UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM | ||
(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, 2019
OR
| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |||||
Commission File Number 001-32502
(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) | ||||||||
___________________________________________________________________________________________
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 | ☐ | |||||||||||
☒ | Smaller reporting company | |||||||||||||
| Emerging growth company | ||||||||||||||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.) Yes ☐ No ☒
Securities registered pursuant to Section 12(b) of the Act:
| Title of each class (a) | Trading Symbol(s) | Name of each exchange on which registered | ||||||||||||
| None | ||||||||||||||
(a)There is no public market for the registrant’s common stock. As of January 31, 2020, the number of shares of the registrant’s common stock, par value $0.001 per share, outstanding was 1,069 . All of the registrant’s common stock is owned by affiliates of Access Industries, Inc. The registrant has filed all Exchange Act reports for the preceding 12 months.
WARNER MUSIC GROUP CORP.
INDEX
| Page Number | ||||||||
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Warner Music Group Corp.
Consolidated Balance Sheets (Unaudited)
| December 31, 2019 | September 30, 2019 | ||||||||||
| (in millions) | |||||||||||
| Assets | |||||||||||
| Current assets: | |||||||||||
| Cash and equivalents | $ | $ | |||||||||
| Accounts receivable, net of allowances of $18 million and $17 million | |||||||||||
| Inventories | |||||||||||
| Royalty advances expected to be recouped within one year | |||||||||||
| Prepaid and other current assets | |||||||||||
| Total current assets | |||||||||||
| Royalty advances expected to be recouped after one year | |||||||||||
| Property, plant and equipment, net | |||||||||||
| Operating lease right-of-use assets, net | — | ||||||||||
| Goodwill | |||||||||||
| Intangible assets subject to amortization, net | |||||||||||
| Intangible assets not subject to amortization | |||||||||||
| Deferred tax assets, net | |||||||||||
| Other assets | |||||||||||
| Total assets | $ | $ | |||||||||
| Liabilities and Equity | |||||||||||
| Current liabilities: | |||||||||||
| Accounts payable | $ | $ | |||||||||
| Accrued royalties | |||||||||||
| Accrued liabilities | |||||||||||
| Accrued interest | |||||||||||
| Operating lease liabilities, current | — | ||||||||||
| Deferred revenue | |||||||||||
| Other current liabilities | |||||||||||
| Total current liabilities | |||||||||||
| Long-term debt | |||||||||||
| Operating lease liabilities, noncurrent | |||||||||||
| Deferred tax liabilities, net | |||||||||||
| Other noncurrent liabilities | |||||||||||
| Total liabilities | $ | $ | |||||||||
| Equity: | |||||||||||
Common stock ($ | $ | $ | |||||||||
| Additional paid-in capital | |||||||||||
| Accumulated deficit | ( | ( | |||||||||
| Accumulated other comprehensive loss, net | ( | ( | |||||||||
| Total Warner Music Group Corp. deficit | ( | ( | |||||||||
| Noncontrolling interest | |||||||||||
| Total equity | ( | ( | |||||||||
| Total liabilities and equity | $ | $ | |||||||||
See accompanying notes
1
Warner Music Group Corp.
Consolidated Statements of Operations (Unaudited)
| Three Months Ended December 31, | |||||||||||
| 2019 | 2018 | ||||||||||
| (in millions) | |||||||||||
| Revenue | $ | $ | |||||||||
| Costs and expenses: | |||||||||||
| Cost of revenue | ( | ( | |||||||||
| Selling, general and administrative expenses (a) | ( | ( | |||||||||
| Amortization expense | ( | ( | |||||||||
| Total costs and expenses | ( | ( | |||||||||
| Operating income | |||||||||||
| Loss on extinguishment of debt | ( | ||||||||||
| Interest expense, net | ( | ( | |||||||||
| Other (expense) income | ( | ||||||||||
| Income before income taxes | |||||||||||
| Income tax expense | ( | ( | |||||||||
| Net income | |||||||||||
| Less: Income attributable to noncontrolling interest | ( | ||||||||||
| Net income attributable to Warner Music Group Corp. | $ | $ | |||||||||
| (a) Includes depreciation expense: | $ | ( | $ | ( | |||||||
See accompanying notes
2
Warner Music Group Corp.
Consolidated Statements of Comprehensive Income (Unaudited)
| Three Months Ended December 31, | |||||||||||
| 2019 | 2018 | ||||||||||
| (in millions) | |||||||||||
| Net income | $ | $ | |||||||||
| Other comprehensive income (loss), net of tax: | |||||||||||
| Foreign currency adjustment | ( | ||||||||||
| Deferred gain (loss) on derivative financial instruments | ( | ||||||||||
| Other comprehensive income (loss), net of tax | ( | ||||||||||
| Total comprehensive income | |||||||||||
| Less: Income attributable to noncontrolling interest | ( | ||||||||||
| Comprehensive income attributable to Warner Music Group Corp. | $ | $ | |||||||||
See accompanying notes
3
Warner Music Group Corp.
Consolidated Statements of Cash Flows (Unaudited)
| Three Months Ended December 31, | |||||||||||
| 2019 | 2018 | ||||||||||
| (in millions) | |||||||||||
| Cash flows from operating activities | |||||||||||
| Net income | $ | $ | |||||||||
| Adjustments to reconcile net income to net cash provided by operating activities: | |||||||||||
| Depreciation and amortization | |||||||||||
| Unrealized gains and remeasurement of foreign-denominated loans | ( | ||||||||||
| Deferred income taxes | ( | ||||||||||
| Loss on extinguishment of debt | |||||||||||
| Net gain on divestitures and investments | ( | ||||||||||
| Non-cash interest expense | |||||||||||
| Equity-based compensation expense | ( | ||||||||||
| Changes in operating assets and liabilities: | |||||||||||
| Accounts receivable, net | ( | ( | |||||||||
| Inventories | |||||||||||
| Royalty advances | ( | ( | |||||||||
| Accounts payable and accrued liabilities | ( | ( | |||||||||
| Royalty payables | |||||||||||
| Accrued interest | ( | ( | |||||||||
| Operating lease liabilities | |||||||||||
| Deferred revenue | ( | ( | |||||||||
| Other balance sheet changes | |||||||||||
| Net cash provided by operating activities | |||||||||||
| Cash flows from investing activities | |||||||||||
| Acquisition of music publishing rights, net | ( | ( | |||||||||
| Capital expenditures | ( | ( | |||||||||
| Investments and acquisitions of businesses, net of cash received | ( | ( | |||||||||
| Net cash used in investing activities | ( | ( | |||||||||
| Cash flows from financing activities | |||||||||||
Proceeds from issuance of Acquisition Corp. | |||||||||||
Repayment of Acquisition Corp. | ( | ||||||||||
Repayment of Acquisition Corp. | ( | ||||||||||
Repayment of Acquisition Corp. | ( | ||||||||||
| Call premiums paid and deposit on early redemption of debt | ( | ||||||||||
| Deferred financing costs paid | ( | ||||||||||
| Distribution to noncontrolling interest holder | ( | ( | |||||||||
| Dividends paid | ( | ||||||||||
| Net cash (used in) provided by financing activities | ( | ||||||||||
| Effect of exchange rate changes on cash and equivalents | ( | ||||||||||
| Net (decrease) increase in cash and equivalents | ( | ||||||||||
| Cash and equivalents at beginning of period | |||||||||||
| Cash and equivalents at end of period | $ | $ | |||||||||
See accompanying notes
4
Warner Music Group Corp.
Consolidated Statements of Deficit (Unaudited)
| Three Months Ended December 31, 2019 | Additional Paid-in Capital | Accumulated Deficit | Accumulated Other Comprehensive Loss | Total Warner Music Group Corp. Deficit | Noncontrolling Interest | Total Deficit | |||||||||||||||||||||||||||||||||||||||||
| Common Stock | |||||||||||||||||||||||||||||||||||||||||||||||
| Shares | Value | ||||||||||||||||||||||||||||||||||||||||||||||
| (in millions, except share amounts) | |||||||||||||||||||||||||||||||||||||||||||||||
| Balance at September 30, 2019 | $ | $ | $ | ( | $ | ( | $ | ( | $ | $ | ( | ||||||||||||||||||||||||||||||||||||
| Cumulative effect of ASC 842 adoption | — | — | — | — | — | ||||||||||||||||||||||||||||||||||||||||||
| Net income | — | — | — | — | |||||||||||||||||||||||||||||||||||||||||||
| Other comprehensive income, net of tax | — | — | — | — | — | ||||||||||||||||||||||||||||||||||||||||||
| Dividends | — | — | — | ( | — | ( | — | ( | |||||||||||||||||||||||||||||||||||||||
| Distribution to noncontrolling interest holders | — | — | — | — | — | — | ( | ( | |||||||||||||||||||||||||||||||||||||||
| Other | — | — | — | — | — | — | |||||||||||||||||||||||||||||||||||||||||
| Balance at December 31, 2019 | $ | $ | $ | ( | $ | ( | $ | ( | $ | $ | ( | ||||||||||||||||||||||||||||||||||||
| Three Months Ended December 31, 2018 | Additional Paid-in Capital | Accumulated Deficit | Accumulated Other Comprehensive Loss | Total Warner Music Group Corp. Deficit | Noncontrolling Interest | Total Deficit | |||||||||||||||||||||||||||||||||||||||||
| Common Stock | |||||||||||||||||||||||||||||||||||||||||||||||
| Shares | Value | ||||||||||||||||||||||||||||||||||||||||||||||
| (in millions, except share amounts) | |||||||||||||||||||||||||||||||||||||||||||||||
| Balance at September 30, 2018 | $ | $ | $ | ( | $ | ( | $ | ( | $ | $ | ( | ||||||||||||||||||||||||||||||||||||
| Cumulative effect of ASC 606 adoption | — | — | — | — | |||||||||||||||||||||||||||||||||||||||||||
| Net income | — | — | — | — | — | ||||||||||||||||||||||||||||||||||||||||||
| Other comprehensive loss, net of tax | — | — | — | — | ( | ( | — | ( | |||||||||||||||||||||||||||||||||||||||
| Dividends | — | — | — | ( | — | ( | — | ( | |||||||||||||||||||||||||||||||||||||||
| Distribution to noncontrolling interest holders | — | — | — | — | — | — | ( | ( | |||||||||||||||||||||||||||||||||||||||
| Other | — | — | — | — | — | — | |||||||||||||||||||||||||||||||||||||||||
| Balance at December 31, 2018 | $ | $ | $ | ( | $ | ( | $ | ( | $ | $ | ( | ||||||||||||||||||||||||||||||||||||
See accompanying notes
5
Warner Music Group Corp.
Notes to Consolidated Interim 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.
Acquisition of Warner Music Group by Access Industries
Pursuant to the Agreement and Plan of Merger, dated as of May 6, 2011 (the “Merger Agreement”), by and among the Company, AI Entertainment Holdings LLC (formerly Airplanes Music LLC), a Delaware limited liability company (“Parent”) and an affiliate of Access Industries, Inc. (“Access”), and Airplanes Merger Sub, Inc., a Delaware corporation and a wholly owned subsidiary of Parent (“Merger Sub”), on July 20, 2011 (the “Merger Closing Date”), Merger Sub merged with and into the Company with the Company surviving as a wholly owned subsidiary of Parent (the “Merger”). In connection with the Merger, the Company delisted its common stock from the New York Stock Exchange (the “NYSE”). The Company continues to voluntarily file with the U.S. Securities and Exchange Commission (the “SEC”) current and periodic reports that would be required to be filed with the SEC pursuant to Section 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) as provided for in certain covenants contained in the instruments covering its outstanding indebtedness. All of the Company’s common stock is owned by affiliates of Access.
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. 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’, 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’ distribution operations include Warner-Elektra-Atlantic Corporation (“WEA Corp.”), which markets, distributes and sells music and video products to retailers and wholesale distributors; 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 Entertainment Group and YouTube, radio services such as iHeart Radio and SiriusXM and download services such as Apple’s iTunes and Google Play.
We have integrated the marketing of digital content into all aspects of our business, including artist 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
6
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 provides for improved long-term relationships with our recording artists and allows us to more effectively connect recording artists and fans.
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 garners a share of the revenues generated from use of the musical compositions.
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. We own or control rights to more than 1.4 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 80,000 songwriters and composers and a diverse range of genres including pop, rock, jazz, classical, country, R&B, hip-hop, rap, reggae, Latin, folk, blues, symphonic, soul, Broadway, techno, alternative and gospel. Warner Chappell 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.
2. Summary of Significant Accounting Policies
Interim Financial Statements
The accompanying unaudited 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 month period ended December 31, 2019 are not necessarily indicative of the results that may be expected for the fiscal year ending September 30, 2020.
The consolidated balance sheet at September 30, 2019 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, 2019 (File No. 001-32502).
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.
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
7
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 maintains a 52-53 week fiscal year ending on the last Friday in each reporting period. As such, all references to December 31, 2019 and December 31, 2018 relate to the periods ended December 27, 2019 and December 28, 2018, respectively. For convenience purposes, the Company continues to date its financial statements as of December 31. The fiscal year ended September 30, 2019 ended on September 27, 2019.
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 February 2016, the FASB issued ASU 2016-02, Leases (“ASU 2016-02”), which established a new ASC Topic 842 (“ASC 842”) that introduces a right-of-use (“ROU”) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases are classified as either finance or operating, with classification affecting the pattern of expense recognition in the statement of operations. In July 2018, the FASB issued ASU 2018-11, Leases – Targeted Improvements (“ASU 2018-11”), which allows for retrospective application with the recognition of a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. Under this option, entities do not need to apply ASC 842 (along with its disclosure requirements) to the comparative prior periods presented. The Company adopted ASU 2016-02 on October 1, 2019, using the modified retrospective transition method provided by ASU 2018-11. The adoption of ASU 2016-02 resulted in the recognition of operating lease liabilities of $366 million and ROU assets of $297 million, which is net of the historical deferred rent liability balance of $69 million, primarily related to real estate leases. The Company also recorded a decrease to opening accumulated deficit of $7 million, net of taxes, related to previously deferred gains related to sale-leaseback transactions.
Upon transition, the Company adopted the “package of three” practical expedient provided by ASC 842 and therefore has not (1) reassessed whether any expired or existing contracts are or contain a lease, (2) reassessed the lease classification for expired or existing leases and (3) reassessed initial direct costs for any existing leases. Rather, the Company will retain the conclusions reached for these items under ASC 840.
In August 2017, the FASB issued ASU 2017-12, Targeted Improvements to Accounting for Hedging Activities (“ASU 2017-12”). This ASU improves certain aspects of the hedge accounting model including making more risk management strategies eligible for hedge accounting and simplifying the assessment of hedge effectiveness. ASU 2017-12 is effective for all annual periods beginning after December 15, 2018 and interim periods within those fiscal years. Early adoption is permitted and requires a prospective adoption with a cumulative-effect adjustment to accumulated deficit as of the beginning of the fiscal year of adoption for existing hedging relationships. The Company adopted ASU 2017-12 in the first quarter of fiscal 2020 and this adoption did not have a significant impact on the Company’s financial statements.
Accounting Pronouncements Not Yet Adopted
In June 2016, the FASB issued ASU 2016-13, Financial Instruments—Credit Losses: Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”). ASU 2016-13 requires that expected credit losses relating to financial assets measured on an amortized cost basis and available-for-sale debt securities be recorded through an allowance for credit losses. ASU 2016-13 limits the amount of credit losses to be recognized for available-for-sale debt securities to the amount by which carrying value exceeds fair value and also requires the reversal of previously recognized credit losses if fair value increases. ASU 2016-13 will be effective for annual periods beginning after December 15, 2019, and interim periods within those fiscal years. Earlier adoption is permitted. The Company is evaluating the impact of the adoption of this standard on its consolidated financial statements.
In December 2019, the FASB issued ASU 2019-12, Simplifying the Accounting for Income Taxes (“ASU 2019-12”). This ASU eliminates certain exceptions to the general principles in ASC 740, Income Taxes. Specifically, it eliminates the exception to (1) the incremental approach for intraperiod tax allocation when there is a loss from continuing operations, and income or a gain from
8
3. Revenue Recognition
For our operating segments, Recorded Music and Music Publishing, the Company accounts for a contract when it has legally enforceable rights and obligations and collectability of consideration is probable. The Company identifies the performance obligations and determines the transaction price associated with the contract, which is then allocated to each performance obligation, using management’s best estimate of standalone selling price for arrangements with multiple performance obligations. Revenue is recognized when, or as, control of the promised services or goods is transferred to the Company’s customers, and in an amount that reflects the consideration the Company is contractually due in exchange for those services or goods. An estimate of variable consideration is included in the transaction price if, in the Company’s judgment, it is probable that a significant future reversal of cumulative revenue under the contract will not occur. Certain of the Company’s arrangements include licenses of intellectual property with consideration in the form of sales- and usage-based royalties. Royalty revenue is recognized when the subsequent sale or usage occurs using the best estimates available of the amounts that will be received by the Company.
Disaggregation of Revenue
The Company’s revenue consists of the following categories, which aggregate into the segments – Recorded Music and Music Publishing:
| For the Three Months Ended December 31, | |||||||||||
| 2019 | 2018 | ||||||||||
| (in millions) | |||||||||||
| Revenue by Type | |||||||||||
| Digital | $ | $ | |||||||||
| Physical | |||||||||||
| Total Digital and Physical | |||||||||||
| Artist services and expanded-rights | |||||||||||
| Licensing | |||||||||||
| Total Recorded Music | |||||||||||
| Performance | |||||||||||
| Digital | |||||||||||
| Mechanical | |||||||||||
| Synchronization | |||||||||||
| Other | |||||||||||
| Total Music Publishing | |||||||||||
| Intersegment eliminations | ( | ( | |||||||||
| Total Revenues | $ | $ | |||||||||
| Revenue by Geographical Location | |||||||||||
| U.S. Recorded Music | $ | $ | |||||||||
| U.S. Music Publishing | |||||||||||
| Total U.S. | |||||||||||
| International Recorded Music | |||||||||||
| International Music Publishing | |||||||||||
| Total International | |||||||||||
| Intersegment eliminations | ( | ( | |||||||||
| Total Revenues | $ | $ | |||||||||
9
Recorded Music
Recorded Music mainly involves selling, marketing, distribution and licensing of recorded music produced by the Company’s recording artists. Recorded Music revenues are derived from four main sources, which include digital, physical, artist services and expanded-rights and licensing.
Digital revenues are generated from the expanded universe of digital partners, including digital streaming services and download services. These licenses typically contain a single performance obligation, which is ongoing access to all intellectual property in an evolving content library, predicated on: (1) the business practice and contractual ability to remove specific content without a requirement to replace the content and without impact to minimum royalty guarantees and (2) the contracts not containing a specific listing of content subject to the license. Digital licensing contracts are generally long-term with consideration in the form of sales- and usage-based royalties that are typically received monthly. Certain contracts contain non-recoupable fixed fees or minimum guarantees, which are recoupable against royalties. Upon contract inception, the Company will assess whether a shortfall or breakage is expected (i.e., where the minimum guarantee will not be recouped through royalties) in order to determine timing of revenue recognition for the fixed fee or minimum guarantee.
For fixed fee and minimum guarantee contracts where breakage is expected, the total transaction price (fixed fee or minimum guarantee) is recognized proportionately over the contract term using an appropriate measure of progress which is typically based on the Company’s digital partner’s subscribers or streaming activity as these are measures of access to an evolving catalog, or on a straight-line basis. The Company updates its assessment of the transaction price each reporting period to see if anticipated royalty earnings exceed the minimum guarantee. For contracts where breakage is not expected, royalties are recognized as revenue as sales or usage occurs based upon the licensee’s usage reports and, when these reports are not available, revenue is based on historical data, industry information and other relevant trends.
Additionally, for certain licenses where the consideration is fixed and the intellectual property being licensed is static, revenue is recognized at the point in time when control of the licensed content is transferred to the customer.
Physical revenues are generated from the sale of physical products such as vinyl, CDs and DVDs. Revenues from the sale of physical Recorded Music products are recognized upon transfer of control to the customer, which typically occurs once the product has been shipped and the ability to direct use and obtain substantially all of the benefit from the asset have been transferred. In accordance with industry practice and as is customary in many territories, certain products, such as CDs and DVDs, are sold to customers with the right to return unsold items. Revenues from such sales are generally recognized upon shipment based on gross sales less a provision for future estimated returns.
Artist services and expanded-rights revenues are generated from artist services businesses and participations in expanded-rights associated with artists, including sponsorship, fan clubs, artist websites, merchandising, touring, concert promotion, ticketing and artist and brand management. Artist services and expanded-rights contracts are generally short term. Revenue is recognized as or when services are provided (e.g., at time of an artist’s event) assuming collectability is probable. In some cases, the Company is reliant on the artist to report revenue generating activities. For certain artist services and expanded-rights contracts, collectability is not considered probable until notification is received from the artist’s management.
Licensing revenues represent 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. In certain territories, the Company may also receive royalties when 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. Licensing contracts are generally short term. For fixed-fee contracts, revenue is recognized at the point in time when control of the licensed content is transferred to the customer. Royalty based contracts are recognized as the underlying sales or usage occurs.
Music Publishing
Music Publishing acts as a copyright owner and/or administrator of the musical compositions and generates revenues related to the exploitation of musical compositions (as opposed to recorded music). Music publishers generally receive royalties from the use of the musical compositions in public performances, digital and physical recordings and in combination with visual images. Music publishing revenues are derived from five main sources: mechanical, performance, synchronization, digital and other.
Performance revenues are received when the musical composition is performed publicly through broadcast of music on television, radio and cable, live performance at a concert or other venue (e.g., arena concerts and nightclubs) and performance of musical compositions in staged theatrical productions. Digital revenues are generated with respect to the musical compositions being embodied in recordings licensed to digital streaming services and digital download services and for digital performance. Mechanical revenues are generated with respect to the musical compositions embodied in recordings sold in any physical format or configuration
10
such as vinyl, CDs and DVDs. Synchronization revenues represent the right to use the 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. Other revenues represent earnings for use in printed sheet music and other uses. Digital and synchronization revenue recognition is similar for both Recorded Music and Music Publishing, therefore refer to the discussion within Recorded Music.
Included in these revenue streams, excluding synchronization and other, are licenses with performing rights organizations or collecting societies (e.g., ASCAP, BMI, SESAC and GEMA), which are long-term contracts containing a single performance obligation, which is ongoing access to all intellectual property in an evolving content library. The most common form of consideration for these contracts is sales- and usage-based royalties. The collecting societies submit usage reports, typically with payment for royalties due, often on a quarterly or biannual reporting period, in arrears. Royalties are recognized as the sale or usage occurs based upon usage reports and, when these reports are not available, royalties are estimated based on historical data, such as recent royalties reported, company-specific information with respect to changes in repertoire, industry information and other relevant trends. Also included in these revenue streams are smaller, short-term contracts for specified content, which generally involve a fixed fee. For fixed-fee contracts, revenue is recognized at the point in time when control of the license is transferred to the customer.
The Company excludes from the measurement of transaction price all taxes assessed by governmental authorities that are both (i) imposed on and concurrent with a specific revenue-producing transaction and (ii) collected from customers.
Sales Returns and Uncollectible Accounts
In accordance with practice in the recorded music industry and as customary in many territories, certain physical revenue products (such as CDs and DVDs) are sold to customers with the right to return unsold items. Revenues from such sales are recognized when the products are shipped based on gross sales less a provision for future estimated returns.
In determining the estimate of physical product sales that will be returned, management analyzes vendor sales of product, historical return trends, current economic conditions, changes in customer demand and commercial acceptance of the Company’s products. Based on this information, management reserves a percentage of each dollar of physical product sales that provide the customer with the right of return and records an asset for the value of the returned goods and liability for the amounts expected to be refunded.
Similarly, management evaluates accounts receivables to determine if they will ultimately be collected. In performing this evaluation, significant judgments and estimates are involved, including an analysis of specific risks on a customer-by-customer basis for larger accounts and customers and a receivables aging analysis that determines the percent that has historically been uncollected by aged category. The time between the Company’s issuance of an invoice and payment due date is not significant; customer payments that are not collected in advance of the transfer of promised services or goods are generally due no later than 30 days from invoice date. Based on this information, management provides a reserve for the estimated amounts believed to be uncollectible.
Based on management’s analysis of sales returns, refund liabilities of $36 million and $23 million were established at December 31, 2019 and September 30, 2019, respectively.
Based on management’s analysis of uncollectible accounts, reserves of $18 million and $17 million were established at December 31, 2019 and September 30, 2019, respectively.
Principal versus Agent Revenue Recognition
The Company reports revenue on a gross or net basis based on management’s assessment of whether the Company acts as a principal or agent in the transaction. The determination of whether the Company acts as a principal or an agent in a transaction is based on an evaluation of whether the Company controls the good or service before transfer to the customer. When the Company concludes that it controls the good or service before transfer to the customer, the Company is considered a principal in the transaction and records revenue on a gross basis. When the Company concludes that it does not control the good or service before transfer to the customer but arranges for another entity to provide the good or service, the Company acts as an agent and records revenue on a net basis in the amount it earns for its agency service.
In the normal course of business, the Company acts as an intermediary with respect to certain payments received from third parties. For example, the Company distributes music content on behalf of third-party record labels. Based on the above guidance, the Company records the distribution of content on behalf of third-party record labels on a gross basis, subject to the terms of the contract, as the Company controls the content before transfer to the customer. Conversely, recorded music compilations distributed by other record companies where the Company has a right to participate in the profits are recorded on a net basis.
11
Deferred Revenue
Deferred revenue principally relates to fixed fees and minimum guarantees received in advance of the Company’s performance or usage by the licensee. Reductions in deferred revenue are a result of the Company’s performance under the contract or usage by the licensee.
Deferred revenue increased $96 million during the three months ended December 31, 2019 related to cash received from customers for fixed fees and minimum guarantees in advance of performance, including amounts recognized in the period. Revenues of $73 million were recognized during the three months ended December 31, 2019 related to the balance of deferred revenue at September 30, 2019. There were no other significant changes to deferred revenue during the reporting period.
Performance Obligations
The Company recognized revenue of $27 million and $17 million from performance obligations satisfied in previous periods for the three month periods ended December 31, 2019 and December 31, 2018, respectively.
Wholly and partially unsatisfied performance obligations represent future revenues not yet recorded under long term intellectual property licensing contracts. Revenues expected to be recognized in the future related to performance obligations that are unsatisfied at December 31, 2019 are as follows (in millions):
| Rest of FY20 | FY21 | FY22 | Thereafter | Total | |||||||||||||||||||||||||
| (in millions) | |||||||||||||||||||||||||||||
| Remaining performance obligations | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
| Total | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
4. Comprehensive Income
Comprehensive income, which is reported in the accompanying consolidated statements of deficit, 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, which include foreign exchange contracts. The following summary sets forth the changes in the components of accumulated other comprehensive loss, net of related taxes of approximately $1 million:
| Foreign Currency Translation Loss (a) | Minimum Pension Liability Adjustment | Deferred Gains (Losses) On Derivative Financial Instruments | Accumulated Other Comprehensive Loss, net | ||||||||||||||||||||
(in millions) | |||||||||||||||||||||||
| Balance at September 30, 2019 | $ | ( | $ | ( | $ | ( | $ | ( | |||||||||||||||
| Other comprehensive income | |||||||||||||||||||||||
| Balance at December 31, 2019 | $ | ( | $ | ( | $ | ( | $ | ( | |||||||||||||||
______________________________________
(a)Includes historical foreign currency translation related to certain intra-entity transactions.
5. Leases
12
extend or terminate is at the Company’s discretion and it is reasonably certain that the Company will exercise the option. Fixed payments are recognized as lease expense on a straight-line basis over the lease term. For leases with a term of one year or less (“short-term leases”), the lease payments are recognized in the consolidated statement of operations on a straight-line basis over the lease term.
ASC 842 requires that only limited types of variable payments be included in the determination of lease payments, which affects lease classification and measurement. Variable lease costs, if any, are recognized as incurred and such costs are excluded from lease balances recorded on the consolidated balance sheet. The initial measurement of the lease liability and ROU asset are determined based on both the fixed lease payments and any variable lease payments that depend on an index or a rate (such as the Consumer Price Index or a market interest rate). The Company initially measures these variable lease payments using the index or rate at lease commencement (i.e., the spot or gross index or rate applied to the base rental amount). All other variable lease payments are recognized in the period in which the payments are incurred.
The Company’s operating ROU assets are included in operating lease right-of-use assets and the Company’s current and non-current operating lease liabilities are included in operating lease liabilities, current and operating lease liabilities, noncurrent, respectively, in the Company’s balance sheet.
Operating lease liabilities are amortized using the effective interest method. That is, in each period, the liability will be increased to reflect the interest that is accrued on the related liability by using the appropriate discount rate and decreased by the lease payments made during the period. The subsequent measurement of the ROU asset is linked to the amount recognized as the lease liability. Accordingly, the ROU asset is measured as the lease liability adjusted by (1) accrued or prepaid rents (i.e., the aggregate difference between the cash payment and straight-line lease cost), (2) remaining unamortized initial direct costs and lease incentives, and (3) impairments of the ROU asset. Operating lease costs are included in Selling, general and administrative expenses.
For lease agreements that contain both lease and non-lease components, the Company has elected the practical expedient provided by ASC 842 that permits the accounting for these components as a single lease component (rather than separating the lease from the non-lease components and accounting for the components individually).
The Company enters into operating leases for buildings, office equipment, production equipment, warehouses, and other types of equipment. Our leases have remaining lease terms of 1 year to 12 years, some of which include options to extend the leases for up to 10 years, and some of which include options to terminate the leases within 1 year.
The Company has two operating leases, for the Ford Factory Building, located at 777 S. Santa Fe Avenue in Los Angeles, California, and for 27 Wrights Lane, Kensington, London, which the landlord for both leases is an affiliate of Access. As of December 31, 2019, the aggregate lease liability related to these leases was $142 million.
There are no restrictions or covenants, such as those relating to dividends or incurring additional financial obligations, relating to our lease portfolio, and residual value guarantees are not significant.
The components of lease expense were as follows:
| Three Months Ended December 31, 2019 | |||||
| (in millions) | |||||
| Lease Cost | |||||
| Operating lease cost | $ | ||||
| Short-term lease cost | |||||
| Variable lease cost | |||||
| Sublease income | |||||
| Total lease cost | $ | ||||
Supplemental cash flow information related to leases was as follows:
| Three Months Ended December 31, 2019 | |||||
| (in millions) | |||||
| Cash paid for amounts included in the measurement of operating lease liabilities | $ | ||||
| Right-of-use assets obtained in exchange for operating lease obligations | |||||
Supplemental balance sheet information related to leases was as follows:
| December 31, 2019 | |||||
| (in millions) | |||||
| Operating Leases | |||||
| Operating lease right-of-use assets | $ | ||||
| Operating lease liabilities, current | $ | ||||
| Operating lease liabilities, noncurrent | |||||
| Total operating lease liabilities | $ | ||||
| Weighted Average Remaining Lease Term | |||||
| Operating leases | |||||
| Weighted Average Discount Rate | |||||
| Operating leases | % | ||||
Maturities of lease liabilities were as follows:
| Years | Operating Leases | |||||||
| (in millions) | ||||||||
| 2020 | $ | |||||||
| 2021 | ||||||||
| 2022 | ||||||||
| 2023 | ||||||||
| 2024 | ||||||||
| Thereafter | ||||||||
| Total lease payments | ||||||||
| Less imputed interest | ( | |||||||
| Total | $ | |||||||
As of December 31, 2019, there have been no leases entered into that have not yet commenced.
6. Goodwill and Intangible Assets
Goodwill
The following analysis details the changes in goodwill for each reportable segment:
| Recorded Music | Music Publishing | Total | |||||||||||||||
| (in millions) | |||||||||||||||||
| Balance at September 30, 2019 | $ | $ | $ | ||||||||||||||
| Acquisitions | |||||||||||||||||
| Other adjustments (a) | |||||||||||||||||
| Balance at December 31, 2019 | $ | $ | $ | ||||||||||||||
______________________________________
(a)Other adjustments during the three months ended December 31, 2019 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 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 Life | |||||||||||||||||