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Warner Music Group Corp. - Quarter Report: 2022 December (Form 10-Q)


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q

(Mark One)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 2022
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number 001-32502

Warner Music Group Corp.
(Exact name of registrant as specified in its charter)

Delaware
(State or other jurisdiction of
incorporation or organization)
13-4271875
(I.R.S. Employer
Identification No.)
1633 Broadway
New York, NY 10019
(Address of principal executive offices)
(212) 275-2000
(Registrant’s telephone number, including area code)
___________________________________________________________________________________________
Securities registered pursuant to Section 12(b) of the Act:
Title of each classTrading Symbol(s)Name of each exchange on which registered
Class A Common Stock, $0.001 par value per shareWMGThe Nasdaq Stock Market LLC
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 Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  ☒    No  ☐
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 the 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 filerSmaller 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  ☒
As of February 6, 2023, there were 138,288,424 shares of Class A Common Stock and 377,650,449 shares of Class B Common Stock of the registrant outstanding.




WARNER MUSIC GROUP CORP.
QUARTERLY REPORT ON FORM 10-Q
FOR THE THREE MONTHS ENDED DECEMBER 31, 2022
TABLE OF CONTENTS
Page
Number




PART I. FINANCIAL INFORMATION
ITEM 1.    FINANCIAL STATEMENTS
Warner Music Group Corp.
Condensed Consolidated Balance Sheets
(In millions, except share amounts which are reflected in thousands)
(Unaudited)
December 31,
2022
September 30,
2022
Assets
Current assets:
Cash and equivalents$720 $584 
Accounts receivable, net of allowances of $21 million and $19 million
1,004 984 
Inventories102 108 
Royalty advances expected to be recouped within one year405 372 
Prepaid and other current assets109 91 
Total current assets2,340 2,139 
Royalty advances expected to be recouped after one year546 503 
Property, plant and equipment, net of accumulated depreciation of $489 million and $461 million
430 415 
Operating lease right-of-use assets, net220 226 
Goodwill1,951 1,920 
Intangible assets subject to amortization, net2,266 2,239 
Intangible assets not subject to amortization149 145 
Deferred tax assets, net29 29 
Other assets198 212 
Total assets$8,129 $7,828 
Liabilities and Equity
Current liabilities:
Accounts payable$220 $268 
Accrued royalties2,091 1,918 
Accrued liabilities477 457 
Accrued interest29 17 
Operating lease liabilities, current39 40 
Deferred revenue327 423 
Other current liabilities158 245 
Total current liabilities3,341 3,368 
Long-term debt3,946 3,732 
Operating lease liabilities, noncurrent234 241 
Deferred tax liabilities, net223 220 
Other noncurrent liabilities103 99 
Total liabilities$7,847 $7,660 
Equity:
Class A common stock, $0.001 par value; 1,000,000 shares authorized, 138,073 and 137,199 shares issued and outstanding as of December 31, 2022 and September 30, 2022, respectively
$— $— 
Class B common stock, $0.001 par value; 1,000,000 shares authorized, 377,650 and 377,650 issued and outstanding as of December 31, 2022 and September 30, 2022, respectively
Additional paid-in capital1,984 1,975 
Accumulated deficit(1,439)(1,477)
Accumulated other comprehensive loss, net(276)(347)
Total Warner Music Group Corp. equity270 152 
Noncontrolling interest12 16 
Total equity282 168 
Total liabilities and equity$8,129 $7,828 
See accompanying notes
1


Warner Music Group Corp.
Condensed Consolidated Statements of Operations
(In millions, except share amounts which are reflected in thousands, and per share data)
(Unaudited)
Three Months Ended
December 31,
20222021
Revenue$1,488 $1,614 
Costs and expenses:
Cost of revenue(761)(818)
Selling, general and administrative expenses (a)(440)(497)
Amortization expense(63)(60)
Total costs and expenses(1,264)(1,375)
Net gain on divestiture41 — 
Operating income265 239 
Interest expense, net(32)(30)
Other (expense) income(61)54 
Income before income taxes172 263 
Income tax expense(48)(75)
Net income124 188 
Less: Income attributable to noncontrolling interest(2)(1)
Net income attributable to Warner Music Group Corp.$122 $187 
Net income per share attributable to common stockholders:
Class A – Basic and Diluted$0.23 $0.36 
Class B – Basic and Diluted$0.23 $0.36 
Weighted average common shares:
Class A – Basic and Diluted137,424123,969
Class B – Basic and Diluted377,650390,952
(a) Includes depreciation expense:$(21)$(21)
See accompanying notes
2


Warner Music Group Corp.
Condensed Consolidated Statements of Comprehensive Income
(In millions)
(Unaudited)
Three Months Ended
December 31,
20222021
Net income$124 $188 
Other comprehensive income (loss), net of tax:
Foreign currency adjustment72 (25)
Deferred (loss) gain on derivative financial instruments(1)
Other comprehensive income (loss), net of tax71 (18)
Total comprehensive income195 170 
Less: Income attributable to noncontrolling interest(2)(1)
Comprehensive income attributable to Warner Music Group Corp.
$193 $169 
See accompanying notes
3


Warner Music Group Corp.
Condensed Consolidated Statements of Cash Flows
(In millions)
(Unaudited)
Three Months Ended
December 31,
20222021
Cash flows from operating activities
Net income$124 $188 
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization84 81 
Unrealized (gains) losses and remeasurement of foreign-denominated loans and foreign currency forward exchange contracts79 (36)
Deferred income taxes(5)19 
Net loss (gain) on divestitures and investments(41)(11)
Non-cash interest expense
Non-cash stock-based compensation expense14 24 
Changes in operating assets and liabilities:
Accounts receivable, net(100)
Inventories13 12 
Royalty advances(55)(177)
Accounts payable and accrued liabilities(61)(2)
Royalty payables117 107 
Accrued interest12 16 
Operating lease liabilities(2)(2)
Deferred revenue(104)(50)
Other balance sheet changes25 59 
Net cash provided by operating activities209 129 
Cash flows from investing activities
Acquisition of music publishing rights and music catalogs, net(33)(165)
Capital expenditures(21)(34)
Investments and acquisitions of businesses, net of cash received(8)(425)
Proceeds from the sale of investments10 — 
Proceeds from divestitures42 — 
Net cash used in investing activities(10)(624)
Cash flows from financing activities
Proceeds from issuance of 3.750% Senior Secured Notes due 2029
— 535 
Proceeds from incremental Senior Term Loan Facility147 — 
Deferred financing costs paid(2)(4)
Distribution to noncontrolling interest holders(6)(1)
Dividends paid(84)(78)
Payment of deferred and contingent consideration(125)(4)
Net cash (used in) provided by financing activities(70)448 
Effect of exchange rate changes on cash and equivalents(2)
Net increase (decrease) in cash and equivalents136 (49)
Cash and equivalents at beginning of period584 499 
Cash and equivalents at end of period$720 $450 
See accompanying notes
4


Warner Music Group Corp.
Condensed Consolidated Statements of Equity
(In millions, except share amounts which are reflected in thousands, and per share data)
(Unaudited)
Three Months Ended December 31, 2022
Class A
Common Stock
Class B
Common Stock
Additional
Paid-in
Capital
Accumulated
Deficit
Accumulated
Other
Comprehensive
Loss
Total
Warner Music
Group Corp.
Equity
Non-controlling
Interest
Total
Equity
SharesValueSharesValue
Balance at September 30, 2022137,199 $— 377,650 $$1,975 $(1,477)$(347)$152 $16 $168 
Net income— — — — — 122 — 122 124 
Other comprehensive income, net of tax— — — — — — 71 71 — 71 
Dividends ($0.16 per Class A and B share)
— — — — — (84)— (84)— (84)
Stock-based compensation expense— — — — — — — 
Distribution to noncontrolling interest holders— — — — — — — — (6)(6)
Shares issued under the Plan869 — — — — — — — — — 
Shares issued under Omnibus Incentive Plan— — — — — — — — — 
Balance at December 31, 2022138,073 $— 377,650 $$1,984 $(1,439)$(276)$270 $12 $282 
Three Months Ended December 31, 2021
Class A
Common Stock
Class B
Common Stock
Additional
Paid-in
Capital
Accumulated
Deficit
Accumulated
Other
Comprehensive
Loss
Total
Warner Music
Group Corp.
Equity
Non-controlling
Interest
Total
Equity
SharesValueSharesValue
Balance at September 30, 2021122,415 $— 391,971 $$1,942 $(1,710)$(202)$31 $15 $46 
Net income— — — — — 187 — 187 188 
Other comprehensive loss, net of tax— — — — — — (18)(18)— (18)
Dividends ($0.15 per Class A and B share)
— — — — — (78)— (78)— (78)
Stock-based compensation expense— — — — 31 — — 31 — 31 
Distribution to noncontrolling interest holders— — — — — — — — (1)(1)
Conversion of Class B shares for Class A shares4,671 — (4,671)— — — — — — — 
Shares issued under Omnibus Incentive Plan151 — — — — — — — — — 
Other— — — — — — — — 
Balance at December 31, 2021127,237 $— 387,300 $$1,973 $(1,601)$(220)$153 $19 $172 
See accompanying notes
5


Warner Music Group Corp.
Notes to Condensed Consolidated Financial Statements (Unaudited)
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 entertainment companies. We classify our business interests into two fundamental operations: Recorded Music and Music Publishing.
Recorded Music Operations
Our Recorded Music business primarily consists of the discovery and development of recording artists and the related marketing, promotion, distribution, sale and licensing of music created by such recording artists. We play an integral role in virtually all aspects of the recorded music value chain from discovering and developing talent to producing, distributing and selling music to marketing and promoting recording artists and their music.
Music Publishing Operations
While Recorded Music is focused on marketing, promoting, distributing and licensing a particular recording of a musical composition, Music Publishing is an intellectual property business focused on generating revenue from uses of the musical 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 shares the revenues generated from use of the musical compositions with the songwriter or other rightsholders.
2. Summary of Significant Accounting Policies
Interim Financial Statements
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with United States generally accepted accounting principles (“U.S. GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all the information and notes required by U.S. GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three months ended December 31, 2022 are not necessarily indicative of the results that may be expected for the fiscal year ending September 30, 2023.
The consolidated balance sheet at September 30, 2022 has been derived from the audited consolidated financial statements at that date but does not include all the information and notes required by U.S. GAAP for complete financial statements.
For further information, refer to the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended September 30, 2022 (File No. 001-32502).
Change in Fiscal Year End
On September 29, 2022, the Board of Directors approved a change, effective for the 2023 fiscal year, to the Company’s fiscal year from a modified 52-53-week calendar, in which reporting periods ended on the last Friday of the calendar quarter, to a reporting calendar in which the reporting periods end on the last day of the calendar quarter. Effective for the 2023 fiscal year, the Company’s fiscal year will begin on October 1 and end on September 30 of each year.
Prior to the start of the 2023 fiscal year, the Company maintained a 52-53 week fiscal year ending on the last Friday in each reporting period. The fiscal year ended September 30, 2022 included 53 weeks, with the additional week falling in the fiscal quarter ended December 31, 2021. Accordingly, the results of operations for the three months ended December 31, 2021 reflect 14 weeks, or 98 days, compared to 92 days for the three months ended December 31, 2022. For the three months ended December 31, 2021, the revenue benefit of the additional week was approximately $73 million, primarily reflected in Recorded Music streaming revenue.
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.
6


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.
The Company has performed a review of all subsequent events through the date the financial statements were issued and has determined that no additional disclosures are necessary.
Income Taxes
The Company uses the estimated annual effective tax rate method in computing its interim tax provision. Certain items, including those deemed to be unusual and infrequent are excluded from the estimated annual effective tax rate. In such cases, the actual tax expense or benefit is reported in the same period as the related item. Certain tax effects are also not reflected in the estimated annual effective tax rate, primarily certain changes in the realizability of deferred tax assets and uncertain tax positions.
New Accounting Pronouncements
Recently Adopted Accounting Pronouncements
In March 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting (“ASU 2020-04”). The amendment provides optional expedients and exceptions for applying U.S. GAAP to contracts, hedging relationships and other transactions affected by the discontinuation of the London Interbank Offered Rate (“LIBOR”) or by another reference rate expected to be discontinued because of reference rate reform, if certain criteria are met. In January 2021, the FASB issued ASU 2021-01, Reference Rate Reform (Topic 848): Scope, which clarified that certain optional expedients and exceptions in Topic 848 apply to derivative instruments that are affected by the discounting transition due to reference rate reform. In December 2022, the FASB issued ASU 2022-06, Reference Rate Reform (Topic 848): Deferral of the Sunset Date, which extended the period in which Topic 848 may be applied until December 31, 2024. These ASUs were effective upon issuance and may be applied prospectively to contract modifications and hedging relationships entered into or evaluated through December 31, 2024. The discontinuation of LIBOR will impact the Senior Term Loan Facility and Revolving Credit Facility as well as a pay-fixed receive-variable interest rate swap which will be outstanding as of the effective date of the discontinuation. The Company is in the process of evaluating the effect that the adoption of these standards will have on its consolidated financial statements, but does not expect it will have a material effect.
3. Earnings per Share
The Company utilizes the two-class method to report earnings per share. Basic earnings per share is computed by dividing net income available to each class of stock by the weighted average number of outstanding common shares for each class of stock. Diluted earnings per share is computed by dividing net income available to each class of stock by the weighted average number of outstanding common shares, plus dilutive potential common shares, which is calculated using the treasury-stock method. The potentially dilutive common shares did not have a dilutive effect on the Company’s EPS calculation for the three months ended December 31, 2022 and 2021, respectively.
The following table sets forth the calculation of basic and diluted net income per common share under the two-class method for the three months ended December 31, 2022 and 2021 (in millions, except share amounts, which are reflected in thousands, and per share data):
Three Months Ended December 31,
20222021
Class AClass BClass AClass B
Basic and Diluted EPS:
Numerator
Net income attributable to Warner Music Group Corp.$34 $88 $47 $140 
Less: Net income attributable to participating securities(2)— (2)— 
Net income attributable to common stockholders$32 $88 $45 $140 
Denominator
Weighted average shares outstanding137,424 377,650 123,969 390,952 
Basic and Diluted EPS$0.23 $0.23 $0.36 $0.36 
7


4. Revenue Recognition
Disaggregation of Revenue
The Company’s revenue consists of the following categories, which aggregate into the segments – Recorded Music and Music Publishing:
Three Months Ended
December 31,
20222021
(in millions)
Revenue by Type
Digital$803 $870 
Physical133 195 
Total Digital and Physical936 1,065 
Artist services and expanded-rights206 232 
Licensing97 89 
Total Recorded Music1,239 1,386 
Performance45 38 
Digital149 133 
Mechanical14 14 
Synchronization39 42 
Other
Total Music Publishing250 229 
Intersegment eliminations(1)(1)
Total Revenues$1,488 $1,614 
Revenue by Geographical Location
U.S. Recorded Music$539 $608 
U.S. Music Publishing133 115 
Total U.S.672 723 
International Recorded Music700 778 
International Music Publishing117 114 
Total International817 892 
Intersegment eliminations(1)(1)
Total Revenues$1,488 $1,614 
Sales Returns and Uncollectible Accounts
Based on management’s analysis of sales returns, refund liabilities of $26 million and $19 million were established at December 31, 2022 and September 30, 2022, respectively.
Based on management’s analysis of estimated credit losses, reserves of $21 million and $19 million were established at December 31, 2022 and September 30, 2022, respectively.
Deferred Revenue
Deferred revenue increased by $103 million during the three months ended December 31, 2022 related to cash received from customers for fixed fees and minimum guarantees in advance of performance, including amounts recognized in the period. Revenues of $144 million were recognized during the three months ended December 31, 2022 related to the balance of deferred revenue at September 30, 2022. There were no other significant changes to deferred revenue during the reporting period.
Performance Obligations
For the three months ended December 31, 2022 and December 31, 2021, the Company recognized revenue of $27 million and $37 million, respectively, from performance obligations satisfied in previous periods.
8


Revenues expected to be recognized in the future related to performance obligations that are unsatisfied at December 31, 2022 are as follows:
Rest of FY23FY24FY25ThereafterTotal
(in millions)
Remaining performance obligations$547 $367 $$$920 
Total$547 $367 $$$920 
5. Acquisition of 300 Entertainment
On December 16, 2021, the Company purchased all outstanding shares of Theory Entertainment LLC d/b/a 300 Entertainment (“300 Entertainment”), an independent U.S. record label. The final consideration paid was determined to be $394 million, which reflects the base purchase price of $400 million, adjusted for, among other items, working capital. At December 31, 2022, the Company updated and finalized the purchase price allocation recorded at September 30, 2022, which resulted in a decrease to intangible assets of approximately $1 million and a net decrease to other acquired assets and liabilities of approximately $2 million, with a corresponding net increase to goodwill of approximately $3 million.
See Note 5, “Acquisition of 300 Entertainment,” to the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2022 for the preliminary purchase price allocation, valuation methodology, and other information related to the 300 Entertainment acquisition.
6. Comprehensive Income
Comprehensive income, which is reported in the accompanying condensed consolidated statements of equity, consists of net income and other gains and losses affecting equity that, under U.S. GAAP, are excluded from net income. For the Company, the components of other comprehensive income primarily consist of foreign currency translation gains and losses, minimum pension liabilities, and deferred gains and losses on financial instruments designated as hedges under ASC 815, Derivatives and Hedging. The following summary sets forth the changes in the components of accumulated other comprehensive loss, net of related tax benefit of less than $1 million:
Foreign Currency Translation Loss (a)Minimum Pension Liability AdjustmentDeferred Gains (Losses) On Derivative Financial InstrumentsAccumulated Other Comprehensive Loss, net
 
(in millions)
Balances at September 30, 2022$(358)$(2)$13 $(347)
Other comprehensive income (loss)72 — (1)71 
Balances at December 31, 2022$(286)$(2)$12 $(276)
______________________________________
(a)Includes historical foreign currency translation related to certain intra-entity transactions.
7. Goodwill and Intangible Assets
Goodwill
The following analysis details the changes in goodwill for each reportable segment:
Recorded
Music
Music
Publishing
Total
(in millions)
Balances at September 30, 2022$1,456 $464 $1,920 
Acquisitions— 
Other adjustments (a)28 — 28 
Balances at December 31, 2022$1,487 $464 $1,951 
______________________________________
(a)Other adjustments during the three months ended December 31, 2022 represent foreign currency movements.
The Company performs its annual goodwill impairment test in accordance with ASC 350, Intangibles—Goodwill and Other (“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. No indicators of
9


impairment were identified during the current period that required the Company to perform an interim assessment or recoverability test.
Intangible Assets
Intangible assets consist of the following:
Weighted-Average Useful LifeDecember 31,
2022
September 30,
2022
(in millions)
Intangible assets subject to amortization:
Recorded music catalog12 years$1,379 $1,316 
Music publishing copyrights25 years1,958 1,889 
Artist and songwriter contracts13 years1,046 1,014 
Trademarks14 years106 103 
Other intangible assets6 years92 89 
Total gross intangible assets subject to amortization4,581 4,411 
Accumulated amortization(2,315)(2,172)
Total net intangible assets subject to amortization2,266 2,239 
Intangible assets not subject to amortization:
Trademarks and tradenamesIndefinite149 145 
Total net intangible assets$2,415 $2,384 
8. Debt
Debt Capitalization
Long-term debt, all of which was issued by Acquisition Corp., consists of the following:
December 31,
2022
September 30,
2022
(in millions)
Revolving Credit Facility (a)$— $— 
Senior Term Loan Facility due 20281,295 1,145 
2.750% Senior Secured Notes due 2028 (€325 face amount)
346 318 
3.750% Senior Secured Notes due 2029
540 540 
3.875% Senior Secured Notes due 2030
535 535 
2.250% Senior Secured Notes due 2031 (€445 face amount)
474 435 
3.000% Senior Secured Notes due 2031
800 800 
Total long-term debt, including the current portion$3,990 $3,773 
Issuance premium less unamortized discount and unamortized deferred financing costs(44)(41)
Total long-term debt, including the current portion, net$3,946 $3,732 
______________________________________
(a)Reflects $300 million of commitments under the Revolving Credit Facility, less letters of credit outstanding of approximately $4 million at both December 31, 2022 and September 30, 2022. There were no loans outstanding under the Revolving Credit Facility at December 31, 2022 or September 30, 2022.
The Company is the direct parent of Holdings, which is the direct parent of Acquisition Corp. As of December 31, 2022 Acquisition Corp. had issued and outstanding the 2.750% Senior Secured Notes due 2028, the 3.750% Senior Secured Notes due 2029, the 3.875% Senior Secured Notes due 2030, the 2.250% Senior Secured Notes due 2031 and the 3.000% Senior Secured Notes due 2031 (together, the “Acquisition Corp. Notes”).
All of the Acquisition Corp. Notes are guaranteed by all of Acquisition Corp.’s domestic wholly-owned subsidiaries. The guarantee of the Acquisition Corp. Notes by Acquisition Corp.’s domestic wholly-owned subsidiaries is full, unconditional and joint and several. The secured notes are guaranteed on a senior secured basis.
10


The Company and Holdings are holding companies that conduct substantially all of their business operations through Acquisition Corp. Accordingly, while Acquisition Corp. and its subsidiaries are not currently restricted from distributing funds to the Company and Holdings under the indentures for the Acquisition Corp. Notes or the credit agreements for the Acquisition Corp. Senior Credit Facilities, including the Revolving Credit Facility and the Senior Term Loan Facility, should Acquisition Corp.’s Total Indebtedness to EBITDA Ratio increase above 3.50:1.00 and the term loans not achieve an investment grade rating, the covenants under the Revolving Credit Facility, which are currently suspended, will be reinstated and the ability of the Company and Holdings to obtain funds from their subsidiaries will be restricted by the Revolving Credit Facility. The Company was in compliance with its covenants under its outstanding notes, the Revolving Credit Facility and the Senior Term Loan Facility as of December 31, 2022.
Fiscal 2023 Transactions
Senior Term Loan Facility Amendment
On November 1, 2022, Acquisition Corp. entered into a Seventh Incremental Commitment Amendment (the “Seventh Incremental Commitment Amendment”), with Credit Suisse AG, New York Branch, as Tranche H term lender, and Credit Suisse AG, as administrative agent, and acknowledged by the guarantors party thereto and WMG Holdings Corp., to the Senior Term Loan Credit Agreement, pursuant to which Acquisition Corp. borrowed additional term loans in the amount of $150 million for an aggregate principal amount outstanding under the Senior Term Loan Credit Agreement of $1,295 million. The Seventh Incremental Commitment Amendment was entered into to fund certain deferred payment obligations owing in respect of certain prior acquisitions, to pay fees and expenses relating thereto and for general corporate purposes.
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 in the case of Initial Revolving Loans (as defined in the Revolving Credit Agreement), or 1.875% per annum in the case of 2020 Revolving Loans (as defined in the Revolving Credit Agreement), 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 in the case of Initial Revolving Loans, or 0.875% per annum in the case of 2020 Revolving Loans; provided that, in respect of 2020 Revolving Loans, the applicable margin with respect to such loans is subject to adjustment as set forth in the pricing grid in the Revolving Credit Agreement. Based on the Senior Secured Indebtedness to EBITDA Ratio of 3.18x at December 31, 2022, the applicable margin for Eurodollar loans would be 1.625% instead of 1.875% and the applicable margin for ABR loans would be 0.625% instead of 0.875% in the case of 2020 Revolving Loans. 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 Tranche G 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, subject to a 1.00% floor, 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 Tranche H loans under the Senior Term Loan Facility bear interest at Acquisition Corp.’s election at a rate equal to (i) the forward-looking term rate based on the secured overnight financing rate as administered by the Federal Reserve Bank of New York for the applicable interest period (“Term SOFR”) subject to a 0.50% floor, plus 3.00% 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 SOFR, plus 1.00% per annum, subject to a 1.50% floor, plus, in each case, 2.00% 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 condensed consolidated financial statements for further discussion.
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Maturity of Senior Term Loan Facility
The loans outstanding under the Senior Term Loan Facility mature on January 20, 2028.
Maturity of Revolving Credit Facility
The maturity date of the Revolving Credit Facility is April 3, 2025.
Maturities of Senior Secured Notes
As of December 31, 2022, there are no scheduled maturities of notes until 2028, when $346 million is scheduled to mature. Thereafter, $2.349 billion is scheduled to mature.
Interest Expense, net
Total interest expense, net was $32 million and $30 million for the three months ended December 31, 2022 and 2021, respectively. The weighted-average interest rate of the Company’s total debt was 3.7% at December 31, 2022, 3.5% at September 30, 2022 and 3.2% at December 31, 2021.
9. Commitments and Contingencies
From time to time the Company is involved in claims and legal proceedings that arise in the ordinary course of business. The Company is currently subject to several such claims and legal proceedings. Based on currently available information, the Company does not believe that resolution of pending matters will have a material adverse effect on its financial condition, cash flows or results of operations. However, litigation is subject to inherent uncertainties, and there can be no assurances that the Company’s defenses will be successful or that any such lawsuit or claim would not have a material adverse impact on the Company’s business, financial condition, cash flows and results of operations in a particular period. Any claims or proceedings against the Company, whether meritorious or not, can have an adverse impact because of defense costs, diversion of management and operational resources, negative publicity and other factors.
10. Equity
Stock-Based Compensation
The Company’s stock-based compensation plans are described in Note 13, “Stock-Based Compensation Plans,” to the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2022. Stock-based compensation consists primarily of restricted stock units (“RSUs”) granted to eligible employees and executives under the Omnibus Incentive Plan.
During the three months ended December 31, 2022, the Company approved the issuance of RSUs under the Omnibus Incentive Plan to eligible employees and executives. For accounting purposes, vesting of such RSUs commenced during the period. Non-cash stock-based compensation associated with these RSUs was $8 million which has been classified as a share-based compensation liability as of December 31, 2022 as further described below.
The Company recognized a total of $14 million of non-cash stock-based compensation expense for the three months ended December 31, 2022, of which $4 million was recorded to additional paid-in capital, and a remaining $10 million has been classified as a share-based compensation liability as of December 31, 2022. The share-based compensation liability represents awards under the Omnibus Incentive Plan where a total value is known and settlement will occur in a variable number of shares of Class A Common Stock and RSUs. During the three months ended December 31, 2022, $5 million was reclassified from share-based compensation liability to additional paid-in capital, representing the grant date fair value of RSUs granted which were previously classified as a share-based compensation liability as of September 30, 2022. The Company recognized approximately $24 million of non-cash stock-based compensation expense for the three months ended December 31, 2021.
Common Stock
During the three months ended December 31, 2022, in connection with the Senior Management Free Cash Flow Plan (the “Plan”), the Company issued a total of approximately 869,000 shares of Class A Common Stock to settle a portion of a participant’s deferred equity units previously issued under the Plan.
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During the three months ended December 31, 2022, the Company satisfied the vesting of RSUs issued to employees by issuing approximately 5,000 shares of Class A Common Stock under the Omnibus Incentive Plan, which is net of shares used to settle employee income tax obligations.
11. Income Taxes
For the three months ended December 31, 2022, the Company recorded an income tax expense of $48 million. The income tax expense for the three months ended December 31, 2022 is higher than the expected tax expense at the statutory rate of 21% primarily due to U.S. state and local taxes, withholding taxes, foreign income taxed at rates higher than the U.S., and non-deductible executive compensation under IRC Section 162(m), offset by a deduction against foreign derived intangible income (“FDII”).
For the three months ended December 31, 2021, the Company recorded an income tax expense of $75 million. The income tax expense for the three months ended December 31, 2021 is higher than the expected tax benefit at the statutory tax rate of 21% primarily due to U.S. state and local taxes, withholding taxes, foreign income taxed at rates higher than the U.S., and non-deductible executive compensation under IRC Section 162(m), offset by a deduction against foreign derived intangible income (“FDII”).
The Company has determined that it is reasonably possible that the gross unrecognized tax benefits as of December 31, 2022 could decrease by up to approximately $1 million related to various ongoing audits and settlement discussions in various foreign jurisdictions during the next twelve months.
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.
The Company’s hedged interest rate transactions as of December 31, 2022 are expected to be recognized within one year. 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 19, “Fair Value Measurements,” to the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2022. Interest income or expense related to interest rate swaps is recognized in interest income (expense), net in the same period as the related expense is recognized. The ineffective portions of interest rate swaps are recognized in other income (expense) in the period measured.
As of December 31, 2022, the Company had outstanding foreign currency forward exchange contracts for the sale of $337 million and the purchase of $197 million of foreign currencies at fixed rates that will be settled by September 2023.
As of December 31, 2022, the Company had outstanding $820 million in pay-fixed receive-variable interest rate swaps with $12 million of unrealized deferred gains in comprehensive income related to the interest rate swaps. As of September 30, 2022, the Company had outstanding $820 million in pay-fixed receive-variable interest rate swaps with $13 million of unrealized deferred gains in comprehensive income related to the interest rate swaps.
The Company recorded realized pre-tax losses of $1 million and unrealized pre-tax losses of $7 million related to its foreign currency forward exchange contracts in the condensed consolidated statement of operations as other expense for the three months ended December 31, 2022. The Company recorded realized pre-tax gains of $1 million and unrealized pre-tax gains of $2 million related to its foreign currency forward exchange contracts in the condensed consolidated statement of operations as other income for the three months ended December 31, 2021.
The unrealized pre-tax losses of the Company’s derivative interest rate swaps designated as cash flow hedges recorded in other comprehensive income during the three months ended December 31, 2022 were $2 million. The unrealized pre-tax gains of the Company’s derivative interest rate swaps designated as cash flow hedges recorded in other comprehensive income during the three months ended December 31, 2021 were $9 million.
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The following is a summary of amounts recorded in the consolidated balance sheets pertaining to the Company’s derivative instruments at December 31, 2022 and September 30, 2022:
December 31,
2022 (a)
September 30,
2022 (b)
(in millions)
Other current assets$17 $
Other current liabilities(8)— 
Other noncurrent assets— 16 
Other noncurrent liabilities— — 
______________________________________
(a)Includes $13 million and $20 million of foreign exchange derivative contracts which net to $1 million of current assets and $8 million of current liabilities, respectively, and $16 million of interest rate swaps in current asset positions.
(b)Includes $2 million and $16 million of interest rate swaps in current and noncurrent asset positions, respectively.
13. Segment Information
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 Note 2, “Summary of Significant Accounting Policies,” to the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2022. 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.
Recorded
Music
Music
Publishing
Corporate
expenses and
eliminations
Total
Three Months Ended(in millions)
December 31, 2022    
Revenues$1,239 $250 $(1)$1,488 
Operating income (loss)283 49 (67)265 
Amortization of intangible assets41 22 — 63 
Depreciation of property, plant and equipment13 21 
OIBDA337 72 (60)349 
December 31, 2021
Revenues$1,386 $229 $(1)$1,614 
Operating income (loss)276 32 (69)239 
Amortization of intangible assets40 20 — 60 
Depreciation of property, plant and equipment14 21 
OIBDA330 54 (64)320 
14. Additional Financial Information
Cash Interest and Taxes
The Company made interest payments of approximately $25 million and $13 million during the three months ended December 31, 2022 and 2021, respectively. The Company paid approximately $45 million and $29 million of income and withholding taxes, net of refunds, for the three months ended December 31, 2022 and 2021, respectively.
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Gain on Divestiture
During the three months ended December 31, 2022, the Company sold its interest in certain sound recording rights and recorded a pre-tax gain of $41 million which was recorded as a net gain on divestiture in the accompanying condensed consolidated statement of operations.
Dividends
The Company’s ability to pay dividends may be restricted by covenants in the credit agreement for the Revolving Credit Facility which are currently suspended but which will be reinstated if Acquisition Corp.’s Total Indebtedness to EBITDA Ratio increases above 3.50:1.00 and the term loans do not achieve an investment grade rating.
The Company intends to pay quarterly cash dividends to holders of its Class A Common Stock and Class B Common Stock. The declaration of each dividend will continue to be at the discretion of the Company’s board of directors and will depend on the Company’s financial condition, earnings, liquidity and capital requirements, level of indebtedness, contractual restrictions with respect to payment of dividends, restrictions imposed by Delaware law, general business conditions and any other factors that the Company’s board of directors deems relevant in making such a determination. Therefore, there can be no assurance that the Company will pay any dividends to holders of the Company’s common stock, or as to the amount of any such dividends.
On November 10, 2022, the Company’s board of directors declared a cash dividend of $0.16 per share on the Company’s Class A Common Stock and Class B Common Stock, as well as related payments under certain stock-based compensation plans, which was paid to stockholders on December 1, 2022. The Company paid an aggregate of approximately $84 million, or $0.16 per share, in cash dividends to stockholders and participating security holders for the three months ended December 31, 2022.
Noncash Investment Activity
Noncash investing activities was approximately $125 million related to the acquisition of music publishing rights and music catalogs, net during the three months ended December 31, 2021.
15. Fair Value Measurements
The following tables show the fair value of the Company’s financial instruments that are required to be measured at fair value as of December 31, 2022 and September 30, 2022.
Fair Value Measurements as of December 31, 2022
(Level 1)(Level 2)(Level 3)Total
(in millions)
Other Current Assets:
Foreign Currency Forward Exchange Contracts (a)$— $$— $
Interest Rate Swaps (d)— 16 — 16 
Other Current Liabilities:
Foreign Currency Forward Exchange Contracts (a)— (8)— (8)
Other Noncurrent Assets:
Equity Investments with Readily Determinable Fair Value (c)25 — — 25 
Other Noncurrent Liabilities:
Contractual Obligations (b)— — (1)(1)

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Fair Value Measurements as of September 30, 2022
(Level 1)(Level 2)(Level 3)Total
(in millions)
Other Current Assets:
Interest Rate Swap (d)$— $$— $
Other Noncurrent Assets:
Interest Rate Swap (d)— 16 — 16 
Equity Investment with Readily Determinable Fair Value (c)36 — — 36 
Other Noncurrent Liabilities:
Contractual Obligations (b)— — (1)(1)
______________________________________
(a)The fair value of foreign currency forward exchange contracts is based on dealer quotes of market forward rates and reflects the amount that the Company would receive or pay at their maturity dates for contracts involving the same currencies and maturity dates.
(b)This represents contingent consideration related to 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 typically included as a component of operating income in the condensed consolidated statements of operations. This amount was mainly calculated using unobservable inputs such as future earnings performance of the acquiree and the expected timing of payments.
(c)These represent equity investments with a readily determinable fair value. The Company has measured its investments to fair value in accordance with ASC 321, Investments—Equity Securities, based on quoted prices in active markets.
(d)The fair value of the interest rate swaps is based on dealer quotes of market forward rates and reflects the amount that the Company would receive or pay as of December 31, 2022 for contracts involving the same attributes and maturity dates.
The following table reconciles the beginning and ending balances of net liabilities classified as Level 3:
Total
(in millions)
Balance at September 30, 2022$(1)
Additions— 
Reductions— 
Payments— 
Balance at December 31, 2022$(1)
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.
Equity Investments Without Readily Determinable Fair Value
The Company evaluates its equity investments without readily determinable fair values for impairment if factors indicate that a significant decrease in value has occurred. The Company has elected to use the measurement alternative to fair value that will allow these investments to be recorded at cost, less impairment, and adjusted for subsequent observable price changes. The Company did not record any impairment charges on these investments during the three months ended December 31, 2022 and 2021. In addition, there were no observable price changes events that were completed during the three months ended December 31, 2022 and 2021.
Fair Value of Debt
Based on the level of interest rates prevailing at December 31, 2022, the fair value of the Company’s debt was $3.542 billion. Based on the level of interest rates prevailing at September 30, 2022, the fair value of the Company’s debt was $3.181 billion. The fair value of the Company’s debt instruments is 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.
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ITEM 2.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should read the following discussion of our results of operations and financial condition with the unaudited interim financial statements included elsewhere in this Quarterly Report on Form 10-Q for the fiscal quarter ended December 31, 2022 (the “Quarterly Report”).
“SAFE HARBOR” STATEMENT UNDER PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
This Quarterly Report includes forward-looking statements and cautionary 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”). Some of the forward-looking statements can be identified by the use of forward-looking terms such as “believes,” “expects,” “may,” “will,” “shall,” “should,” “would,” “could,” “seeks,” “aims,” “projects,” “is optimistic,” “intends,” “plans,” “estimates,” “anticipates” or other comparable terms or the negative thereof. Forward-looking statements include, without limitation, all matters that are not historical facts. They appear in a number of places throughout this Quarterly Report and include, without limitation, our ability to compete in the highly competitive markets in which we operate, statements regarding our ability to develop talent and attract future talent, our ability to reduce future capital expenditures, our ability to monetize our music, including through new distribution channels and formats to capitalize on the growth areas of the music entertainment industry, our ability to effectively deploy our capital, the development of digital music and the effect of digital distribution channels on our business, including whether we will be able to achieve higher margins from digital sales, the success of strategic actions we are taking to accelerate our transformation as we redefine our role in the music entertainment industry, the effectiveness of our ongoing efforts to reduce overhead expenditures and manage our variable and fixed cost structure and our ability to generate expected cost savings from such efforts, our success in limiting piracy, the growth of the music entertainment industry and the effect of our and the industry’s efforts to combat piracy on the industry, our intention and ability to pay dividends or repurchase or retire our outstanding debt or notes in open market purchases, privately or otherwise, the impact on us of potential strategic transactions, our ability to fund our future capital needs and the effect of litigation on us.
Forward-looking statements are subject to known and unknown risks and uncertainties, many of which may be beyond our control. We caution you that forward-looking statements are not guarantees of future performance or outcomes and that actual performance and outcomes, including, without limitation, our actual results of operations, financial condition and liquidity, and the development of the market in which we operate, may differ materially from those made in or suggested by the forward-looking statements contained in this Quarterly Report. In addition, even if our results of operations, financial condition and cash flows, and the development of the market in which we operate, are consistent with the forward-looking statements contained in this Quarterly Report, those results or developments may not be indicative of results or developments in subsequent periods. New factors emerge from time to time that may cause our business not to develop as we expect, and it is not possible for us to accurately predict all of them. Factors that could cause actual results and outcomes to differ from those reflected in forward-looking statements include, without limitation:
our inability to compete successfully in the highly competitive markets in which we operate;
our ability to identify, sign and retain recording artists and songwriters and the existence or absence of superstar releases;
slower growth in streaming adoption and revenue;
our dependence on a limited number of digital music services for the online distribution and marketing of our music and their ability to significantly influence the pricing structure for online music stores;
the ability to further develop a successful business model applicable to a digital environment and to enter into artist services and expanded-rights deals with recording artists in order to broaden our revenue streams in growing segments of the music entertainment business;
the popular demand for particular recording artists and/or songwriters and music and the timely delivery to us of music by major recording artists and/or songwriters;
risks related to the effects of natural or man-made disasters, including pandemics such as COVID-19;
the diversity and quality of our recording artists, songwriters and releases;
trends, developments or other events in some foreign countries in which we operate;
risks associated with our non-U.S. operations, including limited legal protections of our intellectual property rights and restrictions on the repatriation of capital;
unfavorable currency exchange rate fluctuations;
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the impact of heightened and intensive competition in the recorded music and music publishing industries and our inability to execute our business strategy;
significant fluctuations in our operations, cash flows and the trading price of our common stock from period to period;
our failure to attract and retain our executive officers and other key personnel;
a significant portion of our revenues are subject to rate regulation either by government entities or by local third-party collecting societies throughout the world and rates on other income streams may be set by governmental proceedings, which may limit our profitability;
risks associated with obtaining, maintaining, protecting and enforcing our intellectual property rights;
our involvement in intellectual property litigation;
threats to our business associated with digital piracy, including organized industrial piracy;
an impairment in the carrying value of goodwill or other intangible and long-lived assets;
the impact of, and risks inherent in, acquisitions or other business combinations;
risks inherent to our outsourcing certain finance and accounting functions;
the fact that 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;
our ability to maintain the security of information relating to our customers, employees and vendors and our music;
risks related to evolving laws and regulations concerning data privacy which might result in increased regulation and different industry standards;
legislation limiting the terms by which an individual can be bound under a “personal services” contract;
new legislation that affects the terms of our contracts with recording artists and songwriters;
a potential loss of catalog if it is determined that recording artists have a right to recapture U.S. rights in their recordings under the U.S. Copyright Act;
any delays and difficulties in satisfying obligations incident to being a public company;
the impact of our substantial leverage on our ability to raise additional capital to fund our operations, on our ability to react to changes in the economy or our industry and on our ability to meet our obligations under our indebtedness;
the ability to generate sufficient cash to service all of our indebtedness, and the risk that we may be forced to take other actions to satisfy our obligations under our indebtedness, which may not be successful;
the fact that our debt agreements contain restrictions that may limit our flexibility in operating our business;
the significant amount of cash required to service our indebtedness and the ability to generate cash or refinance indebtedness as it becomes due depends on many factors, some of which are beyond our control;
our indebtedness levels, and the fact that we may be able to incur substantially more indebtedness, which may increase the risks created by our substantial indebtedness;
risks of downgrade, suspension or withdrawal of the rating assigned by a rating agency to us could impact our cost of capital;
the dual class structure of our common stock and Access’s existing ownership of our Class B Common Stock have the effect of concentrating control over our management and affairs and over matters requiring stockholder approval with Access; and
risks related to other factors discussed under “Risk Factors” of this Quarterly Report and in our Annual Report on Form 10-K for the fiscal year ended September 30, 2022.
You should read this Quarterly Report completely and with the understanding that actual future results may be materially different from expectations. All forward-looking statements made in this Quarterly Report are qualified by these cautionary statements. Any forward-looking statement speaks only as of the date on which it is made, and we do not undertake any obligation, other than as may be required by law, to update or revise any forward-looking or cautionary statements to reflect changes in assumptions, the occurrence of events, unanticipated or otherwise, and changes in future operating results over time or otherwise. Comparisons of results for current and any prior periods are not intended to express any future trends or indications of future performance, unless expressed as such, and should only be viewed as historical data.
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Other risks, uncertainties and factors, including those discussed in the “Risk Factors” of our Quarterly Reports and our Annual Report on Form 10-K, could cause our actual results to differ materially from those projected in any forward-looking statements we make. You should read carefully the factors described in the “Risk Factors” section of our Quarterly Reports and our Annual Report on Form 10-K to better understand the risks and uncertainties inherent in our business and underlying any forward-looking statements.
INTRODUCTION
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 entertainment 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 financial condition and results of operations (“MD&A”) is provided as a supplement to the unaudited financial statements and related notes thereto 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:
Business 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 three months ended December 31, 2022 and December 31, 2021. 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 three months ended December 31, 2022 and December 31, 2021, as well as a discussion of our financial condition and liquidity as of December 31, 2022. 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.
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. 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.”
Use of Constant Currency
As exchange rates are an important factor in understanding period to period comparisons, we believe the presentation of revenue and OIBDA 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 and OIBDA 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 it, 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.
BUSINESS OVERVIEW
We are one of the world’s leading music entertainment companies. Our renowned family of iconic record labels, including Atlantic Records, Warner Records, Elektra Records and Parlophone Records, is home to many of the world’s most popular and influential recording artists. In addition, Warner Chappell Music, our global music publishing business, boasts an extraordinary
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catalog that includes timeless standards and contemporary hits, representing works by over 100,000 songwriters and composers, with a global collection of more than one million musical compositions. 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.
Components of Our Operating Results
Recorded Music Operations
Our Recorded Music business primarily consists of the discovery and development of recording artists and the related marketing, promotion, distribution, sale and licensing of music created by such recording artists. We play an integral role in virtually all aspects of the recorded music value chain from discovering and developing talent to producing, distributing and selling music to marketing and promoting recording artists and their music.
In the United States, our Recorded Music business is conducted principally through our major record labels—Atlantic Records and Warner 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, and in December 2021, we acquired 300 Entertainment and subsequently launched 300 Elektra Entertainment, or 3EE, a frontline label group that brings together the multi-genre power of 300 Entertainment and Elektra Music Group. Our Recorded Music business also includes Rhino Entertainment, a division that specializes in marketing our recorded 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 business through a collection of additional record labels including Asylum, Big Beat, Canvasback, East West, Erato, FFRR, Nonesuch, Parlophone, Reprise, Sire, Spinnin’ Records, Warner Classics and Warner Music Nashville.
Outside the United States, our Recorded Music business is conducted in more than 70 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, selling, marketing and promoting their music. In most cases, we also market, promote, distribute and sell the music of those recording artists for whom our domestic record labels have international rights. In certain smaller markets, we license the right to distribute and sell our music to non-affiliated third-party record labels.
Our Recorded Music business’ operations include WMX, a next generation services division that connects artists with fans and amplifies brands in creative, immersive, and engaging ways. This division includes a rebranded WEA commercial services & marketing network (formerly Warner-Elektra-Atlantic Corporation, or WEA Corp.), which markets, distributes and sells music and video products to retailers and wholesale distributors, as well as acting as the Company’s media and creative content arm. Our business’ distribution operations also includes Alternative Distribution Alliance (“ADA”), which markets, distributes and sells the products of independent labels to retail and wholesale distributors; and various distribution centers and ventures operated internationally.
In addition to our music being sold in physical retail outlets, our music is also sold in physical form to online physical retailers, such as amazon.com, barnesandnoble.com and bestbuy.com, and distributed in digital form to an expanded universe of digital partners, including streaming services such as those of Amazon, Apple, Deezer, SoundCloud, Spotify, Tencent Music and YouTube, radio services such as iHeart Radio and SiriusXM and other download services.
We have integrated the marketing of digital content into all aspects of our business, including artists and repertoire (“A&R”) 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 attributable to each distribution channel varies by region and proportions may change as the introduction of new technologies continues. As one of the world’s largest music entertainment companies, 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 such artists in other aspects of their careers. Under these agreements, we provide services to and participate in recording 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 marketing and distributing 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 merchandising, VIP ticketing, fan clubs, concert promotion and management has permitted us to diversify revenue streams and capitalize on other revenue opportunities. This
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provides for improved long-term relationships with our recording artists and allows us to more effectively connect recording artists and fans.
Recorded Music revenues are derived from four main sources:
Digital: the rightsholder receives revenues with respect to streaming and download services;
Physical: the rightsholder receives revenues with respect to sales of physical products such as vinyl, CDs and DVDs;
Artist services and expanded-rights: the rightsholder receives revenues with respect to our artist services businesses and our participation in expanded rights, including advertising, merchandising such as direct-to-consumer sales, touring, concert promotion, ticketing, sponsorship, fan clubs, artist websites, social publishing, 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 video games; 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 business are as follows:
A&R costs: the costs associated with (i) paying royalties to recording artists, producers, songwriters, other copyright holders and trade unions; (ii) signing and developing recording 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 recording artists and music, 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 marketing, promoting, distributing and licensing a particular recording of a musical composition, Music Publishing is an intellectual property business focused on generating revenue from uses of the musical 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 shares the revenues generated from use of the musical compositions with the songwriter or other rightsholders.
The operations of our Music Publishing business are conducted principally through Warner Chappell Music, our global music publishing company headquartered in Los Angeles, with operations in over 70 countries through various subsidiaries, affiliates, and non-affiliated licensees and sub-publishers. 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 100,000 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, electronic, alternative and gospel. Warner Chappell Music also administers the music and soundtracks of several third-party television and film producers and studios. We have an extensive production music catalog collectively branded as Warner Chappell Production Music.
Music Publishing revenues are derived from five main sources:
Digital: the rightsholder receives revenues with respect to musical compositions embodied in recordings distributed in streaming services, download services, digital performance and other digital music services;
Performance: the rightsholder receives revenues if the musical composition is performed publicly through broadcast of music on television, radio and cable and in retail locations (e.g., bars and restaurants), live performance at a concert or other venue (e.g., arena concerts and nightclubs), and performance of music in staged theatrical productions;
Mechanical: the rightsholder receives revenues with respect to musical compositions embodied in recordings sold in any physical format or configuration such as vinyl, CDs and DVDs;
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Synchronization: the rightsholder receives revenues for the right to use the musical composition in combination with visual images such as in films or television programs, television commercials and video games as well as from other uses such as in toys or novelty items and merchandise; and
Other: the rightsholder receives revenues for use in sheet music and other uses.
The principal costs associated with our Music Publishing business 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 uses of their 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.
Recent Events and Factors Affecting Results of Operations and Comparability
Fiscal Quarter End
Prior to the start of the 2023 fiscal year, the Company maintained a 52-53 week fiscal year ending on the last Friday in each reporting period. Starting with the 2023 fiscal year, the Company transitioned to a reporting calendar in which the reporting periods end on the last day of the calendar quarter. The fiscal year ended September 30, 2022 included 53 weeks, with the additional week falling in the fiscal quarter ended December 31, 2021. Accordingly, the results of operations for the three months ended December 31, 2021 reflect 14 weeks, or 98 days, compared to 92 days for the three months ended December 31, 2022. For the three months ended December 31, 2021, the revenue benefit of the additional week was approximately $73 million, primarily reflected in Recorded Music streaming revenue.
Russia-Ukraine Conflict
On February 24, 2022, the geopolitical situation in Eastern Europe intensified with Russia's invasion of Ukraine, and the sanctions and other measures imposed in response to this conflict have increased global economic and political uncertainty. WMG operates both its Recorded Music and Music Publishing businesses within Russia and, on March 10, 2022, the Company announced a suspension of these operations in Russia. While our operations in Russia do not constitute a material portion of our business, a significant escalation or expansion of the conflict's current scope, increased or sustained economic disruption, sanctions or countersanctions, further devaluation of the local currency or increased cyber-related disruptions could make it difficult to deliver our content, broaden inflationary costs, and have an adverse effect on our results of operations.
COVID-19 Pandemic
On March 11, 2020, the COVID-19 outbreak (also referred to as “COVID”) was declared a global pandemic by the World Health Organization. The global pandemic and governmental responses thereto disrupted physical and manufacturing supply chains and required the closures of physical retailers, resulting in declines in our physical revenue streams at the onset of the pandemic. Additionally, stay-at-home orders, limited indoor and outdoor gatherings and other restrictions have negatively affected our business in other ways, such as, making it difficult to hold live concert tours, adversely impacting our concert promotion business and the sale of merchandise, delaying the release of new recordings and disrupting the production and release of motion pictures and television programs, which negatively affected licensing revenue in our Recorded Music business and synchronization revenue in our Music Publishing business. However, the disruption from the COVID-19 pandemic, including the disruption caused by the Omicron variant, accelerated growth of other revenue streams such as fitness and interactive gaming (including augmented reality and virtual reality), which may continue to grow. It is unclear how long the global pandemic will last due to the possibility of new variants and sub-variants, increases in infection rates and renewed government action to slow the spread of the virus, and as such, it cannot be predicted to what extent the global pandemic will continue to impact the demand for our music and related services.
Our results of operations, cash flows and financial condition at and for both the three months ended December 31, 2022 and 2021 were adversely affected by the global pandemic despite a partial recovery starting in fiscal year 2021 as businesses began to reopen and concerts and other live music resumed. For both the three months ended December 31, 2022 and 2021, costs recognized by the Company attributable to COVID were not significant.
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RESULTS OF OPERATIONS
Three Months Ended December 31, 2022 Compared with Three Months Ended December 31, 2021
Consolidated Results
Revenues
Our revenues were composed of the following amounts (in millions):
For the Three Months Ended
December 31,
2022 vs. 2021
20222021$ Change% Change
Revenue by Type
Digital$803 $870 $(67)-8 %
Physical133 195 (62)-32 %
Total Digital and Physical936 1,065 (129)-12 %
Artist services and expanded-rights206 232 (26)-11 %
Licensing97 89 %
Total Recorded Music1,239 1,386 (147)-11 %
Performance45 38 18 %
Digital149 133 16 12 %
Mechanical14 14 — — %
Synchronization39 42 (3)-7 %
Other50 %
Total Music Publishing250 229 21 %
Intersegment eliminations(1)(1)— — %
Total Revenues$1,488 $1,614 $(126)-8 %
Revenue by Geographical Location
U.S. Recorded Music$539 $608 $(69)-11 %
U.S. Music Publishing133 115 18 16 %
Total U.S.672 723 (51)-7 %
International Recorded Music700 778 (78)-10 %
International Music Publishing117 114 %
Total International817 892 (75)-8 %
Intersegment eliminations(1)(1)— — %
Total Revenues$1,488 $1,614 $(126)-8 %
Total Revenues
Total revenues decreased by $126 million, or 8%, to $1,488 million for the three months ended December 31, 2022 from $1,614 million for the three months ended December 31, 2021. The prior-year quarter included an additional week, primarily reflected in Recorded Music streaming revenue. The decrease includes $84 million of unfavorable currency exchange fluctuations. Prior to intersegment eliminations, Recorded Music and Music Publishing revenues represented 83% and 17% of total revenue for the three months ended December 31, 2022, respectively, and 86% and 14% of total revenue for the three months ended December 31, 2021, respectively. Prior to intersegment eliminations, U.S. and international revenues represented 45% and 55% of total revenues for each of the three months ended December 31, 2022 and December 31, 2021.
Total digital revenues after intersegment eliminations decreased by $50 million, or 5%, to $952 million for the three months ended December 31, 2022 from $1,002 million for the three months ended December 31, 2021. Total streaming revenue decreased 4% with growth in Music Publishing of 13%, offset by a decline in Recorded Music streaming revenue of 7% which includes $35 million of unfavorable currency exchange fluctuations. Total digital revenues represented 64% and 62% of consolidated revenues for the three months ended December 31, 2022 and December 31, 2021, respectively. Prior to intersegment eliminations, total digital revenues for the three months ended December 31, 2022 were composed of U.S. revenues of $484 million and international revenues of $468 million, or 51% and 49% of total digital revenues, respectively. Prior to intersegment eliminations, total digital revenues for the three months ended December 31, 2021 were composed of U.S. revenues of $514 million and international revenues of $489 million, or 51% and 49% of total digital revenues, respectively.
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Recorded Music revenues decreased by $147 million, or 11%, to $1,239 million for the three months ended December 31, 2022 from $1,386 million for the three months ended December 31, 2021. The decrease includes $74 million of unfavorable currency exchange fluctuations. U.S. Recorded Music revenues were $539 million and $608 million, or 44% of consolidated Recorded Music revenues for each of the three months ended December 31, 2022 and December 31, 2021. International Recorded Music revenues were $700 million and $778 million, or 56% of consolidated Recorded Music revenues for each of the three months ended December 31, 2022 and December 31, 2021.
The overall decrease in Recorded Music revenue was driven by decreases in digital, physical and artist services and expanded-rights revenues. Digital revenue decreased by $67 million, which includes an unfavorable impact of foreign currency exchanges rates of $37 million. Revenue from streaming services decreased by $56 million, or 7%, to $780 million for the three months ended December 31, 2022 from $836 million for the three months ended December 31, 2021 and was impacted by unfavorable foreign currency exchange rates of $35 million, or 4%. Streaming revenue reflects a lighter release schedule and the impact of the additional week in the prior-year quarter, as well as a market-related slowdown in ad-supported revenue. The quarter included carryover success from Ed Sheeran, Dua Lipa, Lizzo and Zach Bryan. Download and other digital revenues decreased by $11 million, or 32%, to $23 million for the three months ended December 31, 2022 from $34 million for the three months ended December 31, 2021 due to the continued shift to streaming services. Physical revenue decreased by $62 million, driven by an unfavorable impact of foreign currency exchange rates of $14 million and a lighter release schedule. Artist services and expanded-rights revenue decreased by $26 million due to an unfavorable impact of foreign currency exchange rates of $17 million, lower direct-to-consumer merchandising revenue at EMP and lower advertising revenue. Licensing revenue increased by $8 million, due to higher broadcast fees, synchronization and other third-party licensing revenue, partially offset by an unfavorable impact of foreign currency exchanges rates of $6 million.
Music Publishing revenues increased by $21 million, or 9%, to $250 million for the three months ended December 31, 2022 from $229 million for the three months ended December 31, 2021. U.S. Music Publishing revenues were $133 million and $115 million, or 53% and 50% of consolidated Music Publishing revenues, for the three months ended December 31, 2022 and December 31, 2021, respectively. International Music Publishing revenues were $117 million and $114 million, or 47% and 50% of consolidated Music Publishing revenues, for the three months ended December 31, 2022 and December 31, 2021, respectively.
The overall increase in Music Publishing revenue was mainly driven by increases in digital revenue of $16 million, or 12%, and performance revenue of $7 million, partially offset by a decrease in synchronization revenue of $3 million. The increase in digital revenue is primarily due to increases in streaming revenue driven by the continued growth in streaming services and timing of new digital deals, partially offset by an unfavorable impact of foreign currency exchange rates of $4 million. Revenue from streaming services grew by $17 million, or 13%, to $146 million for the three months ended December 31, 2022 from $129 million for the three months ended December 31, 2021. Performance revenue increased due to continued growth from bars, restaurants, concerts and live events, partially offset by an unfavorable impact of foreign currency exchange rates of $3 million. The decrease in synchronization revenue is attributable to lower commercial licensing activity in the U.S. and the timing of legal settlements. Mechanical revenue remained constant due to an unfavorable impact of foreign currency exchange rates of $2 million, which offset higher sales.
Revenue by Geographical Location
U.S. revenue decreased by $51 million, or 7%, to $672 million for the three months ended December 31, 2022 from $723 million for the three months ended December 31, 2021. U.S. Recorded Music revenue decreased by $69 million, or 11%. The primary driver was the decrease of U.S. Recorded Music digital revenue of $47 million, or 11%. U.S. Recorded Music streaming revenue decreased by $42 million, or 10%, as a result of a lighter release schedule and the impact of the additional week in the prior-year quarter, as well as a market-related slowdown in ad-supported revenue. Download and other digital decreased by $5 million. Decreases are also attributable to lower U.S. Recorded Music physical revenue of $20 million due to lighter release schedule. U.S. Recorded Music artist services and expanded-rights revenue decreased by $5 million primarily driven by lower advertising revenue. The increase in licensing revenue of $3 million is primarily due to higher other third-party licensing revenue. U.S. Music Publishing revenue increased by $18 million, or 16%, to $133 million for the three months ended December 31, 2022 from $115 million for the three months ended December 31, 2021. This was primarily driven by the increase in U.S. Music Publishing of $17 million in digital revenue due to the continued growth in streaming services and timing of new digital deals. U.S. Music Publishing streaming revenue increased by $18 million, or 25%. Performance revenue increased by $5 million driven by continued growth from bars, restaurants, concerts and live events. The decrease in synchronization revenue of $4 million is due to lower commercial licensing activity and the timing of legal settlements. Mechanical revenue remained constant.
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International revenue decreased by $75 million, or 8%, to $817 million for the three months ended December 31, 2022 from $892 million for the three months ended December 31, 2021. Excluding the unfavorable impact of foreign currency exchange rates of $84 million, International revenue increased by $9 million, or 1%. International Recorded Music revenue decreased by $78 million primarily due to decreases in physical revenue of $42 million, artist services and expanded-rights revenue of $21 million and digital revenue of $20 million, partially offset by an increase in licensing revenue of $5 million. International Recorded Music physical revenue decreased by $42 million, primarily driven by an unfavorable impact of foreign currency exchange rates and lighter release schedule. International Recorded Music artist services and expanded-rights revenue decreased by $21 million due to the unfavorable impact of foreign currency exchange rates of $17 million and lower direct-to-consumer merchandising revenue at EMP. International Recorded Music digital revenue decreased due to a $14 million, or 3%, decrease in streaming revenue which was primarily driven by an unfavorable impact of foreign currency exchange rates of $35 million. International Recorded Music licensing revenue increased by $5 million primarily due to higher broadcast fees and synchronization revenue, partially offset by an unfavorable impact of foreign currency exchange rates. International Music Publishing revenue increased from the prior-year quarter by $3 million, or 3%, to $117 million for the three months ended December 31, 2022 from $114 million for the three months ended December 31, 2021. This was primarily driven by the increase in performance revenue of $2 million and synchronization revenue of $1 million, partially offset by the decrease in digital revenue of $1 million. Performance revenue increased driven by continued growth from bars, restaurants, concerts and live events. Higher synchronization revenue is primarily driven by commercial licensing activity. International Music Publishing streaming revenue decreased by $1 million, or 2%, driven by an unfavorable impact of foreign currency exchange rates of $4 million while download and other digital remained constant. Mechanical revenue remained constant primarily due to an unfavorable impact of foreign currency exchange rates, which offset higher sales.
Cost of revenues
Our cost of revenues was composed of the following amounts (in millions):
For the Three Months Ended
December 31,
2022 vs. 2021
20222021$ Change% Change
Artist and repertoire costs$464 $493 $(29)-6 %
Product costs297 325 (28)-9 %
Total cost of revenues$761 $818 $(57)-7 %
Artist and repertoire costs decreased by $29 million, to $464 million for the three months ended December 31, 2022 from $493 million for the three months ended December 31, 2021. Artist and repertoire costs as a percentage of revenue remained constant at 31% for each of the three months ended December 31, 2022 and December 31, 2021.
Product costs decreased by $28 million, to $297 million for the three months ended December 31, 2022 from $325 million for the three months ended December 31, 2021. Product costs as a percentage of revenue remained constant at 20% for each of the three months ended December 31, 2022 and December 31, 2021.
Selling, general and administrative expenses
Our selling, general and administrative expenses were composed of the following amounts (in millions):
For the Three Months Ended
December 31,
2022 vs. 2021
20222021$ Change% Change
General and administrative expense (1)$221 $242 $(21)-9 %
Selling and marketing expense188 214 (26)-12 %
Distribution expense31 41 (10)-24 %
Total selling, general and administrative expense$440 $497 $(57)-11 %
______________________________________
(1)Includes depreciation expense of $21 million for each of the three months ended December 31, 2022 and December 31, 2021.
Total selling, general and administrative expense decreased by $57 million, or 11%, to $440 million for the three months ended December 31, 2022 from $497 million for the three months ended December 31, 2021. Expressed as a percentage of revenue, total selling, general and administrative expense decreased to 30% for the three months ended December 31, 2022 from 31% for the three months ended December 31, 2021.
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General and administrative expense decreased by $21 million to $221 million for the three months ended December 31, 2022 from $242 million for the three months ended December 31, 2021. The decrease in general and administrative expense was mainly due to lower non-cash stock-based compensation and other related expenses of $9 million, favorable movements in foreign currency exchange rates of $13 million and the impact of the additional week in the prior-year quarter. Expressed as a percentage of revenue, general and administrative expense remained constant at 15% for each of the three months ended December 31, 2022 and December 31, 2021.
Selling and marketing expense decreased by $26 million, or 12%, to $188 million for the three months ended December 31, 2022 from $214 million for the three months ended December 31, 2021. Expressed as a percentage of revenue, selling and marketing expense remained constant at 13% for each of the three months ended December 31, 2022 and December 31, 2021.
Distribution expense was $31 million for the three months ended December 31, 2022 and $41 million for the three months ended December 31, 2021. Expressed as a percentage of revenue, distribution expense decreased to 2% for the three months ended December 31, 2022 from 3% for the three months ended December 31, 2021 due to lower physical and artist services and expanded-rights revenue.
Net gain on divestiture
During the three months ended December 31, 2022, the Company sold its interest in certain sound recording rights and recorded a pre-tax gain of $41 million, which was recorded as a net gain on divestiture in the accompanying condensed consolidated statement of operations.
Reconciliation of Net Income Attributable to Warner Music Group Corp. and Operating Income to Consolidated OIBDA
As previously described, we use OIBDA as our primary measure of financial performance. The following table reconciles operating income to OIBDA, and further provides the components from net income attributable to Warner Music Group Corp. to operating income for purposes of the discussion that follows (in millions):
For the Three Months Ended
December 31,
2022 vs. 2021
20222021$ Change% Change
Net income attributable to Warner Music Group Corp.$122 $187 $(65)-35 %
Income attributable to noncontrolling interest100 %
Net income124 188 (64)-34 %
Income tax expense48 75 (27)-36 %
Income before income taxes172 263 (91)-35 %
Other expense (income)61 (54)115 — %
Interest expense, net32 30 %
Operating income265 239 26 11 %
Amortization expense63 60 %
Depreciation expense21 21 — — %
OIBDA$349 $320 $29 %
OIBDA
OIBDA increased by $29 million to $349 million for the three months ended December 31, 2022 as compared to $320 million for the three months ended December 31, 2021 as a result of lower revenues, offset by lower cost of revenues and selling, general and administrative expenses and the net gain on sale of the Company’s interest in certain sound recording rights. Expressed as a percentage of total revenue, OIBDA margin increased to 23% for the three months ended December 31, 2022 from 20% for the three months ended December 31, 2021 primarily due to the net gain on sale of the Company’s interest in certain sound recording rights and the favorable impact of foreign currency exchange rates. Excluding the net gain on sale of the Company’s interest in certain sound recording rights, as a percentage of revenue, OIBDA margin increased to 21% for the three months ended December 31, 2022 from 20% for the three months ended December 31, 2021.
Depreciation expense
Our depreciation expense remained constant at $21 million for each of the three months ended December 31, 2022 and December 31, 2021.
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Amortization expense
Our amortization expense increased by $3 million, or 5%, to $63 million for the three months ended December 31, 2022 from $60 million for the three months ended December 31, 2021. The increase is primarily due to an increase in amortizable intangible assets primarily related to the acquisition of music-related assets.
Operating income
Our operating income increased by $26 million to $265 million for the three months ended December 31, 2022 from $239 million for the three months ended December 31, 2021. The increase in operating income was due to the factors that led to the increase in OIBDA, partially offset by higher amortization as noted above.
Interest expense, net
Our interest expense, net, increased to $32 million for the three months ended December 31, 2022 from $30 million for the three months ended December 31, 2021 due to a higher principal balance due to the issuance of senior secured notes to partially fund the acquisition of a business and music-related assets.
Other expense (income)
Other expense for the three months ended December 31, 2022 primarily includes foreign currency losses on our Euro-denominated debt of $68 million and unrealized losses on hedging activity of $8 million, partially offset by currency exchange gains on our intercompany loans of $15 million. This compares to foreign currency gains on our Euro-denominated debt of $31 million, unrealized gains of $8 million on the mark-to-market of equity investments, currency exchange gains on our intercompany loans of $6 million and unrealized gains on hedging activity of $4 million for the three months ended December 31, 2021.
Income tax expense
Our income tax expense decreased by $27 million to $48 million for the three months ended December 31, 2022 from $75 million for the three months ended December 31, 2021. The decrease of $27 million in income tax expense is primarily due to the impact of lower pre-tax income in the current-year quarter.
Net income
Net income decreased by $64 million to $124 million for the three months ended December 31, 2022 from $188 million for the three months ended December 31, 2021 as a result of the factors described above.
Noncontrolling interest
There was $2 million of income attributable to noncontrolling interest for the three months ended December 31, 2022 and $1 million of income attributable to noncontrolling interest for the three months ended December 31, 2021.
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Business Segment Results
Revenues, operating income (loss) and OIBDA by business segment were as follows (in millions):
For the Three Months Ended
December 31,
2022 vs. 2021
20222021$ Change% Change
Recorded Music
Revenues$1,239 $1,386 $(147)-11 %
Operating income283 276 %
OIBDA337 330 %
Music Publishing
Revenues250 229 21 %
Operating income49 32 17 53 %
OIBDA72 54 18 33 %
Corporate expenses and eliminations
Revenue eliminations(1)(1)— — %
Operating loss(67)(69)-3 %
OIBDA loss(60)(64)-6 %
Total
Revenues1,488 1,614 (126)-8 %
Operating income265 239 26 11 %
OIBDA349 320 29 %
Recorded Music
Revenues
Recorded Music revenue decreased by $147 million, or 11%, to $1,239 million for the three months ended December 31, 2022 from $1,386 million for the three months ended December 31, 2021. U.S. Recorded Music revenues were $539 million and $608 million, or 44% and 44% of consolidated Recorded Music revenues, for the three months ended December 31, 2022 and December 31, 2021, respectively. International Recorded Music revenues were $700 million and $778 million, or 56% and 56% of consolidated Recorded Music revenues, for the three months ended December 31, 2022 and December 31, 2021, respectively.
The overall decrease in Recorded Music revenue was driven by decreases in digital, physical and artist services and expanded-rights revenues, partially offset by licensing revenue growth as described in the “Total Revenues” and “Revenue by Geographical Location” sections above.
Cost of revenues
Recorded Music cost of revenues was composed of the following amounts (in millions):
For the Three Months Ended
December 31,
2022 vs. 2021
20222021$ Change% Change
Artist and repertoire costs$311 $343 $(32)-9 %
Product costs297 325 (28)-9 %
Total cost of revenues$608 $668 $(60)-9 %
Recorded Music cost of revenues decreased by $60 million, or 9%, to $608 million for the three months ended December 31, 2022 from $668 million for the three months ended December 31, 2021. Expressed as a percentage of Recorded Music revenue, Recorded Music artist and repertoire costs remained constant at 25% for each of the three months ended December 31, 2022 and December 31, 2021. Expressed as a percentage of Recorded Music revenue, Recorded Music product costs increased to 24% for the three months ended December 31, 2022 from 23% for the three months ended December 31, 2021. The overall increase as a percentage of revenue primarily relates to revenue mix due to higher third-party distributed label revenue.
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Selling, general and administrative expense
Recorded Music selling, general and administrative expenses were composed of the following amounts (in millions):
For the Three Months Ended
December 31,
2022 vs. 2021
20222021$ Change% Change
General and administrative expense (1)$132 $151 $(19)-13 %
Selling and marketing expense185 210 (25)-12 %
Distribution expense31 41 (10)-24 %
Total selling, general and administrative expense$348 $402 $(54)-13 %
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(1)Includes depreciation expense of $13 million and $14 million for the three months ended December 31, 2022 and December 31, 2021, respectively.
Recorded Music selling, general and administrative expense decreased by $54 million, or 13%, to $348 million for the three months ended December 31, 2022 from $402 million for the three months ended December 31, 2021. The decrease in general and administrative expense was primarily due to the favorable impact of foreign currency exchange rates and lower non-cash stock-based compensation and other related expenses of $3 million. The decrease in selling and marketing expense was primarily due to lower variable marketing spend. The decrease in distribution expense was primarily due to lower physical and artist services and expanded-rights revenue. Expressed as a percentage of Recorded Music revenue, Recorded Music selling, general and administrative expense decreased to 28% for the three months ended December 31, 2022 from 29% for the three months ended December 31, 2021.
Net gain on divestiture
During the three months ended December 31, 2022, the Company sold its interest in certain sound recording rights and recorded a pre-tax gain of $41 million which was recorded as a net gain on divestiture in the accompanying condensed consolidated statement of operations.
Operating Income and OIBDA
Recorded Music OIBDA included the following amounts (in millions):
 For the Three Months Ended
December 31,
2022 vs. 2021
 20222021$ Change% Change
Operating income$283 $276 $%
Depreciation and amortization54 54 — — %
OIBDA$337 $330 $%
Recorded Music OIBDA increased by $7 million to $337 million for the three months ended December 31, 2022 from $330 million for the three months ended December 31, 2021 as a result of lower revenues, offset by lower cost of revenue and selling, general and administrative expenses and the net gain on sale of the Company’s interest in certain sound recording rights. Expressed as a percentage of Recorded Music revenue, Recorded Music OIBDA margin increased to 27% for the three months ended December 31, 2022 from 24% for the three months ended December 31, 2021 primarily due to the net gain on sale of the Company’s interest in certain sound recording rights and the favorable impact of foreign currency exchange rates. Excluding the net gain on sale of the Company’s interest in certain sound recording rights, OIBDA as a percentage of Recorded Music revenue remained constant at 24% for each of the three months ended December 31, 2022 and December 31, 2021.
Recorded Music operating income increased by $7 million to $283 million for the three months ended December 31, 2022 from $276 million for the three months ended December 31, 2021 due to the factors that led to the increase in Recorded Music OIBDA noted above and lower depreciation, partially offset by an increase in amortizable intangible assets related to the acquisition of music-related assets. Excluding the net gain on sale of the Company’s interest in certain sound recording rights, Recorded Music operating income decreased by $34 million to $242 million for the three months ended December 31, 2022 from $276 million for the three months ended December 31, 2021.
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Music Publishing
Revenues
Music Publishing revenues increased by $21 million, or 9%, to $250 million for the three months ended December 31, 2022 from $229 million for the three months ended December 31, 2021. U.S. Music Publishing revenues were $133 million and $115 million, or 53% and 50% of consolidated Music Publishing revenues, for the three months ended December 31, 2022 and December 31, 2021, respectively. International Music Publishing revenues were $117 million and $114 million, or 47% and 50% of consolidated Music Publishing revenues, for the three months ended December 31, 2022 and December 31, 2021, respectively.
The overall increase in Music Publishing revenue was driven by growth in digital and performance revenues, partially offset by lower synchronization revenue, as described in the “Total Revenues” and “Revenue by Geographical Location” sections above.
Cost of revenues
Music Publishing cost of revenues were composed of the following amounts (in millions):
For the Three Months Ended
December 31,
2022 vs. 2021
20222021$ Change% Change
Artist and repertoire costs$154 $151 $%
Total cost of revenues$154 $151 $%
Music Publishing cost of revenues increased by $3 million, or 2%, to $154 million for the three months ended December 31, 2022 from $151 million for the three months ended December 31, 2021. Expressed as a percentage of Music Publishing revenue, Music Publishing cost of revenues decreased to 62% for the three months ended December 31, 2022 from 66% for the three months ended December 31, 2021, primarily attributable to revenue mix and the favorable impact of foreign currency exchange rates.
Selling, general and administrative expense
Music Publishing selling, general and administrative expenses were composed of the following amounts (in millions):
For the Three Months Ended
December 31,
2022 vs. 2021
20222021$ Change% Change
General and administrative expense (1)$25 $25 $— — %
Selling and marketing expense— (1)-100 %
Total selling, general and administrative expense$25 $26 $(1)-4 %
______________________________________
(1)Includes depreciation expense of $1 million and $2 million for the three months ended December 31, 2022 and December 31, 2021, respectively.
Music Publishing selling, general and administrative expense decreased by $1 million, or 4%, to $25 million for the three months ended December 31, 2022 from $26 million for the three months ended December 31, 2021. Expressed as a percentage of Music Publishing revenue, Music Publishing selling, general and administrative expense decreased to 10% for the three months ended December 31, 2022 from 11% for the three months ended December 31, 2021.
Operating Income and OIBDA
Music Publishing OIBDA included the following amounts (in millions):
For the Three Months Ended
December 31,
2022 vs. 2021
20222021$ Change% Change
Operating income$49 $32 $17 53 %
Depreciation and amortization23 22 %
OIBDA$72 $54 $18 33 %
Music Publishing OIBDA increased by $18 million, or 33%, to $72 million for the three months ended December 31, 2022 from $54 million for the three months ended December 31, 2021. Expressed as a percentage of Music Publishing revenue, Music
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Publishing OIBDA margin increased to 29% for the three months ended December 31, 2022 from 24% for the three months ended December 31, 2021, primarily due to strong operating performance and the favorable impact of foreign currency exchange rates.
Music Publishing operating income increased by $17 million to $49 million for the three months ended December 31, 2022 from $32 million for the three months ended December 31, 2021 due to the factors that led to the increase in Music Publishing OIBDA noted above, partially offset by an increase in amortizable intangible assets related to the acquisition of music-related assets.
Corporate Expenses and Eliminations
Our operating loss from corporate expenses and eliminations decreased by $2 million for the three months ended December 31, 2022 to $67 million from $69 million for the three months ended December 31, 2021, primarily due to lower non-cash stock-based compensation and other related expenses of $5 million from a one-time equity grant in the prior-year quarter and the impact of the additional week in the prior-year quarter, partially offset by an increase in depreciation and expenses related to transformation initiatives.
Our OIBDA loss from corporate expenses and eliminations decreased by $4 million for the three months ended December 31, 2022 to $60 million from $64 million for the three months ended December 31, 2021, primarily due to the operating loss factors noted above.
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FINANCIAL CONDITION AND LIQUIDITY
Financial Condition at December 31, 2022
At December 31, 2022, we had $3.946 billion of debt (which is net of $44 million of premiums, discounts and deferred financing costs), $720 million of cash and equivalents (net debt of $3.226 billion, defined as total debt, less cash and equivalents and premiums, discounts and deferred financing costs) and $270 million of Warner Music Group Corp. equity. This compares to $3.732 billion of debt (which is net of $41 million of premiums, discounts and deferred financing costs), $584 million of cash and equivalents (net debt of $3.148 billion) and $152 million of Warner Music Group Corp. equity at September 30, 2022.
Cash Flows
The following table summarizes our historical cash flows (in millions). The financial data for the three months ended December 31, 2022 and December 31, 2021 are unaudited and have been derived from our condensed consolidated interim financial statements included elsewhere herein.
Three Months Ended
December 31,
20222021
Cash provided by (used in):
Operating activities$209 $129 
Investing activities(10)(624)
Financing activities(70)448 
Operating Activities
Cash provided by operating activities was $209 million for the three months ended December 31, 2022 as compared with cash provided by operating activities of $129 million for the three months ended December 31, 2021. The $80 million increase in cash provided by operating activities was primarily due to timing of A&R investments and other movements within working capital.
Investing Activities
Cash used in investing activities was $10 million for the three months ended December 31, 2022 as compared with cash used in investing activities of $624 million for the three months ended December 31, 2021. The $10 million of cash used in investing activities in the three months ended December 31, 2022 consisted of $8 million relating to investments and acquisitions of businesses, $33 million to acquire music-related assets, and $21 million relating to capital expenditures, partially offset by $42 million of proceeds from divestitures and $10 million of proceeds from the sale of investments. The $624 million of cash used in investing activities in the three months ended December 31, 2021 consisted of $425 million relating to investments and acquisitions of businesses and $165 million to acquire music-related assets, a portion of which was debt-financed, and $34 million relating to capital expenditures.
Financing Activities
Cash used in financing activities was $70 million for the three months ended December 31, 2022 as compared with cash provided by financing activities of $448 million for the three months ended December 31, 2021. The $70 million of cash used in financing activities for the three months ended December 31, 2022 consisted of cash paid to settle deferred consideration related to a fiscal year 2022 acquisition of music publishing rights of $125 million, dividends paid of $84 million, deferred financing costs of $2 million and distributions to noncontrolling interest holders of $6 million, partially offset by proceeds from the incremental Senior Term Loan Facility of $147 million. The $448 million of cash provided by financing activities for the three months ended December 31, 2021 consisted of proceeds from debt issuance of $535 million which was used to fund the acquisition of a business and music-related assets, partially offset by dividends paid of $78 million, deferred financing costs of $4 million, cash paid to settle contingent consideration of $4 million and distributions to noncontrolling interest holders of $1 million.
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 dividends, prepayments of debt, repurchases or retirement of our outstanding debt or notes or repurchases of our outstanding equity securities in open market purchases, privately negotiated purchases or otherwise, we may elect to pay or make in the future.
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We believe that our primary sources of liquidity will be sufficient to support our existing operations over the next twelve months.
We are continuing our financial transformation initiative, launched in August 2019, to upgrade our information technology and finance infrastructure, including related systems and processes, for which we currently expect upfront costs to be approximately $185 million, which includes capital expenditures of approximately $80 million. There has been a delay in the timing of the transformation initiative as a result of the disruption from COVID-19. In addition, the size and scale of this global system implementation requires us to invest more time performing the rigorous system testing and data validation to ensure go-live readiness. Annualized run-rate savings from the financial transformation initiative are expected to be between approximately $35 million and $40 million. We expect that our primary sources of liquidity will be sufficient to fund these expenditures.
Debt Capital Structure
Since Access acquired us in 2011, we have sought to extend the maturity dates on our outstanding indebtedness, reduce interest expense and improve our debt ratings. For example, our S&P corporate credit rating improved from B in 2017 to BB+ in July 2021 with a stable outlook, and our Moody’s corporate family rating improved from B1 in 2016 to Ba3 in 2020. In addition, our weighted-average interest rate on our outstanding indebtedness has decreased from 10.5% in 2011 to 3.7% as of December 31, 2022. Our nearest-term maturity date is in 2028. Subject to market conditions, we expect to continue to take opportunistic steps to extend our maturity dates and reduce related interest expense. From time to time, we may incur additional indebtedness for, among other things, working capital, repurchasing, redeeming or tendering for existing indebtedness and acquisitions or other strategic transactions.
Senior Term Loan Facility Incremental Commitment Amendment
On November 1, 2022, Acquisition Corp. entered into a Seventh Incremental Commitment Amendment (the “Seventh Incremental Commitment Amendment”), with Credit Suisse AG, New York Branch, as Tranche H term lender, and Credit Suisse AG, as administrative agent, and acknowledged by the guarantors party thereto and WMG Holdings Corp., to the Senior Term Loan Credit Agreement, pursuant to which Acquisition Corp. borrowed additional term loans in the amount of $150 million for an aggregate principal amount outstanding under the Senior Term Loan Credit Agreement of $1,295 million. The Seventh Incremental Commitment Amendment was entered into to fund certain deferred payment obligations owing in respect of certain prior acquisitions, to pay fees and expenses relating thereto and for general corporate purposes.
Existing Debt as of December 31, 2022
As of December 31, 2022, our long-term debt, all of which was issued by Acquisition Corp., was as follows (in millions):
Revolving Credit Facility (a)$— 
Senior Term Loan Facility due 20281,295 
2.750% Senior Secured Notes due 2028 (€325 face amount)346 
3.750% Senior Secured Notes due 2029540 
3.875% Senior Secured Notes due 2030535 
2.250% Senior Secured Notes due 2031 (€445 face amount)474 
3.000% Senior Secured Notes due 2031800 
Total long-term debt, including the current portion$3,990 
Issuance premium less unamortized discount and unamortized deferred financing costs(44)
Total long-term debt, including the current portion, net$3,946 
______________________________________
(a)Reflects $300 million of commitments under the Revolving Credit Facility available at December 31, 2022, less letters of credit outstanding of approximately $4 million at December 31, 2022. There were no loans outstanding under the Revolving Credit Facility at December 31, 2022.
For further discussion of our debt agreements, see “Liquidity” in the “Financial Condition and Liquidity” section of our Annual Report on Form 10-K for the fiscal year ended September 30, 2022.
Dividends
The Company’s ability to pay dividends may be restricted by covenants in the credit agreement for the Revolving Credit Facility which are currently suspended but which will be reinstated if Acquisition Corp.’s Total Indebtedness to EBITDA Ratio increases above 3.50:1.00 and the term loans do not achieve an investment grade rating.
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The Company intends to pay quarterly cash dividends to holders of its Class A Common Stock and Class B Common Stock. The declaration of each dividend will continue to be at the discretion of the Company’s board of directors and will depend on the Company’s financial condition, earnings, liquidity and capital requirements, level of indebtedness, contractual restrictions with respect to payment of dividends, restrictions imposed by Delaware law, general business conditions and any other factors that the Company’s board of directors deems relevant in making such a determination. Therefore, there can be no assurance that the Company will pay any dividends to holders of the Company’s common stock, or as to the amount of any such dividends.
On November 10, 2022, the Company’s board of directors declared a cash dividend of $0.16 per share on the Company’s Class A Common Stock and Class B Common Stock, as well as related payments under certain stock-based compensation plans, which was paid to stockholders on December 1, 2022. The Company paid an aggregate of approximately $84 million, or $0.16 per share, in cash dividends to stockholders and participating security holders for the three months ended December 31, 2022.
Covenant Compliance
The Company was in compliance with its covenants under its outstanding notes, the Revolving Credit Facility and the Senior Term Loan Facility as of December 31, 2022.
On January 18, 2019, we delivered a notice to the trustee under the 2012 Secured Indenture and 2014 Unsecured Indenture changing the Fixed GAAP Date, as defined under the indentures, to October 1, 2018. Under the Senior Term Loan Facility, the Revolving Credit Facility and the Secured Notes Indenture, the Fixed GAAP Date is set for April 3, 2020, other than in respect of capital leases, which are frozen at November 1, 2012.
The Revolving Credit Facility contains a springing leverage ratio that is tied to a ratio based on EBITDA, which is defined under the Revolving Credit Agreement. Our ability to borrow funds under the 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. On May 4, 2021, certain covenants set forth in our Revolving Credit Facility were suspended, including the restriction on incurring certain additional indebtedness, based on the determination that the total indebtedness to EBITDA ratio is below the required threshold specified therein. EBITDA as defined in the Revolving Credit Facility is based on Consolidated Net Income (as defined in the Revolving Credit Facility), both of which terms differ from the terms “EBITDA” and “net income” as they are commonly used. For example, the calculation of EBITDA under the Revolving Credit Facility, 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 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; (5) business optimization expenses (including consolidation initiatives, severance costs and other costs relating to initiatives aimed at profitability improvement); (6) transaction expenses; (7) equity-based compensation expense; and (8) certain extraordinary, unusual or non-recurring items. The definition of EBITDA under the Revolving Credit Facility also includes adjustments for the pro forma impact of certain projected cost savings, operating expense reductions and synergies and any quality of earnings analysis prepared by independent certified public accountants in connection with an acquisition, merger, consolidation or other investment. The Senior Term Loan Facility and the Secured Notes Indenture use financial measures called “Consolidated EBITDA” or “EBITDA” and “Consolidated Net Income” that have substantially the same definitions to EBITDA and Consolidated Net Income, each as defined under the Revolving Credit Agreement.
EBITDA as defined in the Revolving Credit Facility (referred to in this section as “Adjusted EBITDA”) is presented herein because it is a material component of the leverage ratio contained in the Revolving Credit Agreement. Non-compliance with the leverage ratio could result in the inability to use the Revolving Credit Facility, which could have a material adverse effect on our results of operations, financial position and cash flow. Adjusted 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 Adjusted 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. Adjusted 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 Adjusted 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.
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Adjusted EBITDA as presented below 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.
In addition, Adjusted EBITDA is a key measure used by our management to understand and evaluate our operating performance, generate future operating plans and make strategic decisions regarding the allocation of capital. Adjusted EBITDA has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of our results as reported under U.S. GAAP. Some of those limitations include: (1) it does not reflect the periodic costs of certain capitalized tangible and intangible assets used in generating revenue for our business; (2) it does not reflect the significant interest expense or cash requirements necessary to service interest or principal payments on our indebtedness; and (3) it does not reflect every cash expenditure, future requirements for capital expenditures or contractual commitments. In particular, this measure adds 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. In addition, Adjusted EBITDA is not the same as net income or cash flow provided by 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. Accordingly, Adjusted EBITDA should be considered in addition to, not as a substitute for, net income (loss) and other measures of financial performance reported in accordance with U.S. GAAP.
The following is a reconciliation of net income (loss), which is a U.S. GAAP measure of our operating results, to Adjusted EBITDA as defined, for the most recently ended four fiscal quarters, or the twelve months ended December 31, 2022, for the twelve months ended December 31, 2021 and for the three months ended December 31, 2022 and December 31, 2021. In addition, the reconciliation includes the calculation of the Senior Secured Indebtedness to Adjusted EBITDA ratio, which we refer to as the Leverage Ratio, under the Revolving Credit Agreement for the most recently ended four fiscal quarters, or the twelve months ended December 31, 2022. 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
December 31,
Three Months Ended
December 31,
2022202120222021
Net Income$491 $396 $124 $188 
Income tax expense158 189 48 75 
Interest expense, net127 121 32 30 
Depreciation and amortization342 316 84 81 
Loss on extinguishment of debt (a)— 22 — — 
Net gains on divestitures and sale of securities (b)(32)(3)(41)— 
Restructuring costs (c)21 30 
Net hedging and foreign exchange (gains) losses (d)(93)(78)61 (41)
Transaction costs (e)17 — 
Business optimization expenses (f)55 48 15 14 
Non-cash stock-based compensation expense (g)29 62 13 23 
Other non-cash charges (h)34 (11)
Pro forma impact of cost savings initiatives and specified transactions (i)27 79 19 
Adjusted EBITDA$1,162 $1,207 $350 $389 
Senior Secured Indebtedness (j)$3,696 
Leverage Ratio (k)3.18x
______________________________________
(a)Reflects loss on extinguishment of debt, primarily including tender fees and unamortized deferred financing costs.
(b)Reflects net gains on sale of securities and divestitures.
(c)Reflects severance costs and other restructuring related expenses.
(d)Reflects unrealized (gains) losses due to foreign exchange on our Euro-denominated debt, losses (gains) from hedging activities and intercompany transactions.
(e)Reflects mainly transaction related costs and mark-to-market adjustments of an earn-out liability related to a transaction in 2021.
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(f)Reflects costs associated with our transformation initiatives and IT system updates, which includes costs of $10 million and $41 million related to our finance transformation and other related costs for the three and twelve months ended December 31, 2022, respectively, as well as $10 million and $37 million for the three and twelve months ended December 31, 2021, respectively.
(g)Reflects non-cash stock-based compensation expense related to the Omnibus Incentive Plan and the Warner Music Group Corp. Senior Management Free Cash Flow Plan.
(h)Reflects non-cash activity, including the unrealized losses (gains) on the mark-to-market adjustment of equity investments, investment losses (gains), mark-to-market adjustments of an earn-out liability in 2022 and other non-cash impairments.
(i)Reflects expected savings resulting from transformation initiatives and the pro forma impact of certain specified transactions for the three and twelve months ended December 31, 2022. Certain of these cost savings initiatives and transactions impacted quarters prior to the quarter during which they were identified within the last twelve-month period. The pro forma impact of these specified transactions and initiatives resulted in a $9 million decrease in the twelve months ended December 31, 2022 Adjusted EBITDA, primarily driven by the shift in the timing of the financial transformation initiative.
(j)Reflects the balance of senior secured debt at Acquisition Corp. of approximately $3.946 billion less cash of $250 million.
(k)Reflects the ratio of Senior Secured Indebtedness, including Revolving Credit Agreement Indebtedness, to Adjusted EBITDA. This is calculated net of cash and equivalents of the Company as of December 31, 2022 not exceeding $250 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 $105 million at the end of a fiscal quarter, the maximum leverage ratio permitted under the Revolving Credit Facility is 5.00:1.00. The Company’s Revolving Credit Facility does not impose any “leverage ratio” maintenance requirement 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 $105 million at the end of a fiscal quarter. On May 4, 2021, certain covenants set forth in our Revolving Credit Facility were suspended, including the restriction on incurring certain additional indebtedness, based on the determination that the total indebtedness to EBITDA ratio is below the required threshold specified therein.
Summary
Management believes that funds generated from our operations and borrowings under the Revolving Credit Facility and available cash and equivalents 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 the 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 formats in the recorded music and music publishing industries. It could also be affected by the severity and duration of geopolitical conflicts or natural or man-made disasters, including pandemics such as COVID-19. 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 or repurchase our outstanding equity 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, from time to time, depending on market conditions and prices, contractual restrictions, our financial liquidity and other factors, we may seek to refinance the 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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ITEM 3.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As discussed in Note 16 to our audited consolidated financial statements for the fiscal year ended September 30, 2022, 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 December 31, 2022, other than as described below, there have been no material changes to the Company’s exposure to market risk since September 30, 2022.
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. companies for the sale or licensing of U.S.-based music and merchandise 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 Euro, British pound sterling, Japanese yen, Canadian dollar, Swedish krona, Australian dollar, Brazilian real, Korean won and Norwegian krone, and in many cases we have natural hedges where we have expenses associated with local operations that offset the revenue in local currency and our Euro-denominated debt, which can offset declines in the Euro. As of December 31, 2022, the Company had outstanding hedge contracts for the sale of $337 million and the purchase of $197 million of foreign currencies at fixed rates. Subsequent to December 31, 2022, certain of our foreign exchange contracts expired.
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 December 31, 2022, 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. The fair value of the foreign exchange forward contracts would have decreased by $14 million based on this analysis. 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 $3.990 billion of principal debt outstanding at December 31, 2022, of which $1.295 billion was variable-rate debt and $2.695 billion was fixed-rate debt. As such, we are exposed to changes in interest rates. At December 31, 2022, 68% of the Company’s debt was at a fixed rate. In addition, as of December 31, 2022, we have the option under our floating rate Tranche G loans under the Senior Term Loan Facility to select a one, two, three or six month LIBOR rate, and we have the option under our floating rate Tranche H loans under the Senior Term Loan Facility to select one, three or six month Term SOFR. To manage interest rate risk on $1.295 billion of U.S. dollar-denominated variable-rate debt, the Company has 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. As a result, as of December 31, 2022, 88% of the Company’s debt was effectively at a fixed rate. As of December 31, 2022, the Company’s interest rate swaps are expected to mature within one year.
Based on the level of interest rates prevailing at December 31, 2022, the fair value of the Company’s fixed-rate and variable-rate debt was approximately $3.542 billion. Further, as of December 31, 2022, based on the amount of the Company’s 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 $36 million or increase the fair value of the fixed-rate debt by approximately $37 million. This potential fluctuation 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.
Inflation Risk
Inflationary factors such as increases in overhead costs may adversely affect our results of operations. We do not believe that inflation has had a material effect on our business, financial condition or results of operations to date. If our costs were to become subject to significant inflationary pressures, we may not be able to fully offset such higher costs through price increases for services. Our inability or failure to do so could harm our business, financial condition or results of operations.
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ITEM 4.    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 the Company’s 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 the Company’s 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.
The Company’s management, including its 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 the 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.
Evaluation of Disclosure Controls and Procedures
Based on management’s evaluation (with the participation of the Company’s principal executive officer and principal financial officer), as of the end of the period covered by this report, the Company’s principal executive officer and principal financial officer have concluded that the Company’s Disclosure Controls are effective to provide reasonable assurance that information required to be disclosed by the Company in reports that it files or submits 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 control over financial reporting or other factors that occurred during the three months ended December 31, 2022 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting. The Company has not experienced any material impact to our internal controls over financial reporting despite the fact that many of our employees continue to work remotely due to the COVID-19 global pandemic.
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PART II. OTHER INFORMATION
ITEM 1.    LEGAL PROCEEDINGS
From time to time the Company is involved in claims and legal proceedings that arise in the ordinary course of business. The Company is currently subject to several such claims and legal proceedings. Based on currently available information, the Company does not believe that resolution of pending matters will have a material adverse effect on its financial condition, cash flows or results of operations. However, litigation is subject to inherent uncertainties, and there can be no assurances that the Company’s defenses will be successful or that any such lawsuit or claim would not have a material adverse impact on the Company’s business, financial condition, cash flows and results of operations in a particular period. Any claims or proceedings against the Company, whether meritorious or not, can have an adverse impact because of defense costs, diversion of management and operational resources, negative publicity and other factors.
ITEM 1A.    RISK FACTORS
There are no material changes to the risk factors discussed in our Annual Report on Form 10-K for the fiscal year ended September 30, 2022.
ITEM 2.    UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Not applicable.
ITEM 3.    DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4.    MINE SAFETY DISCLOSURES
Not applicable.
ITEM 5.    OTHER INFORMATION
Not applicable.
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ITEM 6.    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.
Exhibit
Number
Exhibit Description
10.1*
10.2*†
10.3*†
10.4*†
31.1*
31.2*
32.1**
32.2**
101.INSInline XBRL Instance Document – the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.
101.SCHXBRL Taxonomy Extension Schema Document
101.CALXBRL Taxonomy Extension Calculation Linkbase Document
101.DEFXBRL Taxonomy Extension Definition Linkbase Document
101.LABXBRL Taxonomy Extension Label Linkbase Document
101.PREXBRL Taxonomy Extension Presentation Linkbase Document
104*Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101)
______________________________________
*    Filed herewith.
**    Pursuant to SEC Release No. 33-8212, this certification will be treated as “accompanying” this Quarterly Report on Form 10-Q and not “filed” as part of such report for purposes of Section 18 of the Securities Exchange Act, as amended, or otherwise subject to the liability of Section 18 of the Securities Exchange Act, 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.
†    Identifies each management contract or compensatory plan or arrangement in which directors and/or executive officers are eligible to participate.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
February 9, 2023
WARNER MUSIC GROUP CORP.
By:
/s/    ROBERT KYNCL
Name:
Title:
Robert Kyncl
Chief Executive Officer
(Principal Executive Officer)
By:
/s/    ERIC LEVIN
Name:
Title:
Eric Levin
Chief Financial Officer
(Principal Financial Officer and
Principal Accounting Officer)

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