. Our Compensation Committee adopted the Plan to, among other reasons, reinforce a partnership culture with our executives, by allowing them to participate in our short-term performance (in the form of annual free cash flow bonuses) and long-term performance (in the form of deferred compensation that is indexed to the value of our common stock and with grants of Profits Interests, as described below under “Long-Term Equity Incentives”). We believe it is important for our executives and shareholders to be motivated to work together towards shared financial and operational goals. In addition, our Compensation Committee considered that the Plan offers our executives the opportunity for tax-efficient wealth management creation based on our performance.

For the 2018 fiscal year, Messrs. Cooper and Lousada participated in the Plan with fixed percentages of free cash flow of 2.5% and 1.0%, respectively.  The Company’s free cash flow for the 2018 fiscal year for the Plan was $373 million. Accordingly, for fiscal year 2018, Messrs. Cooper and Lousada earned free cash flow bonuses under the Plan of $9,325,000 and $3,730,000, respectively.  Because in fiscal year 2017, Mr. Cooper acquired the last of his deferred equity units using a portion of his 2016 fiscal year free cash flow bonus under the Plan, he was not entitled to defer any of his free cash flow bonus payable for the 2018 fiscal year and all of it will be paid to him in cash. Mr. Lousada elected to defer 100% of his free cash flow bonus earned from the 2018 fiscal year and, in doing so, to acquire equity interests representing shares of our common stock. The amounts to be paid in cash to Mr. Cooper for his free cash flow bonus under the Plan for the 2018 fiscal year are set forth below under the “Non-Equity Incentive Plan Compensation” column in the Summary Compensation Table.

Discretionary Bonuses

Messrs. Platt, Levin and Robinson do not participate in the Plan.  For the 2018 fiscal year, Mr. Platt had an annual target bonus amount of $2,300,000 set forth in his employment agreement. For the 2018 fiscal year, Mr. Levin had an annual target bonus amount of $500,000 set forth in his employment agreement. For the 2018 fiscal year, Mr. Robinson had an annual target bonus amount of $600,000 set forth in his employment agreement. The actual amount of Messrs. Platt’s, Levin’s and Robinson’s annual bonuses are determined by the Compensation Committee in its sole discretion and may be higher or lower than their target amounts. The amounts of Messrs. Platt’s, Levin’s and Robinson’s bonuses for fiscal year 2018 are set forth below under the “Bonus” column in the Summary Compensation Table.

For Messrs. Platt, Levin and Robinson, the Compensation Committee considered the recommendation of the CEO and the Executive Vice President, Human Resources in making its bonus determinations. The bonuses for each of Messrs. Platt, Levin and Robinson was based on the target bonus set forth in his employment agreement, corporate performance and other discretionary factors, including achievement of strategic objectives, goals in compliance and ethics and teamwork within the Company. A variety of qualitative and quantitative factors that vary by year and are given different weights in different years depending on facts and circumstances were considered, with no single factor material to the overall bonus determination. The factors considered by the Compensation Committee in connection with Messrs. Platt, Levin, and Robinson’s fiscal year 2018 bonuses are discussed in more detail below.

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For fiscal year 2018, after considering the factors described above and management’s recommendations, the Compensation Committee determined that the bonuses for Messrs. Platt, Levin and Robinson would be set at amounts equal to $2,412,455, $677,907 and $633,488, respectively. This reflected the Compensation Committee’s and management’s assessment that overall corporate performance and discretionary factors justified payment of such bonus to each of them based on their and the Company’s performance during the fiscal year. Specifically, the Compensation Committee set the amount of Mr. Platt’s bonus after considering the quality of his individual performance in running the Company’s publishing business, the Compensation Committee set the amount of Mr. Levin’s bonus after considering the quality of his individual performance in running the company-wide finance function and the amount of Mr. Robinson’s bonus after considering the quality of his individual performance in running the company-wide legal and business affairs and public policy functions as well as the performance of the Company and, in the case of Mr. Platt, of the business unit he oversees.

In making the bonus determinations for Messrs. Levin and Robinson, other qualitative factors taken into account included performance in internal and public financial reporting, budgeting and forecasting processes, compliance and infrastructure, investment and cost-savings initiatives. Non-financial factors considered also included, among other items, providing strategic leadership and direction for the Company, including corporate governance matters, managing the strategic direction of the Company, increasing operational efficiency, expanding our digital presence and communicating to investors and other important constituencies.  

Long-Term Equity Incentives

Warner Music Group Corp. Senior Management Cash Flow Plan

As noted above, Messrs. Cooper and Lousada have elected to participate in the Plan. In addition to providing an annual bonus that is based on a percentage of the Company’s free cash flow, as described above, the Plan provides its participants with the opportunity to defer all or a portion of their free cash flow bonuses and receive grants of equity interests, within prescribed limits.  

Deferral of Compensation under the Plan

Subject to prescribed limits under the Plan (including on an individualized participant basis), deferred amounts, if any, will be credited to a participant’s account as and when a deferred bonus is earned and indexed to the fair market value of a share of our common stock (as determined from time to time by the Compensation Committee), except that the initial value of deferred amounts at the time of deferral was based on our fair market value as of January 1, 2013 for the Plan’s initial participants, including Mr. Cooper, and as of the grant date for other participants who joined the Plan at a later date, including Mr. Lousada. The amount that will be deferred in respect of Mr. Lousada’s bonus for the 2018 fiscal year is $3,730,000. As noted above, Mr. Cooper was not entitled to defer any of his 2018 free cash flow bonus because he had previously deferred his maximum allocation under the Plan.

Equity Interests under the Plan

Each of our NEOs who elected to participate in the Plan became a member of WMG Management Holdings, LLC (“Management LLC”), a limited liability company formed in connection with the Plan’s adoption, and was granted a “profits interest” in Management LLC (“Profits Interests”) in amounts equal to 10,000 times the maximum number of shares of our common stock available for issuance to the participants in settlement of his or her deferred accounts (each deferred equity unit is equivalent to 1/10,000 of a share of our common stock). These Profits Interests granted to Messrs. Cooper and Lousada represent an economic entitlement to future appreciation in our common stock above the fair market value on the grant date. In addition, in connection with the increase to the free cash flow percentage allocations of Mr. Cooper, he was granted an additional number of Profits Interests in Management LLC equal to the additional number of deferred equity units that may be granted to him, representing an economic entitlement to future appreciation in our common stock from the date of grant. Terms and conditions of the Plan with respect to the Profits Interests are described below in the narrative accompanying the “Grant of Plan-Based Awards in Fiscal Year 2018” table and under “Potential Payments upon Termination or Change-In-Control.”  

On August 10, 2018, we paid a special cash dividend to our stockholders on all the issued and outstanding shares of our common stock.  Under the Plan, deferred equity unit holders receive dividend equivalents for cash dividends paid on our common stock. Given that the special dividend was paid prior to the payment of the 2018 fiscal year free cash flow bonus, the Compensation Committee accelerated the vesting of a portion of Mr. Lousada’s deferred equity units to that time in order to provide him participation in this special cash dividend, using management’s forecast of free cash flow for the 2018 fiscal year, which resulted in the accelerated vesting of a corresponding number of Mr. Lousada’s Profits Interests.  This acceleration of deferred equity units and Profits Interests was subject to a clawback in the Compensation Committee’s discretion if the actual free cash flow for the 2018 fiscal year would have less than management’s forecast that had been taken into account for this determination.  However, actual free cash flow for fiscal year 2018 exceeded the management forecast used for this accelerated vesting determination, and therefore no clawback applied.  

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Tax Deductibility of Performance-Based Compensation and Other Tax Considerations

Where appropriate, and after taking into account various considerations, including that certain incentives, including the Profits Interests under the Plan, may have competing advantages, we structure our executive employment arrangements and compensation programs to allow us to take a tax deduction for the full amount of the compensation we pay to our executives.

We are a privately held company. As a result, we are not subject to Section 162(m) of the Internal Revenue Code, which generally places limits on the tax deductibility of executive compensation for publicly held companies unless certain requirements are met.

Benefits

Our NEOs also receive health coverage, life insurance, disability benefits and, generally, other similar benefits in the same manner as our U.S. employees and, in the case of Mr. Lousada, UK employees of equivalent status.

Retirement Benefits

We offer a tax-qualified 401(k) plan to our U.S. employees and in November 2010 we adopted a non-qualified deferred compensation plan, which is available to those of our employees whose base salary is at least $200,000 and who are bonus eligible and who are not eligible to participate in the Plan. Both plans are available to the NEOs except for the non-qualified deferred compensation plan if they participate in the Plan.

In accordance with the terms of the Company’s 401(k) plan, the Company matches after one year of service, in cash, 50% of the first 6% amounts contributed to that plan by each plan participant, up to 3% of eligible pay, with a limit of up to $8,250 in 2018, whichever is less. Employees can contribute up to the maximum IRS pre-tax deferral of $18,500 in 2018 (with a catch up of $6,000 in 2018 in the case of participants age 50 or greater), whichever occurs first. The matching contributions made by the Company are initially subject to vesting, based on continued employment, with 25% scheduled to vest on each of the second through fifth anniversaries of the employee’s date of hire.

Additionally, the Company offers a defined contribution pension scheme for UK employees, including Mr. Lousada.  

Perquisites

We generally do not provide perquisites to our NEOs, although Mr. Lousada receives a car allowance and is reimbursed for certain tax preparation costs. See the Summary Compensation Table below for a summary of compensation received by our NEOs, including any perquisites received in fiscal year 2018.

Compensation Committee Report

The Compensation Committee has reviewed and discussed with management the Compensation Discussion and Analysis. Based on the review and discussions, the Compensation Committee recommends to the Board of Directors that the Compensation Discussion and Analysis be included in this Form 10-K.

Members of the Compensation Committee:

Lincoln Benet, Chair

Alex Blavatnik

Len Blavatnik

Thomas H. Lee

Donald A. Wagner

 

 

 

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Summary Compensation Table

The following table provides summary information concerning compensation paid or accrued by us to or, on behalf of, our NEOs, for services rendered to us during the specified fiscal year.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Change in

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Pension Value

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

and

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nonqualified

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Non-Equity

 

 

Deferred

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock

 

 

Incentive Plan

 

 

Compensation

 

All Other

 

 

 

 

 

 

 

 

 

Salary

 

 

Bonus

 

 

Awards

 

 

Compensation

 

 

Earnings

 

Compensation

 

 

 

 

 

Name and Principal Position

 

Year

 

($)

 

 

($) (1)

 

 

($) (2)

 

 

($) (3)

 

 

($)

 

($) (4)

 

 

Total ($)

 

Stephen Cooper (5)

 

2018

 

$

1,000,000

 

 

 

 

 

 

$

9,325,000

 

 

 

$

24,025,974

 

 

$

34,350,974

 

CEO

 

2017

 

$

1,000,000

 

 

 

 

 

 

$

12,025,000

 

 

 

$

2,181,818

 

 

$

15,206,818

 

 

 

2016

 

$

2,000,000

 

 

 

 

$

2,935,068

 

 

$

159,292

 

 

 

 

 

$

5,094,360

 

Max Lousada (6)(7)

 

2018

 

$

5,180,000

 

 

 

 

 

 

 

 

 

$

1,467,059

 

 

$

6,647,059

 

CEO, Warner Recorded Music

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Eric Levin

 

2018

 

$

750,000

 

 

$

677,907

 

 

 

 

 

 

 

$

8,250

 

 

$

1,436,157

 

Executive Vice President and

 

2017

 

$

750,000

 

 

$

625,000

 

 

 

 

 

 

 

$

8,100

 

 

$

1,383,100

 

Chief Financial Officer

 

2016

 

$

650,000

 

 

$

438,400

 

 

 

 

 

 

 

$

10,445

 

 

$

1,098,845

 

Jon Platt

 

2018

 

$

2,300,000

 

 

$

2,412,455

 

 

__

 

 

__

 

 

 

$

8,250

 

 

$

4,720,705

 

Chairman and CEO of

 

2017

 

$

2,300,000

 

 

$

2,346,000

 

 

__

 

 

__

 

 

 

$

8,100

 

 

$

4,654,100

 

Warner/Chappell Music

 

2016

 

$

2,300,000

 

 

$

2,398,900

 

 

__

 

 

__

 

 

 

$

7,950

 

 

$

4,706,850

 

Paul M. Robinson

 

2018

 

$

750,000

 

 

$

633,488

 

 

 

 

 

 

 

$

8,250

 

 

$

1,391,738

 

Executive Vice President

 

2017

 

$

750,000

 

 

$

630,000

 

 

 

 

 

 

 

$

8,100

 

 

$

1,388,100

 

and General Counsel and Secretary

 

2016

 

$

750,000

 

 

$

657,600

 

 

 

 

 

 

 

$

7,950

 

 

$

1,415,550

 

 

(1)

Represents discretionary cash bonuses for fiscal year 2018 performance for each of Messrs. Platt, Levin and Robinson expected to be paid in January 2019, and discretionary cash bonuses for fiscal years 2017 and 2016 to Messrs. Levin, Robinson and Platt, as applicable.

(2)

For fiscal year 2016 (for Mr. Cooper), this column reflects the aggregate grant date fair value of an increase to the maximum number of deferred equity units granted to him and the awards of Profits Interests made to him in fiscal year 2016 in connection with that increase. These grant date fair values were computed in accordance with Financial Accounting Standards Board Accounting Standards Codification Topic 718, Compensation—Stock Compensation, without taking into account estimated forfeitures. Assumptions used in the calculation of this amount are included in Note 9 to our audited financial statements for the year ended September 30, 2018.

(3)

For the 2018 fiscal year, Mr. Cooper’s free cash flow bonus under the Plan will be paid entirely in cash because he previously acquired all of his deferred equity unit allocation. All of his 2017 free cash flow bonus and a portion of his 2016 free cash flow bonus were also paid in cash.

(4)

Fiscal year 2018 includes 401(k) matching contributions of $8,250 for Messrs. Levin, Platt, and Robinson, respectively, and defined contribution pension matching contributions of $24,329 (£18,787) for Mr. Lousada.  Additionally, for Messrs. Cooper and Lousada, includes $24,025,974 and $1,399,995, respectively, in cash dividends paid to them under the Plan in respect of their deferred equity units and Profits Interests. Also, Mr. Lousada received a car allowance and we reimbursed him for certain tax preparation costs.

(5)

For fiscal year 2016, Access had a consulting agreement in respect of Mr. Cooper pursuant to which he received $166,667 a month in connection with his role as CEO of the Company. The Company reimbursed Access for these amounts pursuant to the Management Agreement. Except for his participation in the Plan, the Company did not have any other employment arrangement with Mr. Cooper for that fiscal year.  Effective October 1, 2016 (i.e., the beginning of fiscal year 2017), the Company began to pay Mr. Cooper an annual base salary of $1,000,000 as an employee of the Company, and, in connection with this change, the Company ceased to reimburse Access for Mr. Cooper’s services under a consultancy agreement.

(6)

Mr. Lousada became an NEO in fiscal year 2018.  

(7)

The amounts reported for Mr. Lousada have been converted from British pound sterling to U.S. dollars using a conversion factor of 1.295.

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Grant of Plan-Based Awards in Fiscal Year 2018

No deferred equity units or Profits Interests were granted in fiscal year 2018 to our NEOs.  

Under the Plan, the deferred amounts granted to our NEOs under the Plan are credited to a participant’s account as and when a deferred bonus is earned based on the fair market value of a share of our common stock as of January 1, 2013. Uncredited deferred equity units are forfeited upon an NEO’s termination of employment. Under the Plan, our NEOs’ Profits Interests vest over time as equivalent amounts of their annual free cash flow bonuses are deferred under the Plan. Unvested Profits Interests are forfeited on any termination of employment. As of September 30, 2018, 136,605.07 and 54,642.03 deferred equity units had been granted to Mr. Cooper and Mr. Lousada, respectively.  As of September 30, 2018, all of Mr. Cooper’s deferred equity units had vested and Mr. Lousada had vested in 14,725.98 of his deferred equity units. Also, each of Messrs. Cooper and Lousada had vested in an equal number of the Profits Interests held by him.  

The deferred amounts reflected in the “Outstanding Equity Awards at 2018 Fiscal Year-End” and “Nonqualified Deferred Compensation” tables below are scheduled to be settled in three equal installments as follows: For Mr. Cooper, on the December 2018, 2019 and 2020 redemption dates; and for Mr. Lousada, on the December 2023, 2024, and 2025 redemption dates.  Deferred accounts will be settled at the participants’ election, in shares of our common stock or with a cash payment equal to the then fair market value of the shares. Any shares received on settlement are required to be immediately exchanged for fully-vested equity units (“Acquired LLC Units”) in Management LLC. On each scheduled redemption date, a Plan participant may elect to redeem up to one-third of his or her vested Profits Interests (including any Profits Interests eligible for redemption on a prior redemption date that were not then redeemed) for a cash payment equal to their liquidation value. Also, a Plan participant may also elect to redeem his or her Acquired LLC Units for a cash payment equal to the fair market value of their underlying shares of the Company’s common stock on each redemption date. In addition to a Plan participant’s right to redemption of his or her vested Profits Interests and Acquired LLC Units on the redemption dates and annually thereafter, Management LLC may redeem vested Profits Interests and Acquired LLC Units following a participant’s termination of employment with the Company and its subsidiaries. All remaining Profits Interests will be redeemed in December 2020 for Mr. Cooper and December 2025 for Mr. Lousada. Redemption payments in respect of Profits Interests may be reduced by the amount of any outstanding unrecovered added investment amounts.

For the 2018 redemption date, Mr. Cooper has elected to receive shares of the Company’s common stock for all of his deferred equity units then scheduled for settlement (and all such shares will be immediately contributed to Management LLC in exchange for Class A units, pursuant to the Plan) and elected to retain (and not redeem) all of his Profits Interests then eligible for redemption.  Because Mr. Lousada joined the Plan in 2017, he is not eligible to redeem any deferred equity units or Profits Interests in December 2018.  

As a condition to the grant of Profits Interests to our NEOs who elected to participate in the Plan, each of them agreed to restrictive covenants in the LLC Agreement, including non-competition with the businesses of the Company and its subsidiaries during the participant’s term of employment, non-solicitation of certain artists, labels and employees during the participant’s term of employment and for one year afterwards, as well as obligations of non-disparagement and confidentiality.

Summary of NEO Employment Arrangements

This section describes employment arrangements in effect for our NEOs during fiscal year 2018. Potential payments under the severance agreements and arrangements described below are provided in the section entitled “Potential Payments upon Termination or Change-In-Control.” In addition, for a summary of the meanings of “cause” and “good reason” as discussed below, see “Termination for “Cause”” and “Resignation for “Good Reason” or without “Good Reason”” below.

Employment Arrangements with Stephen Cooper

As noted above, except for Mr. Cooper’s annual base salary of $1,000,000 and his participation in the Plan, the Company does not have any other employment arrangement with Mr. Cooper.  

Employment Arrangement with Max Lousada

During fiscal year 2018, Mr. Lousada was party to an employment agreement with us that provided, among other things, for the following:

(1) the term of Mr. Lousada’s employment agreement ends on September 30, 2022;

(2) Mr. Lousada’s base salary for fiscal year 2018 was $5,180,000 (£4,000,000);

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(3) payment of $3,108,000 (£2,400,000), which represents incentive compensation earned in fiscal year 2017 pursuant to his previous employment agreement;

(4) eligibility to participate in the Plan; and

(5) eligibility to participate in the defined contribution pension plan for UK employees, along with company matching contributions of up to 10% of Mr. Lousada’s base salary.

In the event we terminate his employment for any reason other than “cause” (as defined in his employment agreement) or he is constructively dismissed, Mr. Lousada will be entitled to cash severance benefits equal to $7,770,000 (£6,000,000).

Mr. Lousada’s employment agreement also contains covenants relating to confidentiality, a six-month post-employment non-compete and a one-year post-employment non-solicitation covenant.

Employment Agreement with Eric Levin

During fiscal year 2018, Mr. Levin was party to an employment agreement with us that provided, among other things, for the following:

 

(1)

the term of Mr. Levin’s employment agreement ends on September 30, 2023; and

 

(2)

Mr. Levin’s base salary for fiscal year 2018 was $750,000 and his target bonus was $500,000. Additionally, Mr. Levin’s base salary and target bonus increased to $850,000 for fiscal years 2019, 2020 and 2021, and will increase to $900,000 for fiscal years 2022 and 2023.

Also, his employment agreement provides that, if during the term, we establish a new long-term incentive plan, we will consider offering Mr. Levin an opportunity to participate in it.  

In the event we terminate his employment for any reason other than for “cause” (as defined in his employment agreement), Mr. Levin will be entitled to cash severance benefits equal to the annual base salary payable to him under his employment agreement, except that if we elect to not renew his employment agreement at the end of its term, he will be paid $600,000.

Mr. Levin’s employment agreement also contains standard covenants relating to confidentiality and a one-year post-employment non-solicitation covenant.

Employment Agreement with Paul M. Robinson

For fiscal year 2018, Mr. Robinson was party to an employment agreement with us that provided, among other things, for the following:

 

(1)

the term of Mr. Robinson’s employment agreement ends on September 30, 2022; and

 

(2)

Mr. Robinson’s base salary for fiscal year 2018 was $750,000 and his target bonus was $600,000.  Additionally, Mr. Robinson’s base salary and target bonus increased to $850,000 for fiscal year 2019 and thereafter.

Also, his employment agreement provides that, if during the term, we establish a new long-term incentive plan, we will consider offering Mr. Robinson an opportunity to participate in it.  

In the event we terminate his employment for any reason other than for “cause” (as defined in his employment agreement), death or disability or if Mr. Robinson terminates his employment for “good reason” (as defined in his employment agreement), Mr. Robinson will be entitled to severance benefits equal to $1,250,000 plus a discretionary pro-rated bonus (as determined by the Company in good faith) and continued participation in the Company’s group health and life insurance plans for up to one year after termination.  However, that if we elect to not renew his employment agreement at the end of its term, he will be paid the severance that would be payable to him under our severance policy if he did not have an employment agreement.

Mr. Robinson’s employment agreement also contains standard covenants relating to confidentiality and a one-year post-employment non-solicitation covenant.

Employment Agreement and Separation Agreement with Jon Platt

For fiscal year 2018, Mr. Platt was party to an employment agreement with us that provided, among other things, for a base salary of $2,300,000 and a target bonus of $2,300,000.

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On September 12, 2018, Mr. Platt entered into a separation agreement with us. Under the agreement, he resigned as a director of the board as of September 12, 2018 and will resign as Warner/Chappell Music’s Chairman and CEO effective no later than December 31, 2018. He will continue to receive his base salary through the separation date and will be eligible for a discretionary bonus for fiscal year 2018 in accordance with the terms of his employment agreement. Also, he is subject to a confidentiality covenant and a non-solicitation covenant that applies to our recording artists, publishers, songwriters and employees through September 30, 2020.

Outstanding Equity Awards at 2018 Fiscal Year-End

 

Name

 

Number of
Shares or Units
of Stock That
Have Not
Vested (#) (1)

 

 

Market Value of
Shares or Units of
Stock That Have
Not Vested ($) (4)

 

Stephen Cooper

 

 

(2)

 

$

 

 

 

 

(3)

 

$

 

Max Lousada

 

 

39,916.05

(2)

 

$

12,143,261

 

 

 

 

39,916.05

(3)

 

$

6,071,630

 

 

(1)

An NEO’s deferred equity units and Profits Interests generally vest over time as equivalent amounts of his annual free cash flow bonuses are deferred under the Plan. All of Mr. Cooper’s special deferred equity units and Profits Interests had vested as of September 30, 2018.

(2)

Uncredited deferred equity units approved for grant to the NEO as of September 30, 2018. Each deferred equity unit is equivalent to 1/10,000 of a share of our common stock.  

(3)

Unvested Profits Interests. This table does not include vested Profits Interests held by the NEOs as of September 30, 2018: for Mr. Cooper, 136,605.07 vested Profits Interests, with a value of $25,412,963; and for Mr. Lousada, 14,725.98 vested Profits Interests, with a value of $2,239,969.  A Profits Interest’s benchmark amount reflects the value of 1/10,000 of our common stock on the grant date of the Profits Interest, and the value of a Profits Interest reflects the appreciation in the fair market value of our common stock above its benchmark amount.  

(4)

As of September 30, 2018, the value of 1/10,000 of a share of our common stock, as determined under the Plan, was $304.22.  Assumptions used in the calculation of this amount are included in Note 9 to our audited financial statements for the year ended September 30, 2018.

Equity Awards Vested in 2018 Fiscal Year

 

Name

 

Number of
Shares or Units

of Stock

Acquired on

Vesting (#)

 

 

Value Realized on

Vesting ($) (3)

 

Stephen Cooper

 

 

(1)

 

$

 

 

 

 

(2)

 

$

 

Max Lousada

 

 

14,725.98

(1)

 

$

2,170,020

 

 

 

 

14,725.98

(2)

 

$

2,170,020

 

 

(1)

Generally, an NEO’s deferred equity units vest in the fiscal year following the fiscal year in which the NEO’s free cash flow bonuses are paid.  However, in connection with the special cash dividend we paid in August 2018, our Compensation Committee accelerated the vesting of a portion of Mr. Lousada’s deferred equity units prior to the deferral of his 2018 fiscal year free cash flow bonus.  

(2)

Profits Interests that vested in fiscal year 2018 reflect a number of Profits Interests equal to the number of deferred equity units acquired by the NEOs in fiscal year 2018.

(3)

Reflects the difference between the purchase price of a deferred equity unit and the fair market value of a deferred equity unit on the date Mr. Lousada acquired the vested deferred equity units in August 2018. Pursuant to the Plan and the NEOs’ elections, the deferred equity units and Profits interests will not be settled or redeemed until the scheduled redemption dates or, if earlier, termination of the NEO’s employment.  See the descriptions in the narratives accompanying the “Grants of Plan-Based Awards in Fiscal Year 2018” table above and below under “Potential Payments upon Termination or Change-In-Control.”

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Nonqualified Deferred Compensation

The following table provides information concerning the deferred accounts of our NEOs under the Plan:

 

Name

 

Executive

Contributions in

Last FY ($) (1)

 

 

Registrant

Contributions in

Last FY ($) (2)

 

 

Aggregate

Earnings in

Last FY ($) (3)

 

 

Aggregate

Withdrawals /

Distributions ($)

 

 

Aggregate

Balance at Last

FYE ($) (4)

 

Stephen Cooper

 

$

 

 

$

 

 

$

8,533,719

 

 

 

 

 

$

40,748,442

 

Max Lousada

 

$

2,240,000

 

 

$

2,170,020

 

 

$

69,918

 

 

 

 

 

$

4,479,938

 

 

(1)

Amounts of free cash flow bonuses that were deferred by Mr. Lousada under the Plan through the acquisition of vested deferred equity units in fiscal year 2018.  

(2)

Reflects the difference between the purchase price of a deferred equity unit and the fair market value of a deferred equity unit on the date Mr. Lousada acquired the vested deferred equity units in fiscal year 2018.

(3)

For Mr. Lousada, this reflects the increase in value of vested deferred equity units as of September 30, 2018 since the date he acquired the vested deferred equity units. For Mr. Cooper, this reflects the increase in value of vested deferred equity units as of September 30, 2018 since October 1, 2017.

(4)

For Mr. Cooper, $8,805,205, $2,935,068 and $2,935,068 of this amount was reported in the Summary Compensation Table for fiscal years 2013, 2015 and 2016, respectively. Mr. Lousada was not a NEO in fiscal year 2017 when he received his grant, so his amount is not reported in the Summary Compensation Table for fiscal year 2017.

Potential Payments upon Termination or Change-In-Control

We have entered into employment arrangements that, by their terms, will require us to provide compensation and other benefits to our NEOs if their employment terminates or they resign under specified circumstances. In addition, the Plan provides for certain payments upon a participant’s termination of employment or a change-in-control of the Company.

The following discussion summarizes the potential payments upon a termination of employment in various circumstances. The amounts discussed apply the assumptions that employment terminated on September 30, 2018 and the NEO does not become employed by a new employer or return to work for the Company or that a change in control occurred on September 30, 2018. The discussion that follows addresses Messrs. Lousada, Cooper, Levin and Robinson. See “Summary of NEO Employment Arrangements” above for a description of their respective agreements. The value of a fractional share of our common stock applied to this discussion was $304.22, as determined under the Plan as of September 30, 2018.

Mr. Platt will be resigning as an employee on December 31, 2018 and he will not receive any severance pay in connection with his resignation.

Estimated Benefits upon Termination for “Cause” or Resignation Without “Good Reason”

In the event an NEO is terminated for “cause,” or resigns without “good reason” as such terms are defined below, the NEO is only eligible to receive compensation and benefits accrued through the date of termination. Therefore, no amounts other than accrued amounts would be payable to Messrs. Lousada, Levin and Robinson in this instance pursuant to their employment arrangements. As noted above, Mr. Cooper does not have an employment arrangement directly with the Company and, therefore, he is also not entitled to any benefits from the Company, except under the Plan, if he is terminated for “cause” or he resigns without “good reason.”

140


 

Estimated Benefits upon Termination without “Cause” or Resignation for “Good Reason”

Upon termination without “cause” or resignation for “good reason,” Messrs. Lousada, Levin and Robinson are entitled to contractual severance benefits payable on termination plus, in the case of Mr. Robinson, a pro-rated annual bonus for the year of termination and continued participation in the group health and life insurance plans of the Company in which he currently participates for up to one year after termination. Although annual free cash flow bonuses under the Plan are generally contingent upon the participant being employed with the Company on the date of payment, if, after the first quarter of a fiscal year, the employment of Messrs. Cooper or Lousada is terminated by the Company without “cause”, by him for “good reason” or due to his death or “disability,” he will be entitled under the Plan to a pro rata free cash flow bonus in respect of the year in which such event occurs (as such terms are defined in the Plan). None of our NEOs are entitled to any additional severance upon a termination in connection with a change in control.

 

Name

  

Salary (other
than accrued
amounts) (1)

 

  

Bonus (2)

 

  

Value of Deferred
Compensation (3)

 

  

Acceleration of
Profits
Interests (4)

 

  

Benefits

 

  

Total

 

Stephen Cooper

  

 

 

  

$

9,325,000

  

  

$

40,748,442

 

  

 

 

  

 

 

  

$

50,073,442

 

Eric Levin

 

$

750,000

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

750,000

 

Max Lousada (5)

  

$

7,770,000

  

  

$

1,490,000

  

  

$

4,479,938

 

  

 

 

  

 

 

  

$

13,739,938

  

Paul M. Robinson

 

$

1,250,000

 

 

$

600,000

 

 

 

 

 

 

 

 

 

 

 

$

1,850,000

 

 

(1)

For Messrs. Levin, Robinson and Lousada, the amount represents the severance payable to them on such a qualifying termination.

(2)

For Messrs. Cooper and Lousada, represents a pro rata amount of the annual free cash flow bonus payable under the Plan (or, since the termination date is assumed to be September 30, 2018, their full 2018 annual bonuses), although for Mr. Lousada excludes $2,240,000 of his annual free cash flow bonus for which the vesting of deferred equity units was accelerated in August 2018.  For Mr. Robinson, represents the amount of his full target bonus assuming the Company in its good-faith discretion determined to pay that amount.

(3)

Reflects the value of vested deferred equity units that will be settled on a termination of employment without “cause” or by the NEO for “good reason”.  

(4)

Profits Interests will not accelerate on a termination of employment that is not in connection with a change in control of the Company.  This table does not include vested Profits Interests held by the NEOs.

(5)

The amounts reported for Mr. Lousada have been converted from British pound sterling to U.S. dollars using a conversion factor of 1.295.

Estimated Benefits in connection with a Change in Control

As participants in the Plan, each of Messrs. Lousada and Cooper will be entitled to additional payments upon a change in control in respect of his amounts deferred under the Plan and the Profits Interests granted to him.

 

Name

 

 

Value of Deferred
Compensation (1)

 

 

Acceleration of
Profits Interests (2)

 

 

Total

Stephen Cooper

 

 

$

40,748,442

 

 

$

 

 

$

40,748,442

 

Eric Levin

 

 

 

 

 

 

 

 

 

 

Paul M. Robinson

 

 

 

 

 

 

 

 

 

 

Max Lousada

 

 

 

$4,479,938

 

 

 

$1,490,000

 

 

 

$5,969,938

 

 

(1)

For each of Messrs. Cooper and Lousada represents the value of the NEO’s deferred equity units that were vested on September 30, 2018 and for Mr. Cooper, the additional deferred equity units granted to him in December 2013 to offset the impact of the $54 million of investments that were funded through fiscal year 2013 free cash flow (but reduced for the amount of any unrecovered investment amounts that were allocated to the NEO with such additional grant).  Also, for Mr. Lousada, the deferred equity units that would have been credited to his deferred compensation account with a pro rata portion of the free cash flow bonus in respect of the 2018 fiscal year payable in deferred equity units (i.e., the remainder due to be deferred from his 2018 fiscal year free cash flow bonus, since the change in control would be deemed to occur on September 30, 2018).

(2)

For Mr. Lousada, his Profits Interests that would have vested if 100% of his 2018 free cash flow bonus would have been deferred under the Plan.  The value of a Profits Interest reflects the appreciation in the fair market value of one-ten-thousandth (1/10,000) of a share of our common stock as of September 30, 2018 since the date of grant. In each case, the value of a Profits Interest assumes that Management, LLC was liquidated and its proceeds distributed to its members, including our NEOs. This table does not include vested Profits Interests held by the NEOs.

141


 

Upon a change of control of the Company and upon certain sales of shares of our common stock underlying Profits Interests and Acquired LLC Units, distributions will be made in respect of Profits Interests (to the extent of their liquidation value) and Acquired LLC Units. The LLC Agreement associated with the Plan provides Access with the right to cause Plan participants (including the NEOs) to sell their Profits Interests, Acquired LLC Units or the underlying shares of our common stock on a sale by Access of more than 50% of the outstanding shares of our common stock to third parties (i.e., a “drag-along right”), other than in a public offering of our common stock. Also, the LLC Agreement provides Plan participants (including the NEOs) with the right to sell their vested Profits Interests and Acquired LLC Units in the event that Access proposes to sell to third parties or us shares of our common stock other than certain sales after a public offering of our common stock (i.e., a “tag-along right”).  

Estimated Benefits upon Death or Disability

Death. For Messrs. Lousada, Levin and Robinson, other than accrued benefits and, in the case of Messrs. Cooper and Lousada under the Plan, no other benefits are provided in connection with such NEO’s death.  

Disability. For Messrs. Lousada, Levin and Robinson, other than accrued benefits and short-term disability amounts and, in the case of Messrs. Cooper and Lousada under the Plan, no benefits are provided in connection with such NEO’s disability.  

As participants in the Plan, each of Messrs. Cooper and Lousada will be entitled to the following payments if terminated as a result of death or disability:  

 

Name

 

Bonus (1)

 

 

Value of Deferred
Compensation (2)

 

 

Acceleration of
Profits Interests (3)

 

 

Total

 

Stephen Cooper

 

$

9,325,000

 

 

$

40,748,442

 

 

 

 

 

$

50,073,442

 

Max Lousada

 

$

1,490,000

 

 

$

4,479,938

 

 

 

 

 

$

5,969,938

 

 

(1)

Represents a pro rata amount of the annual free cash flow bonus payable under the Plan (or, since the termination date is assumed to be September 30, 2018, the full 2018 annual bonus) for each of Messrs. Cooper and Lousada.

(2)

Represents the value of each NEOs’ deferred equity units that were vested on September 30, 2018, and the additional deferred equity units granted to Mr. Cooper in December 2013 to offset the impact of the $54 million of investments that were funded through fiscal year 2013 free cash flow (but reduced for the amount of any unrecovered investment amounts that were allocated to the NEO with such additional grant), in each case, based on the value of our common stock as of September 30, 2018.

(3)

Profits Interests will not accelerate on a termination of employment that is not in connection with a change in control of the Company.  This table does not include vested Profits Interests held by the NEOs.

Relevant Provisions of Employment Arrangements

Upon termination of employment for any reason, all of our employees, including our NEOs, are entitled to unpaid salary and vacation time accrued through the termination date.  

Termination for “Cause”

Under the terms of his employment agreement (and for purposes of the Plan), we generally would have “cause” to terminate the employment of Mr. Lousada in any of the following circumstances: (1) serious or repeated breach of any of his material obligations; (2) refusing to carry out any lawful and reasonable order given to him or failing to attend to his duties; (3) committing any financially dishonest or fraudulent act relating to the Company; (4) conviction of a crime that is punishable by imprisonment; (5) guilty of gross misconduct or of any other conduct which brings or is likely to bring serious professional discredit to the Company; (6) unable to perform his duties by reason of ill-health or accident either for a specified period; (7) becoming of unsound mind and a patient for the purpose of any statute relating to mental health; (8) a petition or application for an order in bankruptcy is presented by or against him or any person becomes entitled to petition or apply for any such order; (9) a disqualification order (as defined in Section 1 of the Directors Disqualification Act 1986) is made against him or he otherwise becomes prohibited by law from being a director of the Board; and (10) if he voluntarily resigns as a director of the Board. In the event of (1) or (2) that is curable, we are required to notify Mr. Lousada of such circumstances and give him a reasonable opportunity to cure.

For purposes of the Plan, we would have “cause” to terminate the employment of Mr. Cooper in any of the following circumstances: (1) ceasing to perform his material duties to the Company or its affiliates (other than as a result of vacation, approved leave or incapacity due to physical or mental illness or injury), which failure amounts to an extended neglect of his duties, (2) engaging in conduct that is demonstrably and materially injurious to the business of the Company or its affiliates, (3) conviction of a felony or entered a plea of guilty or no contest to a felony charge or a misdemeanor involving as a material element fraud, dishonest or sale or possession of illicit substances, (4) failing to follow lawful instructions of his direct superiors or the Board and (5) breach of any restrictive covenant addressed in his employee letter.

142


 

Under the terms of his employment agreement, we generally would have “cause” to terminate the employment of Messrs. Levin, or Robinson in any of the following circumstances: (1) repeated and continual refusal to perform his duties with the Company, (2) engaging in willful malfeasance that has a material adverse effect on the Company, (3) breach of his covenants in his employment agreement and (4) conviction of a felony or entered a plea of nolo contendere to a felony charge. We are required to notify Mr. Robinson after any event that constitutes “cause” before terminating his employment, and in general he has no less than 20 days after receiving notice to cure the event.

Resignation for “Good Reason” or without “Good Reason”

For purposes of the Plan, Messrs. Cooper or Lousada generally would have “good reason” to terminate employment in any of the following circumstances: (1) if his salary or annual bonus percentage under the Plan is materially reduced, (2) if we fail to pay him any salary which has become payable and due to him or (3) our failure to pay him any entitlement that that has become payable and due under the Plan.  Messrs. Cooper and Lousada are required to notify us within 30 days after becoming aware of the occurrence of any event that constitutes “good reason,” and in general we have 30 days to cure the event, but failing a cure, he must terminate his employment within 30 days after the cure period expires.

Our employment agreement with Mr. Robinson provides that he generally would have “good reason” to terminate employment in any of the following circumstances: (1) if we assign duties inconsistent with his current positions, duties or responsibilities or if we change the parties to whom he reports, (2) if we remove him from, or fail to re-elect him to, his position, (3) if we reduce his salary, target bonus or other compensation levels, (4) if we require him to be based anywhere other than the New York metropolitan area, (5) if we breach certain of our obligations under the employment agreement, (6) if we fail to cause any successor of the Company to expressly assume his employment agreements or (7) any change in reporting line such that he no longer reports to the CEO or the senior-most executive of the Company. Mr. Robinson is required to notify us within 60 days after becoming aware of the occurrence of any event that constitutes “good reason,” and in general we have 30 days to cure the event.

Restrictive Covenants

Our agreements with our NEOs contain several important restrictive covenants with which an executive must comply following termination of employment. For example, the entitlement of Messrs. Cooper and Lousada to payments under the Plan are each conditioned on the NEO’s compliance with covenants not to solicit certain of our artists and employees. This non-solicitation covenant continues in effect during a period that, for each of our NEOs, will end one year following his termination of employment.

Messrs. Levin’s and Robinson’s employment agreements and the Plan for Messrs. Cooper and Lousada also contain covenants regarding non-disclosure of confidential information.

143


 

DIRECTOR COMPENSATION

The following table provides summary information concerning compensation paid or accrued by us to or, on behalf of, our non-employee directors, as of September 30, 2018, for services rendered to us during the last fiscal year.

Mathias Döpfner is entitled to an annual retainer of €250,000, payable pro rata quarterly in arrears, for his service as a director on the Company’s board. Messrs. Lee and Kreiz and Ms. Hertz were entitled to $75,000 for fiscal year 2018.  Mr. Slipper was paid a prorated portion of $75,000 for his service through the date of his resignation from the board on September 5, 2018.  No other non-employee directors received any compensation for service on the Board of Directors or Board committees during fiscal year 2018.

Directors are entitled to reimbursement of their fees incurred in connection with travel to meetings. In addition, the Company reimburses directors for fees paid to attend director education events.

 

Name

 

Fees Earned
or Paid in Cash
($)

 

 

Stock Awards
($)

 

 

Option Awards
($)

 

 

Non-Equity
Incentive Plan
Compensation
($)

 

 

Change in
Pension Value
and
Nonqualified
Deferred
Compensation
Earnings

 

 

All Other
Compensation
($)

 

 

Total ($)

 

Lincoln Benet

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Alex Blavatnik

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Len Blavatnik

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Mathias Döpfner

 

$    

297,700(1)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

297,700

 

Noreena Hertz

 

$

75,000

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

75,000

 

Ynon Kreiz

 

$

75,000

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

75,000

 

Thomas H. Lee

 

$

75,000

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

75,000

 

Jörg Mohaupt (2)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Oliver Slipper (3)

 

$

69,905

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

69,905

Donald A. Wagner

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(1)

The amount reported for Mr. Döpfner has been converted from Euros to U.S. dollars using a conversion factor of 1.1908 as of September 30, 2018.

(2)

Mr. Mohaupt resigned as a director of the board effective October 13, 2017.

(3)

Mr. Slipper resigned as a director of the board effective September 5, 2018.

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

Mr. Wagner was a Vice President of the Company from July 20, 2011 to October 3, 2011. None of the Compensation Committee’s members is or has been a Company officer or employee during the last fiscal year. During fiscal year 2018, none of the Company’s executive officers served on the board of directors, the Compensation Committee or any similar committee of another entity of which an executive officer served on our Board of Directors or Compensation Committee.

CEO PAY RATIO

As required by Section 953(b) of the Dodd-Frank Wall Street Reform and Consumer Protection Act, and Item 402(u) of Regulation S-K, we are providing the following information about the relationship of the annual total compensation of our employees and the annual total compensation of our CEO:

 

To determine the estimated ratio of CEO pay to median employee pay in accordance with Item 402(u) of Regulation S-K, we considered our entire global employee population of 4,660 employees who were on the payroll as of September 30, 2018. We then used base salary paid during fiscal year 2018 as the form of compensation to determine our median employee. We identified our median employee, whose Summary Compensation Table total compensation, as calculated in accordance with Item 402(u)(2) of Regulation S-K, was $70,416 in fiscal year 2018 (this amount has been converted from British pound sterling to U.S. dollars using a conversion factor of 1.3105).

 

The CEO pay used for purposes of calculating this pay ratio is $34,350,974, which is the annual total compensation of our CEO as reported in the Summary Compensation Table.

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As a result, the reasonable estimated ratio of CEO pay to median employee pay, calculated in a manner consistent with Item 402(u) of Regulation S-K is 487.8 to 1. The SEC’s pay ratio disclosure rules permit the use of estimates, assumptions, and adjustments. As such, the pay ratio reported by other companies may not be comparable to the pay ratio reported above. This pay ratio results from two important factors relating to our CEO’s compensation and participation in the Plan:

 

As described above under “Annual Free Cash Flow Bonus Pool”, a significant portion of our CEO’s annual compensation comes from his free cash flow bonus under the Plan, which for fiscal year 2018 was $9,325,000;

 

As described above, we paid cash dividends to all stockholders of record and participants of the Plan on January 8, 2018, May 7, 2018 and August 7, 2018.  As a result, our CEO was paid $24,025,974 in fiscal year 2018 in respect of his deferred equity units and Profits Interests.  

 

145


 

ITEM 12.

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

Affiliates of Access own 100% of our common stock.

The following table provides information as of December 20, 2018 with respect to beneficial ownership of our capital stock by:

 

each shareholder of the Company who beneficially owns more than 5% of the outstanding capital stock of the Company;

 

each director of the Company;

 

each of the executive officers of the Company named in the Summary Compensation Table appearing under “Executive Compensation” and

 

all executive officers of the Company and directors of the Company as a group.

The amounts and percentages of shares beneficially owned are reported on the basis of regulations of the SEC governing the determination of beneficial ownership of securities. Under SEC rules, a person is deemed to be a “beneficial owner” of a security if that person has or shares voting power or investment power, which includes the power to dispose of or to direct the disposition of such security. A person is also deemed to be a beneficial owner of any securities of which that person has a right to acquire beneficial ownership within 60 days. Securities that can be so acquired are deemed to be outstanding for purposes of computing such person’s ownership percentage, but not for purposes of computing any other person’s percentage. Under these rules, more than one person may be deemed to be a beneficial owner of the same securities and a person may be deemed to be a beneficial owner of securities as to which such person has no economic interest.

Except as otherwise indicated in these footnotes, each of the beneficial owners listed has, to our knowledge, sole voting and investment power with respect to the indicated shares of common stock.

 

Name and Address of Beneficial Owner (1)

  

Title of Class (2)

 

  

Amount
and
Nature of
Beneficial
Ownership

 

  

Percent of
Class
Outstanding

 

AI Entertainment Holdings LLC (formerly Airplanes Music LLC)

  

Common Stock

  

  

 

995.8

  

  

 

94.7

Altep 2012 L.P.

  

Common Stock

  

  

 

4.2

  

  

 

0.4

WMG Management Holdings, LLC

  

Common Stock

  

  

 

51.8590

  

  

 

4.9

Stephen Cooper (3)

  

N/A

  

  

 

N/A

  

  

 

N/A

  

Eric Levin

 

N/A

 

 

 

N/A

 

 

 

N/A

 

Paul M. Robinson

  

N/A

  

  

 

N/A

  

  

 

N/A

  

Max Lousada (3)

 

N/A

 

 

 

N/A

 

 

 

N/A

 

Jon Platt

  

N/A

  

  

 

N/A

  

  

 

N/A

  

Len Blavatnik (2)

  

Common Stock

  

  

 

1,051.8590

  

  

 

100

Lincoln Benet (3)

  

N/A

  

  

 

N/A

  

  

 

N/A

  

Alex Blavatnik

  

N/A

  

  

 

N/A

  

  

 

N/A

  

Mathias Döpfner

  

N/A

  

  

 

N/A

  

  

 

N/A

  

Noreena Hertz

  

N/A

  

  

 

N/A

  

  

 

N/A

  

Ynon Kreiz

  

N/A

  

  

 

N/A

  

  

 

N/A

  

Thomas H. Lee

 

N/A

  

  

 

N/A

  

  

 

N/A

 

Donald A. Wagner (3)

  

N/A

  

  

 

N/A

  

  

 

N/A

  

All executive officers and directors of Warner Music Group Corp. as a group (16 persons)

  

Common Stock

  

  

 

1,051.8590

  

  

 

100

 

(1)

The mailing address of each of these persons is c/o Warner Music Group Corp., 1633 Broadway, New York, NY 10019, (212) 275-2000.

(2)

As of December 20, 2018, the Company, AI Entertainment Holdings LLC (formerly Airplanes Music LLC), Altep 2012 L.P. and WMG Management Holdings, LLC are indirectly controlled by Len Blavatnik.

(3)

Does not reflect shares of the Company’s common stock that may be attributable to the beneficial owners of limited partnership interests in Altep 2012 L.P. or Profits Interests in WMG Management Holdings, LLC. Messrs. Benet and Wagner beneficially own limited partnership interests in Altep 2012 L.P. and disclaim any beneficial ownership of shares of the Company’s common stock. Messrs. Cooper, and Lousada own Profits Interests in WMG Management Holdings, LLC and disclaim any beneficial ownership of shares of the Company’s common stock.

 

 

 

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ITEM 13.

CERTAIN RELATIONSHIPS, RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE

Oversight of Related Person Transactions

Policies and Procedures Dealing with the Review, Approval and Ratification of Related Person Transactions

The Company maintains written procedures for the review, approval and ratification of transactions with related persons. The procedures cover related party transactions between the Company and any of our executive officers and directors. More specifically, the procedures cover: (1) any transaction or arrangement in which the Company is a party and in which a related party has a direct or indirect personal or financial interest and (2) any transaction or arrangement using the services of a related party to provide legal, accounting, financial, consulting or other similar services to the Company.

The Company’s policy generally groups transactions with related persons into two categories: (1) transactions requiring the approval of the Audit Committee and (2) certain ordinary course transactions below established financial thresholds that are deemed pre-approved by the Audit Committee. The Audit Committee is deemed to have pre-approved any transaction or series of related transactions between us and an entity for which a related person is an employee (other than an executive officer), director or beneficial owner of less than 10% of that entity’s voting capital where the aggregate amount of all such transactions on an annual basis does not exceed the lesser of (a) $1 million and (b) 2% of the annual consolidated gross revenues of the other entity. Regardless of whether a transaction is deemed pre-approved, all transactions in any amount are required to be reported to the Audit Committee.

Subsequent to the adoption of the written procedures above in 2005, the Company has followed these procedures regarding all reportable related person transactions. Following is a discussion of related person transactions.

Relationships with Access

Management Agreement

Upon completion of the Merger, the Company and Holdings entered into the Management Agreement, dated as of the Merger Closing Date, pursuant to which Access provides the Company and its subsidiaries with financial, investment banking, management, advisory and other services. Pursuant to the Management Agreement, the Company, or one or more of its subsidiaries, will pay Access an annual fee equal to the higher of a base of $9 million or a formula contained in the agreement and reimburse Access for certain expenses incurred performing services under the agreement. The annual fee is payable quarterly. The Company and Holdings agreed to indemnify Access and certain of its affiliates against all liabilities arising out of performance of the Management Agreement. The Company incurred an expense of $16 million during fiscal year 2018 in connection with the Management Agreement.

Lease Arrangements with Access

On July 29, 2014, AI Wrights Holdings Limited, an affiliate of Access, entered into a lease and related agreements with Warner/Chappell Music Limited and WMG Acquisition (UK) Limited, subsidiaries of the Company, for the lease of 27 Wrights Lane, Kensington, London.  The Company had been the tenant of the building, which Access acquired.  Subsequent to the change in ownership, the Company entered into the new lease arrangements.  Pursuant to the agreements, on January 1, 2015, the rent in the lease was increased to £3,460,250 per year, the term was extended for an additional five years from December 24, 2020 to December 24, 2025, with a market rate rent review that would begin December 25, 2020.  

On August 13, 2015, a subsidiary of the Company, Warner Music Inc., entered into a license agreement with Access Industries, Inc., an affiliate of Access, for the use of office space in our corporate headquarters at 1633 Broadway New York, New York. The license fee of $2,775 per month, plus an IT support fee of $1,000 per month, was based on the per foot lease costs to the Company of its headquarters space, which represented market terms. The space is occupied by The Blavatnik Archive, which is dedicated to the discovery and preservation of historically distinctive and visually compelling artifacts, images and stories that contribute to the study of 20th century Jewish, WWI and WWII history. For the fiscal year ended September 30, 2018, an immaterial amount was recorded as rental income.

147


 

Deezer

Access owns a controlling equity interest in Deezer S.A., which was formerly known as Odyssey Music Group (“Odyssey”), a French company that controls and operates a digital music streaming service, formerly through Odyssey’s subsidiary, Blogmusik SAS (“Blogmusik”), under the name Deezer (“Deezer”), and is represented on Deezer S.A.’s Board of Directors. Subsidiaries of the Company, Warner Music Inc. and WEA International Inc. have been a party to license arrangements with Deezer since 2008 (Warner Music Inc. was added as a party to the license in 2014 in respect of the U.S.), which provide for the use of the Company’s sound recording content on Deezer’s ad-supported and subscription streaming services worldwide (excluding Japan) in exchange for fees paid by Deezer.  Warner Music Inc. and WEA International Inc. have also authorized Deezer to include Warner content in Deezer’s streaming services where such services are offered as a bundle with third-party services or products (e.g., telco services or hardware products), for which Deezer is also required to make payments to Warner Music Inc. and WEA International Inc. Deezer paid to WEA International Inc. an aggregate amount of approximately $39 million and $36 million in connection with the foregoing arrangements during the fiscal year ended September 30, 2018 and 2017, respectively. In addition, in connection with these arrangements, (i) the Company was issued, and currently holds, warrants to purchase shares of Deezer S.A. and (ii) the Company purchased a small number of shares of Deezer S.A., which collectively represent a small minority interest in Deezer S.A.  

Acquisitions of Selected Assets of Songkick

As of July 12, 2017, we acquired selected assets from Songkick, including the concert discovery app and website and the Songkick trademark, for a purchase price of $5 million. Access owns a significant minority interest in the seller.

 

Investment in Tencent Music Entertainment Group 

On October 1, 2018, WMG China, an affiliate of the Company, entered into a share subscription agreement with Tencent Music Entertainment Group pursuant to which WMG China agreed to purchase 37,162,288 ordinary shares of Tencent Music Entertainment Group for $100 million.  WMG China is 80% owned by AI New Holdings 5 LLC, an affiliate of Access, and 20% owned by the Company.  On October 3, 2018, WMG China acquired the shares pursuant to the share subscription agreement.

Relationships with Other Directors, Executive Officers and Affiliates

Lease Arrangements with Cooper Investment Partners

On July 15, 2016, a subsidiary of the Company, Warner Music Inc., entered into a license agreement with Cooper Investment Partners LLC, for the use of office space in our corporate headquarters at 1633 Broadway, New York, New York. The license fee of $16,967.21 per month, was based on the per foot lease costs to the Company of its headquarters space, which represented market terms. For the fiscal year ended September 30, 2016, an immaterial amount was recorded as rental income. The space is occupied by Cooper Investment Partners LLC, which is a private equity fund that pursues a wide range of investment opportunities.  Mr. Cooper is the Managing Partner of Cooper Investment Partners LLC.

Loan Agreement with Max Lousada

On April 16, 2018, we loaned $227,000 to Mr. Lousada in exchange for a promissory note, all of which remains outstanding as of December 20, 2018.  Mr. Lousada must repay this loan upon the earliest of specified events, including April 30, 2019, termination of his employment, the event of a default (as specified therein) or if we or our affiliate becomes an issuer of publicly-traded stock.

Director Independence

Though not formally considered by the Board of Directors because, following the consummation of the Merger, our common stock is no longer listed on a national securities exchange, we believe that Messrs. Döpfner, Kreiz and Lee and Ms. Hertz would be considered “independent” under the listing standards of the NYSE. We do not believe that any of our other directors would be considered “independent” under the listing standards of the NYSE.

 

 

 

148


 

ITEM 14.

PRINCIPAL ACCOUNTANT FEES AND SERVICES

The Audit Committee of the Board of Directors selected the firm of KPMG LLP, to serve as independent registered public accountants for the fiscal years ending September 30, 2018 and September 30, 2017.

Fees Paid to KPMG LLP

The following table sets forth the aggregate fees incurred to KPMG LLP for services rendered in connection with the consolidated financial statements, and reports for the fiscal years ended September 30, 2018 and September 30, 2017 on behalf of the Company and its subsidiaries, as well as all out-of-pocket costs incurred in connection with these services (in thousands):

 

 

Year Ended
September 30,
2018

 

  

Year Ended
September 30,
2017

 

Audit Fees

$

5,030

 

 

$

3,939

 

Audit-Related Fees

 

613

 

 

 

254

 

Tax Fees

 

100

 

 

 

 

All Other Fees

 

123

 

 

 

75

 

Total Fees

$

5,866

 

 

$

4,268

 

 

These fees exclude out-of-pocket costs of approximately $0.25 million and $0.20 million for each of the periods ended September 30, 2018 and September 30, 2017, respectively.

Audit Fees: Consists of fees billed for professional services rendered for the audit of the Company’s consolidated financial statements, the review of the interim condensed consolidated financial statements included in quarterly reports and services that are normally provided by KPMG LLP in connection with statutory and regulatory filings or engagements and attest services, except those not required by statute or regulation.

Audit-Related Fees: Consists of fees billed for assurance and related services that are reasonably related to the performance of the audit or review of the Company’s consolidated financial statements and are not reported under “Audit Fees.” These services include employee benefit plan audits, auditing work on proposed transactions and implementation of new accounting standards, attest services that are not required by statute or regulation and consultations concerning financial accounting and reporting standards.

Tax Fees: Consists of work performed in connection with tax advisory services.

All Other Fees: Consists of work performed in connection with the Company’s debt transactions.

Pre-approval of Audit and Permissible Non-Audit Services of Independent Registered Public Accountants

The Audit Committee pre-approves all audit and permissible non-audit services provided by KPMG LLP. These services may include audit services, audit-related services, tax services and other services. The Audit Committee has adopted a policy for the pre-approval of services provided by KPMG LLP. Under this policy, pre-approval is generally provided for up to one year and any pre-approval is detailed as to the particular service or category of services and includes an anticipated budget. In addition, the Audit Committee may also pre-approve particular services on a case-by-case basis. The Audit Committee has delegated pre-approval authority to the Chair of the Audit Committee. Pursuant to this delegation, the Chair must report any pre-approval decision to the Audit Committee at its first meeting after the pre-approval was obtained.

During fiscal years 2018 and 2017, all professional services provided by KPMG LLP were pre-approved by the Audit Committee in accordance with our policies.

 

149


 

PART IV

 

ITEM 15.

EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

(a)(1) Financial Statements

The Financial Statements listed in the Index to Consolidated Financial Statements, filed as part of this Annual Report on Form 10-K.

(a)(2) Financial Statement Schedule

The Financial Statements Schedule listed in the Index to Consolidated Financial Statements, filed as part of this Annual Report on Form 10-K.

(a)(3) Exhibits

See Item 15(b) below.

(b) Exhibits

The agreements and other documents filed as exhibits to this report are not intended to provide factual information or other disclosure other than with respect to the terms of the agreements or other documents themselves, and you should not rely on them for that purpose. In particular, any representations and warranties made by us in these agreements or other documents were made solely within the specific context of the relevant agreement or document and may not describe the actual state of affairs as of the date they were made or at any other time.

The agreements filed as exhibits to this Report have been attached as exhibits to provide investors and security holders with information regarding their respective terms. They are not intended to provide any other factual information about the Company or any of its affiliates or businesses. The representations, warranties, covenants and agreements contained in such exhibits were made only for the purposes of such agreement and as of specified dates, were solely for the benefit of the parties to such agreement and may be subject to limitations agreed upon by the contracting parties. The representations and warranties may have been made for the purposes of allocating contractual risk between the parties to such agreements instead of establishing these matters as facts, and may be subject to standards of materiality applicable to the contracting parties that differ from those applicable to investors. Investors and security holders are not third-party beneficiaries under any of the agreements attached as exhibits hereto and should not rely on the representations, warranties, covenants and agreements or any descriptions thereof as characterizations of the actual state of facts or condition of the Company or any of its affiliates or businesses. Moreover, the assertions embodied in the representations and warranties contained in each such agreement are qualified by information in confidential disclosure letters or schedules that the parties have exchanged. Moreover, information concerning the subject matter of the representations and warranties may change after the respective dates of such agreements, which subsequent information may or may not be fully reflected in the Company’s public disclosures

 

Exhibit

Number

 

Description

 

 

 

    2.1(32)

 

Sale and Purchase Agreement, dated as of September 11, 2018, by and between SP Merchandising Holding GmbH & Co. KG and Warner Music Group Germany Holding GmbH.

 

 

 

    3.1(8)

 

Third Amended and Restated Certificate of Incorporation of Warner Music Group Corp.

 

 

 

    3.2(1)

 

Third Amended and Restated By-Laws of Warner Music Group Corp.

 

 

 

    4.1(9)

 

Indenture, dated as of November 1, 2012, among WMG Acquisition Corp., the guarantors listed on the signature pages thereto, Credit Suisse AG, as Notes Authorized Agent and as Collateral Agent, and Wells Fargo Bank, National Association, as Trustee, providing for the issuance of secured notes in series (the “Secured Notes”).

 

 

 

    4.2(13)

 

Third Supplemental Indenture, dated as of March 4, 2013, among WMG Acquisition Corp., the guarantors listed on the signature pages thereto and Wells Fargo Bank, National Association, as Trustee, relating to the 6.000% Senior Secured Notes due 2021 and the 6.250% Senior Secured Notes due 2021.

150


 

Exhibit

Number

 

Description

 

 

 

    4.3(16)

 

Fourth Supplemental Indenture, dated as of April 9, 2014, among WMG Acquisition Corp., the guarantors listed on the signature pages thereto and Wells Fargo Bank, National Association, as Trustee, relating to the 5.625% Senior Secured Notes due 2022.

 

 

 

    4.4(20)

 

Fifth Supplemental Indenture, dated as of July 27, 2016, among WMG Acquisition Corp., the guarantors listed on the signature pages thereto and Wells Fargo Bank, National Association, as Trustee, relating to the 5.000% Senior Secured Notes due 2023.

 

 

 

    4.5(21)

 

Sixth Supplemental Indenture, dated as of October 18, 2016, among WMG Acquisition Corp., the guarantors listed on the signature pages thereto and Wells Fargo Bank, National Association, as Trustee, relating to the 4.875% Senior Secured Notes due 2024.

 

 

 

    4.6(21)

 

Seventh Supplemental Indenture, dated as of October 18, 2016, among WMG Acquisition Corp., the guarantors listed on the signature pages thereto and Wells Fargo Bank, National Association, as Trustee, relating to the 4.125% Senior Secured Notes due 2024.

 

 

 

    4.7(33)

 

Eighth Supplemental Indenture, dated as of October 9, 2018, among WMG Acquisition Corp., the guarantors listed on the signature pages thereto and Wells Fargo Bank, National Association, as Trustee, relating to the 3.625% Senior Secured Notes due 2026.

 

 

 

    4.8(16)

 

Indenture, dated as of April 9, 2014, among WMG Acquisition Corp., the guarantors listed on the signature pages thereto and Wells Fargo Bank, National Association, as Trustee, providing for the issuance of unsecured senior notes in series.

 

 

 

    4.9(29)

 

Fifth Supplemental Indenture, dated as of March 14, 2018, among WMG Acquisition Corp., the guarantors listed on the signature pages thereto and Wells Fargo Bank, National Association, as Trustee, relating to the 5.500% Senior Notes due 2026.

 

 

 

    4.10

 

Form of Secured Note of WMG Acquisition Corp. (included in Exhibit 4.2 hereto).

 

 

 

    4.11

 

Form of 5.500% Senior Notes due 2026 of WMG Acquisition Corp. (included in Exhibit 4.9 hereto).

 

 

 

    4.12(15)

 

Guarantee, dated May 7, 2014, issued by Warner Music Group Corp., relating to the 5.625% Senior Secured Notes due 2022 and the 6.750% Senior Notes due 2022.

 

 

 

    4.13(20)

 

Guarantee, dated July 27, 2016, issued by Warner Music Group Corp., relating to the 5.000% Senior Secured Notes due 2023.

 

 

 

    4.14(21)

 

Guarantee, dated October 18, 2016, issued by Warner Music Group Corp., relating to the 4.875% Senior Secured Notes due 2024 and 4.125% Senior Secured Notes due 2024.

 

 

 

    4.15(29)

 

Guarantee, dated March 14, 2018, issued by Warner Music Group Corp., relating to the 5.500% Senior Notes due 2026.

 

 

 

    4.16(33)

 

Guarantee, dated October 9, 2018, issued by Warner Music Group Corp., relating to the 3.625% Senior Secured Notes due 2026.

 

 

 

    4.17(9)

 

Security Agreement, dated as of November 1, 2012, among WMG Acquisition Corp., WMG Holdings Corp., the guarantors listed on the signature pages thereto and Credit Suisse AG, as collateral agent, term loan authorized representative, revolving authorized representative and indenture authorized representative.

 

 

 

    4.18(9)

 

Copyright Security Agreement, dated November 1, 2012, made by WMG Acquisition Corp. and the guarantors listed on the signature pages thereto in favor of Credit Suisse, AG, as collateral agent for the Secured First Lien Parties.

 

 

 

    4.19(9)

 

Patent Security Agreement, dated November 1, 2012, made by WMG Acquisition Corp. and the guarantors listed on the signature pages thereto in favor of Credit Suisse, AG, as collateral agent for the Secured First Lien Parties.

 

 

 

    4.20(9)

 

Trademark Security Agreement, dated November 1, 2012, made by WMG Acquisition Corp. and the guarantors listed on the signature pages thereto in favor of Credit Suisse, AG, as collateral agent for the Secured First Lien Parties.

 

 

 

  10.1(9)

 

Credit Agreement, dated as of November 1, 2012, among WMG Acquisition Corp., each lender from time to time party thereto, Credit Suisse AG, as administrative agent, Credit Suisse Securities (USA) LLC, Barclays Bank PLC, UBS Securities LLC, Macquarie Capital (USA) Inc. and Nomura Securities International, Inc., as joint bookrunners and joint lead arrangers, and Barclays Bank PLC and UBS Securities LLC, as syndication agents, relating to a term loan credit facility.

151


 

Exhibit

Number

 

Description

 

 

 

  10.2(17)

 

Incremental Commitment Amendment, dated as of May 9, 2013, by and among WMG Acquisition Corp., the other Loan Parties (as defined therein), WMG Holdings Corp., and the several banks and financial institutions parties thereto as Lenders and the Administrative Agent, as defined therein.

 

 

 

  10.3(22)

 

Second Amendment to Credit Agreement, dated as of July 13, 2016, among WMG Acquisition Corp., the guarantors party thereto, the lenders party thereto and Credit Suisse AG, as administrative agent, relating to the term loan facility.

 

 

 

  10.4(24)

 

Second Incremental Commitment Amendment, dated as of November 21, 2016, among WMG Acquisition Corp., the guarantors party thereto, the lenders party thereto and Credit Suisse AG, as administrative agent, relating to the term loan facility.

 

 

 

  10.5(26)

 

Third Incremental Commitment Amendment, dated as of May 22, 2017, among WMG Acquisition Corp., the other Loan Parties (as defined therein) party thereto, WMG Holdings Corp., the Administrative Agent (as defined therein) and Credit Suisse AG Cayman Islands Branch, as Tranche D Term Lender.

 

 

 

  10.6(28)

 

Fourth Incremental Commitment Amendment, dated as of December 6, 2017, among WMG Acquisition Corp., the other Loan Parties (as defined therein) party hereto, WMG Holdings Corp., the Administrative Agent (as defined therein) and Credit Suisse AG Cayman Islands Branch, as Tranche E Term Lender.

 

 

 

  10.7(29)

 

Increase Supplement to the Credit Agreement, dated as of March 14, 2018, among WMG Acquisition Corp., the Loan Parties (as defined therein) party thereto, WMG Holdings Corp., Credit Suisse AG, Cayman Islands Branch, as increasing lender, and Credit Suisse AG, as administrative agent, relating to the term loan facility.

 

 

 

  10.8(31)

 

Fifth Incremental Commitment Amendment, dated as of June 7, 2018, among WMG Acquisition Corp., the other Loan Parties (as defined therein) party thereto, WMG Holdings Corp., the Administrative Agent (as defined therein) and Credit Suisse AG Cayman Islands Branch, as Tranche F Term Lender.

 

 

 

  10.9(9)

 

Guarantee Agreement, dated as of November 1, 2012, made by the persons listed on the signature pages thereto under the caption “Subsidiary Guarantors” and the Additional Guarantors in favor of the Secured Parties, relating to the term credit facility.

 

 

 

  10.10(28)

 

Credit Agreement, dated as of January 31, 2018, among WMG Acquisition Corp., the lenders from time to time party thereto, and Credit Suisse AG, as administrative agent, relating to the revolving credit facility.

 

 

 

  10.11(28)

 

 

Subsidiary Guaranty, dated as of January 31, 2018, made by the persons listed on the signature pages thereto under the caption “Guarantors” and the Additional Guarantors (as defined therein) in favor of the Secured Parties (as defined therein), relating to the revolving credit facility.

 

 

 

  10.12**(19)

 

Letter Agreement, dated as of September 30, 2014, between Warner Music Inc. and Eric Levin

 

 

 

  10.13**(23)

 

Letter Agreement, dated as of October 6, 2015, between Warner Music Inc. and Eric Levin

 

 

 

  10.14**(24)

 

Letter Agreement, dated as of December 2, 2016, between Warner Music Inc. and Eric Levin

 

 

 

  10.15**(23)

 

Letter Agreement, dated as of August 4, 2015, between Warner Music Inc. and Paul M. Robinson

 

 

 

  10.16**(27)

 

Service Agreement, dated as of March 20, 2017, between Max Lousada and Warner Music International Services Limited

 

 

 

  10.17(2)

 

Office Lease, dated June 27, 2002, by and between Media Center Development, LLC and Warner Music Group Inc., as amended

 

 

 

  10.18(2)

 

Lease, dated as of February 29, 2004, between Historical TW Inc. and Warner Music Group Inc.

 

 

 

  10.19(12)

 

Lease, dated as of October 1, 2013, between Paramount Group, Inc., as agent for PGREF I 1633 Broadway Tower, L.P., and WMG Acquisition Corp. (the “Headquarters Lease”)

 

 

 

  10.20(12)

 

Guaranty of Headquarters Lease, dated as of October 1, 2013

 

 

 

  10.21(4)

 

Assurance of Discontinuance, dated November 22, 2005

 

 

 

  10.22(1)

 

Management Agreement, made as of July 20, 2011, by and among Warner Music Group Corp., WMG Holdings Corp, and Access Industries Inc.

 

 

 

152


 

Exhibit

Number

 

Description

  10.23*(5)

 

US/Canada Manufacturing and PP&S Agreement, effective as of July 1, 2010, by and between Warner-Elektra-Atlantic Corporation and Cinram International Inc., Cinram Manufacturing LLC and Cinram Distribution LLC

 

 

 

  10.24*(5)

 

US/Canada Transition Agreement, executed as of July 1, 2010, by and between Warner-Elektra-Atlantic Corporation and Cinram International Inc., Cinram Manufacturing LLC and Cinram Distribution LLC

 

 

 

  10.25*(5)

 

International Manufacturing and PP&S Agreement, effective as of July 1, 2010, by and between WEA International, Inc. and Cinram International Inc., Cinram GmbH and Cinram Operations UK Limited

 

 

 

  10.26*(5)

 

International Transition Agreement, executed as of July 1, 2010, by and between WEA International, Inc. and Cinram International Inc., Cinram GmbH and Cinram Operations UK Limited

 

 

 

  10.27**(6)

 

Warner Music Group Corp. Deferred Compensation Plan

 

 

 

  10.28(7)

 

First Letter Amendment, dated January 14, 2011 to the US/Canada Manufacturing and PP&S Agreement, dated as of July 1, 2010, between Warner-Elektra-Atlantic Corporation and Cinram International Inc., Cinram Manufacturing LLC and Cinram Distribution LLC and the International Manufacturing and PP&S Agreement, dated as of July 1, 2010, between WEA International, Inc. and Cinram International Inc., Cinram GmbH and Cinram Operations UK Limited

 

 

 

  10.29*(7)

 

Second Letter Amendment, dated January 21, 2011 to the US/Canada Manufacturing and PP&S Agreement, dated as of July 1, 2010, between Warner-Elektra-Atlantic Corporation and Cinram International Inc., Cinram Manufacturing LLC and Cinram Distribution LLC and Cinram International Inc., Cinram GmbH and Cinram Operations UK Limited

 

 

 

  10.30*(7)

 

Third Letter Amendment, dated January 25, 2011 to the US/Canada Manufacturing and PP&S Agreement, dated as of July 1, 2010, between Warner-Elektra-Atlantic Corporation and Cinram International Inc., Cinram Manufacturing LLC and Cinram Distribution LLC and the International Manufacturing and PP&S Agreement, dated as of July 1, 2010, between WEA International Inc. and Cinram International Inc., Cinram GmbH and Cinram Operations UK Limited

 

 

 

  10.31*(10)

 

Amendment No. 1 to US/Canada Agreements, effective as of January 31, 2012 between Warner-Elektra-Atlantic Corporation and Cinram International Inc., Cinram Manufacturing LLC and Cinram Distribution LLC

 

 

 

  10.32(11)

 

Letter Agreement dated as of August 31, 2012 among Warner-Elektra-Atlantic Corporation, Cinram International Inc., Cinram Manufacturing LLC, Cinram Distribution LLC, Cinram Group, Inc. and Cinram Canada Operations ULC.

 

 

 

  10.33(11)

 

Letter Agreement dated as of August 31, 2012 among WEA International Inc., Cinram International Inc., Cinram GMBH, Cinram Operations UK Limited and Cinram Group, Inc.

 

 

 

  10.34**(3)

 

Form of Indemnification Agreement between Warner Music Group Corp. and its directors

 

 

 

  10.35**(25)

 

Second Amended and Restated Warner Music Group Corp. Senior Management Free Cash Flow Plan

 

 

 

  10.36**(25)

 

Second Amended and Restated Limited Liability Company Agreement of WMG Management Holdings, LLC, dated as of March 10, 2017

 

 

 

  10.37**(18)

 

Form of Election for Warner Music Group Corp. Senior Management Free Cash Flow Plan

 

 

 

  10.38**(14)

 

Form of Award Agreement under Warner Music Group Corp. Senior Management Free Cash Flow Plan

 

 

 

  10.39**(15)

 

Form of Award Agreement for 2014 Additional Unit Allocation under Warner Music Group Corp. Senior Management Free Cash Flow Plan.

 

 

 

  10.40(24)

 

Lease, dated as of October 7, 2016, between Warner Acquisition Corp. and Sri Ten Santa Fe LLC.

 

 

 

  10.41**(30)

 

Letter Agreement, dated May 2, 2018, between Warner Music Inc. and Eric Levin

 

 

 

  10.42**(30)

 

Letter Agreement, dated May 2, 2018, between Warner Music Inc. and Paul M. Robinson

 

 

 

  10.43$

 

Separation Agreement and Release, dated as of September 12, 2018, between Warner/Chappell Music, Inc. and Jon Platt

 

 

 

  21.1$

 

List of Subsidiaries

 

 

 

  24.1$

 

Power of Attorney (see signature page)

 

 

 

  31.1$

 

Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended

 

 

 

153


 

Exhibit

Number

 

Description

  31.2$

 

Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended

 

 

 

  32.1***$

 

Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

 

 

  32.2***$

 

Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

 

 

101.1$

 

Financial statements from the Annual Report on Form 10-K of Warner Music Group Corp. for the fiscal year ended September 30, 2018, filed on December 20, 2018, formatted in XBRL: (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Operations, (iii) Consolidated Statements of Comprehensive Income (Loss), (iv) Consolidated Statements of Cash Flows, (v) Consolidated Statements of Equity and (vi) Notes to Consolidated Audited Financial Statements

 

 

 

(C)

 

Financial Statement Schedules

 

 

 

 

 

Schedule II—Valuation and Qualifying Accounts

 

$

Filed herewith

*

Exhibit omits certain information that has been filed separately with the Securities and Exchange Commission and has been granted confidential treatment

**

Represents management contract, compensatory plan or arrangement in which directors and/or executive officers are eligible to participate

***

Pursuant to SEC Release No. 33-8212, this certification will be treated as “accompanying” this Annual Report on Form 10-K and not “filed” as part of such report for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to the liability of Section 18 of the Securities Exchange Act of 1934, as amended, and this certification will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933, as amended, except to the extent that the registrant specifically incorporates it by reference

(1)

Incorporated by reference to Warner Music Group Corp.’s Current Report on Form 8-K filed on July 26, 2011 (File No. 001-32502)

(2)

Incorporated by reference to WMG Acquisition Corp.’s Amendment No. 2 to the Registration Statement on Form S-4 filed on January 24, 2005 (File No. 333-121322)

(3)

Incorporated by reference to Warner Music Group Corp.’s Current Report on Form 8-K filed on May 20, 2011 (File No. 001-32502)

(4)

Incorporated by reference to Warner Music Group Corp.’s Current Report on Form 8-K filed on November 23, 2005 (File No. 001-32502)

(5)

Incorporated by reference to Warner Music Group Corp.’s Quarterly Report on Form 10-Q for the period ended December 31, 2010 (File No. 001-32502)

(6)

Incorporated by reference to Warner Music Group Corp.’s Registration Statement on Form S-8 filed on November 23, 2010 (File No. 333-170771)

(7)

Incorporated by reference to Warner Music Group Corp.’s Quarterly Report on Form 10-Q for the period ended March 31, 2011 (File No. 001-32502)

(8)

Incorporated by reference to Warner Music Group Corp.’s Current Report on Form 8-K filed on July 20, 2011 (File No. 001-32502)

(9)

Incorporated by reference to Warner Music Group Corp.’s Current Report on Form 8-K filed on November 7, 2012 (File No. 001-32502)

(10)

Incorporated by reference to Warner Music Group Corp.’s Quarterly Report on Form 10-Q for the period ended March 31, 2012 (File No. 001-32502)

(11)

Incorporated by reference to Warner Music Group Corp.’s Current Report on Form 8-K filed on September 6, 2012 (File No. 001-32502)

(12)

Incorporated by reference to Warner Music Group Corp.’s Current Report on Form 8-K filed on October 4, 2013 (File No. 001-32502)

(13)

Incorporated by reference to Warner Music Group Corp.’s Current Report on Form 8-K filed on March 5, 2013 (File No. 001-32502)

(14)

Incorporated by reference to Warner Music Group Corp.’s Current Report on Form 8-K filed on November 27, 2013 (File No. 001-32502)

(15)

Incorporated by reference to Warner Music Group Corp.’s Quarterly Report on Form 10-Q for the period ended March 31, 2014 (File No. 001-32502)

(16)

Incorporated by reference to Warner Music Group Corp.’s Current Report on Form 8-K filed on April 10, 2014 (File No. 001-32502)

154


 

(17)

Incorporated by reference to Warner Music Group Corp.’s Quarterly Report on Form 10-Q for the period ended March 30, 2013 (File No. 001-32502)

(18)

Incorporated by reference to Warner Music Group Corp.’s Annual Report on Form 10-K for the period ended September 30, 2012 (File No. 001-32502)

(19)

Incorporated by reference to Warner Music Group Corp.’s Annual Report on Form 10-K for the period ended September 30, 2014 (File No. 001-32502)

(20)

Incorporated by reference to Warner Music Group Corp.’s Current Report on Form 8-K filed on July 27, 2016 (file No. 001-32502)

(21)

Incorporated by reference to Warner Music Group Corp.’s Current Report on Form 8-K filed on October 18, 2016 (File No. 001-32502)

(22)

Incorporated by reference to Warner Music Group Corp.’s Quarterly Report on Form 10-Q for the period ended June 30, 2016 (File No. 001-32502)

(23)

Incorporated by reference to Warner Music Group Corp.’s Annual Report on Form 10-K for the period ended September 30, 2015 (File No. 001-32502)

(24)

Incorporated by reference to Warner Music Group Corp.’s Annual Report on Form 10-K for the period ended September 30, 2016 (File No. 001-32502)

(25)

Incorporated by reference to Warner Music Group Corp.’s Quarterly Report on Form 10-Q for the period ended March 31, 2017 (File No. 001-32502)

(26)

Incorporated by reference to Warner Music Group Corp.’s Quarterly Report on Form 10-Q for the period ended June 30, 2017 (File No. 001-32502)

(27)

Incorporated by reference to Warner Music Group Corp.’s Annual Report on Form 10-K for the period ended September 30, 2017 (File No. 001-32502)

(28)

Incorporated by reference to Warner Music Group Corp.’s Quarterly Report on Form 10-Q for the period ended December 31, 2017 (File No. 001-32502)

(29)

Incorporated by reference to Warner Music Group Corp.’s Current Report on Form 8-K filed on March 14, 2018 (File No. 001-32502)

(30)

Incorporated by reference to Warner Music Group Corp.’s Quarterly Report on Form 10-Q for the period ended March 31, 2018 (File No. 001-32502)

(31)

Incorporated by reference to Warner Music Group Corp.’s Quarterly Report on Form 10-Q for the period ended June 30, 2018 (File No. 001-32502)

(32)

Incorporated by reference to Warner Music Group Corp.’s Current Report on Form 8-K filed on September 17, 2018 (File No. 001-32502)

(33)

Incorporated by reference to Warner Music Group Corp.’s Current Report on Form 8-K filed on October 9, 2018 (File No. 001-32502)

 

ITEM 16.

FORM 10-K SUMMARY

Not Applicable

 

 

 

 

155


 

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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, on December 20, 2018.

 

Warner Music Group Corp.

 

By:

 

/S/    STEPHEN COOPER

Name:

 

Stephen Cooper

Title:

 

Chief Executive Officer

(Principal Executive Officer)

 

By:

 

/s/    ERIC LEVIN

Name:

 

Eric Levin

Title:

 

Chief Financial Officer (Principal Financial

Officer and Principal Accounting Officer)

 

156


 

POWER OF ATTORNEY

KNOW BY ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints jointly and severally, Paul M. Robinson and Trent N. Tappe, and each of them, his attorneys-in-fact, each with the power of substitution, for him in any and all capacities, to sign any and all amendments to this Annual Report on Form 10-K and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each said attorneys-in-fact, or his substitute or substitutes, may do or cause to be done by virtue hereof.

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities indicated on December 20, 2018.

 

Signature

 

Title

 

/s/   STEPHEN COOPER

 

 

CEO and President and Director (Chief Executive Officer)

Stephen Cooper

 

/s/   MAX LOUSADA

 

 

CEO, Warner Recorded Music and Director

Max Lousada

 

 

 

/s/   LEN BLAVATNIK

 

 

Vice Chairman of the Board of Directors

Len Blavatnik

 

/s/   LINCOLN BENET

 

 

Director

Lincoln Benet

 

/s/   ALEX BLAVATNIK

 

 

Director

Alex Blavatnik

 

/s/   MATHIAS DÖEPFNER

 

 

Director

Mathias Döepfner

 

/s/   NOREENA HERTZ

 

 

Director

Noreena Hertz

 

/s/   YNON KREIZ

 

 

Director

Ynon Kreiz

 

/s/   THOMAS H. LEE

 

 

Director

Thomas H. Lee

 

/s/   DONALD A. WAGNER

 

 

Director

Donald A. Wagner

 

 

157