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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, 2020
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 filerAccelerated filer
Non-accelerated filer
Smaller reporting company
Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.)    Yes      No  ☒
As of January 29, 2021, there were 111,167,356 shares of Class A Common Stock and 403,184,814 shares of Class B Common Stock of the registrant outstanding.




WARNER MUSIC GROUP CORP.
INDEX
Page
Number




PART I. FINANCIAL INFORMATION
ITEM 1.    FINANCIAL STATEMENTS
Warner Music Group Corp.
Consolidated Balance Sheets (Unaudited)
December 31,
2020
September 30,
2020
(in millions, except share data)
Assets
Current assets:
Cash and equivalents$566 $553 
Accounts receivable, net of allowances of $24 million and $23 million
884 771 
Inventories71 79 
Royalty advances expected to be recouped within one year246 220 
Prepaid and other current assets61 55 
Total current assets1,828 1,678 
Royalty advances expected to be recouped after one year307 269 
Property, plant and equipment, net334 331 
Operating lease right-of-use assets, net275 273 
Goodwill1,851 1,831 
Intangible assets subject to amortization, net1,968 1,653 
Intangible assets not subject to amortization156 154 
Deferred tax assets, net62 68 
Other assets162 153 
Total assets$6,943 $6,410 
Liabilities and Equity (Deficit)
Current liabilities:
Accounts payable$214 $264 
Accrued royalties1,722 1,628 
Accrued liabilities414 382 
Accrued interest36 30 
Operating lease liabilities, current41 39 
Deferred revenue326 297 
Other current liabilities137 80 
Total current liabilities2,890 2,720 
Long-term debt3,387 3,104 
Operating lease liabilities, noncurrent298 299 
Deferred tax liabilities, net166 163 
Other noncurrent liabilities169 169 
Total liabilities$6,910 $6,455 
Deficit:
Class A common stock, $0.001 par value; 1,000,000,000 shares authorized, 111,167,356 and 88,578,361 shares issued and outstanding as of December 31, 2020 and September 30, 2020, respectively
$ $ 
Class B common stock, $0.001 par value; 1,000,000,000 shares authorized, 403,184,814 and 421,450,000 issued and outstanding as of December 31, 2020 and September 30, 2020, respectively
1 1 
Additional paid-in capital1,913 1,907 
Accumulated deficit(1,713)(1,749)
Accumulated other comprehensive loss, net(185)(222)
Total Warner Music Group Corp. equity (deficit)16 (63)
Noncontrolling interest17 18 
Total equity (deficit)33 (45)
Total liabilities and equity (deficit)$6,943 $6,410 
See accompanying notes
1


Warner Music Group Corp.
Consolidated Statements of Operations (Unaudited)
Three Months Ended
December 31,
20202019
(in millions, except share and per share data)
Revenue$1,335 $1,256 
Costs and expenses:
Cost of revenue(686)(665)
Selling, general and administrative expenses (a)(401)(379)
Amortization expense(52)(47)
Total costs and expenses(1,139)(1,091)
Operating income196 165 
Interest expense, net(31)(33)
Other expense(31)(5)
Income before income taxes134 127 
Income tax expense(35)(5)
Net income99 122 
Less: Income attributable to noncontrolling interest(1)(2)
Net income attributable to Warner Music Group Corp.$98 $120 
(a) Includes depreciation expense:$(19)$(24)
Net income per share attributable to common stockholders:
Class A – Basic and Diluted$0.18 $ 
Class B – Basic and Diluted$0.19 $0.24 
Weighted average common shares:
Class A – Basic and Diluted94,221,946
Class B – Basic and Diluted416,632,808501,991,944
See accompanying notes
2


Warner Music Group Corp.
Consolidated Statements of Comprehensive Income (Unaudited)
Three Months Ended
December 31,
20202019
(in millions)
Net income$99 $122 
Other comprehensive income, net of tax:
Foreign currency adjustment34 7 
Deferred gain on derivative financial instruments3 3 
Other comprehensive income, net of tax37 10 
Total comprehensive income136 132 
Less: Income attributable to noncontrolling interest(1)(2)
Comprehensive income attributable to Warner Music Group Corp.
$135 $130 
See accompanying notes
3


Warner Music Group Corp.
Consolidated Statements of Cash Flows (Unaudited)
Three Months Ended
December 31,
20202019
(in millions)
Cash flows from operating activities
Net income$99 $122 
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization71 71 
Unrealized losses and remeasurement of foreign-denominated loans and foreign currency forward exchange contracts45 5 
Deferred income taxes2 (29)
Net (gain) loss on divestitures and investments(14)1 
Non-cash interest expense1 1 
Non-cash stock-based compensation expense6 (7)
Changes in operating assets and liabilities:
Accounts receivable, net(98)(101)
Inventories11 10 
Royalty advances(56)(38)
Accounts payable and accrued liabilities(35)(44)
Royalty payables54 84 
Accrued interest6 (11)
Operating lease liabilities(2)1 
Deferred revenue24 (21)
Other balance sheet changes55 34 
Net cash provided by operating activities169 78 
Cash flows from investing activities
Acquisition of music publishing rights and music catalogs, net(324)(11)
Capital expenditures(18)(15)
Investments and acquisitions of businesses, net of cash received(1)(6)
Net cash used in investing activities(343)(32)
Cash flows from financing activities
Proceeds from issuance of 3.000% Senior Secured Notes due 2031
244  
Deferred financing costs paid(3) 
Distribution to noncontrolling interest holder(1)(1)
Dividends paid(62)(206)
Net cash provided by (used in) financing activities178 (207)
Effect of exchange rate changes on cash and equivalents9 4 
Net increase (decrease) in cash and equivalents13 (157)
Cash and equivalents at beginning of period553 619 
Cash and equivalents at end of period$566 $462 
See accompanying notes
4


Warner Music Group Corp.
Consolidated Statements of Equity (Deficit) (Unaudited)
Three Months Ended December 31, 2020
Class A
Common Stock
Class B
Common Stock
Additional
Paid-in
Capital
Accumulated
Deficit
Accumulated
Other
Comprehensive
Loss
Total
Warner Music
Group Corp.
Equity
(Deficit)
Non-controlling
Interest
Total
Equity
(Deficit)
SharesValueSharesValue
(in millions, except share and per share data)
Balance at September 30, 202088,578,361 $ 421,450,000 $1 $1,907 $(1,749)$(222)$(63)$18 $(45)
Net income— — — — — 98 — 98 1 99 
Other comprehensive income, net of tax— — — — — — 37 37 — 37 
Dividends ($0.12 per Class A and B share)
— — — — — (62)— (62)— (62)
Stock-based compensation expense— — — — 6 — — 6 — 6 
Distribution to noncontrolling interest holders— — — — — — — — (2)(2)
Exchange of Class B shares for Class A shares18,265,183 — (18,265,186)— — — — — —  
Shares issued under the Plan4,321,259 — — — — — — — — — 
Shares issued under Omnibus Incentive Plan2,553 — — — — — — — — — 
Balance at December 31, 2020111,167,356 $ 403,184,814 $1 $1,913 $(1,713)$(185)$16 $17 $33 

Three Months Ended December 31, 2019
Class A
Common Stock
Class B
Common Stock
Additional
Paid-in
Capital
Accumulated
Deficit
Accumulated
Other
Comprehensive
Loss
Total
Warner Music
Group Corp.
Deficit
Non-controlling
Interest
Total
Deficit
SharesValueSharesValue
(in millions, except share and per share data)
Balance at September 30, 2019 $ 505,830,022 $1 $1,127 $(1,177)$(240)$(289)$20 $(269)
Cumulative effect of ASC 842 adoption— — — — — 7 — 7 — 7 
Net income— — — — — 120 — 120 2 122 
Other comprehensive income, net of tax— — — — — — 10 10 — 10 
Dividends ($0.07 per Class B share)
— — — — — (38)— (38)— (38)
Distribution to noncontrolling interest holders— — — — — — — — (1)(1)
Other— — 4,169,978 — — — — — —  
Balance at December 31, 2019 $ 510,000,000 $1 $1,127 $(1,088)$(230)$(190)$21 $(169)
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., 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.
Initial Public Offering
On June 5, 2020, the Company completed an initial public offering (“IPO”) of 77,000,000 shares of Class A common stock of the Company, par value $0.001 per share (“Class A Common Stock”) at a public offering price of $25 per share. The Company listed these shares on the NASDAQ stock market under the ticker symbol “WMG.” The offering consisted entirely of secondary shares sold by Access Industries, LLC (collectively with its affiliates, “Access”) and certain related selling stockholders. On July 7, 2020, the Company completed the sale of an additional 11,550,000 shares of Class A Common Stock from the selling stockholders to the underwriters of the Company’s IPO pursuant to the exercise by the underwriters of their option to purchase additional shares of Class A Common Stock. The Company did not receive any of the proceeds of the IPO or exercise of the underwriters’ option.
Following the completion of the IPO and the exercise in full of the underwriters’ option to purchase additional shares, Access and its affiliates held an aggregate of 421,450,000 shares of Class B common stock of the Company, par value $0.001 per share (“Class B Common Stock”), representing approximately 99% of the total combined voting power of the Company’s outstanding common stock and approximately 83% of the economic interest. As a result, the Company is a “controlled company” within the meaning of the corporate governance standards of NASDAQ.
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’ 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’ 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.
6


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.
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 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 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 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 months ended December 31, 2020 are not necessarily indicative of the results that may be expected for the fiscal year ending September 30, 2021.
The consolidated balance sheet at September 30, 2020 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, 2020 (File No. 001-32502).
7


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 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, 2020 and December 31, 2019 relate to the periods ended December 25, 2020 and December 27, 2019, respectively. For convenience purposes, the Company continues to date its first-quarter financial statements as of December 31. The fiscal year ended September 30, 2020 ended on September 25, 2020.
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.
Common Stock
On February 28, 2020, the Company amended its certificate of incorporation to increase its authorized capital stock to 2,100,000,000 shares, consisting of 1,000,000,000 shares of Class A Common Stock, 1,000,000,000 shares of Class B Common Stock, and 100,000,000 shares of preferred stock, par value $1.00 per share. In addition, the February 28, 2020 amendment to the Company’s certificate of incorporation also gave effect to the reclassification and 477,242.614671815-for-1 stock split of the Company’s existing common stock outstanding into 510,000,000 shares of Class B Common Stock. This stock split has been retrospectively presented throughout the interim financial statements. Upon completion of the IPO and the exercise in full of the underwriters’ option to purchase additional shares, 88,550,000 shares of Class A Common Stock, 421,450,000 shares of Class B Common Stock and no shares of preferred stock were outstanding. In connection with the IPO, the Company’s board of directors and stockholders approved the Warner Music Group Corp. 2020 Omnibus Incentive Plan, or the “Omnibus Incentive Plan.” The aggregate number of shares of common stock available for issuance under the Omnibus Incentive Plan is 31,169,099 shares of Class A Common Stock over the 10-year period from the date of adoption, including up to 1,000,000 shares of our Class A Common Stock in connection with the IPO. Since the IPO, a total of 30,914 shares of restricted stock has been issued under the Omnibus Incentive Plan to the Company’s directors, which includes 2,553 issued during the three months ended December 31, 2020. Refer to “Stock-Based Compensation” below regarding additional shares issued under our Omnibus Incentive Plan.
In connection with the Company’s Senior Management Cash Flow Plan (“the Plan”), equity units held by certain participants were required to be settled in December 2020. This resulted in the redemption of Class A and Class B units held by certain participants in WMG Management Holdings, LLC (“Management LLC”) in exchange for 18,265,813 shares of Class B Common Stock. These shares of Class B Common Stock converted to shares of Class A Common Stock upon exchange. Additionally, the Company issued a total of 4,321,259 additional shares of Class A Common Stock to settle the participants’ remaining deferred equity units previously issued under the Plan. As a result of these transactions, the participants received a total of 22,586,442 shares of Class A Common Stock in connection with the final settlement in December 2020 for all interests previously issued under the Plan.
Earnings per Share
The consolidated statements of operations present basic and diluted earnings per share (“EPS”). Prior to the completion of the IPO, basic and diluted earnings per share were computed by dividing net income available to common stockholders by the weighted average number of outstanding common shares less shares issued for the exercise of the deferred equity units since these units were mandatorily redeemable in cash. As such, the deferred equity units were excluded from the denominator of the basic and diluted EPS calculation prior to the IPO completion.
Subsequent to the completion of the IPO, the Company utilizes the two-class method to report earnings per share. The two-class method is an earnings allocation formula that determines earnings per share for each class of common stock according to dividends declared and participation rights in undistributed earnings. Undistributed earnings allocated to participating securities are subtracted from net income in determining net income attributable to common stockholders.
8


Stock-Based Compensation
The Company accounts for stock-based payments as required by ASC 718, Compensation—Stock Compensation (“ASC 718”). Under the recognition provision of ASC 718, the Company’s liability classified stock-based compensation costs are measured each reporting date until settlement. In February 2020, the Company filed a Form S-1 registration statement with the SEC in connection with the IPO, which required a change in accounting policy during the three months ended March 31, 2020 from the intrinsic value method to fair value method in determining the basis of measurement of its stock-based compensation liability.
Upon completion of the IPO in June 2020, the Plan was amended to remove the cash-settlement feature on all future redemptions. As a result, all awards previously issued under the Plan required settlement in equity. The participants in such plan were also allowed to sell a pro rata portion, consistent with Access’s percentage reduction in shares of Class B Common Stock as a result of the IPO, of their vested profits interests and acquired units of Management LLC, in the IPO through a “tag-along right.”
Under the provision of ASC 718, the Company determined the Plan was modified as of June 3, 2020, and as such, converted the awards from liability-classified to equity-classified. Prior to conversion, the Company performed a final measurement of its stock-based compensation liability under the fair value method. Subsequent to the amendment, the awards issued under the Plan will no longer be adjusted for changes in the value of the Company’s common stock. The Company will continue to incur non-cash stock-based compensation expense for awards that were unvested as of the modification date of the Plan and awards issued under the Omnibus Incentive Plan.
During the three months ended December 31, 2020, the Company approved the issuance of restricted stock units (“RSUs”) under the Omnibus Incentive Plan to eligible employees and executives. For accounting purposes, vesting of such restricted stock units commenced during the period. The Company recognized approximately $6 million of stock-based compensation expense for the three months ended December 31, 2020, which is included in additional paid-in capital, for its unvested share awards that were granted prior to the IPO and shares issued under the Omnibus Incentive Plan.
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 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. The Company adopted ASU 2016-13 in the first quarter of fiscal 2021 and this adoption did not have a material impact on the Company’s consolidated financial statements.
Accounting Pronouncements Not Yet Adopted
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 other items; (2) the requirement to recognize a deferred tax liability for equity method investments when a foreign subsidiary becomes an equity method investment; (3) the ability not to recognize a deferred tax liability for a foreign subsidiary when a foreign equity method investment becomes a subsidiary; and (4) the general methodology for calculating income taxes in an interim period when a year-to-date loss exceeds the anticipated loss for the year. ASU 2019-12 also simplifies U.S. GAAP by making other changes. ASU 2019-12 will be effective for the annual periods beginning after December 15, 2021, and for interim periods beginning after December 15, 2022. Earlier adoption is permitted. The Company is evaluating the impact of the adoption of this standard on its consolidated financial statements.
9


3. 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. Under the treasury-stock method, potential common shares are excluded from the computation of EPS in periods in which they have an anti-dilutive effect. The Company did not have any dilutive securities for the three months ended December 31, 2019.
In computing earnings per share subsequent to the completion of our IPO, the Company has allocated dividends declared to Class A Common Stock and Class B Common Stock based on timing and amounts actually declared for each class of stock and the undistributed earnings have been allocated to Class A Common Stock and Class B Common Stock pro rata on a basic weighted average shares outstanding basis since the two classes of stock participate equally on a per share basis upon liquidation.
Subsequent to the completion of the IPO, and modification of our stock-based compensation awards as described in Note 2, the Class B Common Stock issued to Management LLC for the exercise of the vested deferred equity units is included in the basic weighted average number of outstanding shares of Class B Common Stock. Upon issuance to the participants in the Plan, the Class B Common Stock will be converted into Class A Common Stock and included in the basic weighted average number of outstanding shares of Class A Common Stock. Since the shares expected to satisfy the vested portion of the deferred equity units are already included in the basic weighted average number of outstanding common shares, there is no potential dilutive effect associated with the vested portion of these stock-based compensation awards. Refer to Note 2 for a description of current period activity.
Restricted stock units with anti-dilutive effect were excluded from the EPS calculation and they were not material for the three months ended December 31, 2020.
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, 2020 and 2019 (in millions, except share and per share data):
Three Months Ended December 31,
20202019
Class AClass BClass AClass B
Basic and Diluted EPS:
Numerator
Net income attributable to Warner Music Group Corp.$19 $79 $ $120 
Less: Net income attributable to participating securities(2)   
Net income attributable to common stockholders$17 $79 $ $120 
Denominator
Weighted average shares outstanding94,221,946 416,632,808 0 501,991,944 
Basic and Diluted EPS$0.18 $0.19 $ $0.24 

4. 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.
10


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,
20202019
(in millions)
Revenue by Type
Digital$727 $633 
Physical174 184 
Total Digital and Physical901 817 
Artist services and expanded-rights180 188 
Licensing80 79 
Total Recorded Music1,161 1,084 
Performance30 46 
Digital99 73 
Mechanical11 15 
Synchronization33 36 
Other2 3 
Total Music Publishing175 173 
Intersegment eliminations(1)(1)
Total Revenues$1,335 $1,256 
Revenue by Geographical Location
U.S. Recorded Music$481 $453 
U.S. Music Publishing91 81 
Total U.S.572 534 
International Recorded Music680 631 
International Music Publishing84 92 
Total International764 723 
Intersegment eliminations(1)(1)
Total Revenues$1,335 $1,256 
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.
11


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 merchandising, touring, concert promotion, ticketing, sponsorship, fan clubs, artist websites, 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 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 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 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 vinyls, 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.
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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, in addition to other factors to estimate an allowance for credit losses. 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 estimated credit losses.
Based on management’s analysis of sales returns, refund liabilities of $37 million and $24 million were established at December 31, 2020 and September 30, 2020, respectively.
Based on management’s analysis of estimated credit losses, reserves of $24 million and $23 million were established at December 31, 2020 and September 30, 2020, 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 distributes music content on behalf of third-party record labels. Based on the above guidance, the Company records the distribution of content 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.
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 by $128 million during the three months ended December 31, 2020 related to cash received from customers for fixed fees and minimum guarantees in advance of performance, including amounts recognized in the period. Revenues of $87 million were recognized during the three months ended December 31, 2020 related to the balance of deferred revenue at September 30, 2020. There were no other significant changes to deferred revenue during the reporting period.
Performance Obligations
The Company recognized revenue of $20 million and $27 million from performance obligations satisfied in previous periods for the three months ended December 31, 2020 and December 31, 2019, respectively.
Wholly and partially unsatisfied performance obligations represent future revenues not yet recorded under long-term intellectual property licensing contracts containing fixed fees, advances and minimum guarantees. Revenues expected to be recognized in the future related to performance obligations that are unsatisfied at December 31, 2020 are as follows:
Rest of FY21FY22FY23ThereafterTotal
(in millions)
Remaining performance obligations$712 $82 $1 $ $795 
Total$712 $82 $1 $ $795 
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5. Comprehensive Income (Loss)
Comprehensive income (loss), which is reported in the accompanying consolidated statements of equity (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 (loss) 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 tax expense of approximately $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, 2020$(181)$(12)$(29)$(222)
Other comprehensive income34  3 37 
Balances at December 31, 2020$(147)$(12)$(26)$(185)
______________________________________
(a)Includes historical foreign currency translation related to certain intra-entity transactions.
6. Leases
The Company’s lease portfolio consists operating real estate leases for its corporate offices and, to a lesser extent, storage and other equipment. Under ASC 842, a contract is or contains a lease when (1) an explicitly or implicitly identified asset has been deployed in the contract and (2) the customer obtains substantially all of the economic benefits from the use of that underlying asset and directs how and for what purpose the asset is used during the term of the contract. The Company determines if an arrangement is or contains a lease at inception of the contract. For all leases (finance and operating), other than those that qualify for the short-term recognition exemption, the Company will recognize on the balance sheet a lease liability for its obligation to make lease payments arising from the lease and a corresponding ROU asset representing its right to use the underlying asset over the period of use based on the present value of lease payments over the lease term as of the lease commencement date. ROU assets are adjusted for initial direct costs, lease payments made and incentives. As the rates implicit in our leases are not readily determinable, the Company uses its incremental borrowing rate based on the information available at the lease commencement date in determining the present value of lease payments. This rate is based on the estimated rate of interest for collateralized borrowing over a similar term of the lease payments. The lease term used to calculate the lease liability will include options to extend or terminate the lease when the option to 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 statements 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 fixed lease payments. Lease payments that depend on an index or a rate (such as the Consumer Price Index or a market interest rate) are variable and 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.
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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 11 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.
Among the Company’s operating leases are its leases for the Ford Factory Building, located at 777 S. Santa Fe Avenue in Los Angeles, California, and for 27 Wrights Lane, Kensington, London. The landlord for both leases is an affiliate of Access. As of December 31, 2020, the aggregate lease liability related to these leases was $133 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,
20202019
(in millions)
Lease Cost
Operating lease cost$14 14 
Short-term lease cost1  
Variable lease cost2 3 
Sublease income  
Total lease cost$17 $17 
Supplemental cash flow information related to leases was as follows:
Three Months Ended December 31,
20202019
(in millions)
Cash paid for amounts included in the measurement of operating lease liabilities$15 $14 
Right-of-use assets obtained in exchange for operating lease obligations6 5 
Supplemental balance sheet information related to leases was as follows:
December 31,
2020
September 30,
2020
(in millions)
Operating Leases
Operating lease right-of-use assets$275 $273 
Operating lease liabilities, current$41 $39 
Operating lease liabilities, noncurrent298 299 
Total operating lease liabilities$339 $338 
Weighted Average Remaining Lease Term
Operating leases8 years8 years
Weighted Average Discount Rate
Operating leases4.58 %4.58 %
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Maturities of lease liabilities were as follows:
YearsOperating
Leases
(in millions)
2021$42 
202255 
202352 
202449 
202548 
Thereafter161 
Total lease payments407 
Less imputed interest(68)
Total$339 
As of December 31, 2020, there have been no leases entered into that have not yet commenced.
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, 2020$1,367 $464 $1,831 
Acquisitions   
Other adjustments (a)20  20 
Balances at December 31, 2020$1,387 $464 $1,851 
______________________________________
(a)Other adjustments during the three months ended December 31, 2020 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.
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Intangible Assets
Intangible assets consist of the following:
Weighted-Average Useful LifeDecember 31,
2020
September 30,
2020
(in millions)
Intangible assets subject to amortization:
Recorded music catalog11 years$1,028 $876 
Music publishing copyrights26 years1,721 1,597 
Artist and songwriter contracts13 years994 862 
Trademarks16 years83 81 
Other intangible assets6 years87 84 
Total gross intangible asset subject to amortization3,913 3,500 
Accumulated amortization(1,945)(1,847)
Total net intangible assets subject to amortization1,968 1,653 
Intangible assets not subject to amortization:
Trademarks and tradenamesIndefinite156 154 
Total net intangible assets$2,124 $1,807 
The increase in intangible assets during the three months ended December 31, 2020 primarily relates to two acquisition transactions of music-related assets within recorded music catalogs, music publishing copyrights, and artist and songwriter contracts for approximately $318 million.
8. Debt
Debt Capitalization
Long-term debt, all of which was issued by Acquisition Corp., consists of the following:
December 31,
2020
September 30,
2020
(in millions)
Revolving Credit Facility (a)$ $ 
Senior Term Loan Facility due 2023 (b)815 814 
3.625% Senior Secured Notes due 2026 (c)
545 521 
2.750% Senior Secured Notes due 2028 (d)
392 375 
3.875% Senior Secured Notes due 2030 (e)
529 529 
3.000% Senior Secured Notes due 2031 (f)
784 544 
5.500% Senior Notes due 2026 (g)
322 321 
Total long-term debt, including the current portion (h)$3,387 $3,104 
______________________________________
(a)Reflects $300 million of commitments under the Revolving Credit Facility, less letters of credit outstanding of approximately $10 million at both December 31, 2020 and September 30, 2020. There were no loans outstanding under the Revolving Credit Facility at December 31, 2020 or September 30, 2020.
(b)Principal amount of $820 million at both December 31, 2020 and September 30, 2020 less unamortized discount of $1 million and $1 million and unamortized deferred financing costs of $4 million and $5 million at December 31, 2020 and September 30, 2020, respectively. On January 20, 2021, Acquisition Corp. entered into an amendment of the credit agreement governing the Senior Term Loan Facility which, among other things, extends the maturity date of its outstanding term loans from November 1, 2023 to January 20, 2028 and removes a number of negative covenants limiting the ability of Acquisition Corp. to take various actions. See Note 15.
(c)Face amount of €445 million at both December 31, 2020 and September 30, 2020. Above amounts represent the dollar equivalent of such note at December 31, 2020 and September 30, 2020. Principal amount of $543 million and $519 million at December 31, 2020 and September 30, 2020, respectively, an additional issuance premium of $7 million, less unamortized deferred financing costs of $5 million at both December 31, 2020 and September 30, 2020.
(d)Face amount of €325 million at both December 31, 2020 and September 30, 2020. Above amounts represent the dollar equivalent of such note at December 31, 2020 and September 30, 2020. Principal amount of $396 million and $379 million at
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December 31, 2020 and September 30, 2020, respectively, less unamortized deferred financing costs of $4 million and $4 million at both December 31, 2020 and September 30, 2020.
(e)Principal amount of $535 million less unamortized deferred financing costs of $6 million at both December 31, 2020 and September 30, 2020.
(f)Principal amount of $800 million and $550 million at December 31, 2020 and September 30, 2020, respectively, less unamortized discount of $7 million at December 31, 2020 and unamortized deferred financing costs of $9 million and $6 million at December 31, 2020 and September 30, 2020, respectively. On November 2, 2020, Acquisition Corp. issued an additional $250 million in aggregate principal amount of its 3.000% Senior Secured Notes due 2031.
(g)Principal amount of $325 million less unamortized deferred financing costs of $3 million and $4 million at December 31, 2020 and September 30, 2020.
(h)Principal amount of debt of $3.419 billion and $3.127 billion, an additional issuance premium of $7 million and $7 million, less unamortized discount of $8 million and $1 million and unamortized deferred financing costs of $31 million and $29 million at December 31, 2020 and September 30, 2020, respectively.
The Company is the direct parent of Holdings, which is the direct parent of Acquisition Corp. As of December 31, 2020 Acquisition Corp. had issued and outstanding the 3.625% Senior Secured Notes due 2026, the 5.500% Senior Notes due 2026, the 2.750% Senior Secured Notes due 2028, the 3.875% Senior Secured Notes due 2030 and the 3.000% Senior Secured Notes due 2031 (together, the “Acquisition Corp. Notes”).
The 3.625% Senior Secured Notes due 2026 and the 5.500% Senior Notes due 2026 are guaranteed by the Company. The Company’s guarantee of the Acquisition Corp. Notes is full and unconditional. 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 and the unsecured notes are guaranteed on an unsecured senior basis.
The Company and Holdings are holding companies that conduct substantially all of their business operations through Acquisition Corp. Accordingly, the ability of the Company and Holdings to obtain funds from their subsidiaries is restricted by the indentures for the Acquisition Corp. Notes, as well as the credit agreements for the Acquisition Corp. Senior Credit Facilities, including the Revolving Credit Facility and the Senior Term Loan Facility.
Recent Transactions
Additional 3.000% Senior Secured Notes
On November 2, 2020, Acquisition Corp. issued and sold $250 million of additional 3.000% Senior Secured Notes (the “Additional Notes”). Interest on the Additional Notes will accrue at the rate of 3.000% per annum and will be payable semi-annually in arrears on February 15 and August 15, commencing on February 15, 2021. Acquisition Corp. had the option to repurchase all or a portion of the Additional Notes at any time on one or more occasions on or prior to the fifth business day after December 18, 2020 (the “Special Optional Redemption Election Date”), but did not exercise its option to repurchase. The Additional Notes were not initially fungible with the 3.000% Senior Secured Notes issued on August 12, 2020 (the “Original Notes”). Following the Special Optional Redemption Election Date, Acquisition Corp. caused the Additional Notes to bear the same CUSIP and ISIN numbers as the Original Notes (the “CUSIP Merger Event”). Following the CUSIP Merger Event, the Additional Notes have identical terms as (other than the issue date and the issue price) and are fungible with, and treated as a single series of senior secured debt securities with, the Original Notes.
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 3.15x at December 31, 2020, 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
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interest will also be payable on other overdue amounts at a rate of 2.0% per annum above the amount that would apply to an alternative base rate loan.
The loans under the Senior Term Loan Facility bear interest at Acquisition Corp.’s election at a rate equal to (i) the rate for deposits in U.S. dollars in the London interbank market (adjusted for maximum reserves) for the applicable interest period (“Term Loan LIBOR”) subject to a zero floor, plus 2.125% per annum or (ii) the base rate, which is the highest of (x) the corporate base rate established by the administrative agent as its prime rate in effect at its principal office in New York City from time to time, (y) 0.50% in excess of the overnight federal funds rate and (z) one-month Term Loan LIBOR, plus 1.00% per annum, plus, in each case, 1.125% per annum. If there is a payment default at any time, then the interest rate applicable to overdue principal and interest will be the rate otherwise applicable to such loan plus 2.0% per annum. Default interest will also be payable on other overdue amounts at a rate of 2.0% per annum above the amount that would apply to an alternative base rate loan.
The Company has entered into, and in the future may enter into, interest rate swaps to manage interest rate risk. Please refer to Note 11 of our consolidated financial statements for further discussion.
Maturity of Senior Term Loan Facility
The loans outstanding under the Senior Term Loan Facility mature on November 1, 2023. On January 20, 2021, Acquisition Corp. entered into an amendment of the credit agreement governing the Senior Term Loan Facility which, among other things, extends the maturity date of its outstanding term loans from November 1, 2023 to January 20, 2028 and removes a number of negative covenants limiting the ability of Acquisition Corp. to take various actions.
Maturity of Revolving Credit Facility
The maturity date of the Revolving Credit Facility is April 3, 2025.
Maturities of Senior Notes and Senior Secured Notes
As of December 31, 2020, there are no scheduled maturities of notes until 2026, when $868 million is scheduled to mature. Thereafter, $1.731 billion is scheduled to mature.
Interest Expense, net
Total interest expense, net was $31 million and $33 million for the three months ended December 31, 2020 and December 31, 2019, respectively. The weighted-average interest rate of the Company’s total debt was 3.7% at December 31, 2020, 3.7% at September 30, 2020 and 4.2% at December 31, 2019.
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. Income Taxes
On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (“Tax Act”). The Tax Act significantly revised the U.S. federal corporate income tax provisions, including, but not limited to, an income inclusion of global intangible low-taxed income (“GILTI”), a deduction against foreign-derived intangible income (“FDII”) and a new minimum tax, the base erosion anti-abuse tax (“BEAT”). GILTI, FDII and BEAT were effective for the Company’s fiscal year ending September 30, 2019. The Company has elected to recognize the GILTI impact in the specific period in which it occurs.
As a result of final regulations regarding the interest expense allocation rules issued by the Internal Revenue Service in December 2019, the Company concluded that it is more likely than not that the entire amount of the Company’s deferred tax assets relating to foreign tax credit carryforwards will be realized. Consequently, the Company released its $33 million valuation allowance
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at September 30, 2019 relating to such deferred tax assets and recognized a corresponding U.S. tax benefit of $33 million during the three months ended December 31, 2019. The Company will continue to weigh the evidence including the projections of sufficient future taxable income, foreign source income and the reversal of future taxable temporary differences to assess the future realization of our foreign tax credits.
As a result of the IPO in June 2020, the Company is subject to limitation on the deductibility of executive compensation under Internal Revenue Code (“IRC”) Section 162(m).
For the three months ended December 31, 2020, the Company recorded an income tax expense of $35 million. The income tax expense for the three months ended December 31, 2020 is higher than the expected tax expense at the statutory tax rate of 21% primarily due to U.S. state and local taxes, foreign income taxed at rates higher than the US, and non-deductible executive compensation under IRC Section 162(m), offset by FDII and excess tax benefits from long term incentive plan.
For the three months ended December 31, 2019, the Company recorded an income tax expense of $5 million. The income tax expense for the three months ended December 31, 2019 is lower than the expected tax expense at the statutory tax rate of 21% primarily due to tax benefit of a release of a valuation allowance relating to foreign tax credit carryforwards and FDII, offset by non-deductible long term incentive plan, U.S. state and local taxes, foreign income taxed at rates higher than the U.S. statutory tax rate, withholding taxes and foreign losses with no tax benefit.
The Company has determined that it is reasonably possible that the gross unrecognized tax benefits as of December 31, 2020 could decrease by up to approximately $2 million related to various ongoing audits and settlement discussions in various foreign jurisdictions during the next twelve months.
11. Derivative Financial Instruments
The Company uses derivative financial instruments, primarily foreign currency forward exchange contracts and interest rate swaps, for the purposes of managing foreign currency exchange rate risk and interest rate risk on expected future cash flows. However, the Company may choose not to hedge certain exposures for a variety of reasons including, but not limited to, accounting considerations and the prohibitive economic cost of hedging particular exposures. There can be no assurance the hedges will offset more than a portion of the financial impact resulting from movements in foreign currency exchange or interest rates.
The Company enters into foreign currency forward exchange contracts primarily to hedge the risk that unremitted or future royalties and license fees owed to its U.S. companies for the sale or licensing of U.S.-based music and merchandise abroad may be adversely affected by changes in foreign currency exchange rates. The Company focuses on managing the level of exposure to the risk of foreign currency exchange rate fluctuations on its major currencies, which include the Euro, British pound sterling, Japanese yen, Canadian dollar, Swedish krona, Australian dollar, Brazilian real, Korean won and Norwegian krone. The Company also may at times choose to hedge foreign currency risk associated with financing transactions such as third-party debt and other balance sheet items. The Company’s foreign currency forward exchange contracts have not been designated as hedges under the criteria prescribed in ASC 815. The Company records these contracts at fair value on its balance sheet and the related gains and losses are immediately recognized in the consolidated statement of operations where there is an offsetting entry related to the underlying exposure.
The Company has entered into, and in the future may enter into, interest rate swaps to manage interest rate risk. These instruments may offset a portion of changes in income or expense, or changes in fair value of the Company’s long-term debt. The interest rate swap instruments are designated and qualify as cash flow hedges under the criteria prescribed in ASC 815. The Company records these contracts at fair value on its balance sheet and gains or losses on these contracts are deferred in equity (as a component of comprehensive income (loss)).
The fair value of foreign currency forward exchange contracts is determined by using observable market transactions of spot and forward rates (i.e., Level 2 inputs) which is discussed further in Note 14. Additionally, netting provisions are provided for in existing International Swap and Derivative Association Inc. agreements in situations where the Company executes multiple contracts with the same counterparty. As a result, net assets or liabilities resulting from foreign exchange derivatives subject to these netting agreements are classified within other current assets or other current liabilities in the Company’s consolidated balance sheets.
The Company’s hedged interest rate transactions as of December 31, 2020 are expected to be recognized within three years. The fair value of interest rate swaps is based on dealer quotes of market rates (i.e., Level 2 inputs) which is discussed further in Note 14. 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.
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The Company monitors its positions with, and the credit quality of, the financial institutions that are party to any of its financial transactions.
As of December 31, 2020, the Company had outstanding hedge contracts for the sale of $270 million and the purchase of $176 million of foreign currencies at fixed rates that will be settled by September 2021.
As of December 31, 2020, the Company had outstanding $820 million in pay-fixed receive-variable interest rate swaps with $26 million of unrealized deferred losses in comprehensive income related to the interest rate swaps. As of September 30, 2020, the Company had outstanding $820 million in pay-fixed receive-variable interest rate swaps with $29 million of unrealized deferred losses 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 $4 million related to its foreign currency forward exchange contracts in the consolidated statement of operations as other expense for the three months ended December 31, 2020. The Company recorded realized pre-tax losses of $1 million and unrealized pre-tax losses of $3 million related to its foreign currency forward exchange contracts in the consolidated statement of operations as other expense for the three months ended December 31, 2019.
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, 2020 were $4 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, 2019 were $4 million.
The following is a summary of amounts recorded in the consolidated balance sheets pertaining to the Company’s derivative instruments at December 31, 2020 and September 30, 2020:
December 31,
2020 (a)
September 30,
2020 (b)
(in millions)
Other current assets$ $